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COURSECODE: INTERNATIONAL TRADE AND THEORY

TOPIC: FOREIGN DIRECT INVESTMENTS

Answer the following questions:

1. Compare and contrast the explanations of FDI: internalization theory, Vernon's product life cycle and Knickerbocker's theory of FDI.

2. What are the implications of FDI to the business practice of managers?

3. What are the implications of government policy to FDI?

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Since World War II, United States has been the largest: source country for F0], a position it retained during the late 19905 and early 20003. Other important source. countries include the United Kingdom, France, Germany, _ the Netherlands, and Japan. these six countries accounted?! for 60.. parent oral! rm outows foam-201 THE FORM OF FDI: ACQUISITIONS VERSUS GREENFIELD INVESTMENTS FDI can be take the form of a greenfield investment or acquisitions. Majority of cross-boarder investment is in the form of the mergers and acquisitions rather than greenfield investment.UN estimate that some 40 to 80 percent of all FDI inflows were in the form of mergers and acquisitions between 1998 and 2009. In 2001, for example, mergers and acquisitions accounted for some 78% of all FDI inflows. In 2004, the figure was 59%, while in 2008 it was 40%, although the figure slumped to just 23% in 2009 reflecting the impact of the global financial crisis and the difficulties of financing acquisitions through the public capitalTRENDS IN FDI 2.000 TRENDS IN FDI 1,800 The past 30 years have seen a marked increase in both the flow and stock of FDI in the world economy. The average yearly outflow of FDI incremed from $25 billion in 1975 m a record $1 8 trillion in 2007 (see Figure 8.1]. However, FDI outflows did contract to $1.1 trillion in 2009 and 2010 in the wake of the global financial crisis, although they were forecasted to recover in 201 1.' In general, however, over the past 30 years the flow of FD has accelerated faster than the growth in world trade and world output. For ex- ample, between 1992 and 2005, the total flow of FDI from all countries increased more than eightfold while world trade by value grew by some 150 percent and world ourput by around 45 percent.' As a result of the strong FDI flow, by 2009 the global stock of FDI was about $15.5 trillion. At least 87,000 parent companies had 610,000 affiliates in for- cign markets that collectively employed more than 77 million people abroad and gener- ated value accounting for about 11 percent of global GDP. The foreign affiliates of multinationals had more than $30 trillion in global sales, higher than the value of global exports of goods and services, which stood at close to $19.9 trillion. FDI has grown more rapidly than world trade and world output for several reasons. 6/ 15 First, despite the general decline in trade barriers over the past 30 years, firms still fear protectionist pressures. Executives see FDI as a way of circumventing future unde ban- A en. Second, much of the increase in FDI has been driven by the political and economic changes that have been occurring in many of the world's developing nations. The gen-FDI Two Main Forms: *Greenfield Investment - involves the establishment of a new operation in a foreign country. *Acquisition Investment - involves acquiring or merging with an existing firm in the foreign country. Three types of Acquisition 1. Minority - foreign firm takes a 10% to 49% interest in the firm's voting stock 3/ 15 2. Majority - foreign firm takes interest of 50% to 90% 3. Full outright stake - foreign firm takes the 100% interestTHE DIRECTION OF FDI Historically, must FDI has been directed at the developed nations of the world as firms based in advanced countries invested in the others' markets (see Figure 8.3). During the 1980, and 1990s, the United States was often the favorite target for FDI inflows. The United States hall been an attractive target for FDI because of its large and wealthy do- mestic markets, its dynamic and sable economy, a favorable political environment, and the openness of the country to FDI. Investors include firms based in Great Britain, Japan, Germany, Holland, and France. Inward investment into the United States remained high during the 2000, totaling $324 billion in 2008, although it fell.to $1,860 billion in 2010 in the wake of the global financial crisis. The developed nations of the European Union have also been recipients of significant FDI inflows, principally from U.S. and Japanese enterprises and from other member states of the EU. In 2007, inward investment into the EU reached a record $923 billion, although it fell to $289 billion in 2010. The United 1409 Kingdom and France have historically been the largest recipients of inward FDL. Even though developed nations still account for the largest share of FDI inflows, FDI into developing nations has increased (see Figure 8.3), From 1985 to 1990, the annual inflow of FDI into developing nations averaged $27.4 billion, or 17.4 percent of the total global flow. In the mid- to late 1990s, the inflow into developing nations was generally between 35 and 40 percent of the total, before falling back to account for about 25 per- cent of the tocal in the 2000-02 period and then climbing to hit a record 50 percent in 2010. Most recent inflows into developing nations have been targeted at the emerging economies of South, Ent, and Southeast Asia, Driving much of the increase has been 9/ 15Foreign Direct Investment (FDI) occurs when a firm invests directly in facilities to produce or market a product in a foreign country. According to the U.S. Department of Commerce, FDI occurs whenever a U.S. citizen, organization, or affiliated group takes an interest of 10% or more in a foreign business entity. Once a firm undertakes FDI, it becomes a 2 / 15 multinational enterprise. 2Stock of FDI - total accumulated value of foreign-owned assets at a given time. Outflows of FDI - the flow of FDI out of a country Inflows of FDI - the flow of FDI into a country. 5/ 15Why do firms apparently prefer to acquire existing assets rather than undertake greenfield investments? First, mergers and acquisitions are quicker to execute than greenfield investments. Second, foreign firms are acquired because those firms have valuable strategic, assets, such as brand loyalty, customer relationships, trademark or patents, distribution systems, and production systems. Third, firm believe that they can increase the efficiency of the K acquired unit by transferring capital, technology, or management skills.THE PRODUCT LIFE CYCLE -the same firms that pioneer a product in their home markets undertake FDI to produce a product for consumption in foreign markets . However, Vernon's Theory fails to explain why it is profitable for a firm to undertake FDI at such times, rather than continuing to export from its homebase or licensing a foreign firm to produce its product . THE ECLECTRIC PARADIGM The electric paradigm has been championed by the British economist John Dunning, Location-specific advantages -means the advantages that arise from utilizing resource in endowments or assets that are tide to a particular foreign location and that a firm finds valuable to combined with its own unique assets. Economists refer to such knowledge "spillovers" as externalities , and their is a well-established theory suggesting that firms can benefit from such externalities by location close to their source .FIGURE B.2 National Flagulatory Changea Governing 100 FDI. 1892-2009 2600 20 200 200 - More Favorable to FUJI Lais Favorable to FDI Larin America, economic growth, economic deregulation, privatization programs that are open to foreign investor, and removal of many matrictions on FUI have made them countries more attractive to foreign multinationals. According to the United Nations, some 90 percent of the 2,700 changes made worldwide herween 1992 and 2009 in the laws governing forelim direct Investment created a more favorable environment for FDI (oce Figure 8.2)." However, since the early 2000, the number of regulations that are lew favorable coward FDI has increased, suggesting the pendulum may be starting to ming the other way In Latin America, in particular, two things of the reported changes in 7/ 15 2005 and 2009 made the environment for fiorella direct investment hem welcome. Mon of these unfavorable clunges were focused on extractive industries, wich as nil and gas, where government seemed focused on limiting FOl and capturing mom of the economic value frown FDI through. for example, higher taxes and tuguilty min applied to foreign