CHAPTER 7
FOREIGN DIRECT INVESTMENT
LEARNING OBJECTIVES:
7.1 Describe the worldwide pattern of foreign direct investment (FDI).
7.2 Summarize each theory that attempts to explain why FDI occurs.
7.3 Outline the important management issues in the FDI decision.
7.4 Explain why governments intervene in FDI.
7.5 Describe the policy instruments that governments use to promote and restrict FDI.
CHAPTER OUTLINE:
Introduction
Pattern of Foreign Direct Investment
Ups and Downs of FDI
Globalization
Mergers and Acquisitions
Worldwide Flows of FDI
Theories for Foreign Direct Investment
International Product Life Cycle
Market Imperfections (Internalization)
Trade Barriers
Specialized Knowledge
Eclectic Theory
Market Power
Management Issues and Foreign Direct Investment
Control
Partnership Requirements
Benefits of Cooperation
Purchase-or-Build Decision
Production Costs
Rationalized Production
Mexico’s Maquiladora
Cost of Research and Development
Customer Knowledge
Following Clients
Following Rivals
Why Governments Intervene in FDI
Balance of Payments
Current Account
Capital Account
Reasons for Intervention by the Host Country
Control Balance of Payments
Obtain Resources and Benefits
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Access to Technology
Management Skills and Employment
Reasons for Intervention by the Home Country
Government Policy Instruments and FDI
Host Countries: Promotion
Financial Incentives
Infrastructure Improvements
Host Countries: Restriction
Ownership Restrictions
Performance Demands
Home Countries: Promotion
Home Countries: Restriction
Bottom Line for Business
Foreign Direct Investment in Europe
Foreign Direct Investment in Asia
A comprehensive set of specially designed PowerPoint slides is available for use
with Chapter 7. These slides and the lecture outline below form a completely integrated
package that simplifies the teaching of this chapter’s material.
Lecture Outline
I. INTRODUCTION
Foreign direct investment (FDI) is the purchase of physical assets or a significant
amount of the ownership (stock) of a company in another country to gain a
measure of management control. It differs from portfolio investment—an
investment that does not involve obtaining a degree of control in a company. Most
governments set the threshold for an investment to be called FDI at anywhere
from 10 to 25 percent of stock ownership in a company abroad—the U.S.
Commerce Department sets it at 10 percent.
II. PATTERN OF FOREIGN DIRECT INVESTMENT
A. Ups and Downs of FDI
FDI inflows grew around 20 percent per year in the first half of the 1990’s
and expanded about 40 percent per year in the second half of the decade.
Global FDI inflows averaged $548 billion annually between 1994 and
1999. FDI inflows peaked at around $1.4 trillion in 2000 and then slowed.
FDI inflows benefitted from strong economic performance and high
corporate profits in many countries between 2004 and 2007, at which
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2015 whereby developing economies attracted less FDI (44 percent
of the world total) than developed nations did (55 percent).
3. FDI inflows to developing nations were mixed, with China
attracting most in Asia and India attracting a fair amount.
4. Outflows of FDI from developing Asian nations is also rising,
coinciding with the rise of these nations’ own global competitors.
Elsewhere, all of Africa drew in $54 billion of FDI in 2015, or
about 2 percent of the world’s total. FDI flows into Latin America
and the Caribbean $168 billion, or nearly 10 percent of the total
world FDI.
III. THEORIES OF FOREIGN DIRECT INVESTMENT
A. International Product Life Cycle
1. States a company will begin by exporting its product and later
2. In the new product stage, a good is produced entirely in the home
market. In the maturing product stage, a good is produced in the
3. Yet the international product life cycle theory does not explain
why companies choose FDI over other forms of market entry.
B. Market Imperfections (Internalization)
When an imperfection in the market makes a transaction less efficient, a
1. Trade barriers
a. A trade barrier such as a tariff is a common market
2. Specialized knowledge
a. A unique competitive advantage may consist of specialized
knowledge, technical expertise, or special marketing
abilities.
b. Companies charge fees for product knowledge, but when a
company’s specialized knowledge is embodied in its
employees, the only way to exploit an opportunity may be
FDI.
c. A company may undertake FDI if charging another
company for access to its knowledge might create a future
competitor.
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C. Eclectic Theory
1. States that firms undertake foreign direct investment when the
2. A location advantage is the advantage of locating a particular
3. An ownership advantage is the advantage that a company has due
4. An internalization advantage is the advantage that arises from
internalizing a business activity rather than leaving it to a relatively
inefficient market.
D. Market Power
1. The market power theory states that a firm tries to establish a
3. Companies can gain market power through vertical integration—
the extension of activities into production that provide a firm’s
inputs (backward integration) or absorb its output (forward
integration).
IV. MANAGEMENT ISSUES AND FOREIGN DIRECT INVESTMENT
A. Control
Many companies invest abroad because they wish to control activities in
the local market (e.g., to ensure the selling price remains the same across
markets). Yet complete ownership does not guarantee control.
1. Partnership requirements
a. Many companies have strict policies regarding how much
2. Benefits of cooperation
a. Greater harmony exists today between governments and
international companies. Developing nations and emerging
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c. Cooperation can open communication channels to maintain
positive relationships in the host country.
B. Purchase-or-Build Decision
1. The purchase-or-build decision of managers entails deciding
2. An acquiring firm may benefit from the goodwill the existing
company has built over the years and, perhaps, brand recognition
3. Factors that reduce the appeal of purchasing existing facilities are
4. Adequate facilities are sometimes unavailable and a company must
go ahead with a Greenfield investment. Greenfield investments
have their own drawbacks—obtaining the necessary permits and
financing and hiring local personnel can be difficult in some
markets.
C. Production Costs
Labor regulations increase the hourly cost of production, and benefits
packages and training programs add to wage costs. Although the cost of
land and tax rate on profits can be lower locally, they may not remain
constant.
1. Rationalized production
a. Production in which components are produced where the
2. Mexico’s maquiladora
a. The 130-mile-wide strip along the U.S.–Mexican border.
b. Low-wage regional economy next to a prosperous giant is a
3. Cost of research and development
a. Cost of developing subsequent stages of technology has led
to cross-border alliances and acquisitions.
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R&D appears to be spurred by supply factors such as
access to high-quality scientific and technical human
capital.
D. Customer Knowledge
1. The behavior of buyers is an important issue in the decision of
2. Some countries have quality reputations in certain product
categories that make it profitable to produce there.
E. Following Clients
1. FDI puts companies near those firms they supply. “Following
clients” occurs in industries in which component parts are obtained
from suppliers with whom a manufacturer has a close working
relationship.
F. Following Rivals
1. FDI decisions resemble a “follow the leader” scenario in industries
with a limited number of large firms.
2. Many firms believe that not making a move parallel to that of the
“first mover” might result in being shut out of a lucrative market.
V. GOVERNMENT INTERVENTION IN FOREIGN DIRECT INVESTMENT
Nations enact laws, create regulations, or construct administrative hurdles for
foreign companies. A bias toward protectionism or openness is rooted in a
nation’s culture, history, and politics. But FDI tends to raise output and enhance
standards of living. Besides philosophical ideals, countries intervene in FDI for
practical reasons.
A. Balance of Payments
1. National accounting system that records all payments to entities in
other countries and all receipts coming into the nation.
2. International transactions that result in payments (outflows) to
3. International transactions that result in receipts (inflows) from
4. Current account
a. National account that records transactions involving the
import and export of goods and services, income receipts
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5. Capital account
a. National account that records transactions involving the
purchase or sale of assets.
b. Financial assets such as stocks and bonds and physical
assets such as investments in plants and equipment.
B. Reasons for Intervention by the Host Country
1. Control balance of payments
a. Many governments see intervention as the only way to
keep their balance of payments under control.
b. Host countries get a balance-of-payments boost from initial
FDI flows. Local content requirements can lower imports,
providing an added balance-of-payments boost. Exports
from the FDI can further help the balance-of-payments
position.
c. When companies repatriate profits, they deplete the foreign
exchange reserves of their host countries; these capital
2. Obtain resources and benefits
a. Access to technology
Nations encourage FDI in technology because it increases
3. Reasons for Intervention by the Home Country
There are fewer concerns regarding the outflow of FDI among home
nations because they tend to be prosperous, industrialized nations.
1. Reasons for discouraging outward FDI
a. Investing in other nations sends resources out of the home
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2. Reasons for promoting outgoing FDI
a. Outward FDI can increase long-run competitiveness (e.g.,
partnering as a learning opportunity).
b. Nations may encourage FDI in industries that use obsolete
technology or employ low-wage workers with few skills.
VI. GOVERNMENT POLICY INSTRUMENTS AND FOREIGN DIRECT
INVESTMENT
A. Host Countries: Promotion (See Table 7.2)
1. Financial incentives
a. Host governments commonly offer tax incentives or low–
2. Infrastructure improvements
a. Lasting benefits for communities surrounding the
investment location can result from local infrastructure
improvements—better seaports for containerized shipping,
improved roads, and increased telecommunications
systems.
B. Host Countries: Restriction (See Table 7.2)
1. Ownership restrictions
a. Governments impose ownership restrictions that prohibit
2. Performance demands
a. Some performance demands dictate the portion of a
product’s content that originates locally, stipulates the
portion of output that must be exported, or requires that
certain technologies be transferred to local businesses.
C. Home Countries: Promotion (See Table 7.2)
1. Offer insurance to cover the risks of investments abroad.
3. Offer tax breaks on profits earned abroad or negotiate special tax
treaties.
4. Apply political pressure on other nations to get them to relax their
restrictions on inbound investments.
D. Home Countries: Restriction (See Table 7.2)
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2. Impose sanctions that prohibit domestic firms from making
investments in certain nations.
VII. BOTTOM LINE FOR BUSINESS
This chapter presents foreign direct investment (FDI). Like trade decisions, many
factors influence a company’s decision about whether to invest in markets abroad.
Depending on the philosophy of home or host nations and the impact of FDI on
their economic health, a firm can be encouraged or dissuaded to invest in a nation.
A. Foreign Direct Investment in Europe – FDI inflows into the developing
(transition) nations of Southeast Europe and the Commonwealth of
Independent States hit an all-time high in 2008. The main reason for the
B. Foreign Direct Investment in Asia – China attracts the majority of Asia’s
FDI, luring companies with a lower-wage workforce and access to an
Quick Study Questions
Quick Study 1
1. Q: The purchase of physical assets or significant ownership of a company abroad
to gain a measure of management control is called what?
2. Q: What are the main drivers of foreign direct investment flows?
3. Q: Why might a company engage in a cross-border merger or acquisition?
(4) to reduce costs of research and development, production, distribution, and so
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2. Q: A system in which a product’s components are made where cost of producing a
component is lowest is called what?
3. Q: What do we call the situation in which a company engages in FDI because the
firm it supplies has already invested abroad?
Quick Study 4
1. Q: The national accounting system that records all receipts coming in to a nation
and all payments to entities in other countries is called what?
2. Q: Why might a host country intervene in foreign direct investment?
(1) They may want access to technology. Nations encourage the import of
technology because it tends to increase the productivity and competitiveness of
3. Q: Why might a home country intervene in foreign direct investment?
Copyright © 2019 Pearson Education, Inc.
Quick Study 5
1. Q: What policy instruments can host countries use to promote FDI?
2. Q: What policy instruments can home countries use to promote FDI?
3. Q: Ownership restrictions and performance demands are policy instruments used
by whom to do what?
4. Q: Differential tax rates and sanctions are policy instruments used by whom to do
what? A: Home countries may try to restrict FDI by using differential tax rates and
Ethical Challenge
You are the U.S. senator deciding whether to vote yes or no on a new legislation. The
potential new law places restrictions on the practice of outsourcing work to low-wage
countries and is designed to protect U.S. workers’ jobs. These days it is increasingly
common for companies to promise manufacturing contracts to overseas suppliers in
exchange for access to that country’s market. Labor union representatives argue that
these kinds of deals cost jobs as factories close and parts are made in lower cost China.
They also say that the transfer of technology will breed strong competitors in other
nations and thereby threaten even more jobs at home in the future. Yet, others argue that
market access will translate to increased sales of products mad at home and, therefore
create new jobs at home.
A. 7-5 Do you think companies bear an ethical burden when the contract
production to factories abroad and reduce jobs at home? Students responses
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Practicing International Management Case
World Class in the Deep South
7-19 Q: What are the pros and cons of Mercedes’ decision to abandon the culture and
some of its home country practices?
7-20 Q: What do you think were the chief factors involved in Mercedes’ decision to
undertake FDI in the United States rather than build the M-class in Germany?
A: Mercedes chose the United States over Germany because U.S. labor costs were
7-21 Q: Why do you think Mercedes decided to build the plant from the ground up in
Alabama rather than buying an existing plant in, say, Detroit? List as many
reasons as you can and explain your answers.
A: First, Mercedes probably chose to build from the ground up because existing