LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
understand the vocabulary associated with foreign direct investment
(FDI)
2.
use the resource- and institution-based views to explain why FDI
takes place
3.
understand how FDI results in ownership, location, and
internalization (OLI) advantages
4.
identify different political views on FDI based on an understanding of
FDI’s benefits and costs to host and home countries
5.
participate in two leading debates on FDI
6.
draw implications for action
THE FDI VOCABULARY
foreign direct investment (FDI) -
Investments in activities that control and manage value
creation in other countries
multinational enterprise (MNE) - A firm that
engages in foreign direct investment and operates in
multiple countries
THE FDI VOCABULARY
foreign portfolio investment (FPI) -
Investment in a portfolio of foreign securities such as
stocks and bonds that do not entail the active
management of foreign assets
management control rights - The rights to
appoint key managers and establish control mechanisms
THE FDI VOCABULARY
FDI is direct - requires significant equity ownership and
provides the combination of equity ownership rights and
management control rights
significant ownership rights provide much needed
management control rights
FPI represents essentially insignificant ownership rights
and no management control rights
To compete successfully, firms need to deploy
overwhelming resources and capabilities to overcome their
liabilities of foreignness; FDI provides one of the best ways
to facilitate extension of firm-specific resources and
capabilities abroad
THE FDI VOCABULARY
horizontal FDI - A type of FDI in which a firm
duplicates its home country-based activities by producing
the same products or offering the same services in a host
country as firms do at home
vertical FDI - A type of FDI in which a firm moves
upstream or downstream in different value chain stages
in a host country
THE FDI VOCABULARY
upstream vertical FDI - A type of vertical FDI in
which a firm engages in an upstream stage of the value
chain
downstream vertical FDI - A type of vertical
FDI in which a firm engages in an downstream stage of
the value chain
THE FDI VOCABULARY
FDI flow - The amount of FDI moving in a given
period (usually a year) in a certain direction
FDI inflow - Refers to inbound FDI moving into a
country in a year
FDI outflow - Refers to outbound FDI moving
out of a country in a year
FDI stock - The total accumulation of inbound FDI in a
country or outbound FDI from a country
OLI Advantages
A firm’s quest for ownership (O) advantages, location (L)
advantages, and internalization (I) advantages:
Ownership - Refers to MNEs’ possession and leveraging
of certain valuable, rare, hard-to-imitate, and
organizationally embedded (VRIO) assets overseas in the
context of FDI
Location - Refers to advantages enjoyed by firms
operating in certain areas
Internalization - Refers to the replacement of cross-
border markets (such as exporting and importing) with one
firm (the MNE) locating in two or more countries
OLI Advantages
Licensing – An external market transaction in which
firms buy and sell technology and intellectual property
rights.
Market Imperfections (or market failure)
The imperfect rules governing international transactions.
–
OWNERSHIP ADVANTAGES
dissemination risks - risks associated with
unauthorized diffusion of firm-specific know-how
OWNERSHIP ADVANTAGES
Knowledge has two basic categories: (1)
explicit and (2) tacit (implicit).
Explicit – is codifiable (that is, it can be
written down and transferred without losing
much of its richness).
Tacit (implicit) – is noncodifiable, and its
acquisition and transfer require hands-on
practice.
LOCATION ADVANTAGES
agglomeration - location advantages that arise
from the clustering of economic activities in certain
locations
knowledge spillovers - Knowledge diffused from
one firm to others among closely located firms that
attempt to hire individuals from competitors
LOCATION ADVANTAGES
When one firm enters a foreign country
through FDI, its rivals are likely to follow in
order to:
1. Acquire location advantages themselves
2. Neutralize the first mover’s location
advantages
oligopoly – Industries populated by a small
number of players
INTERNALIZATION ADVANTAGES
international transaction costs
-
tend to be
higher than domestic costs – costs associated with doing
business – many times as a result of significant
imperfections and uncertainties associated with
international market transactions
market failure – is a result of high transaction costs
arising from imperfections of the market mechanisms
that make transactions prohibitively costly and
sometimes prevent transactions from taking place
intrafirm trade - international trade between two
subsidiaries in two countries controlled by the same MNE
REALITIES OF FDI – POLITICAL VIEWS
radical view - political view that is hostile to FDI
free market view - political view that suggests that
FDI, unrestricted by government intervention, will enable
countries to tap into their absolute or comparative
advantages by specializing in the production of certain
goods and services (win-win)
pragmatic nationalism - political view that
approves FDI only when its benefits outweigh its costs
Benefits and Costs of FDI to Host
Countries
host country – recipient countries
balance of payments – a country’s
payments to and receipts from other countries
technology spillovers - foreign technology
diffused domestically that benefits domestic
firms and industries
Benefits and Costs of FDI to Host
Countries
demonstration effect (contagion or
imitation effect) - reaction of local firms to
technology spillovers
repatriate – send back
Benefits of FDI to Home Countries
home country – source country
 Repatriated earnings of profits from
FDI
 Increased exports of components and
services to host countries
 Learning via FDI from operations
abroad
HOW MNEs AND HOST
GOVERNMENTS BARGAIN
bargaining power – The ability to extract a favorable
outcome from negotiations due to one party’s
strengths
obsolescing bargain - deal struck by MNEs and host
governments, which change their requirements after
initial FDI entry
expropriation - Government’s tactics that include
removing incentives, demanding a higher share of
profits and taxes, and confiscating foreign assets
sunk costs - point at which a firm has invested
substantial sums of resources
FDI versus Outsourcing
A strategic debate is whether FDI
(captive sourcing) or outsourcing
(offshoring) will serve firms’ purposes
better?
captive sourcing – performing an
activity in-house at an overseas location
Facilitating versus Confronting
Inbound FDI
Can foreigners and foreign firms be
trusted in making decisions important to
the local economy?