Ing. Tom Dud , PhD.

Structure of the presentation

y FDI theories

introduciton and main questions

y FDI theories on macro level y Development theories of FDI y FDI theories on micro level y Eclectic FDI theory (OLI theory)

The basic questions of FDI theories (6W+H)

y Who? (is the investor) y What? (kind of FDI) y Why? (are we investing) y Where? (is the FDI going) y When? (do we invest) y How? (the mode of entry)

FDI theories on macro level

y Capital market theory y One of the oldest theories of FDI (60s) y FDI is determined by interest rates y Dynamic macroeconomic FDI theory y FDI are a long term function of TNC strategies y The timing of the investment depends on the changes in the macroeconomic environment y hysteresis effect

FDI theories on macro level

y FDI theory based on exchange rates y Analyses the relationship of FDI flows and exchange rate changes y FDI as a tool of exchange rate risk reduction y FDI theory based on economic geography y Explores the factors influencing the creation of international production clusters y Innovation as a determinant of FDI Greta Garbo effect

FDI theories on macro level

y Gravity approach to FDI y The closer two countries are (geographically, economically, culturally ...) the higher will be the FDI flows between these countries y FDI theories based on istitutional analysis y Explores the importance of the institutional framework on the FDI flows y Political stability key factor

Life cycle theory

y Raymond Vernon

1966

y It can be used to analyse the relationship of product

life cycle and possible FDI flows

y FDI can be seen mostly in the phases of maturity and

decline

y The conclusions of this theory are questionable

nowadays

Japanese FDI theories

y Were initially developed in the 70s of the last century y Main representant

Terumoto Ozawa

y He analysed the relationship of FDI, competitiveness and economic development based on the ideas of Michael Porter y He identified three main phases of development when he analysed the waves of FDI inflow and outflow from a country

Japanese FDI theories

y I. phase of economic growth y The country is underdeveloped and is targeted by foreign companies wanting to use its potential advantages (especially low labour costs) y Almost no outgoing FDI y II. Phase of economic growth y New FDI is drawn by the growing internal markets and by the growing standards of living y Outgoing FDI are motivated by the raising labour costs

Japanese FDI theories

y III. Phase of economic growth y The competitivness of the country is based on innovation y The incoming and outgoing FDI are motivated by market factors and technological factors

Five Stage Theory - John Dunning

y Stage 1 y Low incoming FDI, but foreign companies are beginning to discover the advantages of the country y No outgoing FDI no specific advantages owned by the domestic firms y Stage 2 y Growing incoming FDI do the advantages of the country especially the low labour costs y The standards of living are rising which is drawing more foreign companies to the country y Still low outgoing FDI

Five Stage Theory - John Dunning

y Stage 3 y Still strong incoming FDI, but their nature is changing due to the rising wages y The outgoing FDI are taking off as domestic companies are getting stronger and develop their competitive advantages y Stage 4 y Strong outgoing FDI seeking advantages abroad (low labour costs)

Five Stage Theory - John Dunning

y Stage 5 y Investment decisions are based on the strategies of TNCs y The flows of outgoing and incoming FDI come into equilibrium

Incoming and outgoing FDI in China between 20012001-2004

70000 60000 50000 40000 30000 20000 10000 0 -10000 2001 2002 2003 2004 FDI inflow FDI outflow

Incoming and outgoing FDI in South Korea between 2001-2004 2001-

8000 7000 6000 5000 4000 3000 2000 1000 0 2001 2002 2003 2004 FDI inflow FDI outflow

Incoming and outgoing FDI in Japan between 20012001-2004

40000 35000 30000 25000 20000 15000 10000 5000 0 2001 2002 2003 2004 FDI inflow FDI outflow

FDI theories on micro level

y Existence of firm specific advantages (Hymer) y Access to raw materials y Economies of scale y Intangible assets such as trade names, patents, superior management etc y Reduced transaction costs when replacing an arm's length transaction in the market by an internal firm transaction y FDI and oligopolistic markets y In oligopolistic markets the companies follow the actions of the market leader y Mutual threats game theory

FDI theories on micro level

y Theory of internalisation y Due to market imperfections, there may be several reasons why a firm wants to make use of its monopolistic advantage itself (or organise an activity itself) y Buckley and Casson (influenced by Coase), suggested that a firm overcomes market imperfections by creating its own market - internalisation
y he theory of internalisation was long regarded as a

theory of why FDI occurs y By internalising across national boundaries, a firm becomes multinational

Eclectic FDI theory John Dunning

y John Dunning attempts to integrate a variety of

strands of thinking
y He draws partly on macroeconomic theory and trade,

as well as microeconomic theory and firm behavior (industrial economics)

O = Ownership advantages
y Some firms have a firm specific capital known as

knowledge capital: Human capital (managers), patents, technologies, brand, reputation

y This capital can be replicated in different countries

without losing its value, and easily transferred within the firm without high transaction costs

L Localization advantages
y Producing close to final consumers or downstream customers y Saving transport costs y Obtaining cheap inputs y Jumping trade barriers y Provide services (for most services production and delivery have to be contemporaneous)

OLI approach - conclusions

y The eclectic, or OLI paradigm, suggests that the

greater the O and I advantages possessed by firms and the more the L advantages of creating, acquiring (or augmenting) and exploiting these advantages from a location outside its home country, the more FDI will be undertaken y Where firms possess substantial O and I advantages but the L advantages favor the home country, then domestic investment will be preferred to FDI and foreign markets will be supplies by exports

I internalization advantages
y Why don't a firm just sign a contract with a

subcontractor (external agent) in a foreign country? y Because contracting out is risky: it implies transferring the specific capital outside the firm and revealing the proprietary information (e.g. how to use the technology or the patent). y Problem:
y If the agent interrupts the contract it can use the

technology to compete with the mother company y In the case of brands/reputation: if the agent damages the brand reputation

4 types of FDI derived from OLI theory

y The typology of FDI was developed by Jere Behrman to

explain the different objectives of FDI:

y Resource seeking FDI y Market seeking FDI y Efficiency seeking (global sourcing FDI) y Strategic asset/capabilities seeking FDI

25

Resource seeking FDI

y To seek and secure natural resources e.g. minerals, raw materials, or lower labor costs for the investing company y For example, a German company opening a plant in Slovakia to produce and re-export to Germany

26

Market seeking FDI

y To identify and exploit new markets for the firms`

finished products y Unique possibility for some type of services for which production and distribution have to be contemporaneous (telecom, water supply, energy supply) y Automotive TNCs have invested heavily in China

27

Efficiency seeking FDI

y To restructure its existing investments so as to

achieve an efficient allocation of international economic activity of the firms

y International specialization whereby firms seek to

benefit from differences in product and factor prices and to diversify risk y Global sourcing resource saving and improved efficiency by rationalizing the structure of their global activities. Undertaken primarily by network based MNCs with global sourcing operations.
28

Strategic asset/capabilities seeking FDI

y MNCs pursue strategic operations through the

purchase of existing firms and/or assets in order to protect O specific advantages in order to sustain or advance its global competitive position
y Acquisition of key established local firms y Acquisition of local capabilities including R&D, knowledge

and human capital y Acquisition of market knowledge y Pre empting market entrance by competitors y Pre empting the acquisition by local firms by competitors
29