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Theories of FDI.
Forms of FDI.
Strategies of FDI
Cost Benefits of FDI

Is a process where by residents of one country(source

country) acquire ownership of assets for the purpose of

controlling the production and distribution and other
IMFs Balance of Payment manual defines FDI as an
investment that is made to acquire lasting interest in an
enterprise operating in an economy other than that of an
investor, the investors purpose being to have voice in
the management of the enterprise.
The United Nations(1999)World Investment
Report(UNICTAD)defines FDI as an investment having
involving long term relationship and reflecting a lasting
interest and control of resident entity in one economy in
an enterprise resident in an economy other than that of
the foreign direct investor.

United States Department of Commerce

regards a foreign business as US foreign

affiliate if a US single investor owns at least
10 percent of the voting securities.
The distinguishing feature of FDI in
comparison with other forms of international
investments is the element of control over the
management policy and decision.

Mac Dougall-Kemp Hypothesis.
FDI moves from capital abundant economy to
capital scarce economy till the marginal
production is equal in both countries. This
leads to improvement in efficiency in
utilization of resources in which leads to
ultimate increase in welfare .According to this
theory, foreing direct investment is a result of
differences in capital abundance between
economies. This theory was developed by
MacDougal(1958) and was later elaborated by

Industrial Organization Theory.
According to this theory, MNC with superior
technology moves to different countries to
supply innovated products making in turn
ample gains .Krugman (1989) points out that
it was technological advantage possessed by
European countries which led to massive
investment in USA .According to this theory,
technological superiority is the main driving
force for foreign direct investment rather that
capital abundance.

Currency Based Approaches.
A firm moves from strong currency country to weak
currency country. Aliber(1971)postulates that firms
from strong currency countries move out to weak
currency countries. Froot and Stain(1989)holds that,
depreciation in real value of currency of a country
lowers the wealth of a domestic residents visa avis
the wealth of the foreign residents ,thus being
cheaper for foreign firms to acquire assets in such
countries. Therefore, foreign direct investments will
move from countries with strong currencies to those
with weak or depreciating currencies.

Location Specific Theory.
Hood and Young(1979) stress on the location
factor. According to them, FDI moves to a
countries with abundant raw materials and
cheap labor force. Since real wage cost varies
among countries, firms with low-cost
technology move to low wage countries.
Abundance of raw materials and cheap labor
force are the main factors for FDI.Countries
with cheap labor and abundant raw material
will tend to attract FDI.

Product Cycle Theory.
FDI takes place only when the product in question
achieve specific stage in its life cycle(Vernon
1966)introduction ,growth, maturity and decline
At maturity stage, the demand for new product in
developed countries grow substantially and rival firms
begin to emerge producing similar products at lower
So in order to compete with rivals, innovators decide to
set up production in the host country so as to beat up
the cost of transportation and tariffs.

Political Economic Theories.
They concentrate on the political risks. Political
stability in the host country leads to
FDI(Fatehi-Sedah and Safizeha
1989).Similarly, political instability in the
home country encourages FDI in other
countries(Tallman 1988).

It takes broadly three forms:
1.Green Field Investment
2.Merger and Acquisitions(M&A)
3.Brown Field Investment.

1.Green Field Investment.
IT is done through opening branches in host
countries or through making investment in the
equity capital of the host country firm.
(Financial collaboration)
If the parent hosts the entire equity of the host
country firm, the late is called wholly owned
subsidiary of the of the parent.
If it is more than half, it is known as subsidiary.
otherwise, it is simply an affiliate.

2.Merger and Acquisition(M&A)
They are either purchase of a running company
abroad or an Amalgamation with a running
foreign company.
For the case of Merger, the acquiring company
maintains its existence and the target
company looses its existence.
For the case of Amalgamation, both loose their
existence in the favor of a new company.
Merger and Acquisition are either Horizontal or
Vertical Conglomerate.


Horizontal Conglomerate is when two or more firms engaged in similar


Vertical is when two firms involved in different stages of production of

a single final product Oil exploration with a refining .
Brown Field.
Is a combination of Green field and M&A and then make huge
investment for replacing plant and machinery in the target company.

Strategy for FDI

Firm-Specific Strategy.
It means offering new kind of product or differentiated
product. When product innovation fails to work, a firm
may adopt product differentiation strategy. This is done
through putting trade mark on the product or branding.
Sometimes a firm may adopt different brands for different
markets to make them suitable for local markets. Bata for
example, operates in 92 countries under the same trade
mark, while Unilivers low - leather fabric washing
product is marketed is market under five different brands
in Western Europe.
Cost Economic Strategy.
This strategy is done through lowering cost by moving the
firm to the places where there are cheap factors of
production(eg.labour and raw materials).The cheapness
of these factors of production reduces the cost of
production and maintains an edge over other firms.

Strategies for Entering New

Joint Venture With a Rival Firm.
Sometimes when a rival firm in a host country is so
powerful that it is not easy for MNC to compete, the later
prefer to join hands with the host country firm for a joint
venture agreement and the MNC is able to operate the
host country market.
Investment Mode Strategy: Merger versus GI.
This strategy depends on the move of investment favored
by the host country. It depends also on the political and
economic environment of the host country. If the host
government does not favor a particular mode, an investing
company can not adopt it even if it is the most suitable.

Cost and Benefits of FDI

Benefits to The Host Country.
1.Availability of scarce factors of production
2.Improvement in Balance of Payments through
export and import substitution.
3.Building of economic and social infrastructure.
4.Fostering of economic linkages.
5.Strengthening of the government budget.
6. Stimulation of national economy. Subsidiaries
of Trans-National Corporations (TNCs), which
bring the vast portion of FDI, are estimated to
produce around a third of total global exports
(UNCTAD 1999).

Benefits to The Home Country.
1.Availability of raw material.
2.Improvement in Balance of Payments.
3.Revenue to the government
4.Employement generation
5.Improved political relations.

Cost to the Home Country.
1.Cultural and political interference.
2.Un healthy competition
3.Over utilization of local resources(both natural
and human resources)
4.Vilation of human rights(child labor eg. the
case of NIKE in Vietnam).
5.Threat to indigenous technology.
6.Threat to local products.

Cost to the Home Country.
It is little compared to the host country.
1.Investment abroad takes away employment
2.It takes away capital.
3.Out flow of factors of production.

UNICTAD(2002) Foreign Direct Investment: A Lead
Driver for Sustainable Development, Economic

Briefing Series No. 1,Whitehall Court, London.

The Location of Foreign Direct Investment

Activities: Country Characteristics and

Experience Effects(1980) Journal of International
Business Studies,Palgrave Macmillan Journals.
Vyuptakesh(2009) International Financial
Management, Delhi, PHI Learning Private.
How does foreign direct investment affect economic
growth?(1998) Journal of International Economics,
Volume 45, Issue 1 , 1 June 1998, Pages 115-135.