Foreign Direct Investment

1
Foreign Direct Investment

• General Definition
• Direct investments in productive assets in a
  foreign country.
• Practical Definition
• Many countries differentiate between portfolio
  investment and FDI using the 10 rule.
• Often, requires investment ? 10 of total capital
  of company to be considered FDI.

2
What is FDI?

• 3 components
• Equity capital
• Reinvested earnings
• Intra-company loans
• Will all of this data actually be available for
  analysis?

3
Defining Characteristics of MNEs

• Larger
• More productive
• Stronger
• Usually already export/import
• ? What are the implications for firms ability to
  raise capital?

4
Why do FDI?

• Arbitrage market imperfections.
• Leverage firm strengths.

5
Trade Barriers

• Why would these lead to FDI?
• More generally, this shows that government
  policies towards specific industries can have a
  profound impact on domestic foreign investment
  in those industries.
• De facto barriers also exist.

6
Imperfect Labor Market

• Output function (capital, labor).
• Capital is largely location-invariant.
• Salaries vary widely by location.
• Non-salary costs associated with labor.

7
Intangible Assets

• Internalization theory of FDI MNEs conduct FDI
  in order to retain control of intangibles while
  enjoying benefits of larger markets.

8
Vertical Integration

• What is it?
• How does it change competitive landscape?
• Backward vs. forward
• Interesting twist double marginalization if and
  only if also have monopoly power.

9
Product Life Cycle

• Not same in all countries
• Example land-lines vs. cell phones.
• Example cell phones in Japan vs. US.
• Reflects high initial importance of RD. Later,
  total costs are more important.
• This leads to FDI in lower cost countries.

10
Product Life Cycle
The U.S.
production
Quantity
exports
imports
consumption
New product Maturing product Standardized product
Less advanced countries
exports
consumption
Quantity
imports
production
New product Maturing product Standardized product
Source McGraw Hill
11
World FDI Inflows Outflows
12
Global Inflows of FDI 1993-2001
13
Global Outflows of FDI 1993-2001
14
Net Global Inflows of FDI 1993-2001
15
Sectoral Allocation of FDI

• General rules averaged over time countries so
  take cautiously
• 35.6 to manufacturing
• 47.4 to services
• 17.0 to primary products

16
Forms of FDI

• Greenfield investment
• Build new production facilities in foreign
  country.
• MA
• Buy existing businesses in foreign countries
• WFOE vs. JV
• Some countries specify 2 types of JVs.

17
Interpreting FDI

• Transfer ownership of productive assets to more
  efficient owners.
• or
• Leverage comparative advantage by moving to more
  suitable locations.

18
Markets View of FDI

• Are there synergistic gains? (i.e. 11 gt 2?)
• Multinationality is positively correlated with
  firms market value because of intangibles.
• Consistent with internalization theory of FDI.
• Morck Yeung (Why Investors Value
  Multinationality, Journal of Business, 1991)

19
FDI Exchange Rates

• Empirical data indicate that exchange rates
• may influence MA FDI.
• have little/no influence on greenfield
  investments.
• Why?

20
Consequences for Host Countries

• Positive
• Direct Technology transfer increased
  employment higher salaries (20 common).
• Indirect Enhances market competitiveness may
  lower domestic prices improve quality of labor
  force.
• Negative
• Direct reduce market power of domestic firms
  profits shipped to MNEs home country foreign
  firms gain domestic influence.

21
Consequences for Home Countries

• Technological innovation.
• Foreign trade expansion positively correlated to
  outward FDI ? mixed net impact on labor market.
• Profit remittance from overseas investments.
• Not always a positive. Why?

22
Policy Changes that Promote FDI

• World Trade Organization (WTO)
• Bilateral Investment Treaties (BITs)
• ? Illustrates political sensitivity of certain
  industries/countries.

23
Political Risk

• Difficult to measure but fundamental to a full
  understanding of a markets projected
  development.
• Macro risk affects all FDI in host country.
• Micro risk affects only certain industries or
  types of firms.

24
Hedging Political Risk

• Geographic diversification
• Minimize exposure
• Form JVs with local companies.
• Form/join international consortium to make
  investments.
• Use local financing.
• Insurance against political risk.