FOREIGN DIRECT INVESTMENT

FDI refers to the purchase of a significant number

of shares of a foreign company in order to gain
certain degree of management control.
According to the report FDI includes three
components, equal capital, reinvested earnings
and intra-company loans.

WHY FDI
The reasons for FDI in India are:-
1.Foreign investment is seen as way of filling the
gap between the domestically available supplies
of savings, foreign exchange, government
revenue and human capital skills.
2.Factories set up the MNCs act as a nuclii of
growth
 THEORIES OF FDI

Market Imperfections

Product Life Cycle FDI

Eclectic

Internalisation
Market Power

A.PRODUCT LIFE CYCLE THEORY

This theory identifies three stages of life cycle of
a product :
In the maturing product stage the firm directly invests in
production facilities in countries where the demand is
high. In the final stage i.e. standardised product stage,
increased competition creates pressures to reduce
production costs.
Merits of the theory-
1.It makes economic sense
2.FDI is a natural phenomenon
3.Venturing to invest in other countries.
Demerits of the country-
1. This theory fails to explain why some MNCs donot
believe in gradual expansion of production facilities.
2. This theory also silent on the reason why companies
choose FDI over other forms of the market entry.
B. MARKET IMPERFECTIONS-
This theory focuses on imperfections in the market that
would decide FDI. A firm choose to invest in overseas
facilities if a transaction with a foreign firm proves to
be more costly. The transaction tends to be costlier
because of lengthy negotiations , entering and
mentoring all brought about by market imperfections.
C. ECLECTIC THEORY-
Advocated by John Dunning, eclectic theory argues that
location in question attracts FDI because it combines
the unique advantages of ownership, location and
internalisation. According to Dunning, FDI will occur
when three conditions are uniquely combined.
1. Ownership advantage
2. Location advantage
3. Internalisation advantage
D. MARKET POWER
This theory states that a firm seeks to establish a
dominant market presence in an industry by undertaking
FDI as it yields higher profits for them. This we can
achieve from vertical integration which talks about the
backward integration i.e. extension of the companys
activities into supply chain or increased control of the
firms suppliers and Forward integration which involves
gaining ownership or increased control over distributors
or retailers. The effective means of implementing
forward integration is franchising.
E. INTERNALISATION APPROACH-
Propounded by Buckley and Casson , the internalisation
theory is based on two principles(1) firms internalise
missing or imperfect external markets until the costs of
further internalisation outweigh the benefits and (2)
Firms choose locations for their constituent activities that
minimise the overall costs of their operations. The
location aspect of the theory suggests three primary
motivations :
a.Foreign market seeking FDI
b.Efficiency (cost reduction) seeking FDI
c.Resource seeking FDI

FACTORS INFLUENCING FDI

A.SUPPLY FACTORS
1.Production costs
2.Logistics
3.Natural Resources
4.Key Technology
B. DEMAND FACTORS
1.Customer Access
2.Competitive Advantage
3.Follow the Clients
4.Follow the Rivals

C. POLITICAL FACTORS
1.Economic Priorities
2.Avoidance of Trade barriers
3.Development Incentives