foreign direct investment 7 copyright © 2014 pearson education, inc
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7 - 2Copyright © 2014 Pearson Education, Inc.
Chapter ObjectivesChapter Objectives
• Describe worldwide patterns of foreign direct investment (FDI) and reasons for those patterns
• Describe each of the theories that attempt to explain why FDI occurs
• Discuss the important management issues in the FDI decision
• Explain why governments intervene in the free flow of FDI
• Discuss the policy instruments that governments use to promote and restrict FDI
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VolkswagenVolkswagen
• Produces 8 million cars a year• Modular production strategy• Special protection in Germany
• Produces 8 million cars a year• Modular production strategy• Special protection in Germany
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Foreign Direct Investment Foreign Direct Investment (FDI)(FDI)
Purchase of physical assets or significant amount of ownership of a company in another country in order to gain some measure of management control
By contrast, portfolio investment does not involve obtaining a degree of control in a company
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Yearly FDI InflowsYearly FDI Inflows
Source: Based on World Investment Report (Geneva, Switzerland: UNCTAD), various years.
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Reasons for FDI GrowthReasons for FDI Growth
Increasingglobalization
International mergersand acquisitions
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Value of Cross-Border M&AsValue of Cross-Border M&As
Source: Based on World Investment Report (Geneva, Switzerland: UNCTAD), various years.
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Worldwide FDI FlowsWorldwide FDI Flows
World FDI inflows
Developed (49%), developing (45%)
European Union: 28% of world FDI
Developing nations
China and India attract most FDI
All of Africa: 2.8% of world FDI
82,000 multinationals
with810,000 affiliates
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Discussion QuestionDiscussion Question
What is the difference between foreign direct investment and portfolio investment?
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Answer to Discussion Answer to Discussion QuestionQuestion
Foreign direct investment is the purchase of physical assets or a significant amount of the ownership of a company in another country to gain a measure of management control.
Portfolio investment does not involve obtaining a degree of control in a company.
International Product Life International Product Life CycleCycle
A company begins by exporting its product and later undertakes foreign direct investment as a product moves through its life cycle
Source: Raymond Vernon and Louis T. Wells, Jr., The Economic Environment of International Business , 5th ed. (Upper Saddle River, N.J.: Prentice Hall, 1991), p. 85.
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Market Imperfections Market Imperfections (Internalization)(Internalization)
Trade barriers(e.g., tariffs)
Unique advantage(e.g., special
knowledge)
A company undertakes FDI to internalize a transaction that is made inefficient because of a market imperfection
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Eclectic TheoryEclectic Theory
FDI when location, ownership, and internalization advantages combine to make a location appealing
Locationadvantage
(optimal location)
Ownershipadvantage(special asset)
Internalizationadvantage
(efficiency)
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Market PowerMarket Power
FDI used to establish a dominant presence in an industry
Vertical integrationExtends company’s activitiesinto stages of production that provide its inputs (backward integration) or absorb its out-puts (forward integration)
Market power= Greater profits
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Discussion QuestionDiscussion Question
The eclectic theory says that firms undertake FDI when location, ownership, and __________ advantages combine to make a location appealing for investment.
a. Internalization
b. First-mover
c. Life-cycle
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Answer to Discussion Answer to Discussion QuestionQuestion
The eclectic theory says that firms undertake FDI when location, ownership, and __________ advantages combine to make a location appealing for investment.
a. Internalization
b. First-mover
c. Life-cycle
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Management Issues IManagement Issues I
Control Purchase-or-build
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Management Issues IIManagement Issues II
Productioncosts
Customerknowledge
Source: LIU JIN/Newscom
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Management Issues IIIManagement Issues III
Following rivalsFollowing clients
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Balance of PaymentsBalance of Payments
Capital accountCapital accountCurrent accountCurrent account
National accounting system that records all payments to entities in other countries and all receipts coming into the nation
The import and export of goods and services, income receipts on assets abroad, and income payments on foreign assets inside the country
The purchase or sale of assets (including assets such as property and shares of common stock in a company)
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Discussion QuestionDiscussion Question
What do we mean by a country’s balance of payments and what is its usefulness?
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Answer to Discussion Answer to Discussion QuestionQuestion
A country’s balance of payments is a national accounting system that records all payments to entities in other countries and all receipts coming into the nation.
The system helps monitor a country’s flows of goods, services, income, and asset transfers between itself and other nations. The balance of payments position sends warning signals about trade deficits with other nations.
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Host Intervention IHost Intervention I
Balance of Payments+
Balance of Payments+
FDI may generate exportsFDI may generate exports
Initial FDI boosts economyInitial FDI boosts economy
FDI may decrease importsFDI may decrease imports
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Host Intervention IIHost Intervention II
Obtain resourcesand benefits
+
Obtain resourcesand benefits
+
Access technologyAccess technology
Access management skillsAccess management skills
Create employmentCreate employment
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Home InterventionHome Intervention
+ Improve competitiveness+ Eliminate low-wage jobs
– Remove national resources– Eliminate export markets– Eliminate domestic jobs
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Host Promotion MethodsHost Promotion Methods
Financial incentives■ Low or waived taxes■ Low-interest loans
Infrastructure benefits■ Better seaports, roads,
and telecom networks
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Host Restriction MethodsHost Restriction Methods
Ownership restrictions■ Prohibit investment in industries or businesses
Performance demands■ Local content requirements■ Export targets■ Technology transfers
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Home Promotion MethodsHome Promotion Methods
Insurance on assets abroad
Loans and loan guarantees
Tax breaks on profits earned abroad
Special tax treaties
Persuade other nations to accept FDI
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Home Restriction MethodsHome Restriction Methods
Higher taxes onforeign income
Sanctions that prohibit investing
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Discussion QuestionDiscussion Question
A host government may encourage an initial FDI because the inflow can __________ its balance-of-payments position.
a. Level
b. Lower
c. Boost
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Answer to Discussion Answer to Discussion QuestionQuestion
A host government may encourage an initial FDI because the inflow can __________ its balance-of-payments position.
a. Level
b. Lower
c. Boost
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any
means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher.
Printed in the United States of America.
Copyright © 2014 Pearson Education, Inc.
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