Lecture 7-1: Foreign Direct Investments (1) (Chapter 8) February 25, 2025 February 27, 2025 February 28,2025 Part 3: FDI International Trade Theories Trade versus FDI In International Market Learning Objectives • Understand the concepts of foreign direct investment. • Understand the different theories of foreign direct investment. What is FDI? • Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market in a foreign country • the firm becomes a multinational enterprise • FDI can be in the form of • Greenfield investments – the establishment of a wholly new operation in a foreign country • Acquisitions or mergers with existing firms in the foreign country Direction and flow/stock • The flow of FDI refers to the amount of FDI undertaken over a given time period • Outflows of FDI are the flows of FDI out of a country • Inflows of FDI are the flows of FDI into a country • The stock of FDI refers to the total accumulated value of foreign-owned assets at a given time Why Choose FDI? 1. Exporting – producing goods at home and then shipping them to the receiving country for sale • • exports can be limited by transportation costs and trade barriers FDI may be a response to actual or threatened trade barriers such as import tariffs or quotas 2. Licensing – granting a foreign entity the right to produce and sell the firm’s product in return for a royalty fee on every unit that the foreign entity sells • Internalization theory suggests that licensing has three major drawbacks compared to FDI: • • • firm could give away valuable technological know-how to a potential foreign competitor does not give a firm the control over manufacturing, marketing, and strategy in the foreign country the firm’s competitive advantage may be based on its management, marketing, and manufacturing capabilities (difficult to articulate or codify) The Effects of FDI Monopolistic Advantage and Market Power • Further ownership advantages might be derived from the size of a firm. Multinationals, which are also large firms, possess an important source of market power because of economies of scale. • The main advantages are derived from the centralization of research, marketing, finance, and other management functions that will not be available to smaller local competitors. • According to a theory proposed by Knickerbocker (1973), multinational strategies can be understood in terms of the rivalry of oligopolistic firms which follow one another into new foreign markets as a defensive strategy. • Why do firms in the same industry undertake FDI at about the same time and the same locations? • Knickerbocker - FDI flows are a reflection of strategic rivalry between firms in the global marketplace • multipoint competition -when two or more enterprises encounter each other in different regional markets, national markets, or industries https://www.traqline.com/newsroom/blog/the-goliaths-of-thereplacement-tire-industry-are-getting-bigger-how-can-the-davidscompete/ Liability of Foreignness • In foreign markets, local firms were assumed to possess superior knowledge about the markets, resources, legal and political system, language, and culture. • Foreign firms appeared to have no incentive to locate in such a market, or ability to survive in it, without an advantage. • An underlying assumption of most theories of the multinational was that a firm required an 'advantage' over local firms in order to overcome the 'liability of foreignness'. Knowledge-based Theories of the Firm • These approaches provide a basis for the view that multinationals specialize in the transfer of knowledge that is difficult to understand and codify. • As such they do not arise out of the failure of markets, but out of their superior efficiency as an organizational vehicle to transfer knowledge across borders. The role of opportunistic behavior is downgraded in this approach. • The critical assumption is that knowledge transmission is not costless. Firms define a community in which there exists a body of knowledge regarding how to cooperate and communicate. Through repeated interactions, individuals and groups within firms develop a common understanding by which to transfer knowledge from ideas into production and markets. • The choice of wholly owned subsidiaries as opposed to licensing or joint ventures can be seen as depending on the level of complexity, the degree of codifiability, and the extent of teachability of the knowledge. • Their mistake is that they’re confusing information with knowledge. (p.18) • “Information is a message, one-dimensional and bounded by its form: a document, an image, a speech, a genome, a recipe, a symphony score. You can package it and instantly distribute it to anyone, anywhere. ” (p.19) • “Knowledge results from the assimilation and connecting of information through experience, most often through apprenticeship or mentoring. As a result, it becomes embedded in organizations in ways that, so far, have largely evaded codification.” (p.19) • “…… while the cost of obtaining, storing, and moving information has plummeted, the cost of doing so with knowledge hasn’t dropped much at all…… That’s because no amount of IT can– at least not yet – crack the problem of how to speed knowledge acquisition.” (p. 19) • “…… simply giving everyone access to e-mail and Google will never in itself flatten the earth…… ” (p. 20) Prusak (2006) When should a firm do FDI? Eclectic (OLI) Paradigm and FDI • Location: What location has to offer? • Internalization: In which manner, a firm will internalize? • Ownership: What resources a firm has which give them more advantage compared to the domestic firms? Vinfast in the US Location specific advantage? Ownership specific advantage? https://www.youtube.com/watch?v=i8I6waf_1RU Incremental Internationalization Incremental Internationalization • “Swedish firms often develop their international operations in small steps, rather than by making large foreign production investments at single points in time. • Typically, firms start exporting to a country via an agent, later establish a sales subsidiary, and eventually, in some cases, begin production in the host country.” (Johanson and Vahlne, 1977: 24) • “the time order of such establishments seems to be related to the psychic distance between the home and the import/host countries” (Johanson and Vahlne, 1977: 24) Incremental Internationalization • Typically, firms start exporting to a country via an agent, later establish a sales subsidiary, and eventually, in some cases, begin production in the host country.” (Johanson and Vahlne, 1977: 24) Production Export Sales Subsidiary Summary Theories • • • • • Monopolistic Advantage and Market Power Liability of Foreignness Knowledge-based theories of the Firm Incremental Internationalization Eclectic (aka OLI) Paradigm Questions? 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