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?
Communication
communication.png (740×427) (xkcd.com)