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MGT520 - International Business - Lecture Handout 32

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Learning Objectives:

  • To explain why investors and governments view direct investments differently than portfolio investments
  • To demonstrate how companies acquire foreign direct investments
  • To evaluate the relationship between foreign trade and international factor mobility, especially direct investment
  • To classify companies’ motivations for foreign direct investment
  • To explain companies’ advantages from foreign direct investments
  • To show the major global patterns of foreign direct investment

Types of International Investments:

  • International investment can be divided into portfolio investment and foreign direct investment (FDI) (see Chapter 1). The former represents passive holdings of foreign stocks, bonds, or other financial assets that entail no active management or control of the issuer of the securities by the foreign investor. The latter represents acquisition of foreign assets for the purpose of control.
  • FDI may take many forms including: purchases of existing assets in a foreign country; new investments in plant, property, and equipment; or participation in joint ventures with a local partner. The text provides examples of each type of investment.
  • Controversy often surrounds FDI because while it may increase employment, enhance productivity, and raise wage rates, it also raises concerns that control of the national economy is being passed to foreigners.

The Growth of Foreign Direct Investment:

  • The past 30 years have seen a dramatic rise in foreign direct investment. Current worldwide FDI is about $6.8 trillion (2001).

Foreign Direct Investment in the United States:

  • The United Kingdom has accounted for the greatest portion of FDI into the United States.
  • The high levels of FDI to Bermuda, the Bahamas, and other small Caribbean islands relate to their role as offshore financial centers.
  • Over the past decade, outward FDI has remained larger than inward FDI for the United States, but both categories have more than doubled in size.


Ownership Advantages:

  • Researchers trying to explain why FDI occurs initially focused on the impact of firm-specific (or monopolistic) advantages. They argued that a firm that owned a superior technology, a well-known brand name, or economies of scale that created a monopolistic advantage could clone its domestic advantage to penetrate foreign markets. The text provides the example of Caterpillar and Komatsu, both of which capitalized on proprietary technology and brand names to expand into other markets.

Internalization Theory:

  • The answers to the questions outlined above were explored using internalization theory. The theory suggests that FDI is more likely to occur (a firm will internalize its operations) when the costs of negotiating, monitoring, and enforcing a contract (transaction costs) with a second firm are high.

Dunning's Eclectic Theory:

Dunning’s eclectic theory ties together location advantage, ownership advantage, and internalization advantage. Dunning proposes that FDI will take place when three conditions are satisfied.

  • First, the firm must own some unique competitive advantage that overcomes the disadvantages of competing with foreign firms in their own market (ownership advantage).
  • Second, it must be more profitable to undertake a business activity in a foreign location than a domestic location (location advantage).
  • Third, the firm must benefit from controlling the foreign business activity, rather than hiring an independent local company to provide the service (internalization advantage).

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