7

Foreign Direct
Investment

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Chapter Objectives

Describe worldwide patterns of foreign direct investment

(FDI) and reasons for those patterns

Describe each of the theories that attempt to explain why

FDI occurs

Discuss the important management issues in the FDI

decision

Explain why governments intervene in the free flow of FDI

Discuss the policy instruments that governments use to

promote and restrict FDI

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Volkswagen
Produces 8 million cars a year
Modular production strategy
Special protection in Germany

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Foreign Direct Investment

(FDI)

Purchase of physical assets or

significant amount of ownership
of a company in another country
in order to gain some measure of
management control

By contrast, portfolio investment

does not involve obtaining a
degree of control in a company

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Yearly FDI Inflows

Source: Based on World Investment Report (Geneva, Switzerland: UNCTAD), various years.

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Reasons for FDI Growth

Increasing
globalization

International mergers
and acquisitions
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Value of Cross-Border M&As

Source: Based on World Investment Report (Geneva, Switzerland: UNCTAD), various years.

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Worldwide FDI Flows

World FDI inflows

Developed (49%), developing (45%)

European Union: 28% of world FDI

82,000 multinationals

Developing nations

China and India attract most FDI

All of Africa: 2.8% of world FDI

Copyright 2014 Pearson Education, Inc.

with
810,000 affiliates
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Discussion Question
What is the
difference between
foreign direct
investment and
portfolio
investment?
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Answer to Discussion
Question
Foreign direct investment is the
purchase of physical assets or a
significant amount of the
ownership of a company in
another country to gain a
measure of management
control.
Portfolio investment does not
involve obtaining a degree of
control in a company.
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International Product Life

Cycle
A company begins by exporting its product and later undertakes
foreign direct investment as a product moves through its life cycle

Source: Raymond Vernon and Louis T. Wells, Jr., The Economic Environment of International Business, 5th ed. (Upper Saddle River, N.J.: Prentice
Hall, 1991), p. 85.

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Market Imperfections
(Internalization)
A company undertakes FDI to
internalize a transaction that
is made inefficient because of
a market imperfection

Trade barriers
(e.g., tariffs)

Unique advantage
(e.g., special
knowledge)

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Eclectic Theory
FDI when location, ownership, and internalization
advantages combine to make a location appealing

Location
advantage

Ownership
advantage

Internalization
advantage

(optimal location)

(special asset)

(efficiency)

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Market Power
FDI used to establish a dominant presence in an industry
Market power
= Greater profits
Vertical integration
Extends companys
activities
into stages of production
that provide its inputs
(backward integration) or
absorb its out-puts
(forward integration)
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Discussion Question
The eclectic theory says
that firms undertake FDI
when location, ownership,
and __________
advantages combine to
make a location appealing
for investment.
a. Internalization
b. First-mover
c. Life-cycle
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Answer to Discussion
Question
The eclectic theory says
that firms undertake FDI
when location, ownership,
and __________
advantages combine to
make a location appealing
for investment.
a. Internalization
b. First-mover
c. Life-cycle
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Management Issues I
Control

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Purchase-or-build

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Management Issues II
Production
costs

Customer
knowledge

Source: LIU JIN/Newscom

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Management Issues III

Following clients

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Following rivals

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Balance of Payments
National accounting system that records all payments to entities
in other countries and all receipts coming into the nation

Current account

Capital account

The import and export of

goods and services,
income receipts on
assets abroad, and
income payments on
foreign assets inside the
country

The purchase or sale of

assets (including assets
such as property and
shares of common stock
in a company)

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U.S. Balance of Payments

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Discussion Question
What do we mean
by a countrys
balance of
payments and
what is its
usefulness?
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Answer to Discussion
Question
A countrys balance of payments is
a national accounting system that
records all payments to entities in
other countries and all receipts
coming into the nation.
The system helps monitor a
countrys flows of goods, services,
income, and asset transfers
between itself and other nations.
The balance of payments position
sends warning signals about trade
deficits with other nations.
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Host Intervention I
Initial FDI boosts economy

Balance of Payments

FDI may decrease imports

FDI may generate exports

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Host Intervention II
Access technology

Obtain resources
and benefits

Access management skills

+
Create employment

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Home Intervention
Remove national resources
Eliminate export markets
Eliminate domestic jobs

+ Improve competitiveness
+ Eliminate low-wage jobs
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Host Promotion Methods

Financial incentives
Low or waived taxes
Low-interest loans

Infrastructure benefits
Better seaports, roads,

and telecom networks

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Host Restriction Methods

Ownership restrictions
Prohibit investment in

industries or businesses

Performance demands
Local content requirements
Export targets
Technology transfers

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Home Promotion Methods

Insurance on
assets abroad

Loans and loan

guarantees

Tax breaks on profits

earned abroad

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Special tax
treaties

Persuade other nations

to accept FDI

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Home Restriction Methods

Higher taxes on
foreign income

Sanctions that
prohibit investing
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Discussion Question
A host government may
encourage an initial FDI
because the inflow can
__________ its balanceof-payments position.
a. Level
b. Lower
c. Boost
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Answer to Discussion
Question
A host government may
encourage an initial FDI
because the inflow can
__________ its balanceof-payments position.
a. Level
b. Lower
c. Boost
Copyright 2014 Pearson Education, Inc.

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All rights reserved. No part of this publication may be reproduced,

stored in a retrieval system, or transmitted, in any form or by any
means, electronic, mechanical, photocopying, recording, or
otherwise, without the prior written permission of the publisher.
Printed in the United States of America.

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