Global Business Environment

Economic environment: capital movement, FDI

Readings

World Investment Report 2009. Overview. pp. 4-22. http://www.unctad.org/en/docs/wir2009overview_en.pdf

The OLI Paradigm. http://www.investmentsandincome.com/investments/oli-paradigm.html

International movements of capital

1. Types of capital movements:– Official flows (grants)– International borrowings and lendings

2. Portfolio investments

3. Foreign direct investments

FDI

Foreign direct investment refers to investment in which a firm in one country directly controls or owns a subsidiary in another.

If a foreign company invests in at least 10% of the stock in a subsidiary, the two firms are typically classified as a multinational corporation.

– 10% or more of ownership in stock is deemed to be sufficient for direct control of business operations.

– In addition, international borrowing and lending sometimes occurs between a parent company and its subsidiary

Location and internalization

Why are multinational corporations created and why do they undertake direct foreign investment?

– Location: why is a good produced in two countries rather than in one country and then exported to the second country?

– Internalization: why is production in different locations done by one firm rather that by separate firms?

Location

Why production occurs in separate location is often determined by

– the location of necessary factors of production: mining occurs where minerals are; labor intensive production occurs where relatively large

pools of labor live.

– transportation costs and other barriers to trade may also influence the location of production.

– These factors also influence the pattern of trade.

Internalisation

Internalization occurs because it is more profitable to conduct transactions and production within a single organization than in separate organizations. Reasons for this include:

1. Technology transfers: transfer of knowledge or another form of technology may be easier within a single organization than through a market transaction between separate organizations.

– Patent or property rights may be weak or non-existent.– Knowledge may not be easily packaged and sold.

Internalisation

2. Vertical integration involves consolidation of different stages of a production process.

– Vertical integration would involve consolidation of one firm that produces a good that is used as an input for another firm.

– This may be more efficient than having production operated by separate firms.

– For example, having farms and flour mills consolidate into one organization to make flour may be more efficient that have farms and flour mills as separate organizations.

Trends in FDI

Flow and stock increased in the last 20 years In spite of decline of trade barriers, FDI has grown

more rapidly than world trade because– Businesses fear protectionist pressures– FDI is seen a a way of circumventing trade barriers– Dramatic political and economic changes in many parts

of the world– Globalization of the world economy has raised the vision of

firms who now see the entire world as their market

The Direction of FDI

Historically, most FDI has been directed at the developed nations of the world as firms based in advanced countries invested in other markets

– The US has been the favorite target for FDI inflows

While developed nations still account for the largest share of FDI inflows, FDI into developing nations has increased

– Most recent inflows into developing nations have been targeted at the emerging economies of South, East, and Southeast Asia

Costs of FDI to Host Countries

Adverse effects on competition

Adverse effects on the balance of payments– After the initial capital inflow there is normally a

subsequent outflow of earnings– Foreign subsidiaries could import a substantial

number of inputs

National sovereignty and autonomy– Some host governments worry that FDI is

accompanied by some loss of economic independence resulting in the host country’s economy being controlled by a foreign corporation

Political Ideology and FDI

RadicalView

PragmaticNationalism

FreeMarket

The Radical View

Marxist view: MNE’s exploit less-developed host countries

– Extract profits– Give nothing of value in exchange– Instrument of domination, not development– Keep less-developed countries relatively

backward and dependent on capitalist nations for investment, jobs, and technology

The Radical View

By the end of the 1980s radical view was in retreat

– Collapse of communism – Bad economic performance of countries that

embraced the radical view– Strong economic performance of countries who

embraced capitalism rather than the radical view

The Free Market View

Nations specialize in goods and services that they can produce most efficiently

Resource transfers benefit and strengthen the host country

Positive changes in laws and growth of bilateral agreements attest to strength of free market view

All countries impose some restrictions on FDI

Pragmatic Nationalism

FDI has benefits and costs Allow FDI if benefits outweigh costs

– Block FDI that harms indigenous industry– Court FDI that is in national interest

Tax breaksSubsidies

Regional development implications of FDI

Post Communist Eastern Europe, e.g. Czech Republic, Slovenia

Foreign direct investment (FDI) has been accorded a central role in the post-communist economic transformation of Central and Eastern Europe.

Regional effects of FDI in Central Europe (Czech Republic, Hungary, Poland and Slovakia) in the 1990s.

Defining FDI’s role in regional economic transformations– Intensification of uneven development– Development of a Dual Economy– Failure to develop linkages with local and regional

economies– Contribution to increased regional economic instability

Motivations of foreign direct investments

Resource-seeking investments:– Row materials, energy, natural resources,– Low-cost labour,– Low-cost human capital.

Market-seeking investments:– Green-field investments,– Brown-field investments,– Mergers & acquisitions.

Efficiency-seeking investments:– Factor proportions,– Differentiation of products,– Economy of scales.

Strategic-advantage-seeking investments:– Long-term advantage of acquisition.

Motivations of foreign direct investments

Main sources of advantages of multinational firms

Ownership-specific advantages Location-specific advantage Internalization (technology transfer, vertical

integration)

= OLI paradigm (Dunning) Dunning: productivity of US firms in UK in the

1950’s – US firms in the UK are more productive than UK firms (because of best managerial skills, know-how, etc.)

Vernon’s Product Life Cycle (PLC) theory

Phases: home production; export; export of capital; foreign production.

Porter – strategic management Three groups of international enterprises

– Exporting domestic enterprise,– Multi-domestic enterprise (management in every

country, negligible central co-ordination)– Global enterprise (centrally co-ordinated).

Main specificities of strategic alliances:– Basic autonomy of the partners remain,– Long-term,– Mutually advantageous co-operation,– Resources make available for one another,– Integration of specific functions.

Strategic alliances

Advantages:– Increase of financial resources,– Foreign trade sufficit,– Positive effect on employment (both direct and

indirect),– Technology transfer,– Import of know-how,– Better structure of foreign relations,– Diminution of risks.

Advantages and disadvantages for recipient countries

Disadvantages– Less economic autonomy,– Technological dependence,– Local resources in foreign control,– Increasing foreign involvement,– Undesired structural changes,– Increasing risks (profit),– Bad structure of foreign relations.

Advantages and disadvantages for recipient countries