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Foreign Direct Investment

Chapter seven

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Then main sections 1. Introduction2. FDI in the world Economy 3. Theories of FDI4. Political Ideology and FDI5. Benefits and Cost of FDI6. Govt Policy Instruments and FDI

FDA

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FDI when a firm invests directly in a foreign country leading to a multinational enterprise.

Two forms of FDI:1. Greenfield investment http://www.sagia.gov.sa/PageFiles/4132/Annual_Report_FDI%20_SAUDI_ARABIA.pdf2. Acquiring or merging with a firm in the

foreign country.2. See Telephonica case study

Introduction

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Key concepts:1. The Flow of FDI: the amount of the FDI

undertaken over a year.2. The Stock of FDI: the total accumulated

value of foreign owned assets at a given time.

3. Outflows of FDI: the flow of FDI out of the country.

4. Inflows of FDI: the flow of FDI into a country

Foreign Direct Investment in the World Economy

section number one

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Trends in FDI The direction of FDI The source of FDI The form of FDI The shift to services

Foreign Direct Investment in the World Economy

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Outflow of FDI from $25 billion in 1975 to 1.4 trillion in 2000.

2007 = 1.8 trillion dollars 2008 = 1.4 trillion. 2011 = 1.66 trillion an increase by 16% See

http://www.twnside.org.sg/title2/finance/2012/finance120412.htm

See figure 1.7. The global stock of FDI exceeded $15 trillion

by 2007.

Trends in FDI

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The direction from developed to developed countries.

$232billion in 2008 inward investment to the USA EU reached 604 billion in 2007. UK and France 323 and 272 respectively. FDI into developing nations has increased to reach

27.4 billion. Don't forget the emerging economies, China for example

China attracted 60 billion of FDI in 2004 to hit 92 billion in 2008.

Gross fixed capital formation is an important indicator see figure 7.4

The directions of FDI

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USA since WWll up to 2000 UK, France, Germany and Japan.

Source of FDI

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Acquisitions Vs Greenfield Investments. Acquisitions account for more than

Greenfields up to 40-90 percent Less in developing countries of about one-

third is in the form of cross-border mergers and acquisitions. There are fewer firms to acquire in developing nations.

Maybe you have to start from scratch- Greenfield investments

The form of FDI

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Why to acquire vs undertake greenfield investments?

The form of FDI

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Services account for about more than 70% of the GDP The shift to services is driven by many factors 1-

including the shift from goods to services.2-Services can not be traded internationally because of

they are inseparable 3-Regime liberalization in services –telecommunication

and power4- the internet based global telecommunications

networks has allowed some services to relocate some of their value creation activities to different nations- Proctor and Gample shifting its back office accounting function to the Philippines.

The Shift to Services

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Why FDI? Maybe it is more risky and expensive.Why not exporting and Licensing?What are their limitations?

Theories of FDIsection number two

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Limitations of exporting Transportation costs and trade barriers Limitations of licensing The risk of giving away valuable technological know

how to a foreign potential competitor. Be careful of losing your secret formula.

Lost control over important functions like manufacturing, marketing and strategy.

The licensee might not be able to do it right affecting the firm’s competitive advantage.

Culture can not be licensed! Check Toyota example page 242. culture is immitigable

Theories of FDI

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The pattern of FDI or FDI pattern: firms in the same industry for example tend to undertake FDI at around the same time and towards certain locations.

Theories that explain the pattern that we observe in FDI flows:

1-Strategic behaviour: One theory is based on the idea that FDI is

based on strategic rivalry between firms

Theories of FDI

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1-Strategic behaviour: One theory is based on the idea that FDI is

based on strategic rivalry between firms Example is the rivalry in oligopolistic

industries An oligopoly: like 4 firms control 80% of

domestic market. Imitation is high in prices and DFI

Theories of FDI

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Using Multipoint competition: when two or more companies encounter each other in different regional markets, national markets, or industries. Playing like chess, matching each other moves in different markets to try to get advantage one over the other.

The case of Kodak and Fuji Burger King Following McDonald’s

Theories of FDI

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The product life cycle is not very clear in terms of why firms use FDI not other forms like exporting or licensing! So shift to the

Eclectic Paradigm is a very interesting one: location-specific advantages for FDI

including resource endowments or assets So it is:Location specific assets + firm’s own

capabilities = FDI

Theories of FDI

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Look at the example of Silicon Valley – good example- on top of page 245.

The location specific advantage in Silicon Valley is KNOWLEDGE in computer and semiconductor industries attracting computer companies from all over the world to DFI there.

Also oil companies.

Eclectic Paradigm

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1- the Radical view against FDI lead by Marxist political theory.

2- the Free Market View – Adam Smith and David Ricardo views theories.

3- Pragmatic Nationalism – the case of Al-Hassan City in Jordan.

Japan weights benefits against costs of FDI- IBM and Texas instruments.

Nissan, Toyota, and Honda are now operating in the UK by offering tax breaks and subsidies. The shift now is from the radical approach to the free market approach.

Political Ideology and FDI(section number three)

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Host-country benefits 1. Resource-transfer Effects-like capital,

technology, and management resources and training managers and job creation- THE KNOW-HOW.

2. Balance of payments effects; avoiding trade deficit. China exports reached $969 Billion in 2006 due to the presence of foreign multinationals that invested heavily in China during the 1990.

Benefits and costs of FDIsection four

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Effects on competition and economic growth

This improves prices, quality and economic prosperity, R&D., productivity.

Benefits and costs of FDIsection four

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Host-country costs:1. Adverse effects on competition 2. Adverse effects on the balance of

payments3. National sovereignty and autonomyHome country benefits: home country

balance of payments, employment and skill development

Home country costs-balance of payments and employment

Benefits and costs of FDIsection four

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Home country policies Host country policies

Govt Policy instruments and FDIsection number five

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Encouraging outward FDI Restricting outward FDI

The first one: encouraging outward FDI:1- insurance 2- elimination of double taxation Using political influence to relax restriction,

barriers and rules. The Case of toys “R” Us in Japan

Home country policies

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The second policy is restricting outward FDI1- to limit capital outflows for protecting the

country balance of payments 2- to create jobs at home3- for political reasons. Ex Iran.

Home country policies

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Encouraging inward FDITax concessions, low interest loans, and

grantsFrance and UK compete for inward FDI from

Toyota in 1995. Restricting inward FDIIn ownership restraints and performance

requirements. For example Inward FDI in Natural resources like water, cement and potash and other minerals

National security issues

Host country policies

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Ownership restraints is also based on a belief that local owners can help to maximize the resource transfer and employment benefits.

International institutions and FDI Liberalization page 256.

Restricting inward FDI

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You need to: Know the differences between Greenfield

investments Vs acquisitions. FDI keywords like flow of FDI...etc. View links related to FDI in these slides. Have a general knowledge about trends in FDI,

direction, and sources of FDI. The shift to services Know the theories of FDI including the

internalization theory, strategic behaviour, multipoint competition.

Chapter summary and guidelines

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More important is the eclectic paradigm- In The political ideology page 245 look at

the 3 views. Benefits and cost of FDI – the main

elements only like 2-3 benefits and costs of each. and

the same thing for govt policy instruments.Case studies (opening and closing).

Good luck to you.

Chapter summary and guidelines