REVIEW:

FDI is essential for developing and emerging market countries. FDI benefits the
global economy as well as individual businesses and countries. Investors take advantage of
low labour and production costs in other countries. Additionally, firms are able to gain a
better insight into what works well for the local markets that they are investing in. Some
general benefits of FDI include higher output and jobs which provides local economic
benefits and stimulates local economic growth. FDI also helps limit tariffs that gives local
businesses more control over the market while maintaining price competition. FDI can also
create educational opportunities that can improve working skills and increase productivity.

Though FDI can have benefits, it also has disadvantages. FDI can stop domestic
investments and lead to exploitation. New products arriving at lower prices create
competition and force local businesses to lower their prices and reorganize their operations
in terms of costs. Because political issues in other countries can instantly change, foreign
direct investment is very risky. Differences in cultural norms can also cause disputes and
may lead to failed business ventures. Thus, it is important for both businesses to
understand each other.
Example: A Japanese fashion brand opens a retail location in London.

★ What is FDI?
○ US Definition: Whenever a US citizen, organization, or affiliated group takes an interest of
10% or more in a foreign business-entity
○ Greenfield Investment: The establishment of a new operation in a foreign country
○ (Mergers and Acquisition More popular): Purchase of an existing firm in a foreign
country
★ Terms for FDI
○ Flow of FDI: The amount of FDI undertaken over a given time period (normally a year)
○ Stock of FDI: The total accumulated value of foreign-owned assets at a given time
○ Outflows of FDI: The flow of FDI out of a country
○ Inflows of FDI: The flow of FDI into a country
○ Gross Fixed Capital Formation: Summarizes the total amount of capital invested in fixed
physical capital such as property
○ Balance-of-Payments Accounts: National accounts that track both payments to and
receipts from other countries
○ Current Account: In the balance-of-payments, records of transactions of the import and
export of goods and services
○ Offshore Production: FDI undertaken to serve the home market
★ FDI Growth
○ From 1975 to 2007 FDI outflows grew from USD $25B to $1.7T
 ○ Over the past three past decades FDI flows have accelerated faster than growth in world
trade and output
○ By 2009 foreign affiliates of MNCs had over USD $30T in global sales as compared to
the USD $19.9T in the global exports of goods and services
○ Economic development, deregulation and the reduction of trade barriers has increased
the attractiveness of foreign investment
○ Some regions have become more protectionist such as South America wherein some
leaders have strong anti-western sentiment
○ Most FDI flows are to developed countries, particularly the US, UK and France
○ Developing countries have been attracting larger investments in recent years
■ China, India, Mexico, Brazil, Vietnam, Angola
■ There has particularly been an increase in a gross fixed capital
■ In the postwar era the US has been the largest contributor towards FDI
■ Most FDI is through M&A instead of Greenfield
★ Positions on FDI
○ Exporting: Why do countries develop operations in a country when they can simply
export?
○ Costs – Transportation, Relationships, Market Information, Trade Barriers,
Administrative,
○ Licensing: When a firm licenses the right to produce its product, its production processes,
or is brand name or trademark to another firm in return for giving the licenses these
rights, the licensor collects royalty fee on every unit the license sells
○ Internalization Theory: The argument that firms prefer FDI over licensing to retain
control over know-how , manufacturing, marketing and strategy or because some
firm capabilities are not amenable to licensing, also known as the market
imperfections approach
○ Firms in the same industry tend to invest at the same time
■ Firms imitate each other in concentrated markets because of the strong influence
that their actions have on one another
■ Theory by Knickerbocker
○ Multipoint Competition: Arises when 2 or more enterprises encounter each other in
different regional markets, national markets or industries
○ Product life-cycle theory and FDI
■ Firms expand to other advanced countries once they develop sufficient demand
and henceforth to developing countries
○ Does not explain how this chain of events is the most profitable
○ ***Location-Specific Advantages: Advantages that arise from utilizing resource
endowments or assets that are tied to a particular foreign location and that a firm
finds valuable to combine with its own unique assets
■ John Dunning
○ ***Eclectic Paradigm: Argument that combining location-specific assets or
resource endowments and the firm’s own unique assets often require FDI; it
 requires the firm to establish production facilities where those foreign assets or
resource endowments are located.
★ Political Ideology and FDI
○ Communist and socialist regimes are very opposed to FDI as they believe it is a tool of
imperialist capitalism.
■ These governments often nationalize strategic industries that are foreign owned
○ Market economies promote FDI as it is viewed as improving market efficiency
○ Pragmatic Nationalism: An FDI policy approach that maximizes national benefits and
minimizes national costs
○ Governments are shifting away from radical ideologies to pragmatic nationalism and free
market policies
★ Benefits and Costs of FDI for Host Country
○ Resource-Transfer Effects
○ Employment
○ Balance-of-Payments
○ Capital Inflows
○ Current Account
○ Exports surplus
○ Competition and Growth
■ Driving out Domestic Competition
■ Balance-of-Payments
■ Outflow of earnings
■ Current Account Deficit
■ Excessive imports of capital
■ Sovereignty
■ Loss of economic independence
★ Benefits and Costs of FDI for Home Country
○ Balance-of-Payments
■ Foreign Earnings
○ Increased Demand
■ Employment

● Balance-of-Payments
● Capital Outflows
● Reduced employment from foreign investment
★ Policy and FDI of Home Country
○ Special funding mechanisms for FDI
○ Political and economic pressure to influence foreign investment policy of foreign countries
○ Limiting foreign investment to lessen capital outflows
○ Limiting foreign investment for political reasons
 ★ Policy and FDI of Host Country
○ Tax incentives, subsidies, etc. that attract foreign investors
○ Restricting investment in strategic industries

This chapter reviewed theories that attempt to explain the pattern of FDI between countries and to
examine the influence of governments on firms' decisions to invest in foreign countries. The
chapter made the following points:
1. Any theory seeking to explain FDI must explain why firms go to the trouble of acquiring or
establishing operations abroad when the alternatives of exporting and licensing are
available to them.
2. High transportation costs or tariffs imposed on imports help explain why many firms prefer
FDI or licensing over exporting.
3. Firms often prefer FDI to licensing when...
a. (a) a firm has valuable know-how that cannot be adequately protected by a licensing
contract
b. (b) a firm needs tight control over a foreign entity in order to maximize its market share
and earnings in that country
c. (c) a firm's skills and capabilities are not amenable to licensing.
4. Knickerbocker's theory suggests that much FDI is explained by imitative behavior by rival
firms in an oligopolistic industry.
5. Dunning has argued that location-specific advantages are of considerable importance in
explaining the nature and direction of FDI. According to Dunning, firms undertake FDI to
exploit resource endowments or assets that are location specific.
6. Political ideology is an important determinant of government policy toward FDI. Ideology
ranges from a radical stance that is hostile to FDI to a noninterventionist, free market stance.
Between the two extremes is an approach best described as pragmatic nationalism.
a. Benefits of FDI to a host country arise from resource-transfer effects, employment
effects, and balance-of-payments effects.
i. improvement in the balance of payments as a result of the inward flow of foreign
earnings
ii. positive employment effects when the foreign subsidiary creates demand for
home-country exports
iii. benefits from a reverse resource-transfer effect. A reverse resource-transfer
effect arises when the foreign subsidiary learns valuable skills abroad that can be
transferred back to the home country.

b. The costs of FDI to a host country include adverse effects on competition and balance of
payments and a perceived loss of national sovereignty.
i. adverse balance-of-payments effects that arise from the initial capital outflow
from the export substitution effects of FDI
 ii. Costs also arise when FDI exports jobs abroad.
7. Home countries can adopt policies designed to both encourage and restrict FDI. Host
countries try to attract FDI by offering incentives, and try to restrict FDI by dictating
ownership restraints and requiring that foreign MNEs meet specific performance
requirements.