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What TNCs seek in host countries

determines the types of FDI


Access to a large domestic
(Brazil, China, India) or regional
market (EU, NAFTA, ASEAN)
horizontal FDI

Mining
Tourism
Oil and gas extraction,

Natural resource
-seeking

Market-seeking
TNCs

Efficiency-seeking
Divide and specialize production
in line with the comparative advantages
of different locations vertical FDI
export-oriented FDI

Strategic-asset
seeking
primarily through M&As

Host Country Determinants of


FDI
Host country determinants
I. Policy framework for FDI
Economic, political and social
stability
Rules regarding entry and
operations
Standards
Policies on of
functioning
structure
treatmentand
of foreign
of markets (especially competition and
affiliates
M&A policies)

Type of FDI by motives of


TNCs

Market size and per capita income


Market growth

A. Marketseeking

Access to regional and global market


Country specific consumer preferences
Structure of markets

International trade and


FDI agreements
Privatization policy
Trade policy (tariffs and NTBs) and
coherence of FDI and trade policies
Tax policy
TO NAME A FEW..

Principal economic determinants in host


countries

Availability of raw materials and natural resources


(e.g., for tourism)

B. Resource
-seeking

Cost of raw materials


Physical infrastructure (ports, roads, railways,
Availability
power,
telecom) & cost of skilled labor
Low-cost unskilled labour or skilled labour

II. Economic determinants


III. Business
facilitation
Investment promotion

Cost of resources and labour adjusted for


productivity

C. Efficiencyseeking

Investment incentives
Hassle costs or red tape (corruption,
administrative efficiency, etc)
Social amenities (quality of life,
bilingual schools etc.)
Good infrastructure and support
services e.g. banking, legal accountancy
services
Social capital; attitude to work

D. Strategic
assetseeking

Other input costs, e.g. transport and


communication costs to and from and within host
economy
Regional integration agreements (inter-country
division of labour)
Note: this type of FDI takes place
through cross-border M&As for a variety
of strategic reasons
Availability of firm-specific assets:
technological, innovatory, marketing,
brand names, etc.
Buying market power or new markets,
spreading risks, lowering transaction
costs

Each type of FDI has a different set of economic requirements

Sorting out host country FDI determinants


Key factors determining FDI inflows into countries
As a rule, countries that offer what TNCs seek stand a
greater chance to attract more FDI
TNCs seek many things (called locational advantages)
in host countries. Key among them are economic
attractions including:
natural resources (giving TNCs access to, and control of,
natural resources)
large and dynamic domestic markets and access to
international markets
(permitting TNCs to grow faster than in
national markets, spread the risks and better service the markets)
lower costs of resources such as labour and other inputs,
e.g., infrastructure services (permitting TNCs to reduce costs of
production and operations)
availability of firms possessing assets needed by TNCs (e.g.,
R&D, brands, customers base, marketing or other capabilities)

Factors Influencing FDI


Inflows

http://www.univ-lille1.fr/afsemedee/communications/toubal_farid.pdf

Key general policies that affect FDI


Trade policy

Tax policy

import-substitution vs.
export-orientation
membership of regional
integration schemes

tax heavens
tax incentives
corporate and
personal taxes

General policies affecting FDI

Policies affecting
economic,
political and
social stability

Monetary
fiscal
exchange rate policies

Privatization policy
can be a powerful
determinant of FDI
inflows

NOTE: THERE ARE MANY OTHER POLICIES AFFECTING FDI IN ONE WAY OR THE OTHER,
RANGING FROM EDUCATIONAL POLICIES THROUGH LABOUR MARKET POLICIES TO
ENVIRONMENTAL AND SECTORAL (E.G., MINING) POLICIES

3 Specific Policies determining FDI


1. Rules

and regulations governing the


entry and establishment of foreign
investors in a host country
e.g., prohibition of entry, restrictions on ownership
(joint venture requirement) or liberalization of entry

2. Treatment

of foreign investors

non-discrimination in the treatment of foreign and


domestic firms (NT)
preferential treatment of foreign or domestic firms
(e.g., incentives)
distinguish treatment before and after entry

3. Protection

of foreign investors

expropriation and nationalization; fund transfers; and

FDI: Benefits to the Host


Country

Resource Transfer Effects


Capital
MNE invests capital in foreign markets
Technology
Research supports that MNEs do transfer technology when they invest in a
foreign country
Management
When MNEs invest and manage in a foreign country, they often transfer
management skills to the host countrys workforce
Employment Effects
MNEs, by investing in foreign countries, can create employment opportunities
for the local workforce
But: Acquisition vs. Greenfield Investment
Balance of Payment Effects
Balance of Payment: A countrys balance-of-payment is the difference between
the payments to and receipts from other countries
FDI can have beneficial and negative effects on a countrys balance of payment.
We look at the beneficial effects next
Effect on Competition
Efficient functioning of markets require adequate level of competition between
producers

FDI: Benefits to Host Countrys


Balance of Payment
Initial Capital Inflow

When a company invests in a foreign country,


it brings capital into that country

Substitute for Imports

To the extent that the goods/services produced


by the FDI substitute for imported
goods/services, there is a positive effect on Bof-P

Inflow of payments from export of goods


and services

To the extent that the goods/services produced


by the FDI are exported to another country,
there is a positive effect on the host countrys
B-of-P

FDI: Costs to Host Countries


Adverse Effects on Competition
MNEs may have too much power and kill off
competition

Adverse Effects on Balance of Payments


After initial inflow of capital, subsequent
outflow of capital from the earnings of the FDI
FDI may import inputs from abroad

National Sovereignty and Autonomy


Key decisions that affect the host countrys
economy may be made by a foreign parent
that has no real commitment to the host
country

FDI: Benefits & Costs to Home


Country
Benefits

Stream of income from foreign earnings


FDI may import intermediate goods or inputs for
production from the home country, creating jobs
MNEs may learn skills from exposure to foreign countries

Costs

Balance of payment:

Initial capital outflow (but often set off by future stream of


foreign earnings)
Current account suffers if FDI is to serve home market from
low-cost production location
Current account suffers if FDI is a substitute for direct
export

Employment effects:

FDI a substitute for domestic production (e.g., Etch-ASketch)

Government Policy Instruments and


FDI: Host Country Policies
Encouraging Inward FDI

Tax concessions
Low-interest loans
Grants
Subsidies

Restricting Inward FDI


Ownership restraints

Exclusion from certain industries


Why do so?

To protect national interest (defense, etc)


To facilitate resource-transfer

Performance requirements

Local content, exports, technology transfer, and local


participation in top management

Government Policy Instruments and


FDI: Home Country Policies
Encouraging Outward FDI

Insurance programs to cover major types of


foreign investment risks
Special funds or banks to make government
loans
Political influence to persuade host countries to
relax restrictions on inbound FDI

Restricting Outward FDI

Limit capital outflows


Manipulate tax rules to encourage investment
at home
Outright prohibition from investing in certain
countries

Ensuring Growth from


Organizational Learning
MNEs exposed to multiple stimuli,
developing:
Diversity capabilities
Broader learning opportunities

Exposed to:
New
New
New
New
New

markets
practices
ideas
cultures
competition

Chapter 3: Foreign
Direct Investment
Theory and

Slide
6-14

Decision Framework for FDI


No

Are transportation costs


high?
Yes

No

Is know-how easy to
license?
Yes

Tight control over foreign


ops required?
No

Is know-how valuable and


is protection possible?

Import
Barriers?

No
Export

Yes
FDI

Yes
FDI
Yes

No

FDI
License

The Theory of FDI


A Decision Framework

Defining Political Risk

In order for an MNE to identify,


measure, and manage its political
risks, it needs to define and classify
these risks which include
Firm-specific risks
Country-specific risks
Global-specific risks

1822

Predicting Risks
Predicting firm-specific risk
Different foreign firms operating within
the same country may have very different
degrees of vulnerability to changes in
host-country policy or regulations

Predicting country-specific risk


Political risk analysis is still an emerging
field, though firms need to attempt to
conduct this analysis

Firm-Specific Risks: BP Global oil spilt


Governance risks
Governance risk is the ability to exercise
effective control over an MNEs
operations within a host countrys legal
and political environment
Historically, conflicts of interest between
objectives of MNEs and host
governments have arisen over such
issues as the firms impact on economic
development, the environment, control
over export markets, balance of
payments (to name a few)
The best approach to conflict
management is to anticipate problems
and negotiate understanding ahead of

Firm-Specific Risks
Negotiating Investment Agreements
An investment agreement spells out
specific rights and responsibilities of both
the foreign firm and the host government
The presence of the MNE is as often
sought by development-seeking
governments of host countries
An investment agreement should define
policies on a wide range of financial and
managerial issues

Operating Strategies after the FDI


Decision
Although an investment agreement
creates obligations on the part of both
foreign investor and host government,
conditions change and agreements are
often revised in the light of such changes
The firm that sticks rigidly to the legal
interpretation of its original agreement
may well find that the host government
first applies pressure in areas not covered
by the agreement and then possibly
reinterprets the agreement to conform to
the political reality of that country

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