Transcript Lecture-10x

Global Business Management
(MGT380)
Lecture #10: Foreign Direct
Investment
Learning Objectives
Understand the costs and benefits of FDI for
home country
 Understand the costs and benefits of FDI for
host country
 understand the government policy instruments
and FDI
 What is the Implication for business

A Quick Recap of last lecture



Why do firms in the same industry undertake FDI at about the
same time and the same locations?
Knickerbocker : Suggests that firms follow their domestic
competitors overseas. FDI flows are a reflection of strategic
rivalry between firms in the global marketplace; More
pertinent in Oligopolistic market. For example: Toyota and
Nissan responded to investment of Honda; Electrolux did in
response of G.E and Whirlpool.
Vernon - firms undertake FDI at particular stages in the life
cycle of a product; Xerox; This theory is did well to explain


When demand of country support the production and shift
production to low-cost markets when competition is high
It fails to explain that why firm do FDI when export/license is
profitable (because of economies of scale)



According to Dunning’s eclectic paradigm- it is important to
consider: location-specific advantages - that arise from using
resource endowments or assets that are tied to a particular
location and that a firm finds valuable to combine with its own
unique assets. Electrolux in China, externalities - knowledge
spillovers that occur when companies in the same industry
locate in the same area. Firms willing to take advantage of
low-cost labor/natural resources/ technology they go
accordingly. Silicon Valley in CA.
How does a government’s attitude affect FDI?
1. Radical view (traces its roots to Marxist political and
economic theory). This perspective argues that the MNE is an
instrument of imperialist domination and a means of exploiting
host countries for the benefit of their capitalist-imperialist home
countries. Socialists and Nationalists , world is changing


Free market perspective which argues that international
production should be distributed among countries according to
the theory of comparative advantage. This perspective
suggests that countries specialize in the production of the
goods they can produce most efficiently and trade for
everything else. It then follows, that FDI will actually increase
the overall efficiency of the global economy. Not fully
embraced.
In the middle of the continuum is pragmatic nationalism which
argues that FDI has both benefits and costs. Benefits include
things like inflows of capital, technology, skills, and jobs, while
costs include the repatriation of profits and negative balance
of payments effects. Pragmatic nationalism suggests that FDI
should only be allowed if the benefits outweigh the costs.
How Does FDI Benefit
The Host Country?


Resource transfer effects - we’ve actually already talked a
bit about this. Remember that FDI can benefit a country by
bringing in capital, technology, and management skills helping
the country to increase its economic growth.
Bring jobs. Well cited example is

Many people in Middle Tennessee are employed at Nissan facilities
there, and because the Nissan workers need houses to live in, grocery
stores, and schools, a host of other jobs have been created as well.
Keep in mind of course, that some of these jobs will be canceled out by
the loss of jobs in Detroit that will occur when U.S. consumers buy Nissans
instead of Fords!

Balance of payment effect:
 BOP:
record of a country’s payments to an receipts
from other countries.
 Current Account: Record of a country’s export and
import of goods and services.
 Government wants to see CA surplus.
 FDI helps BOP in two ways:
 FDI
is substitute for imports of goods/services, it increases
CA. For instance, Japanese FDI in EU and USA.
 When MNCs export product to other countries




FDI affects competition and economic growth
If FDI is in the form of greenfield investment,
competition will increase in a market. This should
drive down prices and benefit consumers.
More competition also promotes increased
productivity, innovation, and then, economic growth.
We’ve seen huge improvements in world
telecommunications for example, since the 1997 WTO
agreement to liberalize the industry.
What Are The Costs Of
FDI To The Host Country?
There are three main costs of inward FDI.
 1. Adverse effect on competition: subsidiaries
of foreign MNE’s might end up having greater
economic power than indigenous competitors. It
gives the negative effects on competition.
 So, for example, if an MNE supports its
subsidiary while it becomes established in the
host market, it might be stronger than an
indigenous company, and could drive the local
company out of business.
 Host governments, particularly those of
developing countries, worry. Infant industry.

2. Negative effects on the balance of payments
 When it comes to the balance of payments, host countries
worry that along with the capital inflows that come will the FDI,
will be the capital outflows that occur when the subsidiary
repatriates profits to the parent company. Some countries
actually limit the amount of profits that can be repatriated to
limit the negative effects of this.
 Host countries are also concerned that some subsidiaries import
a substantial number of their inputs. These imports will show
up in the current account of the balance of payments.
 Japanese automakers, for example, import from Japan, many
of the components they use in their U.S. operations. The
companies have responded to criticism about this by pledging
to buy more inputs locally.
3. Loss of national sovereignty and autonomy
 Sometimes host governments worry that they may lose
some economic independence as a result of FDI. They
worry that since foreign companies have no particular
commitment to the host country, they won’t really
worry about the consequences of their decisions on
the host country. Loss of economic independence,
 However, Robert Reich, a former member of the
Clinton cabinet, notes that this is really outdated
thinking. In today’s interdependent economy, no
company maintains strong loyalty to any country.
How Does FDI Benefit
The Home Country?
1.
2.
3.
The effect on the capital account of the home
country’s balance of payments from the
inward flow of foreign earnings.
The employment effects that arise from
outward FDI when importing parts.
The gains from learning valuable skills from
foreign markets that can subsequently be
transferred back to the home country. Reverse
resource-transfer. GM-Isuzu & Ford-Mazda
in Japan
What Are The Costs Of
FDI To The Home Country?
1.
The home country’s balance of payments can suffer



2.

from the initial capital outflow required to finance the FDI
if the purpose of the FDI is to serve the home market from a low cost
labor location
if the FDI is a substitute for direct exports
Employment may also be negatively affected if the FDI is a
substitute for domestic production
But, international trade theory suggests that home country
concerns about the negative economic effects of offshore
production (FDI undertaken to serve the home market) may
not be valid. It is actually be freeing up resources that could
be used more effectively elsewhere.
How Does Government
Influence FDI?




Well, there are various ways that home countries can
encourage or discourage FDI by local firms.
We’ll begin with policies to encourage FDI.
A key reason that firms may resist FDI is because of
the risk involved. To minimize this concern, many
countries have government-backed programs that
cover the major forms of risk like the risk of
expropriation, war losses, or the inability to
repatriate profits. Some countries have also
developed special loan programs for companies
investing in developing countries, created tax
incentives, and encouraged host nations to relax their
restrictions on inward FDI.
Toys R Us entered in Japan

To discourage outward FDI, countries regulate
the amount of capital that can be taken out of
a country, use tax incentives to keep
investments at home, and actually forbid
investments in certain countries like the U.S. has
done for companies trying to invest in Cuba
and Iran.





Host countries can also restrict or encourage FDI.
Recall that we’ve moved away from the radical
stance that discouraged FDI in general and towards a
more free market approach, and pragmatic
nationalism.
To encourage inward FDI, host countries usually offer
incentives for investment like tax breaks, low interest
loans, or subsidies.
Why would countries offer these benefits to foreign
firms?
Kentucky for example, offered a $112 million
package to Toyota to get it to build its U.S. plants in
the state!



When a country wants to restrict FDI, it will usually implement
ownership restraints or performance requirements.
In Sweden for example, foreign companies aren’t allowed to
invest in the tobacco industry. US airline 25%.
Ownership restraints accomplish two things.




First, they keep foreign firms out of certain industries on the grounds
of national security or competition, allowing the local firms to
develop.
Second, they help maximize the resource transfer effect and
employment benefits that are associated with FDI.
In Japan for example, until the early 1980s, most FDI was
prohibited unless the foreign firm had valuable technology.
Then, the foreign firm was allowed to form a joint venture with
a Japanese company because the government believed this
would speed up the diffusion of the technology throughout the
Japanese economy.
How Do International
Institutions Influence FDI?
Are there any international agreements on FDI that limit country
policies?
 Well, until recently, there hasn’t been any consistent
involvement by multinational institutions on how FDI should be
handled, but in 1995, the WTO got involved through its
agreement on services.
 Remember, that in order to sell services internationally, FDI is
often required.
 So, as you might expect, the WTO is pushing for the
liberalization of regulations governing FDI. OECD.
 Already, agreements on the liberalization of
telecommunications and financial services have been reached.
What Does FDI
Mean For Managers?
We know from Dunning’s eclectic theory that FDI may make sense for location reasons, but the
theories can also help firms identify the trade-offs between exporting, licensing, and foreign
direct investment.
For example, we know that exporting will be preferable to licensing as long as transportation
costs and trade barriers are low. We also know that licensing isn’t attractive when the firm has
know-how that can’t be properly protected by a licensing agreement, when the firm need control
over a foreign entity in order to maximize profits, and when the firm’s skills and capabilities
aren’t amenable to licensing.
In fact, licensing is going to be most likely in fragmented, low-tech industries where globally
dispersed manufacturing isn’t an alternative.
So, for companies like McDonald’s, which use the service-industry version of licensing,
franchising, licensing or franchising makes sense.
Finally, a government’s policy toward FDI can be an important factor in decisions about where to
locate foreign production facilities.
Clearly, firms will prefer to establish operations in countries with permissive attitudes toward
FDI, like the U.S.
Firms may be able to negotiate with foreign governments and receive favorable terms for their
investments like Toyota did when it invested in Kentucky.
A decision framework
Mini-case: FDI in Russia





After five years of launching reforms, still was experiencing unprecedented
capital flight. In 1996, some $22.3 billion left the country and $2.2 billion
came in the country. Russian FDI was $5.3 billion, $11.5 billion in Hungary.
Reasons was tax code, weak and untested property and contract
safeguards, regulations, privatization laws.
In a attempt to generate capital, they did privatization of many state-run
organizations.
In 1997, Yelstin allowed FDI in Oil and gas industry. Shell/Royal Dutch
attempted to bid for Rosneft, BP tried for 10% shares in Sidanco. It was
estimated to create 550,000 jobs and $450 billion revenue of capital.
Discussion Questions: 1)what are the benefits to the Russian economy from
FDI in general and Oil& gas industry in particular. 2) Can firms reduce the
risks associated with Russian economy.
Summary of the lecture



Host country benefits: Resource transfer effects we’ve actually already talked a bit about this.
Remember that FDI can benefit a country by
bringing in capital, technology, and management
skills helping the country to increase its economic
growth.
Bring jobs. Well cited example is
FDI helps BOP in two ways:
 FDI
is substitute for imports of goods/services, it increases
CA. For instance, Japanese FDI in EU and USA.
 When MNCs export product to other countries


FDI affects competition and economic growth: If FDI is in the
form of greenfield investment, competition will increase in a
market. This should drive down prices and benefit consumers.
More competition also promotes increased productivity,
innovation, and then, economic growth.
There are three main costs of inward FDI. 1. Adverse effect on
competition: subsidiaries of foreign MNE’s might end up having
greater economic power than indigenous competitors. It gives
the negative effects on competition. 2. Negative effects on the
balance of payments. When it comes to the balance of
payments, host countries worry that along with the capital
inflows that come will the FDI, will be the capital outflows that
occur when the subsidiary repatriates profits to the parent
company. Some countries actually limit the amount of profits
that can be repatriated to limit the negative effects of this.
Host countries are also concerned that some subsidiaries import
a substantial number of their inputs.



Loss of national sovereignty and autonomy: Sometimes host
governments worry that they may lose some economic
independence as a result of FDI. They worry that since foreign
companies have no particular commitment to the host country,
they won’t really worry about the consequences of their
decisions on the host country. Loss of economic independence.
The effect on the capital account of the home country’s
balance of payments, the employment effects that arise from
outward FDI when importing parts, the gains from learning
valuable skills from foreign markets that can subsequently be
transferred back to the home country. Reverse resourcetransfer.
The home country’s balance of payments can suffer and
employment.


Well, there are various ways that home and host
countries can encourage or discourage FDI (ownership
and performance restraints)
Decision to export/license/FDI