Foreign Direct Investment

Foreign Direct Investment
Foreign Direct Investment

• Foreign direct investment (FDI) occurs when a
firm invests directly in facilities to produce or
market a product in a foreign country.
• Once a firm undertakes FDI, it becomes a
multinational enterprise.
• FDI takes on two main forms. The first is a
greenfield investment, which involves the
establishment of a new operation in a foreign
country. The second involves acquiring or
merging with an existing firm in the foreign
country
Types of Foreign Direct Investment
• Horizontal FDI
• Horizontal FDI is where funds are invested abroad in the
same industry. In other words, a business invests in a
foreign firm that produces similar goods. For instance Nike,
a US based firm, may purchase Puma, a Germany based
firm. They are both in the industry of sportswear and
therefore would be classified as a form of horizontal FDI.
• Vertical FDI
• Vertical FDI is where an investment is made within the
supply chain, but not directly in the same industry. In other
words, a business invests in a foreign firm that it may
supply or sell too.
• For instance, Hersheys, a US chocolate
manufacturer, may look to invest in cocoa
producers in Brazil. This is known as backwards
vertical integration because the firm is purchasing
a supplier, or potential supplier, in the supply
chain.
• We then have forwards vertical integration. So
this is where a firm invests in a foreign company
that is further along in the supply chain. For
instance, Hersheys may look to purchase a share
in Alibaba; where it sells its products.
• Conglomerate FDI
• Conglomerate FDI is where an investment is made in a
completely different industry. In other words, it is not
linked in any direct way to the investors business. For
instance, Walmart, a US retailer, may invest in BMW, a
German automobile manufacturer.
• This may seem strange to some but offers big
businesses an opportunity to expand and diversify
into new areas. In order to survive, it must invest in
new ventures. Even big businesses with strong
demand may look to new industries where growth
and return on investment are significantly larger.
FDI in the World Economy
• Over the past 30 years the flow of FDI has accelerated
faster than the growth in world trade and world output.
• For example, between 1992 and 2008, the total flow of
FDI from all countries increased more than eightfold
while world trade by value grew by some 150% and
world output by around 45%.
• FDI has grown more rapidly than world trade and world
output for several reasons.
• First, despite the general decline in trade barriers over
the past 30 years, firms still fear protectionist pressures.
Executives see FDI as a way of circumventing future
trade barriers.
• Second, much of the increase in FDI has been driven
by the political and economic changes that have been
occurring in many of the world's developing nations.
• The general shift toward democratic political
institutions and free market economies has
encouraged FDI.
• Across much of Asia, Eastern Europe, and Latin
America, economic growth, economic deregulation,
privatization programs that are open to foreign
investors, and removal of many restrictions on FDI
have made these countries more attractive to foreign
multinationals.
• In some nations, the general desire of
governments to facilitate FDI also has been
reflected in a sharp increase in the number of
bilateral investment treaties designed to protect
and promote investment between two countries.
• The globalization of the world economy is also
having a positive impact on the volume of FDI.
• Many firms such as Walmart now see the whole
world as their market, and they are undertaking
FDI in an attempt to make sure they have a
significant presence in many regions of the world.
THE DIRECTION OF FDI
• Historically, most FDI has been directed at the
developed nations of the world as firms based in
advanced countries invested in the others' markets.
• FDI in the United States – the largest host economy –
increased by 114% to $323 billion.
• The United States has been an attractive target for FDI
because of its large and wealthy domestic markets, its
dynamic and stable economy, a favorable political
environment, and the openness of the country to FDI.
• Investors include firms based in Great Britain, Japan,
Germany, Holland, and France.
• The developed nations of the EU have also been
recipients of significant FDI inflows, principally from
U.S. and Japanese enterprises and from other member
states of the EU. FDI in the European Union was up 8%.
• The United Kingdom and France have historically been
the largest recipients of inward FDI.
• Even though developed nations still account for the
largest share of FDI inflows, FDI into developing nations
has increased.
• Most recent inflows into developing nations have been
targeted at the emerging economies of South, East,
and Southeast Asia.
• Driving much of the increase has been the growing
importance of China as a recipient of FDI. China saw a
record $179 billion of inflows – a 20% increase.
• ASEAN resumed its role as an engine of growth for FDI in Asia
and globally, with inflows up 35% and increases across most
members.
• Latin America emerged as the next most important region in
the developing world for FDI inflows. In 2008, total inward
investments into this region reached about $141 billion.
• Mexico and Brazil have historically been the two top recipients of
inward FDI in Latin America, a trend that continued in the late
2000s.
• Africa has long received the smallest amount of inward
investment $50 billion in 2010.
FDI in Bangladesh
• Bangladesh’s FDI stock was $16.9 billion in 2019, with the United
States being the top investing country with $3.5 billion in
accumulated investments. Bangladesh received $1.6 billion FDI in
2019. The rate of FDI inflows was only 0.53 percent of GDP, one of
the lowest of rates in Asia.
• In 2020, foreign investors invested around USD 17 billion in
Vietnam, USD 64 billion in India, USD 18.58 billion in Indonesia,
whereas Bangladesh received USD 2.56 billion and of the amount
USD 1.6 billion accounted for reinvested earnings by the already
existing foreign companies in the country.
• In recent years Bangladesh has attracted an increased amount of FDI in-
flow because of significant foreign investments in the power generation
sector and labor incentive industries such as readymade garments
alongside the recent acquisition of United Dhaka Tobacco (Akij Group) by
Japan Tobacco ($1.47bn).
FDI in Bangladesh
• A foreign investor generally evaluates a country based on
its ease of doing business ranking and overall economic
climate. Although Bangladesh advanced eight notches in
the World Bank's ease of doing business 2020 ranking to
168 out of 190 countries, there are still significant
bottlenecks in doing business.
• For instance, transferring a property title in Bangladesh
takes an average of 271 days, almost six times longer than
the global average of 47 days.
• Resolving a commercial dispute through a local first-
instance court takes an average of 1,442 days, almost three
times more than the 590 days' average among OECD high-
income economies.
FDI in Bangladesh
• According to the World Bank, to get electricity
connection in Bangladesh, a new business needs
150.2 days, whereas in Vietnam it takes 31 days, in
Singapore 30 days, in Malaysia 24 days and in
neighbouring India 55 days.
• Existing foreign investors often complain about
bureaucratic tangles in Bangladesh that stand in the
way of business operations and obtaining various
licenses. Then there are hidden costs in matters
related to procedure, policy, law and infrastructure
that seriously weigh upon the cost of doing
business.
FDI in Bangladesh
• There are allegations that some investors have gone back
to their country after finding long periods of waiting and
hassles of overcoming many obstacles a bit too much.
• Industry experts say, the deterrents that discourage
foreign investors include time-consuming bureaucracy,
poor socio-economic and physical infrastructure,
unreliable energy supply, corruption, absence of good
governance, low labour productivity, undeveloped
money and capital markets, high-cost of doing business,
complicated tax system, frequent changes in policies on
import duties for raw materials, machinery and
equipment, delays in decision-making, etc.
FDI in Bangladesh
• According to the World Economic Forum's Global
Competitiveness Index (GCI) 2019, Bangladesh's
position slipped two notches to 105th among the 141
countries surveyed.
• As per the report, the country's competitiveness
declined in 10 out of 12 pillars, where significant
deterioration in ranks was observed in macroeconomic
stability, labour market, ICT adoption and infrastructure.
• Beside poor infrastructure, lack of land, acute shortage
of power and gas for new industries, finding the right
people and getting them to work productively are the
biggest problems of Bangladesh today.
FDI in Bangladesh
• We have made remarkable progress in expanding primary
education, especially in raising enrolment of students and
reducing gender disparity.
• But our education system and curriculum do not serve the
goals of human development. There is a lack of
communication and collaboration between the government,
academia and industry, and as such we are not producing
quality or skilled persons for modern industry.
• To cover the shortage, a good number of foreign professionals
and technicians have been imported from neighbouring
countries to run the industries such as apparel, textile, buying
house, telecommunication, information technology, poultry,
etc.
Why Bangladesh Needs FDI
• Investment (both foreign and domestic) is a key
determinant of economic growth and development. It is
also considered an engine for job creation.
• Although Bangladesh has experienced exceptional
economic growth in recent years, it has failed to create
adequate jobs for the millions of young Bangladeshis
joining the workforce every year.
• At present, about two-thirds of our total population is of
working age. Approximately 2 million people enter the
labour market every year. Providing employment
opportunities to such a huge population is quite a difficult
task for the government as well as for the local private
sector.
Why Bangladesh Needs FDI
• Therefore, the government needs to continue to create
more investment opportunities for foreign investors in
sectors like garments, pharmaceuticals, textiles, agricultural
processing, manufacturing, infrastructure including roads,
highways, flyovers, water treatment plants, hospitals,
power etc., which will create more jobs and foster
sustainable economic growth.
• In recent times, the government has taken various steps to
attract FDI in the country but it seems those are not enough
to gain investors' confidence as Bangladesh severely lacks in
two most used global indicators—Ease of Doing Business
(EDB) by the World Bank Group and the Global
Competitiveness Index (GCI) by the World Economic Forum.
What to Do?
• When investors intend to come to a country, the level of
convenience of doing business in the host country plays a crucial
role in making investment decisions. They assess the clarity in
existing policies, reliability of government officials and adherence
to rules and regulations, look at the rate of return on their
investment and whether they will be able to repatriate their profit
or funds, and most importantly, whether there is sufficient
security for their investments.
• Therefore, urgent policy focus is required to remove the
deterrents discussed above that are responsible for the high cost
of investment.
• If implemented successfully, the country will not only become a
lucrative investment destination but it will also help to raise our
ease of doing business ranking, an important indicator for FDI
decisions of foreign investors.
• In recent years, Chinese enterprises have emerged as major
investors in Africa, particularly in extraction industries where
they seem to be trying to assure future supplies of valuable
raw materials.
• The inability of Africa to attract greater investment is in part
a reflection of the political unrest, armed conflict, and
frequent changes in economic policy in the region.
• FDI can be seen as an important source of capital
investment and a determinant of the future growth rate of
an economy.
• The FDI flows accounted for about 14% of gross fixed capital
formation, suggesting that FDI had become an increasingly
important source of investment in the world's economies.
THE SOURCE OF FDI
• Since World War II, the United States has been the largest
source country for FDI, a position it retained during the late
1990s and early 2000s.
• Other important source countries include the United
Kingdom, France, Germany, the Netherlands, and Japan.
Collectively, these six countries accounted for 60 percent of
all FDI outflows for 1998-2010.
• As might be expected, these countries also predominate in
rankings of the world's largest multinationals.
• These nations dominate primarily because they were the
most developed nations with the largest economies during
much of the postwar period and therefore home to many of
the largest and best-capitalized enterprises.
THE SOURCE OF FDI
• Many of these countries also had a long
history as trading nations and naturally looked
to foreign markets to fuel their economic
expansion.
• Thus, it is no surprise that enterprises based
there have been at the forefront of foreign
investment trends.
THE FORM OF FDI
• FDI can take the form of a Greenfield investment in a new
facility or an acquisition of or a merger with an existing
local firm.
• The majority of cross-border investment is in the form of
mergers and acquisitions rather than greenfield
investments. UN estimates indicate that some 40 to 80
percent of all FDI inflows were in the form of mergers and
acquisitions between 1998 and 2009.
• However, FDI flows into developed nations differ markedly
from those into developing nations.
• In the case of developing nations, only about one third of
FDI is in the form of cross-border mergers and acquisitions.
THE FORM OF FDI
• Why do firms apparently prefer to acquire existing
assets rather than undertake Greenfield investments?
• First, mergers and acquisitions are quicker to execute
than Greenfield investments. This is an important
consideration in the modem business world where
markets evolve very rapidly.
• Second, foreign firms are acquired because those
firms have valuable strategic assets, such as brand
loyalty, customer relationships, trademarks or
patents, distribution systems, production systems,
and the like.
THE FORM OF FDI
• It is easier and perhaps less risky for a firm to
acquire those assets than to build them from
the ground up through a Greenfield
investment.
• Third, firms make acquisitions because they
believe they can increase the efficiency of the
acquired unit by transferring capital,
technology, or management skills.
Theories of Foreign Direct Investment
• One set of theories seeks to explain why a firm will
favor direct investment as a means of entering a
foreign market when two other alternatives, exporting
and licensing, are open to it.
• Another set of theories seeks to explain why firms in
the same industry often undertake FDI at the same
time, and why they favor certain locations over others
as targets for FDI i.e., it explains the observed pattern
of FDI flows.
• A third theoretical perspective, known as the eclectic
paradigm, attempts to combine the two other
perspectives into a single holistic explanation.
WHY FOREIGN DIRECT INVESTMENT?
• Why do firms go to all of the trouble of establishing
operations abroad through FDI when two
alternatives, exporting and licensing, are available to
them for exploiting the profit opportunities in a
foreign market?
• Exporting involves producing goods at home and
then shipping them to the receiving country for sale.
• Licensing involves granting a foreign entity (the
licensee) the right to produce and sell the firm's
product in return for a royalty fee on every unit sold.
• FDI may be both expensive and risky compared with
exporting and licensing.
• FDI is expensive because a firm must bear the costs of
establishing production facilities in a foreign country
or of acquiring a foreign enterprise.
• FDI is risky because of the problems associated with
doing business in a different culture where the rules of
the game may be very different.
• So why do so many firms apparently prefer FDI over
either exporting or licensing? The answer can be
found by examining the limitations of exporting and
licensing.
• Limitations of Exporting
• When transportation costs are added to production costs, it
becomes unprofitable to ship some products over a large
distance. This is particularly true of products that have a low
value-to-weight ratio and that can be produced in almost any
location. For such products, the attractiveness of exporting
decreases.
• Thus Cemex, the large Mexican cement maker, has expanded
internationally by pursuing FDI, rather than exporting.
• By placing tariffs on imported goods, governments can
increase the cost of exporting.
• Similarly, by limiting imports through quotas, governments
increase the attractiveness of FDI.
• Limitations of Licensing
• According to internalization theory, licensing has three
major drawbacks as a strategy for exploiting foreign
market opportunities.
• FDI is more profitable than licensing:
(1) when the firm has valuable know-how that cannot be
adequately protected by a licensing contract;
(2) when the firm needs tight control over a foreign entity
to maximize its market share and earnings in that
country; and
(3) when a firm's skills and know-how are not amenable
to licensing.
• In the 1960s, RCA licensed its leading-edge color
television technology to a number of Japanese
companies, including Matsushita and Sony.
• RCA saw licensing as a way to earn a good return from its
technological know-how in the Japanese market without
the costs and risks associated with foreign direct
investment.
• However, Matsushita and Sony quickly assimilated RCA's
technology and used it to enter the U.S. market to
compete directly against RCA.
• As a result, RCA is now a minor player in its home market,
while Matsushita and Sony have a much bigger market
share.
• With licensing, control over manufacturing, marketing,
and strategy are granted to a licensee in return for a
royalty fee.
• However, for both strategic and operational reasons, a
firm may want to retain control over these functions.
• Unlike a wholly owned subsidiary, a licensee would
probably not accept such an imposition, because it
would likely reduce the licensee's profit, or it might
even cause the licensee to take a loss. Also, it would
limit the licensee's autonomy.
• Thus, when tight control over a foreign entity is
desirable, FDI is preferable to licensing.
• Toyota can produce higher-quality automobiles at a
lower cost than its global rivals.
• If Toyota were to allow a foreign entity to produce its
cars under license, the chances are that the entity
could not do so as efficiently as could Toyota.
• In turn, this would limit the ability of the foreign entity
to fully develop the market potential of that product.
• Such reasoning underlies Toyota's preference for
direct investment in foreign markets, as opposed to
allowing foreign automobile companies to produce its
cars under license.
THE PATTERN OF FOREIGN DIRECT INVESTMENT
• Two theories we consider in this section attempt to
explain the patterns that we observe in FDI flows.
• Strategic Behavior
• One theory is based on the idea that FDI flows are a
reflection of strategic rivalry between firms in the global
marketplace. An early variant of this argument was
expounded by F. T. Knickerbocker, who looked at the
relationship between FDI and rivalry in oligopolistic
industries. An oligopoly is an industry composed of a
limited number of large firms.
• Knickerbocker's theory suggests that much FDI is explained
by imitative behavior by rival firms in an oligopolistic
industry.
• For example, Toyota and Nissan responded to
investments by Honda in the US and Europe by
undertaking their own FDI in the US and Europe.
• More recently, research has shown that models of
strategic behavior in a global oligopoly can explain the
pattern of FDI in the global tire industry.
• Kodak and Fuji Photo Film Co., for example, compete
against each other around the world. If Kodak enters a
particular foreign market, Fuji will not be far behind.
• Fuji feels compelled to follow Kodak to ensure that
Kodak does not gain a dominant position in the foreign
market.
• Vernon's product life-cycle theory suggests that firms undertake
FDI at particular stages in the life cycle of products they have
pioneered. Xerox introduced the photocopier in the US, and it
was Xerox that set up production facilities in Japan (Fuji-Xerox)
and Great Britain (Rank-Xerox) to serve those markets.
• Vernon's view is that firms undertake FDI at particular stages in
the life cycle of a product they have pioneered. They invest in
other advanced countries when local demand in those countries
grows large enough to support local production (as Xerox did).
• They subsequently shift production to developing countries
when product standardization and market saturation give rise to
price competition and cost pressures. Investment in developing
countries, where labor costs are lower, is seen as the best way
to reduce costs.
• However, Vernon's theory does not address the
issue of whether FDI is more efficient than
exporting or licensing for expanding abroad.
• The eclectic paradigm has been championed by
the John Dunning (British Economist). He argued
that location-specific advantages are of
considerable importance in explaining the nature
and direction of FDI.
• According to Dunning, firms undertake FDI to
exploit resource endowments or assets that are
location specific.
• An obvious example of Dunning's arguments are
natural resources, such as oil and other minerals,
which are by their character specific to certain
locations. Dunning suggests that to exploit such
foreign resources, a firm must undertake FDI.
• Another obvious example is valuable human resources,
such as low-cost, highly skilled labor. The cost and skill
of labor varies from country to country. Since labor is
not internationally mobile, according to Dunning it
makes sense for a firm to locate production facilities in
those countries where the cost and skills of local labor
are most suited to its particular production processes.
• Consider Silicon Valley, which is the world center
for the computer and semiconductor industry.
• Many of the world's major computer and
semiconductor companies, such as Apple
Computer, Hewlett-Packard, and Intel, are
located close to each other in the Silicon Valley
region of California.
• This means that Silicon Valley has a location-
specific advantage in the generation of
knowledge related to the computer.
Political Ideology and FDI
• THE RADICAL VIEW
• They note that key technology is tightly controlled by
the MNE, and that important jobs in the foreign
subsidiaries of MNEs go to home-country nationals
rather than to citizens of the host country.
• FDI by the MNEs of advanced capitalist nations keeps
the less developed countries of the world relatively
backward and dependent on advanced capitalist
nations for investment, jobs, and technology.
• FDI can never be instruments of economic
development, only of economic domination.
• The countries of Eastern Europe were opposed to
FDI. Similarly, communist countries elsewhere, such
as China, Cambodia, and Cuba, were all opposed in
principle to FDI.
• Many socialist countries, particularly in Africa where
one of the first actions of many newly independent
states was to nationalize foreign-owned enterprises,
also embraced the radical position.
• Countries whose political ideology was more
nationalistic than socialistic further embraced the
radical position. This was true in Iran and India.
• By the end of the 1980s, the radical position was in
retreat almost everywhere. There seem to be three
reasons for this:
( 1) the collapse of communism in Eastern Europe;
(2) the generally abysmal economic performance of those
countries that embraced the radical position, and a
growing belief by many of these countries that FDI can
be an important source of technology and jobs and can
stimulate economic growth; and
(3) the strong economic performance of those developing
countries that embraced capitalism rather than radical
ideology (e.g., Singapore, Hong Kong, and Taiwan).
• THE FREE MARKET VIEW
• The free market view argues that international
production should be distributed among countries
according to the theory of comparative advantage.
• Countries should specialize in the production of those
goods and services that they can produce most efficiently.
• Within this framework, the MNE is an instrument for
dispersing the production of goods and services to the
most efficient locations around the globe.
• Dell decided to move assembly operations for many of its
personal computers from the United States to Mexico to
take advantage of lower labor costs in Mexico.
• PRAGMATIC NATIONALISM
• The pragmatic nationalist view is that FDI has both
benefits and costs. Many countries are also concerned
that a foreign owned manufacturing plant may import
many components from its home country, which has
negative implications for the host country 's balance-
of-payments position.
• Recognizing this, countries adopting a pragmatic
stance pursue policies designed to maximize the
national benefits and minimize the national costs.
• According to this view, FDI should be allowed so long
as the benefits outweigh the costs.
• Japan offers an example of pragmatic nationalism.
Until the 1980s, Japan's policy was probably one of
the most restrictive among countries adopting a
pragmatic nationalist stance.
• This was due to Japan's perception that direct entry
of foreign (especially U.S.) firms with ample
managerial resources into the Japanese markets
could hamper the development and growth of their
own industry and technology.
• This belief led Japan to block the majority of
applications to invest in Japan.
Benefits and Costs of FDI
• HOST-COUNTRY BENEFITS
• The main benefits of inward FDI for a host country
arise from resource-transfer effects, employment
effects, balance-of-payments effects, and effects on
competition and economic growth.
• Resource-Transfer Effects
• Foreign direct investment can make a positive
contribution to a host economy by supplying capital,
technology, and management resources that would
otherwise not be available and thus boost that
country's economic growth rate.
Employment Effects
• Direct effects arise when a foreign MNE employs a
number of host-country citizens. Indirect effects arise
when jobs are created in local suppliers as a result of
the investment and when jobs are created because
of increased local spending by employees of the
MNE.
• When Toyota decided to open a new auto plant in
France, estimates suggested the plant would create
2,000 direct jobs and perhaps another 2,000 jobs in
support industries.
• An OECD study found that foreign firms created new
jobs at a faster rate than their domestic counterparts
• In America, the workforce of foreign firms grew by 1.4%
per year, compared with 0.8% per year for domestic
firms
• Foreign firms tended to pay higher wage rates than
domestic firms, suggesting that the quality of
employment was better.
Balance-of-Payments Effects
• The persistent U.S. current account deficit has been
financed by a steady sale of U.S. assets (stocks, bonds,
real estate, and whole corporations) to foreigners.
• First, if the FDI is a substitute for imports of goods or
services, the effect can be to improve the current
account of the host country's balance of payments.
• Much of the FDI by Japanese automobile companies
in the United States and Europe, for example, can be
seen as substituting for imports from Japan.
• A second potential benefit arises when the MNE uses
a foreign subsidiary to export goods and services to
other countries. Much of the dramatic export growth
was due to the presence of foreign multinationals
that invested heavily in China during the 1990s.
• In mobile phones, for example, the Chinese
subsidiaries of foreign multinationals-primarily Nokia,
Motorola, Ericsson, and Siemens-accounted for 95
percent of China's exports.
• Effect on Competition and Economic Growth
• When FDI takes the form of a Greenfield investment,
the result is to establish a new enterprise, increasing
the number of players in a market and thus consumer
choice.
• In turn, this can increase the level of competition in a
national market, thereby driving down prices and
increasing the economic welfare of consumers.
• Such beneficial effects seem to have occurred in the South
Korean retail sector following the liberalization of FDI
regulations in 1996. FDI by large Western discount stores,
including Walmart, Costco, Carrefour, and Tesco, benefit
South Korean consumers.
• FDI's impact on competition in domestic markets may be
particularly important in the case of services, such as
telecommunications, retailing, and many financial services.
• First, inward investment has increased competition and
stimulated investment in the modernization of telephone
networks around the world, leading to better service.
• Second, the increased competition has resulted in lower
prices.
HOST-COUNTRY COSTS
Adverse Effects on Competition
• When a foreign investor acquires two or more firms in a host
country, and subsequently merges them, the effect may be to reduce
the level of competition in that market, create monopoly power for
the foreign firm, reduce consumer choice, and raise prices.
• Hindustan Lever Ltd., the Indian subsidiary of Unilever, acquired
its main local rival, Tata Oil Mills, to assume a dominant position
in the bath soap (75%) and detergents (30%) markets.
• Hindustan Lever also acquired several local companies in other
markets, such as the ice cream makers Dollops, Kwality, and
Milkfood. By combining these companies, Hindustan Lever's
share of the Indian ice cream market went from zero in 1992 to
74 percent in 1997.
HOST-COUNTRY COSTS
Adverse Effects on the Balance of Payments
• First, set against the initial capital inflow that comes
with FDI must be the subsequent outflow of earnings
from the foreign subsidiary to its parent company.
• A second concern arises when a foreign subsidiary
imports a substantial number of its inputs from
abroad, which results in a debit on the current
account of the host country's balance of payments.
• One criticism leveled against Japanese-owned auto
assembly operations in the United States, for example,
is that they tend to import many component parts
from Japan.
HOST-COUNTRY COSTS
National Sovereignty and Autonomy
• Some host governments worry that FDI is
accompanied by some loss of economic
independence.
• The concern is that key decisions that can affect the
host country's economy will be made by a foreign
parent that has no real commitment to the host
country, and over which the host country's
government has no real control.
HOME-COUNTRY BENEFITS
• The benefits of FDI to the home (source) country arise
from three sources. First, the home country's BOPs
benefits from the inward flow of foreign earnings.
• FDI can also benefit the home country's BOPs if the
foreign subsidiary creates demands for home-country
exports of capital equipment, intermediate goods,
complementary products, and the like.
• Second, benefits to the home country from outward FDI
arise from employment effects. As with the BOPs,
positive employment effects arise when the foreign
subsidiary creates demand for home-country exports.
• Thus, Toyota's investment in auto assembly
operations in Europe has benefited both the
Japanese balance-of-payments position and
employment in Japan, because Toyota imports some
component parts for its European-based auto
assembly operations directly from Japan.
• Third, benefits arise when the home-country MNE
learns valuable skills from its exposure to foreign
markets that can subsequently be transferred back to
the home country.
• This amounts to a reverse resource-transfer effect.
• For example, one reason General Motors and Ford
invested in Japanese automobile companies (GM
owns part of Isuzu, and Ford owns part of Mazda)
was to learn about their production processes.
• If GM and Ford are successful in transferring this
know-how back to their U.S. operations, the result
may be a net gain for the U.S. economy.
HOME-COUNTRY COSTS
• First, the BOPs suffers from the initial capital outflow
required to finance the FDI. This effect, however, is usually
more than offset by the subsequent inflow of foreign
earnings.
• Second, the current account of the BOPs suffers if the
purpose of the foreign investment is to serve the home
market from a low-cost production location.
• Third, the current account of the balance of payments
suffers if the FDI is a substitute for direct exports.
• Thus, insofar as Toyota's assembly operations in the United
States are intended to substitute for direct exports from
Japan, the current account position of Japan will
deteriorate.
HOME-COUNTRY COSTS
• FDI is reduced home-country employment.
• One objection frequently raised by U.S. labor leaders
to the free trade pact between the United States,
Mexico, and Canada is that the United States will lose
hundreds of thousands of jobs as U.S. firms invest in
Mexico to take advantage of cheaper labor and then
export back to the United States.

Foreign Direct Investment

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