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IB chapter 8
Terms in this set (38)
Foreign Direct Investment (FDI)
occurs when a firm invests directly in facilities to product or market a product in a foreign country.
Once a firm undertakes FDI, it becomes a _______ enterprise.
FDI takes on two main forms which are:
1. Greenfield investment (the establishment of a new operation in a foreign country)
2. acquiring or merging with an existing firm in the foreign country.
flow of FDI
refers to the amount of FDI undertaken over a given time period (normally a year)
stock of FDI
refers to the total accumulated value of foreign-owned assets at a given time.
outflows of FDI
meaning the flow of FDI out of a country
inflows of FDI
the flow of FDI into a country
trends in FDI
outflow has increased
flow has accelerated faster than the growth in world trade and world output
has grown more rapidly than the world trade and output for reasons such as:
- firms still fear protectionist pressures.
- much of the increase in FDI has been driven by the
political and economic changes that have been
occurring in many of the world's developing
firms choose to establish operations abroad through FDI instead of exporting or licensing because:
- exporting involves producing goods at home and then shipping then to the receiving country for sale
- licensing involves granting a foreign entity the right to produce and sell the firms product in return for a royalty fee on every unit sold.
given that FDI is $$ (costs of est. production facilities in a foreign country or acquiring a foreign enterprise) and risky (rules may be different in foreign culture) you would think that firms choose to export or use licensing to avoid those risks and costs, but there are limitations to exporting and licensing.
Limitations of exporting
transportation costs, when added to production costs, make it unprofitable to ship products.
limitations of licensing
- internalization theory: explains 3 drawbacks of licensing
1. licensing may result in a firm's giving away valuable technological know-how to a potential foreign competitor.
2. licensing does not give a firm the tight control over manufacturing, marketing, and strategy in a foreign country that may be required to maximize its profitability. With licensing, control over manufacturing, marketing, and strategy are granted to a licensee in return for a royalty fee.
3. when the firm's competitive advantage is based not as much on its products as on the management, marketing, and manufacturing capabilities that produce those products. The problem here is that such capabilities are often not amenable to licensing.
an industry composed of a limited number of large firms (e.g., an industry in which four firms control 80 percent of a domestic market)
- A critical competitive feature of such industries is interdependence
- the interdependence between firms in an oligopoly leads to imitative behavior; rivals often quickly imitate what a firm does in an oligopoly.
arises when two or more enterprises encounter each other in different regional markets, national markets, or industries.
F. T. Knickerbocker
looked at the relationship between FDI and rivalry in oligopolistic industries
The radical view
Radical writers argue that the multinational enterprise (MNE) is an instrument of imperialist domination. They see the MNE as a tool for exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries. They argue that MNEs extract profits from the host country and take them to their home country, giving nothing of value to the host country in exchange
Marxist view is that MNEs enslave less developed countries.
Instrument of domination not development.
Popular from WWII to the 1980s.
Practiced by Eastern Europe, India, China, 3d World Countries.
Dependencia theory: Latin America
In less favor, at the moment.
Bad performance by those countries vs those with other approaches.
the free market view
argues that international production should be distributed among countries according to the theory of comparative advantage. Countries should specialize in the production of those goods and services that they can produce most efficiently. Within this framework, the MNE is an instrument for dispersing the production of goods and services to the most efficient locations around the globe.
traces its roots to classical economics and the international trade theories of Adam Smith and David Ricardo
Sees FDI as way to disperse production and flow of goods and services in the most efficient manner.
Supported by Smith and Ricardo and 'market imperfection' explanations of FDI.
However, all countries impose some restrictions on FDI.
- one benefit of FDI for host countries
- FDI can make a positive contribution to a host economy by supplying capital, technology, and management resources that would otherwise not be available and thus boost that country's economic growth rate
balance of payment effects
- benefit of FDI for host countries
- balance of payments accounts are national accounts that track both payment to and receipts from foreigners
- the current account tracks the export and import of goods and services.
a current account deficit occurs when ________
a country is importing more goods & services than it is exporting.
the economic theory tells us that....
the efficient functioning of markets depends on an adequate level of competition between producers. When FDI takes the form of a greenfield investment, the result is to establish a new enterprise, increasing the number of players in a market and thus consumer choice. In turn, this can increase the level of competition in a national market, thereby driving down prices and increasing the economic welfare of consumers. Increased competition tends to stimulate capital investments by firms in plant, equipment, and R&D as they struggle to gain an edge over their rivals.
Three costs of FDI concern host countries =
adverse effects on competition within the host nation, adverse effects on the balance of payments, and the perceived loss of national sovereignty and autonomy.
Adverse Effects on Competition (cost concern of FDI)
Host governments sometimes worry that the subsidiaries of foreign MNEs may have greater economic power than indigenous competitors. If it is part of a larger international organization, the foreign MNE may be able to draw on funds generated elsewhere to subsidize its costs in the host market, which could drive indigenous companies out of business and allow the firm to monopolize the market.
Adverse Effects on the Balance of Payments (cost concern of FDI)
First, set against the initial capital inflow that comes with FDI must be the subsequent outflow of earnings from the foreign subsidiary to its parent company.
A second concern arises when a foreign subsidiary imports a substantial number of its inputs from abroad, which results in a debit on the current account of the host country's balance of payments.
National Sovereignty and Autonomy (cost concern of FDI)
host governments worry that FDI is accompanied by some loss of economic independence. The concern is that key decisions that can affect the host country's economy will be made by a foreign parent that has no real commitment to the host country, and over which the host country's government has no real control.
Home country benefits of FDI
1. the home country's balance of payments benefits from the inward flow of foreign earnings.
2. from outward FDI arise from employment effects
3. when the home-country MNE learns valuable skills from its exposure to foreign markets that can subsequently be transferred back to the home country.
key features of FDI
Involves Ownership of Productive Assets
The Concept of Control
---- Direct investment usually implies an ownership
share of at least 10 percent
Contrasts with Passive Ownership in Foreign Portfolio Investment
The Need for Control in Investment
----to transfer technology & other competitive assets, as
----to control production process
What is the relationship between GCF and FDI
GFCF (gross fixed capital formation) is A summary of the total amount of capital invested in factories, stores office buildings, and the like.
All things being equal, the greater the capital investment in an economy, the more favorable its future growth prospects are likely to be.
FDI helps to develop GFC (under developed countries) in countries
When is fdi better than trade?
Transportation costs too high for exporting
Tariff and non-tariff barriers very high
Lack of excess domestic capacity
Scale economies not significant in competitiveness (especially when products are more differentiated)
country-of-origin effects important (preference for local production)
Location specific advantages (e.g., natural resources)
what makes FDI successful ?
Firms must have some unique advantage(s) for competing, which they can use abroad
local firms do not have this advantage, or it is unavailable at the same price
FDI experience has been found to make firms more successful in competing domestically
They have more stable profits and earnings
why do governments intervene in FDI?
MNCs operate in multiple countries, decisions made in one can have a negative repercussions on another
The sheer size of MNCs is an issue; some MNCs have sales greater than the GNP of some countries
MNCs take market share away from local firms, driving them to bankruptcy
Gov'ts should maximize national benefits and minimize costs of FDI. AKA gov should intervene in FDI
- helps host countries more b/c they are making foreign companies change in order to benefit them (the host country)
brings in additional capital
brings in additional revenue via taxation
technology transfer to local firms
skill development and training
industry linkage effects
FREE MARKET examples
BENEFITS - resource transfers from the home country benefit the host country
COMPARATIVE ADVANTAGE - International production should be distributed among countries
LOWER WAGES - company moves to a foreign country for lower wages that enhance efficiency
radical view examples
SOCIALIST COUNTRIES - africa embraced this view
COMMUNIST COUNTRIES - russian and easten europe had this view when they were communist
IRAN - threw out foreign oil companies
* domination not development, enslave undeveloped countries
* marxist views
* popular during WWII-1980s
PROFITS - host government tries to keep jobs & profits in host country
TAX SUBSIDIES - host gov can offer tax subsidies to attract MNEs that bring valuable skills to the host country
When the Japanese government realized it needed more foreign investment, though that would have both benefits and costs, it was adopting the __________ view of FDI.
theories of FDI
One set of theories seeks to explain why a firm will favor direct investment as a means of entering a foreign market when two other alternatives, exporting and licensing, are open to it.
Another set of theories seeks to explain why firms in the same industry often undertake foreign direct investment at the same time (
) and why they favor certain locations over others as targets for foreign direct investment (
) . Put differently, these theories attempt to explain the observed pattern of foreign direct investment flows.
A third theoretical perspective, known as the
, attempts to combine the two other perspectives
argument that combining location specific assets or resource endowments and the firms own unique assets often requires FDI. It requires the firm to establish production facilities where those foreign assets or resource endowments are located AKA LOCATION SPECIFIC ADVANTAGES- advantages that arise from utilizing resource endowments or assets that are tied to a particular foreign location and that a firm finds valuable to combine with its own unique assets. * requires the firm to establish production facilities where those foreign assets or resource endowments are located
Dependencia theory: Latin America
how latin america teaches their students
under radical / marxist view
resources flow from a "periphery" of poor and underdeveloped states to a "core" of wealthy states, enriching the latter at the expense of the former. It is a central contention of dependency theory that poor states are impoverished and rich ones enriched by the way poor states are integrated into the "world system".
societies progress through similar stages of development, that today's underdeveloped areas are thus in a similar situation to that of today's developed areas at some time in the past, and that therefore the task in helping the underdeveloped areas out of poverty is to accelerate them along this supposed common path of development, by various means such as investment, technology transfers, and closer integration into the world market.
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