MGT520 - International Business - Lecture Handout 31

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FOREIGN DIRECT INVESTMENT

Foreign Direct Investment in the World Economy:

  1. When discussing foreign direct investment, it is important to distinguish between the flow of FDI and the stock of FDI. The flow of FDI refers to the amount of FDI undertaken over a given time period (normally one year). The stock of FDI refers to the total accumulated value of foreign owned assets at a given point in time.
  2. Figure 6.1 illustrates the great increase in the flows of FDI between 1992-2001. The significant growth in FDI has both to do with the political economy of trade as outlined in the previous chapter and the political and economic changes that have been taking place in developing countries.
  3. The opening case on Starbucks helps illustrate one very important trend in FDI - the globalization of the world economy is causing firms to invest worldwide in order to assure their presence in every region of the world.
  4. Another important trend is has been the rise of inflows into the US. The stock of foreign FDI in the US increased more rapidly than US FDI abroad.
  5. The rapid increase in FDI growth into the US may be due to the attractiveness of the US market, the falling value of the dollar, and a belief by some foreign corporations that they could manage US assets and workers more efficiently than their American managers could.
  6. It is difficult to say whether the increase in the FDI into the US is good for the country or not. To the extent that foreigners are making more productive use of US assets and workers, it is probably good for the country.
  7. Figures 6.2, 6.3, 6.4 and 6.5 provide some insight into the countries that have been the major recipients and sources of foreign direct investment in recent years.
  8. The management focuses box details the techniques of Mexican cement manufacturer Cemex for its aggressive international expansion of cement manufacturing. Because cement is a product that is not easily exported due to its low ratio of value to weight, Cemex sought international expansion by acquisition.

Horizontal Foreign Direct Investment:

  1. Horizontal FDI is FDI in the same industry abroad as a firm operates in at home. A Japanese automobile manufacturer in Japan seeks to produce the same product in the US. FDI would seem to be more expensive and risky than exporting or licensing, so there must be some other good reasons for firms to undertake FDI.
  2. Transportation costs can make export infeasible, especially for products that have a low value/weight ratio (i.e. cement, soft drinks), or would require refrigeration or similar controlled environments. For items like electronics, software, and medical equipment, transportation costs may not be an impediment to exporting.
  3. The most accepted reason for horizontal FDI relates to market imperfections. By imposing quotas, tariffs, or impediments, governments can make FDI and licensing more attractive than exporting.
  4. Technological or managerial know-how can be difficult and dangerous to license, however, making it an infeasible alternative. A firm can lose control of critical competitive know-how, may not be able to optimize the flow and configuration of operations between countries, or simply may be unable to codify its knowledge in a way that would make licensing a practical option.
  5. Firms may choose to undertake FDI simply to follow the lead of a competitor so as not be left behind or locked out of an opportunity.
  6. FDI may be most likely to occur in certain stages of a product’s lifecycle - when other countries have a large enough market to justify local production or when there is a need to locate production in a low cost location.
  7. A firm may choose to undertake FDI in a particular country or region due to location specific advantages. An obvious example occurs with respect to natural resources, but it also applies to the ability to tap into a particular expertise (e.g. Silicon Valley) or be located near customers or suppliers with unique characteristics. Porter’s diamond, as discussed in chapter 4, provides a partial explanation why firms in certain industries may find it attractive to invest in a particular country.

Vertical Foreign Direct Investment:

  1. Backward vertical FDI involves investment into an industry that provides inputs for a firm's domestic production processes. Forward vertical FDI involves investment in an industry that utilizes the outputs of a firm's domestic production processes.
  2. The strategic behavior explanation for vertical FDI suggests that firms try to either create new entry barriers or erode competitors’ entry barriers. While there certainly are some examples where the strategic behavior explanation seems to apply, the market imperfections explanation seems to present a more complete explanation.
  3. Market imperfections can result from impediments to the sale of know-how and the need to invest in specialized assets.
  4. Because specialized know-how can be difficult to sell or license, a firm may have to integrate vertically to be successful. The establishments of sales and services centers in high technology industries or the investment in knowledge intensive extractive processes are two examples.
  5. When specialized assets must be invested in (i.e. the aluminum smelter), companies may need to secure a supply of the needed inputs to assure that those assets can be used efficiently.

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