© Prentice Hall, 2008 International Business 4e Chapter 7 - 2
Chapter PreviewChapter Preview
• Characterize global FDI flows and patterns
• Discuss each theory that tries to explain FDI
• Identify important management issues in the FDI decision
• Explain why home and host nations intervene in FDI flows
• List the methods that nations use to promote and restrict FDI
© Prentice Hall, 2008 International Business 4e Chapter 7 - 3
Foreign Direct InvestmentForeign Direct Investment
Purchase of physical assets or significant amount of ownership of a company in another country to gain some measure of management control
By contrast, portfolio investment does not involve obtaining a degree of control in a company
© Prentice Hall, 2008 International Business 4e Chapter 7 - 4
Growth of World FDI vs. GDPGrowth of World FDI vs. GDP
© Prentice Hall, 2008 International Business 4e Chapter 7 - 5
Reasons for FDI GrowthReasons for FDI Growth
IncreasingIncreasingglobalizationglobalization
International mergersInternational mergersand acquisitionsand acquisitions
EntrepreneurshipEntrepreneurshipand small firmsand small firms
© Prentice Hall, 2008 International Business 4e Chapter 7 - 6
Value of Cross-Border M&AsValue of Cross-Border M&As
© Prentice Hall, 2008 International Business 4e Chapter 7 - 7
Worldwide FDI FlowsWorldwide FDI Flows
World FDI inflows
Developed (58%), developing (36%)
European Union: 33% of world FDI
Developing nations
China: 9% of world FDI
All of Africa: 3% of world FDI
70,000 multinationals
with690,000 affiliates
© Prentice Hall, 2008 International Business 4e Chapter 7 - 8
International Product Life International Product Life CycleCycle
A company begins by exporting its product and later undertakes foreign direct investment as a product moves through its life cycle
© Prentice Hall, 2008 International Business 4e Chapter 7 - 9
Market Imperfections Market Imperfections (Internalization)(Internalization)
Trade barriers(e.g., tariffs)
Specialized knowledge(e.g., managerial ability)
Company undertakes FDI tointernalize a transaction thatis being made inefficient bya market imperfection
© Prentice Hall, 2008 International Business 4e Chapter 7 - 10
Eclectic TheoryEclectic Theory
A firm undertakes FDI when location, ownership, and internalization advantages combine to make a location appealing
Locationadvantage
(optimal location)
Ownershipadvantage
(special asset)
Internalizationadvantage(efficiency)
© Prentice Hall, 2008 International Business 4e Chapter 7 - 11
Market PowerMarket Power
A firm undertakes FDI to establish a dominant presence in an industry
Vertical integrationExtends company’s activitiesinto stages of production that provide its inputs (backward integration) or absorb its out-puts (forward integration)
Market power= Greater profits
© Prentice Hall, 2008 International Business 4e Chapter 7 - 12
Management Issues and FDIManagement Issues and FDI
ControlControl• Partnership requirements• Benefits of cooperation
ControlControl• Partnership requirements• Benefits of cooperation
Purchase-or-buildPurchase-or-builddecisiondecision
Purchase-or-buildPurchase-or-builddecisiondecision
Production costsProduction costs• Rationalized production• Cost of R&D
Production costsProduction costs• Rationalized production• Cost of R&D
CustomerCustomerknowledgeknowledgeCustomerCustomerknowledgeknowledge
FollowingFollowingrivalsrivals
FollowingFollowingrivalsrivals
FollowingFollowingclientsclients
FollowingFollowingclientsclients
© Prentice Hall, 2008 International Business 4e Chapter 7 - 13
Balance of PaymentsBalance of Payments
Capital accountCapital accountCurrent accountCurrent account
National accounting system that records all payments to entities in other countries and all receipts coming into the nation
Records transactions involving the import and export of goods and services, income receipts on assets abroad, and income payments on foreign assets inside the country
Records transactions involving the purchase or sale of assets (including assets such as property and shares of common stock in a company)
© Prentice Hall, 2008 International Business 4e Chapter 7 - 14
Why Host Intervenes in FDIWhy Host Intervenes in FDI
Balance of Payments+
Balance of Payments+
FDI may generate exportsFDI may generate exports
Initial FDI boosts economyInitial FDI boosts economy
Obtain resourcesand benefits
+
Obtain resourcesand benefits
+
Access technologyAccess technology
Access management skillsAccess management skills
Create employmentCreate employment
FDI may decrease import demand
© Prentice Hall, 2008 International Business 4e Chapter 7 - 15
Why Home Intervenes in FDIWhy Home Intervenes in FDI
– Removes resources from the nation– Can eliminate an export market– Might eliminate domestic jobs
+ May improve national competitiveness+ Can offshore ‘sunset’ industries
– Removes resources from the nation– Can eliminate an export market– Might eliminate domestic jobs
+ May improve national competitiveness+ Can offshore ‘sunset’ industries
FDI
© Prentice Hall, 2008 International Business 4e Chapter 7 - 16
Host Promotion MethodsHost Promotion Methods
Financial Financial incentivesincentives
Low or waived taxesLow-interest loans
Financial Financial incentivesincentives
Low or waived taxesLow-interest loans
Infrastructure Infrastructure improvementimprovement
ss
Improved seaports, roads,telecommunications
networks
Infrastructure Infrastructure improvementimprovement
ss
Improved seaports, roads,telecommunications
networks
© Prentice Hall, 2008 International Business 4e Chapter 7 - 17
Host Restriction MethodsHost Restriction Methods
Ownership Ownership restrictionsrestrictions
Prohibit investment in certain industries
or businesses
Ownership Ownership restrictionsrestrictions
Prohibit investment in certain industries
or businesses
Performance Performance demandsdemands
Local content reqmnt.Technology transfers
Export targets
Performance Performance demandsdemands
Local content reqmnt.Technology transfers
Export targets
© Prentice Hall, 2008 International Business 4e Chapter 7 - 18
Home Promotion MethodsHome Promotion Methods
Insurance on assets abroad
Loans and loan guarantees
Tax breaks on profits earned abroad
Special tax treaties
Persuade other nations to accept FDI
© Prentice Hall, 2008 International Business 4e Chapter 7 - 19
Home Restriction MethodsHome Restriction Methods
Higher tax rates onforeign income
Sanctions on specific nations
© Prentice Hall, 2008 International Business 4e Chapter 7 - 20
Chapter ReviewChapter Review
• Characterize global FDI flows and patterns
• Discuss each theory that tries to explain FDI
• Identify important management issues in the FDI decision
• Explain why home and host nations intervene in FDI flows
• List the methods that nations use to promote and restrict FDI