An Overview of International Investments: Unit 4 Section

AN OVERVIEW OF INTERNATIONAL INVESTMENTS
INTERNATIONAL
UNIT 4 SECTION
BUSINESS
3
Unit 4, section 3: An overview of international business
You are welcome to Section 3 of Unit 4. As studied earlier in the previous

units, International business is the study of transactions taking place across
national borders for the purpose of satisfying the needs of individuals and
organisations. The parties involved in such transactions may include private
individuals, individual companies, groups of companies, and/or
governmental agencies. International business activity first took the form of
exporting and importing. However, in today’s complex world of
international activity, other forms have been introduced such as international
investment, licensing and franchising etc. This Section looks at the
overview of international investment.
By the end of this Section, you should be able to;

 explain the nature of international investment
 differentiate between foreign direct investment and foreign portfolio
investment
An Overview of International Investments

Most MNE activity can be classified into two major categories: Trade
(exports and imports) and foreign direct investment (FDI). In recent years,
both have been on the rise. Much of this is a result of large multinational
enterprises (MNEs) headquartered in triad countries. At the present time, the
world’s most developed economies are slowing down and many MNEs are
cutting back their workforces in order to compete more effectively in this
environment. Small and medium-sized enterprises are also finding
themselves being challenged. Another important international business
development is the emergence of trade regulation. Today the World Trade
Organisation (WTO) is the major group responsible for governing the
international trading system. A third major development that is changing the
way MNEs do business is change in technology - communication,
marketing and production technologies.
Types of International Investment

Trade is important to all countries but not the only form of international
business. Another form is international investment, whereby residents of
one country supply capital to a second country. International investment is
divided into two type’s namely foreign direct investment (FDI) and foreign
portfolio investment (FPI). The distinction between the two rests on the
question of control: Does the investor seek an active management role in the
firm or merely a return from a passive investment.
Foreign Portfolio Investment (FPI)

This involves the purchases of foreign financial assets (stocks, bonds, and
certificates of deposit) for a purpose other than control. This type of
investment represents passive holdings of securities such as foreign stocks,
bonds, or other financial assets, none of which entails active management or
control of the securities’ issuer by the investor. Foreign Portfolio
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Unit 4, section 3: An overview of international business BUSINESS
Investments are motivated by attempts to seek an attractive rate of return as

well as risk reduction that come from geographically diversifying one’s
investment portfolio. Many investors have bought shares of mutual funds
that specialise in foreign stocks and bonds. An example of foreign portfolio
investment is the purchase of shares by a Ghanaian or Ghanaian company
(e.g. Zoomlion) in the UK or UK Company (e.g. British gas). With this
investment the Ghanaian or Ghanaian company is trying to raise the rate of
return on its assets portfolio rather than control the UK Company’s decision
making.
Foreign Direct Investment (FDI)

These are investments made for the purpose of actively controlling property,
assets or companies located in host countries. The USA government
statistician defines FDI as ‘ownership or control of 10 percent or more of an
enterprise’s voting securities or the equivalent interest in an unincorporated
business. FDI may take many forms, including purchase of existing assets in
a foreign country, new investment in properties, plant, and equipment, and
participation in a joint venture with a local partner. An example of an FDI is
the purchase of all the common stock of Sweden’s Volvo Corporation by
Ford Motor Company. Ford installed its own executives to oversee Volvo’s
operation and integrate them into Ford’s global procurement and marketing
programmes.
International Investment Theory

In addition to the above explanations, certain theories further explain why
and how FDI takes place. Some of the theories are ownership advantage
theory, internationalisation theory and Dunning's eclectic theory.
According to the ownership advantage theory, a firm that owns a valuable

asset that creates a monopolistic advantage domestically can use that
advantage to penetrate foreign markets through FDI. That valuable asset may
be a superior technology that has intellectual property right. This offers the
firm special benefit as a sole producer to take advantage of foreign markets
where demand is high. One key thrust of this theory is that the monopolistic
advantage enjoyed in the home country offers the firm the opportunity to
move quickly along its experience curve, enjoy economies of scale and offer
superior quality to its customers locally and abroad.
The internalisation theory has at its core the concept of transaction cost. The
firm must benefit from controlling the foreign business activity than from
hiring an independent local company to provide the service. Control is
paramount and advantageous so as to prevent the firm’s brand or reputation
being damaged by the local company. A firm must decide whether it is better
to own and operate its own factory overseas or to contract with a foreign firm.
Thus, FDI becomes a better option especially when transaction costs with a
UEW/IEDE 135
INTERNATIONAL
BUSINESS Unit 4, section 3: An overview of international business
second firm (such as potential distributor or merchant in the host country) are
high.
Dunning's eclectic theory explains the need to undertake a business activity

that is more profitable in a foreign location than in a domestic location.
Enjoying lower labour costs and avoiding high tariffs in foreign locations
are recommended. To successfully enter and conduct business in a foreign
market, the MNE must possess ownership-specific advantages relative to
other firms already doing business in the market. That is, it should hold
knowledge, skills, capabilities, key relationships, and other assets that allow
it to compete effectively in foreign markets. To ensure international success,
the advantages (proprietary technology, managerial skills, trademarks or
brand names) must be substantial enough to offset the costs the firm incurs
in establishing and operating foreign operations. The more valuable the
firm’s ownership-specific advantages, the more likely it is to
internationalise via FDI. According to the theory, a firm will go
international when it will benefit from location advantages (such as
relatively cheap source of resources), ownership advantages and
internalisation advantage (as explained above).
It is highly likely that both FPI and FDI will continue to increase as
countries continue to trade amongst themselves. One of the most compelling
reasons is that FDI has been continually increasing and likely to attract even
greater FDI. International trade is increasing on an annual basis and FDI is
an important element in this development. The investment theories also
threw more light on the reasons for firms to go international.
Now assess your understanding of this Section by answering the following
self-assessment questions. Good luck!
Activity 4.3
 Differentiate between foreign direct investment and foreign portfolio
investment
 Explain any one of the investment theories.
Did you score all? That’s great! Keep it up.
136 UEW/IEDE
INTERNATIONAL
Unit 4, section 3: An overview of international business BUSINESS
UEW/IEDE 137

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AN OVERVIEW OF INTERNATIONAL INVESTMENTS

You are welcome to Section 3 of Unit 4. As studied earlier in the previous

By the end of this Section, you should be able to;

An Overview of International Investments

Types of International Investment

Foreign Portfolio Investment (FPI)

Investments are motivated by attempts to seek an attractive rate of return as

Foreign Direct Investment (FDI)

International Investment Theory

According to the ownership advantage theory, a firm that owns a valuable

Dunning's eclectic theory explains the need to undertake a business activity

Did you score all? That’s great! Keep it up.

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