Foreign Direct Investment
Discussion Section
February 16, 2007
Brian Chen
Agenda
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Administrative
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Index cards
Starbucks FDI case due
Word on section participation
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Review
 Political Economy of FDI
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Concepts/Definitions
Application: Chinese Corporations Law relating to wholly
foreign-owned enterprises
Foreign Direct Investment
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(Time permitting)
Concepts/Definitions
Review
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International Trade
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“Chicago school” economists tend to favor free trade
But there are political and economic grounds to governments
to intervene to check absolute free trade
These tools include:
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Tariffs, subsidies, quotas, administrative policies, local content
requirement, antidumping policies
Boeing v. Airbus
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Both received government subsidies: One direct, one indirect,
and the question is whether one form is worse than the other
Also, there may be room to argue whether there are acceptable
political and economic grounds for government intervention in
these industries
Chapter 8
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The Political Economy of Foreign Direct
Investment
Political Economy of FDI: Outline
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Three Views
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Radical View
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Free Market
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“Imperialist” extraction of host country wealth
Implication: Always bad for the host country
Different countries have different comparative advantages; best
to allow countries to engage activities for which they do so most
efficiently
Implication: Always good when countries are specializing in
activities for which they have a comparative advantage
Pragmatic Nationalism
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Belief that FDI has costs and benefits, and whether to engage in
FDI depends on whether the benefits exceed the cost
What are the costs and benefits to the host country?
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Benefits
Costs
FDI: Benefits to the Host Country
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Resource Transfer Effects
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Capital
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Technology
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MNEs, by investing in foreign countries, can create employment opportunities for the
local workforce
But: Acquisition vs. Greenfield Investment
Balance of Payment Effects
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When MNEs invest and manage in a foreign country, they often transfer management skills to the
host country’s workforce
Employment Effects
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Research supports that MNEs do transfer technology when they invest in a foreign country
Management
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MNE invests capital in foreign markets
Balance of Payment: A country’s balance-of-payment is the difference between the
payments to and receipts from other countries
FDI can have beneficial and negative effects on a country’s balance of payment. We look
at the beneficial effects next
Effect on Competition
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Efficient functioning of markets require adequate level of competition between producers
FDI: Benefits to Host Country’s
Balance of Payment
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Initial Capital Inflow
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Substitute for Imports
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When a company invests in a foreign country, it
brings capital into that country
To the extent that the goods/services produced by
the FDI substitute for imported goods/services,
there is a positive effect on B-of-P
Inflow of payments from export of goods and
services
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To the extent that the goods/services produced by
the FDI are exported to another country, there is a
positive effect on the host country’s B-of-P
FDI: Costs to Host Countries
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Adverse Effects on Competition
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Adverse Effects on Balance of Payments
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MNEs may have “too much” power and kill off
competition
After initial inflow of capital, subsequent outflow of
capital from the earnings of the FDI
FDI may import inputs from abroad
National Sovereignty and Autonomy
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Key decisions that affect the host country’s
economy may be made by a foreign parent that has
no real commitment to the host country
FDI: Benefits & Costs to Home
Country
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Benefits
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Stream of income from foreign earnings
FDI may import intermediate goods or inputs for production
from the home country, creating jobs
MNEs may learn skills from exposure to foreign countries
Costs
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Balance of payment:
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Initial capital outflow (but often set off by future stream of foreign
earnings)
Current account suffers if FDI is to serve home market from lowcost production location
Current account suffers if FDI is a substitute for direct export
Employment effects:
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FDI a substitute for domestic production (e.g., Etch-A-Sketch)
Government Policy Instruments and
FDI: Host Country Policies
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Encouraging Inward FDI
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Tax concessions
Low-interest loans
Grants
Subsidies
Restricting Inward FDI
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Ownership restraints
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Exclusion from certain industries
Why do so?
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To protect national interest (defense, etc)
To facilitate resource-transfer
Performance requirements
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Local content, exports, technology transfer, and local
participation in top management
Government Policy Instruments and
FDI: Home Country Policies
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Encouraging Outward FDI
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Insurance programs to cover major types of foreign
investment risks
Special funds or banks to make government loans
Political influence to persuade host countries to
relax restrictions on inbound FDI
Restricting Outward FDI
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Limit capital outflows
Manipulate tax rules to encourage investment at
home
Outright prohibition from investing in certain
countries
Chinese Law on WOFC
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What type of FDI did Starbucks engage in (in Thailand)?
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Suppose Starbucks invested in China instead, with the same
facts. Does this law apply to your firm?
What are the articles of law that protect the host country?
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What are they trying to protect?
What are the article of law that protect the foreign investor?
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Acquisition? Greenfield?
Horizontal? Vertical?
Wholly owned subsidiary? Joint Venture?
Why are they important to you?
How would you judge China’s WOFC law?
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Does it subscribe to the Radical View, the Free Market View, or the
National Pragmatism View?
Why do you say so?
Chapter 7
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Foreign Direct Investment
FDI: Definition
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What is FDI?
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FDI occurs when a firm invests directly in facilities to produce
and/or market a product in a foreign country
Examples:
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Motorola sets up a plant in China to manufacture cell phones
Starbuck purchases an existing UK firm, “British Coffee,” to sell
coffee, tea and desserts in the UK
Volkswagen and two Chinese joint venture partners Shanghai
Automotive Industry Corporation (SAIC) and First Automotive
Works (FAW) open their newly built gearbox plant in Shanghai
"Volkswagen Transmission (Shanghai) Co. Ltd"
Alternatives to FDI
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Licensing; Direct Export
FDI: Forms
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Forms of FDI
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Acquisitions
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Greenfield Investments
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Purchase an existing company in the foreign country
Set up a new company “from the ground up” in the foreign
country
Examples:
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Motorola investments money in China and builds a new
plant to produce cell phones
Starbucks purchases an existing UK firm “British Coffee”
and sells coffee/tea/desserts under the name “Starbucks”
FDI: Forms (II)
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Forms of FDI (II)
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Wholly Owned Subsidiary
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Occurs when the company in the foreign country is entirely
controlled/owned by one single company.
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Motorola’s company that manufactures cell phones in China
Starbuck’s acquisition that sells coffee/tea/desserts in the
UK
Joint Ventures
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Occurs when two or more companies together form a new
company in the host country
In the international context, usually occurs when one (or
more) foreign company and one (or more) local company
join to form a new company
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Volkswagon + Shanghai Automotive Industry Corporation
(SAIC) + First Automotive Works (FAW)
FDI: Horizontal vs. Vertical
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Horizontal vs. Vertical Direct Investment
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Horizontal
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Investment in the “same” industry as a firm operates in at home
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Examples:
Starbucks and its international expansion
MacDonald’s and its international expansion
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Vertical
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Investment in a downstream supplier (backward) or upstream
purchaser (forward) as compared to the business that the firm
operates in its home country
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Examples:
Backward: Volkswagon + SAIC + FAW to produce gearbox (an
input to Volkswagon’s home operation)
Forward: Less common. Volkswagon’s acquisitions of dealers
in the US (Volkswagon “sold” cars to the dealers in the US.
I.e., Volkswagon sold the output of its home country operations
to the US dealers that it acquired)
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Why Horizontal FDI?
Transportation Costs
 Market Imperfections
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Impediments to exporting
 Impediments to Sale of Know-How
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Strategic Behavior
 Product Life Cycle
 Location Specific Advantages
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Why Vertical FDI?
Strategic Behavior
 Market Imperfections
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Impediments to Know-How
 Investment in Specialized Assets
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