Foreign Direct Investment Overview

Foreign Direct Investment (FDI)

• FDI occurs when a firm invests directly in new facilities in a foreign country to produce or market goods.
• This makes the firm a multinational enterprise (MNE).
• FDI can be in the form of greenfield investments (building new facilities) or acquisitions/mergers with existing firms.
• Most cross-border investment is in the form of mergers and acquisitions, not greenfield investments.

Why Companies Choose Acquisitions over Greenfield Investments

• Acquisitions are faster to execute than greenfield investments.
• Acquiring existing assets is often easier and less risky than building them from scratch.
• Firms believe they can increase efficiency by transferring capital, technology, or management skills to the acquired unit.
• Companies want to acquire assets more quickly.

Patterns of FDI

• FDI flow = the amount of FDI undertaken over a given time period.
  • Outflows = FDI out of a country.
  • Inflows = FDI into a country.
• FDI stock = the total accumulated value of foreign-owned assets at a given time.
• Both FDI flow and stock have increased over the past 30 years.

Reasons for FDI Growth

• Fear of protectionism. Companies seek to bypass trade barriers.
• Political/economic changes, such as deregulation and privatization. This leads to less restrictions on FDI.
• New bilateral investment treaties to facilitate investment.
• Globalization of the world economy. Companies often view the entire world as their market.
• Companies need to be closer to customers.

Sources of FDI

• In 1998-2010, the United States had the highest cumulative FDI outflow, followed by the United Kingdom, Netherlands, Germany, Japan, and France.

Reasons for Choosing FDI over Exporting/Licensing

• Exporting involves producing domestically and shipping to a foreign market.
• Licensing involves granting a foreign entity the right to produce and sell a product for a fee.
• FDI is preferred when:
  • Transportation costs and/or tariffs are high.
  • Company know-how is not amenable to licensing.
  • Tight control over a foreign operation is required.
  • Know-how is difficult to protect with a licensing contract

Dunning's Eclectic Paradigm

• Important to consider location-specific advantages (resources tied to a particular place).
• Valuable for combining with a firm's unique assets.
• Firms seek externalities - knowledge spillovers when companies are in the same industry and area.

Theoretical Approaches to FDI

• Radical view: MNEs are instruments of imperialist exploitation.
• Free market view: International production should be based on comparative advantage.
• Pragmatic nationalism: FDI benefits countries but can also create costs (profits sent back to the home country, negative balance of payments).

FDI Benefits for the Host Country

• Resource transfer effects (technology, skills, capital).
• Employment effects.
• Balance of payments effects (inflows exceed outflows).
• Effects on competition and economic growth.

FDI Costs for the Host Country

• Adverse effects on competition.
• Adverse effects on the balance of payments (outflows of profits).
• Perceived loss of national sovereignty and autonomy.

FDI Benefits for the Home Country

• Positive effect on the capital account (inward flows of foreign earnings).
• Employment effects (from outward FDI).
• Learning valuable skills from foreign markets.

FDI Costs for the Home Country

• Negative effect on the balance of payments (outflows to foreign entities).
• Employment may be negatively affected if FDI substitutes for domestic production.

Government Influence on FDI

• Governments can encourage outward FDI with insurance programs to cover investment risks.
• They can limit capital outflows, control tax rules, or prohibit FDI.
• Governments encourage inward FDI through incentives for foreign companies to invest.
• Governments can limit inward FDI via ownership restraints and performance requirements.

FDI for Managers

• Managers must consider trade theories and government policies relevant to FDI.
• The direction of FDI can be explained using location-specific advantages.
• Governments' attitudes toward FDI are important for deciding where to locate foreign production facilities.

FDI Decision Framework for Managers

• High transportation costs/tariffs discourage exporting; consider FDI.
• If know-how is easily licensed, licensing might be preferred.
• If tight control is needed, direct investment is likely better.
• If know-how can be protected, licensing is a possible alternative.

This quiz covers the essential concepts of Foreign Direct Investment (FDI), including its definition, forms, and the reasons companies prefer acquisitions over greenfield investments. It also explores patterns of FDI flows and their significance in multinational enterprises.