By: Ms Adina Malik (ALK)
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What is FDI? What is the source of FDI?
Trends and Direction of FDI
The form of FDI
Logics supporting FDI over Exporting and Licensing
The Pattern of FDI
How FDI Benefits the Host Country and Home Country?
How is FDI Costly for the Host Country and Home Country?
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Foreign
direct investment (FDI) occurs when a firm invests
directly in new facilities to produce and/or market in a
foreign country
Once a firm undertakes FDI it becomes a multinational
enterprise
FDI can be:
Greenfield investments - the establishment of a wholly new
operation in a foreign country
Acquisitions
or Mergers with existing firms in the foreign
country
Acquisitions can involve:
A minority stake (10%-49%)
A majority stake (50%-99%)
A full outright stake (100%)
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The
flow of FDI refers to the amount of FDI undertaken
over a given time period
The stock of FDI refers to the total accumulated value of
foreign-owned assets at a given time
Outflows of FDI are the flows of FDI out of a country
Inflows of FDI are the flows of FDI into a country
Gross
Fixed Capital Formation-the total amount of capital
invested in factories, stores, office buildings and the like.
FDI
can be seen as an important source of capital
investment and a determinant of the future growth rate of
an economy.
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Since World War II, the U.S. has been the largest source country
for FDI
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The United Kingdom, the Netherlands, France, Germany, and
Japan are other important source countries
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Together, these countries account for 56% of all FDI outflows
from 1998-2006, and 61% of the total global stock of FDI in 2007
Cumulative FDI Outflows 1998-2007 ($ billions)
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The growth of FDI has been more than
world trade and world output.
What are the Reasons?
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Despite there has been general decline in trade barrier,
companies still fear protectionist. FDI is a way to avoid future
trade barrier.
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E.g. Japanese companies started investing in USA to combat
US trade barriers. (Cars)
Dramatic economic and political changes in developing
countries and increase of free market economies in developing
nations encourages FDI.
According to UN, laws governing FDI created more favourable
environment for FDI.
Globalization of the world economy has encouraged companies
to think world as their markets.
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Historically, most FDI has been directed at the developed
nations of the world. E.g. USA
In 2001, China was the largest recipient of FDI among
developing nations. E.g. cheap labor, tax incentive, entry
into the WTO. (FDI in 2004-$60 billion; 2010-$101 billion)
After South, East and South East Asia, the next most
important region in the developing world is Latin
America. (FDI inflow in Latin American region in 2008$141 billion. Historically, Mexico and Brazil were the top
two recipients of inward FDI, a trend that continued in the
late 2000s)
Africa attracts lowest inflow due to political unrest,
armed conflict and frequent changes. ($72 billion in 2004,
which slumped to $50 billion in 2010)
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FDI
FLOWS
1995-2004
(Annual Avg)
2005-2007
(Annual Avg)
2008
2009
2010
Inward
386
768
1,086
700
913
Outward
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Figures are presented in millions of dollars (USD).
Source is www.unctad.org
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Bharti Airtel acquired Abu Dhabi Group’s Warid Telecom in
Bangladesh for $300 million
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In September 2004, Orascom Telecom Holdings purchased 100% of
the shares of Sheba Telecom (Pvt.) Ltd. for US$ 60 million (‘Sheba’,
which was a Bangladesh and Malaysia joint venture). Orascom is now
known as Global Telecom Ltd.
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Sanofi , GSK in Bangladesh (MNCs in Pharmaceutical sector)
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HSBC, SCB, Unilever BD, BATB (MNCs in Bangladesh)
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Launched in 1997, Grameenphone was the first Telenor venture in the
Asian Telecom market. It is a joint venture between Telenor and
Grameen Telecom Corporation, a non-profit sister concern of the
internationally acclaimed microfinance organization and community
development bank , Grameen Bank.
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Bangladesh does not have an extensive outward FDI industry.
According to UNCTAD data, FDI outflows from Bangladesh are below
$0.1 billion.
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Bangladesh has opened an NGO named BRAC in Afghanistan.
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In Middle East, Bangladesh is seeking to increase economic ties with
Saudi Arabia by investing in ceramics, pharmaceuticals and leather
products.
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Indonesia has recently signed a deal with Eskayef Bangladesh Ltd.
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Bangladesh has invested in Sudan in the pharmaceutical industry;
while in agro-processing, pharmaceuticals, science, technology and
tourism sector in Egypt. In Sudan & Egypt, Bangladesh has also
invested in the form of higher education.
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Large FDI shift towards Service Industry
 Reasons:
The general move of developed nations away from manufacturing
toward service industry
 Many service cannot be traded internationally and requires to be
produced in the foreign land.
 E.g. Starbucks cannot sell hot latte coffee to a consumer in Japan
from Seattle store.
 Many country liberalized their regimes for the service Industry.
 E.g. WTO engineered to remove cross-border trade and
investment in telecommunications and financial services in the
late 1990s.
 E.g. Brazilian telecommunication sector
 Rise of Internet based global communication network.
 E.g. Procter and Gamble (back-office accounting functions shifted
to the Philippines)
 E.g. Dell (call answering center in India)
 E.g. IBM & Microsoft (software development and testing facilities
in India)
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Exporting involves producing goods at home and then
shipping them to the receiving country for sale. Usually
done by native sales agent.
Licensing involves granting a foreign entity (the licensee)
the right to produce and sell the firm’s product in return
for a royalty fee on every unit sold.
Cons of FDI over exporting or licensing:
 FDI is expensive- cost of establishment or acquisition
 FDI is risky- cultural, political and economical situation
of the host country (firm might not know the rules of the
game in the host country)
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Limitations of Exports
Transportation Cost:
Transportation costs increases the
cost of products that have low valueto-weight ratio - FDI is preferable
E.g. Cemex (cement), soft drinks, etc.
 Transportation cost will be a little
percentage of production cost for
products that have high value-toweight ratio. –Export is preferable
E.g. electronic components, personal
computers, medical equipment,
computer software, etc.
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Limitations of Exports
Trade Barriers:
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FDI can also increase due to
increased threats of trade
barriers such as import tariffs
and import quotas.
Exporting
will
decrease
profitability.
 E.g. during the 1980s and
1990s, protectionist threat
by the US Congress via
import quotas on Japanese
cars increased FDI flow to
USA by Japanese auto
companies
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Limitations of Licensing
Internationalization Theory (also known as Market
Imperfection Approach)
Licensing has three major drawbacks:
 Licensing may result in firms giving away valuable
technological know-how to potential foreign competitor.
E.g. RCA color television (USA)-Matsushita and Sony (Japan)
 The firm’s lack of tight control over manufacturing,
marketing and strategy in a foreign country that are
required to maximize their market share and profitability.
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A firm’s competitive advantage is based on its
management,
marketing
and
manufacturing
capabilities, rather than its products. The problem here
is that such capabilities may not be amenable to
licensing.
E.g. Toyota’s competitive advantage is in its innovative
production process, management know-how and
organizational capabilities which are embedded in the
whole organizational culture. So this culture cannot be
transferred via licensing.
Toyota and Lean Production.
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Observation suggests that firms in the same industry often
undertake FDI around the same time and direct their
investment activities toward certain locations.
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2 theories are used to explain this pattern
Strategic Behavior (specially in oligopolistic industries)
Product Life Cycle Theory
However, these theories lack in their rationale as they fail
to explain why wouldn’t a firm choose exporting or
licensing over FDI.
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Note: Oligopoly means when a limited number of large
firms exist in a market. (e.g. an industry in which four
firms control 80% of a domestic market). There is
interdepence of the major players, that leads to imitative
behavior.
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Strategic Behavior
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This theory suggests that FDI flows are a reflection of strategic
rivalry between firms in the global marketplace. Knickerbocker
looked at the relationship between FDI and rivalry in oligopolistic
industry (imitative behavior).
 E.g. Honda invested in the US and Europe. Toyota and Nissan
also follow suit.
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Multipoint competition: This arises when two or more enterprises
encounter each other in different regional markets, national
markets or industries.
 E.g. Kodak & Fuji Photo Film Co.; Coke & Pepsi Co.
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Product Life Cycle Theory
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Vernon’s theory suggest that firm undertake FDI at a particular
stage in the life cycle of a product they have pioneered.
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Firms do invest in a foreign country when demand in that country
will support local production and they do invest in low cost
locations when cost pressure become intense.
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E.g. Xerox introduced photocopier in the US, then set up
production facilities in Japan (Fuji-Xerox) and UK (Rank-Xerox)
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The Eclectic Paradigm
Proponent: British economist John Dunning
Location factor affects the direction or pattern of FDI.
 By location-specific advantage, Dunning means advantages
that arise from using resource endowments or assets that
are tied to particular foreign location and that firms find
valuable to combine with their own assets (technological,
managerial or marketing know-how capabilities).
 Examples: Oil companies investment middle eastern
countries; US investment in labor intensive RMG industries
based in India, China & Bangladesh; European & Japanese
firms invest in the Silicon Valley region of California.
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There are four main benefits of inward FDI for a host
country
1.
Resource transfer effects - FDI brings capital,
technology, and management resources
Employment effects - FDI can bring jobs
Balance of payments effects - FDI can help a country to
achieve a current account surplus
Effects on competition and economic growth greenfield investments increase the level of
competition in a market, driving down prices and
improving the welfare of consumers
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can lead to increased productivity growth, product
and process innovation, and greater economic
growth
2.
3.
4.
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Inward FDI has three main costs:
1.
Adverse effects of FDI on competition within the host
nation
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subsidiaries of foreign MNEs may have greater economic
power than indigenous competitors because they may be
part of a larger international organization
Adverse effects on the balance of payments
2.
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when a foreign subsidiary imports a substantial number
of its inputs from abroad, there is a debit on the current
account of the host country’s balance of payments
Perceived loss of national sovereignty and autonomy
3.
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decisions that affect the host country will be made by a
foreign parent that has no real commitment to the host
country, and over which the host country’s government
has no real control
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1.
2.
3.
The benefits of FDI for the home country
include
The effect on the capital account of the home country’s
balance of payments from the inward flow of foreign
earnings
The employment effects that arise from outward FDI
The gains from learning valuable skills from foreign
markets that can subsequently be transferred back to
the home country
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1.
The home country’s balance of payments can suffer
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from the initial capital outflow required to finance the FDI
if the purpose of the FDI is to serve the home market from
a low cost labor location
if the FDI is a substitute for direct exports
2.
Employment may also be negatively affected if the FDI is
a substitute for domestic production
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But, international trade theory suggests that home country
concerns about the negative economic effects of offshore
production (FDI undertaken to serve the home market) may
not be valid
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