Guus Hendriks

Global Environment of Business

15 and 17 October 2019

Foreign Direct Investment

Outline

1. What is Foreign Direct Investment?

2. What are important FDI-related trends?

3. FDI from a firm’s perspective

4. Theoretical frameworks – Eclectic paradigm & CAGE

5. What are determinants of FDI?

6. Policy opportunities
What is FDI?

• UNCTAD defines FDI as: “an investment involving a long-term

relationship and reflecting a lasting interest and control by a
resident entity in one economy (foreign direct investor or parent
enterprise) in an enterprise resident in an economy other than that
of the foreign direct investor”.

• Different from portfolio investments: no direct control

• But what is “control”? UNCTAD uses the cut-off equity stake of 10%

• By definition, firms conducting FDI are multinational enterprises

• “Companies coordinating and controlling operations in more than one
country, even if it does not own them” (Dicken)
Important FDI trends

• UNCTAD the single biggest authority on FDI statistics: World

Investment Report great source of information

• Distinction between FDI stocks and FDI flows

• In 2017, global FDI flows fell by 23 per cent to $1.43 trillion, and in
2018 even further, by 13 per cent to $1.3 trillion
Changing world?
Changing world?
Characteristics of FDI
• Important to distinguish between greenfield investments and M&As

• Also called: brownfield investments, or a firm that purchases existing

production facilities to launch a new production activity.
Theoretical frameworks - OLI

• OLI framework widely used to assess necessary conditions for FDI

• Also dubbed the eclectic paradigm as it draws on economics, economic geography
and organization theory

• Ownership advantages: firms need to have some advantage of ownership,

e.g. patents or substantial R&D knowledge, or advantage of nationality:
access to strong domestic networks

• Location advantages: the location into which a firm wants to expand

should be attractive enough for the firm by offering certain advantages (e.g.
large market, low taxes etc.)

• Internalization advantages: it should be advantageous to the firm to

organize the investment itself, rather than through a partnership
arrangement or outsourcing
Theoretical frameworks - OLI

• But there is some criticism, too..

• Too eclectic? Tautology? Do firms really need ownership advantages?
Theoretical frameworks - CAGE
What are determinants of FDI?

• Ask economists and get a more straightforward answer:

• Size of the economy
• Distance and transportation costs
• Taxation
• Former colony
• Resource endowments

• Business scholars will likely say it depends

• Firm’s motive
• Match between firm-specific advantages and location advantages
• Transaction costs
• Firm’s portfolio
More recent trends

• Does FDI by emerging market MNEs differ from that of their

developed economy counterparts?
• Aggressive acquisition strategy (rather than greenfield)?
• Experience navigating environments with comparatively underdeveloped
institutions can be of use in other developing economies and give EMNEs a
competitive edge
• Home-country governments typically play a more important role for the
internationalization trajectories of EMNEs

• FDI in the digital age

• Does additive manufacturing (3D printing) affect FDI flows?
Criticism – FDI statistics

• So, considering what we discussed, do FDI statistics give an accurate

picture of MNE activity?

• Business scholars would object, and also point at the discussed

trends (Beugelsdijk et al., 2010)
• Inward FDI does not necessarily mean inward MNE activity
• A lot of FDI goes towards tax havens
• MNEs also raise funds locally
• Labor productivity varies in an MNE’s foreign affiliate network
• FDI statistics capture intricacies of MNE global strategy?
FDI Policy

• But is it really only a firm’s decision? What about governments?

• Governments have a range of measures at their disposal that

potentially influence inward and outward FDI decisions:
• Information provision
• Ministerial support (missions)
• Subsidies, loans
• Investment insurance
• Tax breaks
• Antitrust laws – merger control

• Governments may also work together to create a more secure

investment climate
• International investment agreements, bilateral investment treaties
FDI Policy trends
FDI Policy
• Perhaps less clear-cut: industrial policy
• “the strategic effort by the state to encourage the development and growth of a
sector of the economy”

• Last year’s World Investment Report delves into the topic (see Chapter IV)

• The theme chapter of the report shows that over 100 countries have
adopted industrial development strategies in recent years

• “Foreign investment policies – policies to attract, anchor and upgrade FDI

and to regulate it – are an important element of industrial policies.
Investment promotion is integral to industrial policy because FDI is more
than a flow of capital that can stimulate economic growth. It comprises a
package of assets that includes long-term capital, technology, market
access, skills and know-how, all of which are crucial for industrial
development” (p. 131)
FDI Policy

• Leeway for (industrial) policy measures?

• Many investment treaties include a system for investor-state dispute

settlement
• Serves as investment protection, as investors may sue state for alleged
discriminatory practices

• Are these treaties then a threat to democracy?

• E.g., Swedish energy company Vattenfall and its case against

Germany’s decision to phase out nuclear power
FDI Policy

• UNCTAD has gathered information on 800 cases since the 1990s

http://blogs.lse.ac.uk/businessreview/2018/09/08/understanding-the-
international-arbitration-of-investment-disputes-in-europe/
FDI Policy
• Yet, the litigious European firms are not particularly successful

• But public sentiment has its effect

• In the new USMCA, investors will see more limited protection than
previously available under NAFTA
In short

• Foreign direct investment plays an important role in a world

increasingly characterized by globalization

• Yet, FDI flows vary from year to year despite several structural trends

• Different perspectives apply: country-level or firm-level

determinants?

• Scope for governments to influence FDI with policy measures

• What are important trends? Are they structural? And what is the
scope for policy exactly?
Relevance to business?

• Important to know which policies affect decision to enter a foreign

country

• Protected by a bilateral investment treaty? To what extent?

• Keep up with trends and changing competition

• Understand (dis)advantages of a location and match with company’s

own resources/assets