Foreign Direct Investment.ppt

Investment by Multinational companies

1. Foreign Direct Investment

2. Foreign Direct Investment
Definition
•ForeignDirectinvestmentisaprocesswherebyresidentsof
onecountry(sourcecountry)acquireownershipofassetsin
anothercountryforthepurposeofcontrollingproductionand
anddistributionandotheractivities
•IMFdefinesFDIasaninvestmentthatismadetoacquire
lastinginterests(10%ormoreofshares)inanenterprise
operatinginaneconomyotherthanthatofaninvestor,the
investor’spurposebeingtohaveavoiceinthemanagement
oftheenterprise

3. Foreign Direct Investment
•Broadly,FDIincludesmergersandacquisitions,buildingnew
facilities,reinvestingprofitsearnedfromoverseasoperations
andintracompanyloans
•AfirmthatengagesinFDIbecomesamultinationalenterprise
enterprise(multi=many,somultinationalmeansoperatingin
morethanonecountry)
•FDImaybeforproduction,marketing,serviceprovision,
researchanddevelopment,orforaccesstorawmaterial
•Whenacompanyownsonlyasmallerpercentageofshares
(<10%),itwillhavenomanagerialinvolvement
•Itisknownasportfolioinvestment

4. Foreign Direct Investment
Types of FDI
•TherearethreetypesofFDI:Greenfieldinvestment,Merger
andAcquisition(M&A)andBrownfieldinvestment
1.Greenfieldinvestment:Theterm"greenfieldinvestment"refers
tothetypeofFDIwhereacompanybuildsoperationsina
foreignmarketstartingfromscratch,oraso-calledgreenfield.
•TheseprojectsareFDIsthatprovidethehighestdegreeof
controlforthesponsoringcompanywhencomparedtoother
methodsofFDI,suchasforeignacquisitions

5. Foreign Direct Investment
Types
2.Merger and Acquisition:This involves either
•Apurchaseofanoperatingcompanyabroador
•An amalgamation with a running foreign company
For a merger: the acquiring company maintains its existence and
the target company loses its existence
For an amalgamation: both lose their existence in the favourof a
new company
Mergers and acquisition are either horizontal or vertical
conglomerate

6. Foreign Direct Investment
Types
•Horizontal Conglomerate: is a type of merger and acquisition
when two or more firms that engage in similar activities
combine
•Vertical conglomerate: is the type of merger and acquisition
when two firms that are in different stages of production of a
single final product combine, e.g. oil exploration with a
refinery
3.Brown Field Investment: is a combination of greenfield and
M&A to replace plant and machinery in the target company

7. Foreign Direct Investment
GlobalTrendinFDI(FiguresinBillionsof$)

8. Foreign Direct Investment
FDI in the World for 2016

9. Foreign Direct Investment
FDI in the Top ten recipients (Figures in Billions $)

10. Foreign Direct Investment
FDItoDevelopingeconomiesfellin2016
Reasons
1.Slowingeconomicgrowthaffectingthestartingofnew
businessesanddiscouragingM&As
2.Fallingcommoditiespricesdiscouragedrawmaterialseeking
FDIs

11. Foreign Direct Investment
Trend of Greenfield and Cross Border M&A FDIs

12. Foreign Direct Investment
TheoriesofFDI
MacDougallKempHypothesis
•AccordingtothehypothesisFDImovesfromcapitalabundant
economytocapitalscarceeconomytillthemarginal
productionisequalinbothcountries
•Thisleadstoimprovementinefficiencyinutilizationof
resources,andultimatelyincreaseinwelfare
•FDIisaresultofdifferencesincapitalendowments
•ItwasdevelopedbyMacDougal(1958andelaboratedby
Kemp1964)

13. Foreign Direct Investment
TheoriesofFDI
IndustrialOrganizationtheory
•Accordingtothistheory,MNCwithsuperiortechnology
movestodifferentcountriestosupplyinnovatedproducts
andmakebigprofits
•Krugman(1989)pointsoutthatitwastechnological
advantagepossessedbytheEuropeancountrieswhichledto
massiveinvestmentsintheUSA
•TechnologicalsuperiorityisthemaindrivingforceforFDI
ratherthancapitalabundanceaccordingtoIOT.

14. Foreign Direct Investment
TheoriesofFDI
CurrencyBasedapproach
•Afirmmovesfromstrongcurrencycountrytoweakcurrency
country
•Aliber(1971)postulatesthatfirmsfromstrongcurrency
countriesmoveouttoweakcurrencycountries
•FrootandStain(1989)holdsthatdepreciationinrealvalueof
currencyofacountrylowersthewealthofdomestic
residentsvisavisthewealthofforeignresidents,makingit
cheaperforforeignfirmstoacquireassetsinsuchcountries
•SoFDIsmovefromstrongcurrencycountriestoweakones

15. Foreign Direct Investment
TheoriesofFDI
LocationSpecificTheory
•HoodandYoung(1979)stressonthelocationfactor
•Accordingtothem,FDImovestocountrieswithabundant
rawmaterialsandcheaplabourforce
•Sincerealwagecostvariesamongcountries,firmswithhigh
technologymovetolowwagecountries
•Abundanceofrawmaterialandcheaplabourforcewill
attractFDItoflowtothosecountries

16. Foreign Direct Investment
TheoriesofFDI
ProductCycleTheory
•FDItakesplaceonlywhentheproductinquestionachieve
specificstageinitslifecycle
•Vernon(1966)pointsoutthatanyproductpassesthrough
thestagesofIntroduction,growth,maturityanddecline
stage
•Atmaturitystage,thedemandfortheproductindeveloped
countriesgrowsubstantiallyandrivalfirmsenterproduction
•Tocompetewithrivals,innovatorssetupproductioninhost
countriestosaveontariffsandtransportcosts

17. Foreign Direct Investment
TheoriesofFDI
PoliticalEconomyTheories
•Theseconcentrateonpoliticalrisks
•Politicalstabilityinthehostcountryleadstohigherinflowsof
FDI
•Fatehi-SedahandSafizeha(1989)aretheauthorsofthis
theory
•AsimilartheorybyTallman(1988)emphasizedthatpolitical
instabilityinthehostcountryencouragesFDIinother
countries

18. Foreign Direct Investment
WhydoMultinationalsInvestoverseas
•JohnDunning(1977)identifiesfourreasons
1.MarketSeeking(horizontal):Firmsinvestoverseastotake
theadvantageofmarketsofgreaterdimensions
•Whenproducershavesaturatedsalesintheirhomemarket
theonlywaytoexpandistoinvestoverseas,especially
whentheproducersbelievethatinvestmentoverseaswill
bringhigherreturnsthanadditionalinvestmentathome
•“theminimumsizeofmarketneededtosupporttechnological
developmentincertainindustryisnowlargerthanthelargest
market”

19. Foreign Direct Investment
WhydoMultinationalsInvestoverseas
2.ResourceSeeking(vertical):
•Acompanymayfinditcheapertoproduceitsproductina
foreignsubsidiaryforthepurposeofsellingiteitherathome
orinforeignmarkets
•Soamultinationalmayaimtoacquireparticulartypesof
resourcesthatarenotavailableathome(naturalresources
orrawmaterials)orthatareavailableatalowercost(such
asunskilledlabourthatisofferedatacheaperpricethanat
thehomemarket
•LesscostlyaccesstoinputsofproductionattractsMNEs

20. Foreign Direct Investment
WhydoMultinationalsInvestoverseas
3.StrategicAssetSeeking
•Thepurposeoftheinvestmentisthatofacquiringand
complementanewtechnologicalbaseratherthanexploiting
theexistingasset
•Thefirmseekstogainaccesstoknowledgeorcompetences
thatarenotinsideit
•Thismayinvolvepartnershipswithotherexistingforeign
firmsthatspecializeincertainaspectsofproduction

21. Foreign Direct Investment
WhydoMultinationalsInvestoverseas
4.EfficiencySeeking
•Thefirmmayinvestoverseastotakeadvantageof
differencesintheavailabilityandcostsoftraditionalfactor
endowmentindifferentcountries
•Thefirmmayalsoseektotakeadvantageoftheeconomies
ofscaleandscope,ofdifferencesinconsumertastesand
supplycapabilities
•Thefirmmayalsoseektolowertariffs,ortofollowamore
favourableexchangerate

22. Foreign Direct Investment
HowtoInvestAbroad:ModesofInvolvement
MultinationalCorporationsoperateinthefollowingways:
1.Franchising
•Inthisform,multinationalcorporationgrantsfirmsin
foreigncountriestherighttouseitstrademarks,patents,
brandnamesetc.
•Thefirmsgettherightorlicencetooperatetheirbusinessas
perthetermsandconditionsoffranchiseagreement
•Theypayroyaltyorlicencefeetomultinationalcorporations
•Incasethefirmholdingfranchiseviolatethetermsand
conditionsofagreement,thelicencemaybecancelled

23. Foreign Direct Investment
HowtoInvestAbroad:ModesofInvolvement
2.Branches
•Inthissystem,multinationalcorporationopenbranchesin
differentcountries
•Thebranchesworkunderthedirectionandcontrolofhead
office
•Theheadquartersframespoliciestobefollowedbythe
branches
•Everybranchfollowslawsandregulationsoftheheadoffice
andhostcompany

24. Foreign Direct Investment
HowtoInvestAbroad:ModesofInvolvement
3.Subsidiaries
•Amultinationalcorporationmayestablishwhollyowned
subsidiariesinforeigncountries
•Incaseofpartlyownedsubsidiaries,peopleinthehost
countriesalsoownshares
•Thesubsidiariesinforeigncountryfollowthepolicieslaid
downbytheholdingcompany(parentcompany
•Amultinationalcompanycanexpanditsbusinessoperations
throughsubsidiaries

25. Foreign Direct Investment
HowtoInvestAbroad:ModesofInvolvement
4.JointVenture
•Inthissystemamultinationalcorporationestablishesa
companyinforeigncountryinpartnershipwithlocalfirms
•Themultinationalandlocalfirmsharetheownershipand
controlofthebusiness
•Generally,themultinationalprovidestechnologyand
managerialskillandthedaytodaymanagementisleftto
thelocalfirm
•E.g.MarutiSuzukiisajointventurebetweentheJapanese
CompanySuzukiandtheIndianCompanyMaruti

26. Foreign Direct Investment
FDIinDevelopingCountries
ThedatafromUNCTADshows
•DevelopingcountriesarenotthemajorrecepientsofFDI
•AsianDevelopingcountriesreceivefarmoreFDIthanthe
otherdevelopingcountries

27. Foreign Direct Investment
FDIinDevelopingCountries

28. Foreign Direct Investment
FDIinDevelopingCountries
FactorsthatdeterminetheFDIflow
1.GrowthRateandopennesstotrade
•Countrieswithhighgrowthrateandmoreopentoglobal
marketthroughinternationaltradearemorelikelytobe
successfulinattractingFDIthanothers
•MarketseekingFDIspreferinvestinginthesecountries
becauseoflargeinternalmarket
•Thesesaveontransportandmarketingcosts
•However,iftheytargetamarketotherthanlocal,then
opennesstotradeisahugefactor

29. Foreign Direct Investment
FactorsthatdeterminetheFDIflow
2.BusinessEnvironment
•Countriesthatprovidebetterbusinessfriendlyenvironment
receivemoreFDI
•MNCsseektoinvestwhereinputcostsandoperationcosts
aswellashiddencostsarelow
•MNCsseekplaceswhereskilled-labourisplentyandlowcost
•MNCsseektoinvestwhereinfrastructureisdeveloped:
electricityisavailableandreliable,transportand
communicationefficientand
•MNCsseekdestinationswhereinvestmentrulesarefriendly

30. Foreign Direct Investment
FactorsthatdeterminetheFDIflow
3.ForeignAidRecipients
•Itisarguedthatcountriesthatreceiveforeigndevelopment
aidtendtowelcomeFDI
•TheyhavemorefriendlyenvironmentthatassurestheMNCs
ofsafeandprofitableinvestmentdestination
•Theyhavelowerpoliticalrisk:Sincetheydependonaid,itis
difficultforthemtonationalizetheassetsinvestedinFDI

31. Foreign Direct Investment
ForeignDirectInvestmentandCountryRisk
•CountryRiskreferstothewholeenvironmentofuncertainty
aboutthereturnsthataninvestorisdealingwithina
particularcountry
•TherearetwomajortypesofCountryriskthatareofconcern
tomultinational:PoliticalriskandFinancialRisk
•PoliticalRiskistheriskthatreturnstoinvestmentmaysuffer
asaresultoflowinstitutionalqualityandpoliticalinstability
•Lowinstitutionalquality:referstoinadequaciesand
loopholesinlawsandmechanismofenforcingthelaw(inthis
casethatpertainstobusinessoperations)

32. Foreign Direct Investment
ForeignDirectInvestmentandCountryRisk
•Lowinstitutionalquality:affecttheoperationsofMNCin
thefollowingway
1.Increasesunkcosts:thisincludessuchcostsintheinitial
stagesofabusinesstransactionsuchascostofacquiring
information
2.Increaseuncertaintyassociatedwithhumaninteractions:
•Inthiscaseitisaboutwhetherornotthecontracts
agreeduponaregoingtobefulfilled
•Suchenvironmentcausestheriskpremiumstobehigh
3.Increaseoperatingcostsduetolongdelays,red-tape,bribes

33. Foreign Direct Investment
ForeignDirectInvestmentandCountryRisk
•PoliticalInstability
•Thisreferstothesituationwherethereareethnictensions,
internalconflicts,lackoflawandorder,lackofdemocratic
accountability,highcorruption,andlackofgovernment
stability
•Allthesecauseanenvironmentofuncertaintyandhence
repeltheFDIs

34. Foreign Direct Investment
ForeignDirectInvestmentandCountryRisk
•FinancialRisk
•Thisistheriskthatacountrymaynotpayitsforeignliabilities
•Financialriskisnormallycausedbythemacroeconomic
conditionsofthecountry,especiallythesituationofhigh
debt,highinflationandexchangerateinstability
•HighDebtrelativetoGDPreducestheabilityofthecountry
topayitsdebts
•ThisconditiondoesnotattractFDI
•ExchangerateinstabilityandHighinflation
•ThesecauseuncertaintyinthefinancialplansoftheMNC

35. Foreign Direct Investment
AdvantagesofFDIstoDevelopingCountries
A.ResourceTransferAdvantages
1.Capital:MNCsarelargeandstrongfinancially,andcanhave
accesstofinancialresourcesnotaccessibletohostcountry
firms
•Thiscouldbefromtheirowninternalsourcesorbecause
oftheirreputation
2.Technology:manydevelopingcountrieslackresearchand
developmentresourcesandskillsrequiredtodeveloptheir
ownindigenousproductsandprocesses
•FDIcomingthroughMNCcanbringthattechnology

36. Foreign Direct Investment
AdvantagesofFDIstoDevelopingCountries
3.Management:Foreignmanagementskillscanbeacquired
throughFDI.
•ThisisespeciallywhenhostgovernmentforcesMNCto
reservemanagerialpositionsforthelocalmanagers
•SometimesthelocalmanagerstrainedbyMNCscanmove
toforeignfirms
B.EmploymentEffects:FDIsbringjobstoahostcountrythat
wouldnototherwisebecreatedthere:Directeffectisthe
employmentofcitizens,indirecteffectisthroughjobcreation
duetoinvestmentandspendingbyMNCemployees

37. Foreign Direct Investment
AdvantagesofFDIstoDevelopingCountries
C.BalanceofPaymentEffects
Generic Balance of Payments
ACurrent Account
1Net Exports/imports of goods (trade balance)
2Net exports/imports of services
3Net transfers (sums sent home by migrants and permanent workers abroad & gifts
A1 to 3 = Current Account Balance
BCapital Account (capital transfers: purchase and sale of fixed assets e.g. real estates)
C.Financial Account
1.Net Foreign direct investment
2.Net Portfolio investment
3.Other financial items
A+B+C = Basic balance
D.Net Errors and Omissions (missing data such as illegal transfers)
E.Reserves and related items (changes in official reserves including gold, foreign exchange and IMF position)

38. Foreign Direct Investment
AdvantagesofFDIstoDevelopingCountries
C.BalanceofPaymentEffects
WhenaMNCestablishesaforeignsubsidiary
•Capitalaccountofthehostcountrybenefitsfromtheinitial
capitalinflow–aone-time-onlyeffect
IftheFDIinvestsintheproductionofagoodthatisasubstitute
forimports
•Itcanimprovethebalanceofthecurrentaccountofthehost
countrybalanceofpayments
•e.g.IfToyotabuildsafactoryinTanzania,Tanzanianswill
bebuyingcarslocallyproduced–reducingimports

39. Foreign Direct Investment
AdvantagesofFDIstoDevelopingCountries
D.EffectsonEconomicGrowth
•Efficientfunctioningofmarketsdependsonanadequate
levelofcompetitionamongproducers
•FDIincreasesconsumerchoiceandhencecompetitionlevel
inthenationalmarkets
•Priceswillbereducedandeconomicwelfareimprove
•Increasedcompetitionstimulatesinvestmentinfactories,
equipmentandResearchanddevelopment
•Longtermresultis:increasedproductivity,product
innovationsandultimatelyeconomicgrowth

40. Foreign Direct Investment
DisadvantagesofFDIstoDevelopingCountries
AdverseeffectsonCompetition
1.Multinationalsarestrongfinanciallyandtechnologically
•Theyhavethustheadvantageofbeingabletoproduceat
lowcost
•Thismaydrivelocalcompetitorsoutofbusinessandlet
theMNCmonopolisethemarket
•Thisisofspecialconcerntobusinessesofdeveloping
countries
2.Threattoinfantindustries
•Indigenousinfantfirmsmaynotbeabletodevelop

41. Foreign Direct Investment
DisadvantagesofFDIstoDevelopingCountries
AdverseeffectsontheBalanceofpayments
Ifmultinationalsarenotproperlyregulated
1.Allprofitswillbeoutflowingtothehomecountry
•Thesewillberecordedasdebitsonthecapitalaccountof
thebalanceofpayments
2.Theforeignsubsidiarywillimportasubstantialnumberofits
inputsfromabroad,whichresultsinadebitonthecurrent
accountofthehostcountry’sbalanceofpayment

42. Foreign Direct Investment
DisadvantagesofFDIstoDevelopingCountries
Effectstonationalsovereigntyandautonomy
ManyhostgovernmentsworrythatFDIisaccompaniedbysome
lossofeconomicindependence
•Manykeydecisionsthataffectthehostcountry’seconomy
willbemadebyaforeignparentcompany
•Thathasnorealcommitmenttothehostcountryand
•Overwhichthehostcountrygovernmenthasnocontrol