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Cost advantages Reduce cost of trade
Avoid trade barrier (costs from import/export)
This positive effect of FDI relates to the trade diversionary aspect of regional integration. This type occurs when there are location advantages for foreign companies in their home country but the existence of tariffs or other barriers of trade prevent the companies from exporting to the host country. Even as free trade has become more prevalent, national protectionism can still surface from time to time. Countries tend to impose trade barriers as they don't think that importing alone would benefit their economies in terms of increasing producing capacity and improving technology uses. Moreover, buying foreign exports may lead to more and easier consumptions, as well as use up foreign currency reserves. Thus, companies may find it ineffective to focus solely on trade when expanding to foreign markets. The foreign companies therefore jump the barriers by establishing a local presence within the host economy in order to gain access to the local market. The local manufacturing presence need only be sufficient to circumvent the trade barriers, since the foreign company wants to maintain as much of the value-added in its home economy. Foreign direct investment offers an alternative of producing goods where they are sold. Fuji Photo Film Company has invested $200 million to set up a manufacturing plant in the US. Earlier, the company supplied film to its US customers from its factories in the Netherlands and Japan. While exporting to the US, Fuji was paying 3.7 percent tariff imposed by the US Government. This tax has been saved by producing film in the US itself.
Home country’s multinational companies seek to invest in subsidiaries in foreign markets if the cost of shipping raw material is high. Coke and Pepsi have set up bottling plants in India as the cost of transporting water from the country is considerable. Also, international businesses often make investments in host countries to reduce distribution costs. The liberalization of Latin America markets brought a surge of foreign direct investment in transportation and physical distribution, and foreign logistic providers have upgraded the region’s transportation and warehousing facilities.
Transaction costs are the costs of entering into a transaction, that is, those connected to negotiating, monitoring, and enforcing a contract. A firm must decide whether it is better to own and operate its own factory overseas or to contract with a foreign firm to do this
Natural resources Home countries tend to utilize FDI to access natural resources that are critical to them. Mexico and Vietnam. THIS ENABLES Nippon Seishi to have access to an essential resource. monitoring.through a franchise. or supply agreement. Caterpillar (a USA company) produces bulldozers in Brail to enjoy lower labor costs and avoid high tariff walls on goods exported from its U. But Japan’s largest paper mill. Natural resources attract many multinational companies of home countries. Likewise. factories. several Japanese firms are relocating production on China. The MNCs can utilize the host country's natural resources and harvest such resources efficiently and manage to keep their costs low and thus increase their price competency Location Undertaking the business activity may be more profitable in a foreign location than undertaking it in a domestic location. For example. FDI is more likely to occur-that is. where energy costs are lower. Nippon Seishi.S. For example. international production will be internalized within the firm-when the costs of negotiating. Because McDonald’s is so successful in reducing transaction costs between itself and its franchisees. to access cheaper energy resources used in manufacturing. licensing. is a densely populated island nation with very few natural resources of its own. US oil companies are a classic example. it has continued to rely on franchising for its international operations. Take advantages of host countries resources Foreign direct investment helps investors from foreign countries to invest and take advantage of certain resources which may be available in abundance in another geography or location for a much cheaper. Toyota’s primary competitive advantages are its reputation for high quality and its sophisticated manufacturing techniques-neither of which are easily conveyed by contract. firms are more likely to contract with outsiders and internationalize by licensing their brand names or franchising their business operation. many oil companies have been forced to make significant investments worldwide to obtain new oil reserves. The company owns huge forests and corresponding processing facilities in Australia. FDI can produce transaction costs for firms whose competitive advantages cannot be easily conveyed by contracts or import and export. does more than simply import wood pulp. and enforcing a contract with a second firm are high. when transaction costs are low. Canada and US. for example. Conversely. For example. . Japan. Because of the decrease in oil production in the US. So Toyota has chosen to maintain ownership of its overseas automobile assembly plants. McDonald’s is the premier expert in the United States in devising easily enforceable franchising agreements. especially forests.
as a package to major drug makers and to other research laboratories trying to assimilate research data being generated in human gene research. more than 2000 maquiladoras have sprung up near the US-Mexico border. for example. Britain’s Smith Kline (now merged with pharmaceutical firm Glasgow) invested $86 million in Cadus Pharmaceutical Corporation of New York to access the latter’s yeastwork. Over two decades. Similarly. 4 countries suffer heavy losses. so carrying out operations in other countries help them get exposure to such country related economic cycles. etc. so diversification leads to the company having minimized its operational risks. . Low-cost factors (labor. lower real estate prices and lower taxes. for example. real estates. 3. have invested in US small biogenetics companies in order to gain cutting-edge technology. IBM and Lion Bioscience AG (German Company) established a joint venture in 2001 in which the alliance partners will develop and market their computer technologies and data-mining software. the company will not suffer much as the profits from the other 16 countries may more than offset the losses from these 4 countries. It is just not low labor cost. Many of the Swiss Pharmaceutical companies. The reason to get this exposure can also be attributed to the fact that as the number of countries the company operates in. Ford plans to export cars to South Africa from Chennai. taxes. that much more it becomes diversified. Besides. An MNC by definition is a company which operates in many countries. these firms locate production facilities in low wage countries. inside Mexico. meaning say that if an MNC operates in 20 countries. Key technology One of the motives of home countries behind FDI is to gain access to technology. Japanese. thus this diversification helps protect the interests of the shareholders of the foreign investing entity. Similarly. say during the course of the financial year due to some region-specific risk. The partners say that their alliance will shorten the discovery and development time for new medicines. a host of other factors also figure in the low cost. German and American automotive firms have assembly facilities that ship final products to the US and elsewhere. Exposure to other countries: MNCs prefer to have exposure to many countries. These plants take advantage of low wages to assemble American-made components for re-export to the US.) Home country’s firms seek competitive advantage through low production cost. Obviously. local incentives were the main motive behind establishing manufacturing plant by Mercesdes in Alabama.