© ram mudambi, temple university, 2007 1 lecture 4 foreign direct investment
TRANSCRIPT
© Ram Mudambi, Temple University, 2007 2
1. Foreign Direct Investment
2. The Political Economy of Foreign Direct Investment
© Ram Mudambi, Temple University, 2007 3
DaimlerChrysler – Group Sales by Region - 2004
Units in ‘000s
Is this an accurate picture of the firm’s global footprint?
71.1%
West Europe20.5%
Japan1.1%
9.9%
WORLD Total = 3,903
GermanyNAFTA
US62.3%
© Ram Mudambi, Temple University, 2007 4
Mercedes – Group Sales by Region - 2004
Units in ‘000s
What is the unit value of Mercedes relative to Chrysler?
WORLD Total = 3,903
19.9%
West Europe66.6%
Japan3.5%
32.2%
GermanyNAFTA
US18.5%
© Ram Mudambi, Temple University, 2007 5
What is Foreign Direct Investment (FDI)?
FDI occurs when a firm invests directly in facilities to produce and/or market a product or service in a foreign country.
FDI is not the investment by individuals, firms or public bodies in foreign financial instruments (PORTFOLIO INVESTMENT)
© Ram Mudambi, Temple University, 2007 6
FDI Taxonomy
MODE
Greenfield Acquisition
Wholly-owned 1 3
Partially owned 2 4
Controllinginterest
Minorityinterest
A firm settingup a de novooperation in
another country
A firm buying a firm in
another country
Targets necessary
© Ram Mudambi, Temple University, 2007 7
Flow vs Stock of FDI
Flow: Amount of FDI over a period of time (one year).
Stock: Total accumulated value of foreign owned assets at a given point in time.
© Ram Mudambi, Temple University, 2007 10
FDI outflows by select country1998-2001
© Ram Mudambi, Temple University, 2007 11
World GDP, exports and FDI
World GDP and FDI 1990-2001 (index = 100 in 1990)
© Ram Mudambi, Temple University, 2007 13
Gross Fixed Capital Formation
A summary of the total amount of capital invested in factories, stores office buildings, and the like.
All things being equal, the greater the capital investment in an economy, the more favorable its future growth prospects are likely to be.
© Ram Mudambi, Temple University, 2007 14
Inward FDI flows As a percentage of gross fixed capital formation, 2000
© Ram Mudambi, Temple University, 2007 15
FDI Inflow for Selected Countries% of total capital investment, 2005
0
5
1 0
1 5
2 0
2 5
3 0
3 5
4 0
4 5
2 0 0 5
U KS w e d e nC h i l eA r g e n t i n aC h i n aI n d i aJ a p a n
© Ram Mudambi, Temple University, 2007 16
Why is FDI growing more rapidly than world trade or output?
World political and economic change
Wider acceptanceof MNC operations
Movement of operations to the most efficient location
MACRO
© Ram Mudambi, Temple University, 2007 17
Why is FDI growing more rapidly than world trade or output?
Growing power of regionaleconomic blocs
EU, NAFTA, Mercosur, etc.
Strategy of extra-bloc firms to become ‘domestic’
– ‘tariff-jumping’
MICRO
Improved logistics
Movement of operations to the most efficient location
Most internationaltrade is intra-firm
© Ram Mudambi, Temple University, 2007 18
Two Forms of FDIV
alue
cha
in Location 1Stage 1
Location 2Stage 1Horizontal FDI
Location 2Stage 0
BackwardVertical FDI
Location 2Stage 2
ForwardVertical FDI
HOME
HOST
© Ram Mudambi, Temple University, 2007 19
FDI – composition changes FDI been growing in terms of volume, but
it has also been changing in its composition Increasingly FDI represents a considerable
amount of transfer of knowledge Know-how and skills Scientific knowledge Organizational knowledge
Multinational firms do not like to give up control of this knowledge
Impediments to the Sale of Know-how
Impediments to the sale of know- how
Risk giving away know-
how to competitors
Licensing implies low control over
foreign entityKnow-how not amenable to
licensing
© Ram Mudambi, Temple University, 2001
© Ram Mudambi, Temple University, 2007 21
HFDI, When and Why?
Transportation too costly? Most cited: Market Imperfections (Internalization
Theory). Impediments to the free flow of products between nations. Impediments to the sale of know-how.
Follow the lead of a competitor - strategic rivalry. Product Life Cycle - however, does not explain when it’s
profitable to invest abroad.
Location specific advantages (natural resources).
© Ram Mudambi, Temple University, 2007 22
HFDI, Where?
Firms first expand into host countries that are culturally close to the home country
British firms US firms
The Stage Theory of FDI
US, Australia, New Zealand
Canada, Mexico
© Ram Mudambi, Temple University, 2007 23
The Stage Theory: Wal-Mart International
INTERNATIONAL DISCOUNT STORES SUPERCENTERS SAM'S CLUBArgentina 0 6 3Brazil 0 5 3Canada 144 0 0Mexico 347 27 28Puerto Rico 9 0 5China 0 2 1Germany 0 21 0
International Totals: 500 61 40
Wal-mart has since withdrawnfrom Germany
HFDI – A Decision FrameworkHow high are How high are
transportation costs transportation costs and tariffs?and tariffs?
Is know-how amenable Is know-how amenable to licensing?to licensing?
Is tight control over foreign Is tight control over foreign operation required?operation required?
Can know-how be protected Can know-how be protected by licensing contractby licensing contract??
LicenseLicense
ExportExport
Horizontal FDIHorizontal FDI
Horizontal FDIHorizontal FDI
Horizontal FDIHorizontal FDI
No
High
Yes
Yes
Low
No
Yes
No
© Ram Mudambi, Temple University, 2007 25
Case: FDI and the Irish miracle FDI in Ireland grew from $164m (1985) to
$24b (2000) (roughly 150 fold!) By 2000 two-thirds of Irelands top exporters
were MNEs Reasons for Ireland’s success
Member of EU (access to EU markets) Highly educated workforce; Good infrastructure
In 1985, Ireland was the 2nd poorest W.European country. Today it is the 2nd richest.
© Ram Mudambi, Temple University, 2007 26
FDI into China – Success story?
Japan TaiwanUS
Other
Hong KongHong KongOtherUSJapanTaiwan
Second Largest Recipient of FDI After US
© Ram Mudambi, Temple University, 2007 27
Changing Face of China’s Foreign Investment
Source: McKinsey & Co
1992 2002
Joint Ventures 70% 48%
Wholly owned foreign subsidiaries
30% 52%
© Ram Mudambi, Temple University, 2007 28
FDI – China vs. the US
• High percentage fromother developedcountries • Largely by acquisition• Largely market seeking
The US
• High percentage fromother developingcountries • Largely greenfield• Largely asset seeking• Large amount of‘round-tripping’
China
However, recently:• More market seeking FDI• More FDI from developed countries
© Ram Mudambi, Temple University, 2007 29
The Political Economy of Foreign Direct Investment
© Ram Mudambi, Temple University, 2007 30
The Spectrum of Political Ideology Toward FDI
RadicalView
PragmaticNationalism
FreeMarket
© Ram Mudambi, Temple University, 2007 31
Radical View Marxist view is that MNE’s enslave less
developed countries. Instrument of domination not
development. Popular from WWII to the 1980s.
Practiced by Eastern Europe, India, China, 3rd World Countries.
Ended with the collapse of Communism. Bad performance by those countries vs. those
with freer market approach
© Ram Mudambi, Temple University, 2007 32
Free Market View
Sees FDI as way to disperse production and flow of goods and services in the most efficient manner. Supported by Smith and Ricardo and ‘market
imperfection’ explanations of FDI.
However, all countries impose some restrictions on FDI.
© Ram Mudambi, Temple University, 2007 33
Pragmatic View
Lies somewhere between radical and free market views.
Governments should maximize national benefits and minimize costs of FDI.
© Ram Mudambi, Temple University, 2007 34
Ideology and FDIIdeology Characteristics
Host-Government Policy Implications
Radical
Marxist rootsViews FDI as an imperialist tool
Prohibit FDINationalize MNC
subsidiaries
Free Market
Classical economic roots
FDI as a tool for efficient location of
operations
No restrictions on FDI
Pragmatic Nationalis
m
FDI has both benefits and costs
Court targeted MNCsTailor incentives
© Ram Mudambi, Temple University, 2007 35
What do the data tell us? – 1 MNC economic interests are
overwhelmingly concentrated in the triad – North America, Europe and Japan/East Asia
There is no evidence that triad governments are subject to ‘control’ by MNCs Competitive pressures cause MNCs to cancel each
other out
Activities outside the triad are too insignificant to justify expense of political activities E.g., a recent CIMA study found that most MNCs
followed ‘whiter than white’ accounting practices
© Ram Mudambi, Temple University, 2007 36
What do the data tell us? – 2 Globalization refers to FDI, not financial flows FDI flows are extremely stable MNC strategies tend to be regional, rather than
global, reflecting regional trading blocs Fears of global homogenization are over-rated EU, NAFTA, Mercosur, APEC
MNCs tend to be “flagship firms” – serve as hubs of extensive business networks/clusters
© Ram Mudambi, Temple University, 2007 37
Benefits of FDI to Host Countries
Resource-transfer effects Capital, technology, management
Employment effects Balance-of-payments effects Economic growth
© Ram Mudambi, Temple University, 2007 38
FDI and resource-transfer effects
HOME
Parent
HOST
Subsidiary
Spilloverof
technologyand
managementpractices
Inflow of capital
© Ram Mudambi, Temple University, 2007 39
FDI and employment effects
HOST
Subsidiary
Directlocaljobs
created
Jobs createdin local
supplier &ancillary network
Jobs created due to increasedincome generation
Jobs lost in localfirms that are driven out ofbusiness
© Ram Mudambi, Temple University, 2007 40
FDI and balance of payments
HOME
Parent
HOST
Subsidiary
Localoutput
replacesimports
(+)
Inflow of capital(+)
Repatriated profits (-)
3rd CountrySubsidiary
exports(+)
Taxes, tariffsand otherpaymentsto the govt.(+)
© Ram Mudambi, Temple University, 2007 41
Economic Growth
Increased: productivity growth, product and process innovation, and greater economic growth,
Stemming from increased competition of MNE’s investments.
© Ram Mudambi, Temple University, 2007 42
How Do Countries Encourage FDI?*
Risk insurance.(Home) Elimination of double taxation. (Home) Tax incentives.(Host) Low interest rates. (Host) Grants for land and training of workforce
(Host) Stable government and stable policies (Host)
*See http://sbm.temple.edu/~rmudambi/Publications/Mudambi%20IJEB.pdf
© Ram Mudambi, Temple University, 2007 43
How Do Countries Discourage FDI?
Limit capital outflows. (Home) Manipulate tax code to encourage domestic
investment. (Home) Political restrictions on investing in certain
countries. (Home) Ownership restraints. (Host) Performance requirements. (Host)
© Ram Mudambi, Temple University, 2007 44
Vernon’s Obsolescing Bargain: Determinants of Bargaining Power
Bargaining Power of FirmHigh Low
Firms time horizon Long Short
Comparable alternatives open to firm
Many Few
Value placed by host government on investment
LowHigh
© Ram Mudambi, Temple University, 2007 45
Takeaways
FDI has been rising faster than GDP or trade Rising power of regional blocs; better logistics
HFDI – customization VFDI – value chain disaggregation FDI as a powerful economic stimulant
Examples – Ireland, China
Pragmatic view of MNEs – use with care Potential benefits of FDI
Resource transfer, employment, BOP, growth