The Many Forms of International Investment

1
The Many Forms of International Investment

• The international integration of capital and
  commodity markets goes further and runs deeper
  now than ever before.
• (Michael Bordo, Barry Eichengreen, and Douglas
  Irwin)

2
The Goals of this Chapter

• Detail the principal types of international
  investment flows and their recent growth.
• Discuss the reasons why firms operate in more
  than one country and become MNEs.
• Show how portfolio investment has grown in recent
  decades as governments liberalized investment
  flows and financial markets have developed.
• Explain international banking and the growth of
  the eurocurrency markets.
• Discuss foreign aid and the reasons why developed
  country governments have reduced their foreign
  aid transfers.

3
Multi-National Enterprises (MNEs)

• MNEs are involved in over three-fourths of all
  international trade.
• MNEs account for a major portion of international
  investment.
• MNE investments are categorized as Foreign Direct
  Investment (FDI).
• There is extensive evidence that FDI is the
  international investment most likely to
  facilitate international technology transfers.

4
Vertical and Horizontal FDI

• Foreign direct investment undertaken by MNEs is
  often classified as either vertical and
  horizontal.
• Vertical FDI implies that an MNE owns facilities
  that fit into different stages of the supply
  chain.
• Horizontal FDI, on the other hand, consists of
  MNE investments that duplicate facilities and
  operation in several countries.

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Among the reasons for the growth of MNEs are

• It can be less costly to internalize transactions
  within a business organization than to deal with
  outside firms.
• Proprietory knowledge is often best exploited
  in-house.
• By expanding overseas, economies of scale can be
  exploited.
• Reputations can be exploited in more than one
  market.
• Trade restrictions can be avoided by producing
  overseas behind tariff walls.

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Among the reasons for the growth of MNEs are

• Taxes and regulations induce business to move
  activities across borders.
• Exchange rate risk inherent to international
  trade and investment can be reduced by spreading
  expenses and earnings across borders.
• FDI may be possible when financial markets do not
  exist to otherwise channel funds to profitable
  projects.
• A local presence can help firms anticipating
  favorable local business opportunities.

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MNEs and International Technology Transfers

• MNEs use FDI to establish their methods and
  proprietary techniques in foreign countries.
• MNEs also transfer people, designs, business
  philosophies, and management techniques across
  borders.
• The evidence strongly suggests that the
  technological leaders in each industry are also
  the more active foreign investors.
• Because firms do not easily part with proprietary
  technology, FDI may be the only way to introduce
  cutting-edge technology into a country.

8
Portfolio Investment

• Portfolio investment consists of purchases and
  sales of securities, such as bonds and stocks, in
  amounts that do not imply any direct management
  control or influence on the businesses issuing
  the securities.
• Portfolio investment has, along with FDI, become
  one of the two largest categories of
  international investment.
• The prominence of international portfolio
  investment is been a very recent phenomenon,
  however.
• International portfolio investment first required
  the development of stock and bond markets in
  other countries.
• Portfolio investment is widely used by investors
  to spread risk as well as to raise overall
  returns to savings.

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International Investment A Historical Perspective

• When measured as a proportion of GDP, capital
  flows in the 1800s were much larger then than
  they are now.
• But, because financial markets were not as
  developed, international investment was not
  nearly as diverse as today.
• International investment flows were always
  subject to occasional defaults and renegotiation.
• Most foreign debt was serviced on schedule by
  borrowers, and, in the case of Great Britain, the
  overall returns on foreign bonds were at least as
  high as they were on domestic British assets.
• International investment came to a complete halt
  during the 1930s, only to recover toward the end
  of the 20th century.

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International Investment A Historical Perspective

• International investment grew rapidly after World
  War II, but this growth was not uniform.
• Immediately after World War II, foreign aid
  dominated.
• During the 1950s, MNEs began to spread across
  borders and the eurocurrency market was born.
• International bank lending and FDI accounted for
  much of the international investment among
  developed economies.
• In the 1970s the eurocurrency lending to the
  developing economies grew rapidly, but the 1982
  debt crisis slowed bank lending during the 1980s.
• In the 1990s, bank lending was surpassed by FDI
  and portfolio investment as the largest
  categories of international investment.

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The rapid growth of international investment that
we are experiencing raises interesting questions

• What will be international investments role in
  the process of globalization in the future?
• Will future international investment flows be as
  volatile as they have been over the past 25
  years, or will they be more stable?