FOREIGN DIRECT

INVESTMENT
FOREIGN DIRECT
INVESTMENT
A foreign direct investment
involves the purchase or
expansion of a business in
one country by business in a
foreign country.
United States is the largest
owner of FDI stock in the
world – it owns almost 22 %
of the total world foreign
direct investment.
 Example: A car company might
invest in assembly and production
FORMS OF FDI: facilities abroad.
HORIZONTAL
INVESTMENT

Investment into broadly

similar activities as those of
the investing company.
 Example: An oil drilling firm
might branch into shipping and
FORMS OF FDI: refining and retail outlets.
VERTICAL
INVESTMENT

Investment activities higher

or lower in the production
chain.
Based in the Netherlands, Royal Dutch Shell
explores, produces, and refines petroleum
through its subsidiary companies. In addition
to operating gas stations around the world,
Shell produces and sells fuels, lubricants, and
other chemicals.
FORMS OF FDI: Example: An oil drilling firm
might branch into shipping and
TACTICAL
refining and retail outlets.
INVESTMENT
Firms that shift foreign direct
investment and even their
headquarters to profit from
differences in regulatory
regimes and tax levels.

The iconic Swedish furniture giant Ikea,

almost 350 stores in 43 countries and
earnings of 4 billion dollars, is not based in
Sweden – it's based in the university town in
Leiden in the Netherlands.
 THEORIES OF FOREIGN
DIRECT INVESTMENT

Question: Why do firms prefer To answer this question, we

FDI to either exporting
need to look at the limitations
(producing goods at home and
then shipping them to the
of exporting and licensing,
receiving country for sale) or and the advantages of FDI
licensing (granting a foreign
entity the right to produce and
sell the firm’s product in return
for a royalty fee on every unit
that the foreign entity sells)?

THEORIES OF FOREIGN
DIRECT INVESTMENT
Limitations of Exporting
The viability of an exporting
strategy can be constrained
by transportation costs and
trade barriers
ANALYSIS
• When transportation costs
are high, exporting can be
unprofitable
• Foreign direct investment
may be a response to
actual or threatened trade
barriers such as import
tariffs or quotas

THEORIES OF FOREIGN
DIRECT INVESTMENT
Limitations of Licensing
Internalization theory (also
known as market
imperfections) suggests that
licensing has three major
drawbacks
ANALYSIS
• it may result in a firm’s giving
away valuable technological
know-how to a potential foreign
competitor
• it does not give a firm the tight
control over manufacturing,
marketing, and strategy in a
foreign country that may be
required to maximize its
profitability
• It may be difficult if the firm’s
competitive advantage is not
amendable to licensing
 ADVANTAGES OF FDI
ADVANTAGES OF FDI
A firm will favor FDI over
licensing when
A firm will favor FDI over
exporting as an entry • it wants control over its
strategy when
technological know-how
• transportation costs are
• it wants over its operations
high
and business strategy
• trade barriers are high
• the firm’s capabilities are
not amenable to licensing
 BENEFITS AND COSTS OF
FDI

The benefits and costs of FDI

Question: What are the must be explored from the
benefits and costs of FDI? perspective of both the host
(receiving) country and the
home (source) country

HOST COUNTRY
BENEFITS
The main benefits of inward
FDI for a host country are
• the resource transfer effect
• the employment effect
• the balance of payments
effect
• effects on competition and
economic growth
HOST COUNTRY
COSTS
There are three main costs
of inward FDI
• the possible adverse effects
of FDI on competition
within the host nation
• adverse effects on the
balance of payments
• the perceived loss of national
sovereignty and autonomy
 INTERNATIONAL TRADE
THEORY AND FDI
Home Country Benefits

The benefits of FDI to the home • FDI may actually stimulate

country include economic growth by freeing
home country resources to
• the effect on the capital account of the concentrate on activities
home country’s balance of payments
from the inward flow of foreign where the home country has
earnings a comparative advantage
• the employment effects that arise from • Consumers may also benefit
outward FDI
in the form of lower prices
• the gains from learning valuable skills
from foreign markets that can
subsequently be transferred back to the
home country
 THE THEORY OF FDI
A DECISION FRAMEWORK
How high are
low
transportation costs EXPORT
and tariffs? high no

yes
Is know-how amenable
FDI
to licensing? yes
no
no

Is tight control over yes no FDI

foreign operation
required?

Can know-how be FDI

protected by licensing
agreement?

FDI

Then License