The Global Trade and Investment Environment Learning Objectives

LO 8-1 Recognize current trends regarding foreign direct

investment (FDI) in the world economy.
LO 8-2 Explain the different theories of FDI.

Source: © Silviu Doroftei/ZUMA Press/London/Newscom

LO 8-3 Understand how political ideology shapes a government’s
attitudes toward FDI.
LO 8-4 Describe the benefits and costs of FDI to home and host
countries.
LO 8-5 Explain the range of policy instruments that governments
use to influence FDI.
Chapter 8: Foreign Direct Investment LO 8-6 Identify the implications for managers of the theory and
government policies associated with FDI

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Opening Case: Introduction

Burberry Shifts Its Strategy in Japan
Foreign direct investment (FDI): a firm invests directly
 Until recently, Burberry branded products sold in Japan under
a licensing agreement with Sanyo Shokai in new facilities to produce or market in a foreign
country
 Typically sold at prices significantly lower than prices Burberry
 A firm engaged in FDI is a multinational enterprise
charged for its high-end products
 In 2007, Burberry’s CEO didn’t like the way the company’s
core brand image was being diluted
 Began to terminate license agreements
 Sanyo Shokai required to close nearly 400 licensed stores
 Burberry now sells its products through wholly-owned stores
 Burberry expects sales to initially fall as it rebuilds the brand

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Foreign Direct Investment in the World Economy 1 of 5 Foreign Direct Investment in the World Economy 2 of 5
The flow of FDI - the amount of FDI undertaken over a Trends in FDI
given time period  Both the flow and stock of FDI in the world economy have
 Outflows of FDI are the flows of FDI out of a country increased over the last 35 years
 Inflows of FDI are the flows of FDI into a country  FDI has grown more rapidly than world trade and world
output
The stock of FDI - the total accumulated value of
 Firms still fear protectionist policies
foreign-owned assets at a given time
 The shift toward democratic political institutions and free market
economies encourages FDI
 Globalization is prompting firms to ensure they have a significant
presence in many regions of the world

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Basic Marketing – Chapter 6

Handout 6-1
 Figure 8.1 FDI Outflows 1980-2014 ($billions) Foreign Direct Investment in the World Economy 3 of 5
The Direction of FDI
 Historically, most FDI has been directed at the developed
nations of the world
 The United States is a favorite target as is the European Union
 More recently, developing nations have been the
recipients of FDI
 South, East, and Southeast Asia, and particularly China have
received significant inflows
 Latin America is also emerging as an important region for FDI

Source: UNCTAD statistical data set. http://unctadstat.unctad.org

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Figure 8.2 FDI Inflows by Region 1995-2014 ($billions) Foreign Direct Investment in the World Economy 4 of 5
The Source of FDI
 Since World War II, the U.S. has been the largest source
country for FDI
 Other important source countries: the United Kingdom,
the Netherlands, France, Germany, and Japan
 Chinese firms have recently emerged as major foreign
investors

Source: United Nations World Investment Report, various editions.

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description

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Figure 8.3 Cumulative FDI Outflows 1998-2014 ($billions) Did You Know?

Did you know that

America is the world's
largest foreign investor
and the largest
recipient of foreign
investment?

Click to play video

Source: United Nations World Investment Report, various editions

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Basic Marketing – Chapter 6

Handout 6-2
 Foreign Direct Investment in the World Economy 5 of 5 Theories of Foreign Direct Investment 1 of 7
The Form of FDI: Acquisitions versus Greenfield Three complementary perspectives
Investments  Why does a firm favor direct investment over exporting
 Greenfield investments involve establishing new operation and licensing?
in a foreign country
 Why do firms in same industry undertake foreign direct
 Acquisitions are attractive because: investment at the same time and favor certain locations as
 They are quicker to execute than greenfield investments targets for FDI?
 It is easier and less risky for a firm to acquire desired assets than  Eclectic paradigm combines these two perspectives
build them from the ground up
 Firms believe they can increase the efficiency of an acquired unit
by transferring capital, technology, or management skills

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Theories of Foreign Direct Investment 2 of 7 Theories of Foreign Direct Investment 3 of 7

Why Foreign Direct Investment? Why Foreign Direct Investment? continued
 Exporting: producing goods at home and then shipping  Limitations of Exporting
them to the receiving country for sale  An exporting strategy can be limited by transportation costs and
trade barriers
 Licensing: granting a foreign entity the right to produce
 When transportation costs are high, exporting can be unprofitable
and sell the firm’s product in return for a royalty fee on
every unit that the foreign entity sells  Low value-to-weight ratio
 Foreign direct investment may be a response to actual or
threatened trade barriers such as import tariffs or quotas

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Theories of Foreign Direct Investment 4 of 7 Theories of Foreign Direct Investment 5 of 7

Why Foreign Direct Investment? continued Why Foreign Direct Investment? continued
 Limitations of Licensing  Advantages of Foreign Direct Investment
 Internalization theory (aka market imperfections)  FDI will be favored over exporting when
 Licensing could result in a firm’s giving away valuable
 Transportation costs are high
technological know-how to a potential foreign competitor
 Trade barriers are high
 Licensing does not give a firm the tight control over
manufacturing, marketing, and strategy in a foreign country that  FDI will be favored over licensing when
may be required to maximize its profitability  The firm wants control over its technological know-how
 Licensing may be difficult if the firm’s competitive advantage is  The firm wants control over its operations and business
not amenable to it strategy
 The firm’s capabilities are not amenable to licensing

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Basic Marketing – Chapter 6

Handout 6-3
 Theories of Foreign Direct Investment 6 of 7 Theories of Foreign Direct Investment 7 of 7
The Pattern of Foreign Direct Investment The Eclectic Paradigm
 Strategic Behavior  Dunning’s eclectic paradigm - in addition to the various
factors discussed earlier, two additional factors must be
 Knickerbocker explored the relationship between FDI and rivalry in
oligopolistic industries (industries composed of a limited number
considered when explaining both the rationale for and the
of large firms) direction of foreign direct investment
 FDI flows reflect strategic rivalry between firms  Location-specific advantages - arise from using resource
endowments or assets that are tied to a particular location and
 This theory can be extended to multipoint competition (when two
that a firm finds valuable to combine with its own unique assets
or more enterprises encounter each other in different regional
 Externalities - knowledge spillovers that occur when companies in
markets, national markets, or industries)
the same industry locate in the same area

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Location Factors and FDI Political Ideology and Foreign Direct Investment 1 of 5
Ideology toward FDI has ranged from a radical stance
that is hostile to all FDI to the non-interventionist
principle of free market economies
 Between these two extremes is an approach that might be
called pragmatic nationalism
Source: © Phillip Bond/Alamy Stock Photo

Silicon Valley, where Google is based, has long been known as

the epicenter of the computer and semiconductor industry.

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Political Ideology and Foreign Direct Investment 2 of 5 Political Ideology and Foreign Direct Investment 3 of 5
The Radical View The Free Market View
 MNE is an instrument of imperialist domination and a tool  International production should be distributed among
for exploiting host countries to the exclusive benefit of countries according to the theory of comparative
their capitalist-imperialist home countries advantage
 The radical view has been in retreat  Countries should specialize in the production of goods and
 The collapse of communism in Eastern Europe services they can produce most efficiently
 The poor economic performance of those countries that had  The MNE increases the overall efficiency of the world economy
embraced the policy
 The strong economic performance of developing countries that
had embraced capitalism

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Basic Marketing – Chapter 6

Handout 6-4
 Political Ideology and Foreign Direct Investment 4 of 5 Political Ideology and Foreign Direct Investment 5 of 5
Pragmatic Nationalism Shifting Ideology
 FDI has benefits and costs  In recent years, there has been a strong shift toward the
 Benefits: inflows of capital, technology, skills and jobs free market stance
 Costs: repatriation of profits to the home country and a negative  A surge in the volume of FDI worldwide
balance of payments effect  An increase in the volume of FDI directed at countries that have
recently liberalized their regimes
 FDI should be allowed only if the benefits outweigh the
costs China, India, Vietnam
 But, some countries are becoming more hostile to FDI
Venezuela, Bolivia

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Benefits and Costs of FDI 1 of 9 Benefits and Costs of FDI 2 of 9

Host-Country Benefits Host-Country Benefits continued
 Resource Transfer Effects  Balance-of-Payments Effects
 FDI can bring capital, technology, and management resources that  The balance-of-payments account records a country’s payments
would otherwise not be available to and receipts from other countries
 Employment Effects  The current account records a country’s export and import of
 FDI can bring jobs that would otherwise not be created there goods and services
 Opponents say not all “new jobs” represent net additions in  A surplus is usually favored over a deficit
employment  FDI can help achieve a current account surplus
 If it is a substitute for imports of goods and services
 If the MNE uses a foreign subsidiary to export goods and
services to other countries

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Benefits and Costs of FDI 3 of 9 Does Foreign Direct Investment Promote Growth?
Host-Country Benefits continued There are multiple reasons for companies to make foreign direct
investments. Lowering the cost of production, increasing
 Effect on Competition and Economic Growth
capacity (volume) of production, and strategically locating
 FDI in the form of greenfield investment
production facilities to serve world regions are some of the many
 Increases the level of competition in a market reasons for FDI by a company. For the host countries that receive
 Drives down prices the investment by multinational corporations, the logic is that
 Improves the welfare of consumers the influx of capital and increase in tax revenues will benefit the
 Increased competition leads to host country in the form of new infrastructure, increased
 Increased productivity growth knowledge, and general economic development. However, the
 Product and process innovation
evidence so far is very mixed on the value of FDI to the host,
ranging from beneficial to detrimental. What do you think? Does
 Greater economic growth
FDI promote growth in the host country?
Source: L. Alfaro, A. Chanda, S. Kalemli-Ozcan, and S. Sayek, Does Foreign Direct Investment Promote Growth?
Exploring the Role of Financial Markets on Linkages (Cambridge, MA: Harvard Business School,
2009), www.people.hbs.edu/lalfaro/fdiandlinkages.pdf

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Basic Marketing – Chapter 6

Handout 6-5
 FDI and Job Creation Benefits and Costs of FDI 4 of 9
Host Country Costs
 Adverse Effects on Competition
Job creation is a  The subsidiaries of foreign MNEs may have greater economic
result of FDI. power than indigenous competitors because they may be part of a
These French larger international organization
workers  The MNE could draw on funds generated elsewhere to
assemble cars at subsidize costs in the local market
Toyota’s  Doing so could allow the MNE to drive indigenous competitors
Valenciennes out of the market and create a monopoly position
manufacturing
plant.
Source: © Philippe Huguen/AFP/Getty Images

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Benefits and Costs of FDI 5 of 9 Benefits and Costs of FDI 6 of 9

Host Country Costs continued Host Country Costs continued
 Adverse Effects on the Balance of Payments  Possible Effects on National Sovereignty and Autonomy
 There are two possible adverse effects of FDI on a host country’s  FDI can mean some loss of economic independence
balance-of-payments
 Key decisions that can affect the host country’s economy will be
1. The capital outflows as foreign subsidiaries repatriate earnings to made by a foreign parent that has no real commitment to the host
the parent country country, and over which the host country’s government has no real
2. There is a debit on the current account of the host country’s control
balance of payments associated with imports of input products by
the foreign subsidiary

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Benefits and Costs of FDI 7 of 9 Benefits and Costs of FDI 8 of 9

Home Country Benefits Home Country Costs
 The balance-of-payments
1. The effect on the capital account of the home country’s
 The balance of payments suffers from the initial capital outflow
balance of payments from the inward flow of foreign required to finance the FDI
earnings  The current account is negatively affected if the purpose of the
FDI is to serve the home market from a low-cost production
2. The employment effects that arise from outward FDI location
 The current account suffers if the FDI is a substitute for direct
3. The gains from learning valuable skills from foreign exports
markets that can subsequently be transferred back to the  Employment effects of outward FDI
home country  If the home country is suffering from unemployment, there may
be concern about the export of jobs

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Basic Marketing – Chapter 6

Handout 6-6
 Benefits and Costs of FDI 9 of 9 Government Policy Instruments and FDI 1 of 5
International Trade Theory and FDI Home-Country Policies
 Home country concerns about the negative economic  Encouraging Outward FDI
effects of offshore production (FDI undertaken to serve  Have government-backed insurance programs to cover major
the home market) may not be valid types of foreign investment risk
 FDI may actually stimulate economic growth by freeing home  Have special funds or banks that make governmental loans to
firms investing in developing countries
country resources to concentrate on activities where the home
 Have eliminated double taxation of foreign income
country has a comparative advantage
 Many host nations have relaxed restrictions on inbound FDI
 Consumers may also benefit in the form of lower prices

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Government Policy Instruments and FDI 2 of 5 Government Policy Instruments and FDI 3 of 5
Home-Country Policies continued Host-Country Policies
 Restricting Outward FDI  Encouraging Inward FDI
 Virtually all investor countries, including the United States, have  Governments offer incentives to foreign firms to invest in their
exercised some control over outward FDI from time to time countries
 Countries manipulate tax rules to make it more favorable for firms  Gain from the resource-transfer and employment effects of FDI
to invest at home  Capture FDI away from other potential host countries
 Countries may restrict firms from investing in certain nations for
political reasons

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Government Policy Instruments and FDI 4 of 5 Government Policy Instruments and FDI 5 of 5
Host-Country Policies continued International Institutions and the Liberalization of FDI
 Restricting Inward FDI  Until recently there has been no consistent involvement by
 Ownership restraints: exclude foreign firms from certain sectors on multinational institutions in the governing of FDI
the grounds of national security or competition
 Local owners can help to maximize the resource transfer and  The formation of the World Trade Organization in 1995
employment benefits of FDI changed this
 Performance requirements: used to maximize the benefits and
 The WTO has had some success in establishing a universal set of
minimize the costs of FDI for the host country
rules to promote the liberalization of FDI

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Basic Marketing – Chapter 6

Handout 6-7
 Focus on Managerial Implications 1 of 3 Focus on Managerial Implications 2 of 3
FDI AND GOVERNMENT POLICY Licensing is unattractive when
 The location-specific advantages argument  The firm’s proprietary property cannot be properly
protected by a licensing agreement
associated with Dunning help explain the direction of
FDI  The firm needs tight control over a foreign entity in order
to maximize its market share and earnings in that country
 However, internalization theory is needed to explain  The firm’s skills and capabilities are not amenable to
why firms prefer FDI to licensing or exporting licensing
 Exporting is preferable to licensing and FDI as long as
transportation costs and trade barriers are low

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Focus on Managerial Implications 3 of 3 Figure 8.4

Government Policy A Decision
A firm’s bargaining power with the host government is Framework
highest when
 The host government places a high value on what the firm has to
offer
 When there are few comparable alternatives available
 When the firm has a long time to negotiate

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Summary Appendix 1 Figure 8.4 A Decision Framework

In this chapter we have
Four questions to consider:
Recognized current trends regarding foreign direct
investment (FDI) in the world economy. How high are transportation costs and tariffs? If low,
Explained the different theories of FDI. then export. If high, ask
Understood how political ideology shapes a Is know-how amenable to licensing? If no, then FDI. If
government’s attitudes toward FDI. yes, then ask
Described the benefits and costs of FDI to home and Is tight control over foreign operation required? If yes,
host countries. then FDI. If no, then ask
Explained the range of policy instruments that
governments use to influence FDI. Can know-how be protected by licensing contract? If
no, then FDI. If yes, than license.
Identified the implications for managers of the theory
and government policies associated with FDI.
Return to slide

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Basic Marketing – Chapter 6

Handout 6-8
 Appendix 2 Figure 8.2 FDI Inflows by Region 1995-2014 ($billions)

From 1995 to 2002 this involved mostly developed and

developing nations (with the majority of inflows
occurring in developed nations). Transition economies
gained presence around 2003 and continue to hold a
small share of inflows. By 2014, developing nations had
the majority of FDI inflows.

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Basic Marketing – Chapter 6

Handout 6-9