Foreign Direct Investment

Topics: Market economy, Market, Free market Pages: 11 (2362 words) Published: January 3, 2013
* Occurs when a firm invest directly in a foreign country.
* Becomes a multinational enterprise
* FDI can be both – Greenfield (establish new ops)
Acquisition/Merger (with existing firms)
* Flow of FDI –refers to the amount of FDI over a time period. * Stock of FDI - total accumulated value of foreign-owned assets * Outflows – flows of FDI out of a country
* Inflows – flows of FDI into a country
Gross fixed capital formation summarises the total amount of capital invested in factories, stores, buildings(fixed assets)

Source of FDI:
Since World War II, the U.S. has been the largest source country for FDI. United Kingdom, Netherlands, France, Germany and Japan are other important source countries. China is upcoming major source.

Form of FDI
Acquisition versus greenfield:
* Most are mergers and acquisitions, rather than greenfield. * Easier and less risky rather than to build from scratch. * Firms believe that they can increase the efficiency of an acquired unit by transferring capital, technology or management skills.

The shift to services is being driven by 4 factors:
* general move in developed economies, away from manufacturing and toward service * Many services cannot be traded internationally.
* Countries liberalised their regimes governing FDI in services. * Rise of internet-based global telecom networks allowed service enterprises to relocate their value creation activities to different nations, take advantage of cheaper factor costs.

Other forms of FDI:
* Exporting: producing goods at home then shipping them to the receiving country for sale * Licensing: granting a foreign entity right to produce and sell the firm’s product in return for royalty fee on every unit sold

Flip side of FDI:
Horizontal direct investment:
* FDI in the same industry abroad as company operates in at home. * Expensive, must bear costs of establishing production facilities in a foreign country or of acquiring an enterprise. * Risky, because of the problems associated with doing business in another culture, in which the rules of the game may be different.

So when to use horizontal FDI?
* High transport costs for a product
* Market imperfections (internalisation theory) which explains why FDI is attractive. * Barriers to free flow of products between nations
* Barriers to the sale of know-how
* Following the lead of a competitor - strategic rivalry
* Product life cycle (but does not explain when it is profitable to invest abroad) * Location specific advantages (natural resources)

Vertical FDI takes two forms:
* Backward vertical FDI - investment in an industry abroad that provides inputs for a firm’s domestic production processes. -To gains control over the source of raw materials & raise entry barriers -To overcome the barriers established by firms already doing business in a country. * Forward vertical FDI occurs when an industry abroad sells the outputs of a firm’s domestic production processes ( less common than backward vertical FDI).

Internalisation theory (aka market imperfections theory) suggests 3 reasons why licensing is undesirable:

1. May give away valuable tech know-how
2. No tight control over manufacturing, marketing, & strategy in a foreign place that may be required to maximise profit 3. Ineffective when the firm’s competitive advantage is based more on management, marketing, and manufacturing capabilities than on product.

FDI Patterns

* Firms in the same industry often undertake FDI:
1. Around the same time
2. Similar locations.
* Knickerbocker looked at the relationship between FDI and rivalry in oligopolistic industries (industries composed of a limited number of large firms), this reflects strategic rivalry among firms.

* This leads to multipoint competition, when firms compete with each other in different markets. * Vernon - argued that...
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