Chapter 08 – Foreign Direct Investment
8-1
Foreign Direct Investment
Learning objectives
• Recognize current trends
regarding FDI in the world
economy.
• Explain the different theories of
foreign direct investment.
• Understand how political
ideology shapes a government’s
attitudes towards FDI.
• Describe the benefits and costs of
FDI to home and host countries.
• Explain the range of policy
instruments that governments use
to influence FDI.
• Identify the implications for
management practice of the
theory and government policies
associated with FDI.
The focus of this chapter is foreign direct
investment (FDI). The growth of foreign direct
investment in the last 25 years has been
phenomenal. FDI can take the form of a foreign
firm buying a firm in a different country, or
deciding to invest in a different country by
building operations there.
With FDI, a firm has a significant ownership in a
foreign operation and the potential to affect
managerial decisions of the operation.
The goal of our coverage of FDI is to understand
the pattern of FDI that occurs between countries,
and why firms undertake FDI and become
multinational in their operations as well as why
firms undertake FDI rather than simply exporting
products or licensing their know-how.
The opening case explores Wal–Mart’s investment
in Japan. Wal-Mart’s initial venture into Japan has
been challenging and has forced the company to
change its approach to better compete with local
retailers and meet the needs of Japanese
consumers. The closing case describes the
international growth of Spain’s Telefonica. Until
the 1990s, Telefonica was a typical state-owned
firm. Today, it has expanded into Latin America
and Europe.
8
7
Chapter 08 – Foreign Direct Investment
8-2
OUTLINE OF CHAPTER 8: FOREIGN DIRECT INVESTMENT
Opening Case: Wal-Mart in Japan
Introduction
Foreign Direct Investment in the World Economy
Trends in FDI
The Direction of FDI
The Source of FDI
The Form of FDI: Acquisitions versus Greenfield Investments
The Shift to Services
Country Focus: Foreign Direct Investment in China
Theories of Foreign Direct Investment
Why Foreign Direct Investment?
The Pattern of Foreign Direct Investment
The Eclectic Paradigm
Management Focus: Foreign Direct Investment by Cemex
Political Ideology and Foreign Direct Investment
The Radical View
The Free Market View
Pragmatic Nationalism
Shifting Ideology
Management Focus: DP World and the United States
Benefits and Costs of FDI
Host Country Benefits
Host Country Costs
Home Country Benefits
Home Country Costs
International Trade Theory and FDI
Government Policy Instruments and FDI
Home Country Policies
Host Country Policies
International Institutions and the Liberalization of FDI
Implications for Managers
The Theory of FDI
Government Policy
Chapter Summary
Critical Thinking and Discussion Questions
Closing Case: Spain’s Telefonica
Chapter 08 – Foreign Direct Investment
8-3
CLASSROOM DISCUSSION POINT
Ask students for examples of foreign firms that have invested in the U.S. Jot them down
on the board.
Then, discuss why these companies invested in the U.S. Try to follow the framework
presented in the text, and refer back to the board during the presentation of the material.
Next, explore what the investment means for the U.S.
OPENING CASE: Wal-Mart in Japan
The opening case explores Wal-Mart’s investment in Japan. For years, Japan has been
relatively closed to significant foreign direct investment, but more recently the
government has changed its policy and actually now encourages inward investment.
Wal-Mart, taking advantage of this shift in policy, acquired a large Japanese retailer in
2002. Wal-Mart’s initial venture into Japan has been challenging and has forced the
company to change its approach to better compete with local retailers and meet the needs
of Japanese consumers. Discussion of the case can revolve around the following
questions:
1. How would you characterize Wal-Mart’s investment in Japan? Why was Japan an
attractive destination for the company?
2. Why did Japan change its position on inward foreign direct investment? How will
Wal–Mart’s investment benefit Japan?
3. Discuss the strategic changes Wal-Mart’s Japanese rivals are making in response to the
entry of Wal-Mart. What does this tell you about the power of Wal-Mart? What changes
has Wal-Mart had to make to attract Japanese consumers? What can Wal-Mart learn
from this experience?
Another Perspective: Wal-Mart’s web site is available at {http://www.walmart.com/}.
LECTURE OUTLINE
This lecture outline follows the Power Point Presentation (PPT) provided along with this
instructor’s manual. The PPT slides include additional notes that can be viewed by
Chapter 08 – Foreign Direct Investment
8-4
clicking on “view”, then on “notes”. The following provides a brief overview of each
Power Point slide along with teaching tips, and additional perspectives.
Slides 8-3-8-4 What Is Foreign Direct Investment?
Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to
produce and/or market in a foreign country. Once a firm undertakes FDI it becomes a
multinational enterprise.
Another Perspective: Each year Fortune magazine publishes a list of the 500 largest
global corporations in the world. Fortune calls its list the “Global 500.” This list can be
accessed at {http://money.cnn.com/magazines/fortune/global500/2011/}. The article
contains an excellent discussion of the role of global firms in the world economy.
FDI can take the form of a greenfield investment where a wholly new operation is
established in a foreign country, or it can take place via acquisitions or mergers with
existing firms in the foreign country.
Slides 8-5-8-10 Trends in FDI
There has been a marked increase in both the flow and stock of FDI in the world
economy over the last 30 years.
While the United States remains a top destination for FDI flows, South, East, and
Southeast Asia, and particularly China, are now seeing an increase of FDI inflows, and
Latin America is also emerging as an important region for FDI.
Another Perspective: In contrast to China and India, Britain and the EU countries in
general are seeing inward FDI drop. A similar trend can be found in the United States.
To learn more about these trends go to
{http://www.businessweek.com/globalbiz/content/feb2010/gb20100224_156946.htm}
Chapter 08 – Foreign Direct Investment
8-5
Slides 8-11-8-12 The Source of FDI
Since World War II, the U.S. has been the largest source country for FDI. The United
Kingdom, the Netherlands, France, Germany, and Japan are other important source
countries.
Slides 8-13-8-14 The Form of FDI: Acquisitions Versus Greenfield Investments
Most cross-border investment is in the form of mergers and acquisitions rather than
greenfield investments.
Slides 8-15-8-16 Why Foreign Direct Investment?
Why do firms choose FDI instead of exporting or licensing? Internalization theory
(also known as market imperfections theory) suggests that licensing has three major
drawbacks.
Slides 8-17-8-18 The Pattern of Foreign Direct Investment
Knickerbocker looked at the relationship between FDI and rivalry in oligopolistic
industries (industries composed of a limited number of large firms) and suggested that
FDI flows are a reflection of strategic rivalry between firms in the global marketplace.
Vernon argued that firms undertake FDI at particular stages in the life cycle of a product
they have pioneered.
According to the eclectic paradigm, in addition to the various factors discussed earlier, it
is important to consider:
Slides 8-19-8-20 Political Ideology and Foreign Direct Investment
Ideology toward FDI ranges from a radical stance that is hostile to all FDI to the non-
interventionist principle of free market economies. Between these two extremes is an
approach that might be called pragmatic nationalism.
Pragmatic nationalism suggests that FDI has both benefits, such as inflows of capital,
technology, skills and jobs, and costs, such as repatriation of profits to the home country
and a negative balance of payments effect.
Chapter 08 – Foreign Direct Investment
8-6
Slides 8-21-8-22 Host Country Benefits of FDI
Government policy is often shaped by a consideration of the costs and benefits of FDI.
There are four main benefits of inward FDI for host countries: resource transfer effects;
employment effects; balance of payments effects, and effects on competition and growth.
Slides 8-23-8-25 Host Country Costs
There are three mains costs from inward FDI for the host country: the possible adverse
effects of FDI on competition within the host nation; adverse effects on the balance of
payments; and the perceived loss of national sovereignty and autonomy.
Slide 8-25 Home Country Benefits
The benefits of FDI for the home country include: the effect on the capital account of the
Slides 8-26-8-27 Home Country Costs
The home country’s balance of payments can suffer from the initial capital outflow
required to finance the FDI; if the purpose of the FDI is to serve the home market from a
low cost labor location; and if the FDI is a substitute for direct exports.
International trade theory suggests that home country concerns about the negative
economic effects of offshore production (FDI undertaken to serve the home market) may
not be valid.
Slide 8-28-8-29 Government Policy Instruments and FDI
Home countries and host countries use various policies to regulate FDI.
Governments can both encourage and restrict FDI
Another Perspective: India has recently revised its regulations regarding FDI raising
Chapter 08 – Foreign Direct Investment
8-7
Slide 8-30 International Institutions and the Liberalization of FDI
The World Trade Organization is trying to establish a universal set of rules designed to promote
the liberalization of FDI.
Slides 8-31-8-33 Implications for Managers
Managers need to consider what trade theory implies, and the link between government
policy and FDI.
The direction of FDI can be explained through the location-specific advantages argument
associated with John Dunning.
CRITICAL THINKING AND DISCUSSION QUESTIONS
QUESTION 1: In 2004, inward FDI accounted for some 24% of the gross fixed capital
formation in Ireland, but only 0.6% in Japan. What do you think explains the difference
in FDI inflows into the two countries?
ANSWER 1: One approach to this question is to look at government policy: Ireland is
QUESTION 2: Compare and contrast these explanations of FDI: internalization theory,
Vernon’s product life cycle theory, and Knickerbocker’s theory of FDI. Which theory do
you think offers the best explanation of the historical pattern of FDI? Why?
ANSWER 2: Knickerbocker’s theory suggests that firms imitate other firms in
oligopolistic industries, and will “follow the leader” in undertaking FDI in certain
countries, as sort of strategic defensive moves. This theory does not explain why the first
Chapter 08 – Foreign Direct Investment
8-8
QUESTION 3: Read the Management Focus on Cemex and then answer the following
questions:
a) Which theoretical explanation, or explanations, of FDI best explains Cemex’s FDI?
b) What is the value that Cemex brings to the host economy? Can you see any potential
drawbacks of inward investment by Cemex in an economy?
c) Cemex has a strong preference for acquisitions over greenfield ventures as an entry
mode. Why?
d) Why do you think Cemex decided to exit Indonesia after failing to gain majority
control of Semen Gresik? Why is majority control so important to Cemex?
e) Why do you think politicians in Indonesia tried to block Cemex’s attempt to gain
majority control over Semen Gresik? Do you think Indonesia’s best interests were served
by limiting Cemex’s FDI in the country?
ANSWER 3:
a) Cemex is a cement company. Consequently, exporting is difficult because of the
weight of the product. If Cemex wants to expand into new markets, the company would
b) Cemex is the third largest cement company in the world, and a powerhouse in Mexico
where it controls 60 percent of the market. Cemex is highly focused on efficient
c) Cemex has successfully acquired established cement makers in many countries. By
d) Much of Cemex’s success appears to be built around its customer service and attention
to distributors. Indeed, it could be argued that what sets Cemex apart from its
e) In 2006, Cemex announced that it would be pulling out of Indonesia. Cemex entered
the Indonesian market in 1998, as part of an IMF sponsored privatization program.
Cemex purchased a 25 percent stake in Semen Gresik, a government owned cement
Chapter 08 – Foreign Direct Investment
8-9
Gresik could learn from Cemex, and utilize its knowledge to improve its own operations.
However, allowing a foreign company to control an industry that is necessary to a
country could be detrimental to the nation.
Another Perspective: Cemex’s web site is available at {http://www.cemex.com}.
QUESTION 4: You are the international manager of a US business that has just invented
a revolutionary new personal computer that can perform the same functions as existing
PCs but costs only half as much to manufacture. Several patents protect the unique
design of this computer. Your CEO has asked you to formulate a recommendation for
how to expand into Western Europe. Your options are (a) to export from the US, (b) to
license a European firm to manufacture and market the computer in Europe, and (c) to set
up a wholly owned subsidiary in Europe. Evaluate the pros and cons of each alternative
and suggest a course of action to your CEO.
ANSWER 4: In considering expansion into Western Europe, an international manager
might consider three options: FDI, licensing, and export. With export, assuming there are
no trade barriers, the key considerations would likely be transport costs and localization.
While transport costs may be quite low for a relatively light and high value product like a
CLOSING CASE: Spain’s Telefonica
Summary
The closing case explores the international growth of Telefonica, a Spanish
telecommunications firm. For decades, Telefonica had operated as a typical state-owned
enterprise, but privatization and deregulation changes that path in the 1990s. Telefonica began to
aggressively pursue expansion opportunities in Latin America where it quickly became the
number 1 or 2 player in nearly every country. Later, Telefonica turned its sights on Europe where
Chapter 08 – Foreign Direct Investment
8-10
its acquisitions helped transform the company into the second biggest mobile phone operator in
the world. Discussion of the case can revolve around the following questions:
QUESTION 1: What changes in the political and economic environment allowed
Telefonica to start expanding globally?
ANSWER 1: Telefonica began as a state-owned company, but was privatized in the
1990s when Spain deregulated its telecommunications market. Privatization placed new
QUESTION 2: Why did Telefonica initially focus on Latin America? Why was it
slower to expand in Europe, even though Spain is a member of the European Union?
ANSWER 2: Telefonica initially focused on Latin America because the market was
growing rapidly and more people were using mobile phones and Internet connections. In
QUESTION 3: Telefonica has used acquisitions rather than greenfield ventures as its
entry strategy. Why do you think this has been the case? What are the potential risks
associated with this entry strategy?
ANSWER 3: Many students will probably attribute Telefonica’s preference for
expansion via acquisition as opposed to greenfield ventures to speed to market. By
QUESTION 4: What is the value that Telefonica brings to the companies that it acquires?
ANSWER 4: Telefonica is the second largest mobile phone operator in the world. Most
students will probably recognize that this gives Telefonica considerable power in the
Chapter 08 – Foreign Direct Investment
8-11
QUESTION 5: In your judgment, does inward investment by Telefonica benefit a host
nation? Explain your reasoning.
ANSWER 5: Most countries typically welcome investment by companies. Such
investments usually bring new jobs, capital, and other benefits like infrastructure
improvements and technology to the host country. Most students will probably agree that
INTEGRATING iGLOBES
There are several iGLOBE video clips that can be integrated with the material presented
in this chapter. In particular, you might consider the following:
Title: Ireland’s New Leader Wrestles With Lingering Debt Problems, EU
Bailout
Run Time: 5:23
Abstract: This video explores the efforts of Ireland’s new Prime Minister Enda Kenny
to jump start the nation’s economic recovery and reestablish the country as an attractive
destination for investment.
Key Concepts: European Union, economic integration, political economy, foreign
direct investment, country risk, global economy, euro, International Monetary Fund,
globalization
Notes: Just eight days into the job, Ireland’s new Prime Minister Enda Kenny, was
already meeting with U.S. President Barack Obama in the hopes of drumming up new
investment from U.S. firms. Enda Kenny takes on the role of Irish Prime Minister
following a complete collapse of the country’s economy. After growing rapidly for more
than a decade and becoming a poster child for economic success, Ireland suddenly found
itself back in economic chaos in 2008 when its speculative real estate market burst, and it
Chapter 08 – Foreign Direct Investment
8-12
banks were on the brink of collapse. In fact, the country’s banks survived only because
the government pumped billions of euros into the system in order to avert total disaster.
Even so, Ireland was forced to ask for a bailout from the European Union and the
International Monetary Fund. Now the hope is that new leadership will help give Ireland
a new lease on life and a chance to make a comeback.
During its boom years in mid-1990s, Ireland was the place to be. Some 600 U.S.
multinationals made investments in the country and brought with them the jobs, capital,
and technology that helped make the country an economic success. After the country’s
financial crisis though, investment flows slowed and even reversed. Now, Enda Kenny
wants to attract more firms. Kenny sees increased foreign investment as being a vital
component in the country’s effort to recover from its financial disaster and to that end,
has been firm that the relatively low 12.5 percent corporate tax rate for foreign investors
will remain unchanged. In addition, Kenny is keen to restore Ireland’s international
reputation, and is insistent that Ireland will work with U.S. companies that invest in the
country. Kenny promises that companies making investments will not be disappointed.
Other countries in the European Union however are not happy with Ireland’s courting of
U.S. firms. France and Germany would like to see Ireland’s corporate tax rate higher.
They believe that currently it is too low, and effectively gives Ireland’s a competitive
advantage when it comes to attracting foreign direct investment. While Ireland has
maintained that it will not change the rate, it also knows that it cannot isolate itself from
other countries in the bloc because it is relying on them for financial assistance. In fact,
Ireland is hoping that the European Union will agree to a lower interest rate on its bailout
package, a rate Kenny feels is necessary if Ireland is to kick-start its economic recovery.
Analysts agree that it is in the best interests of the rest of the European Union to ensure
Ireland’s financial and economic stability in order to prevent downward pressure on the
euro, but so far, Germany and France are demanding some sort of quid pro quo.
Discussion Questions:
1. Comment on the controversy over Ireland’s corporate tax rate for foreign investors.
Why is it so important for Ireland to maintain its current rate? What are the benefits to
Ireland of foreign direct investment?
2. In your opinion, does the 12.5 percent tax rate give Ireland an unfair competitive
advantage? How do other European Union countries view the situation?
3. Reflect on the drawbacks associated with economic integration. How is the debate
between Ireland and other European Union countries over its corporate tax rate been
influenced by the fact that the countries are all part of the trading bloc?
4. How would you describe the current investment climate in Ireland? Why does Ireland
need investment from U.S. companies?
Chapter 08 – Foreign Direct Investment
8-13
INTEGRATING VIDEOS
There are also several longer video clips that can be integrated with the material
presented in this chapter. In particular, you might consider the following from
International Business DVD Volume 6:
Title: Google Leaves China after Cyber Attacks
Learning Objectives
The purpose of this video is to help you:
❖ Explore the ethical dilemmas facing companies as they operate in foreign markets.
❖ Define political risk and identify the macro and micro risks that companies face in
China.
❖ Understand foreign direct investment and recognize what makes a country an
attractive destination for investment.
❖ Recognize the impact of foreign companies on the host country.
Key Words
❖ Ethics and social responsibility
❖ Foreign direct investment
❖ Impact of the multinational company on the host country
❖ Political risk
❖ Political economy
❖ Globalization
Synopsis
After a string of cyber attacks on the email accounts of several prominent human rights
activists, Google, the world’s most powerful Internet company, made the decision to
close its search engine units in China and move them offshore to Hong Kong. While
Secretary of State Hillary Clinton demanded a full investigation of the attacks by Chinese
authorities, Google announced that it had stopped censoring its search engine services
which meant that it would automatically be banned from operating inside the country.
The decision to leave the market was not an easy one. With its 384 million users, China
was Google’s largest market.
The relationship between Google and the Chinese government has been fraught with
tension from the beginning. In order to gain permission to enter the market in the first
place, Google had to agree to limit access to controversial subjects including the
Tiananmen Square incident and the Tibet protests. For a company like Google that
promotes a ‘don’t be evil” value system, this was not an easy compromise, and a promise
that became impossible to keep once Chinese spies hacked into its system. Now, Chinese
citizens, much to the surprise of the government, are protesting the move. Users like
Michael Yao, a Harvard-educated Internet junkie who claims to spend some ten hours a
day online, say that without Google, they cannot live a modern life.
Chapter 08 – Foreign Direct Investment
8-14
Google insists that it did not want to leave the country, especially given the enormous
growth potential in the market, but after the cyber attacks it was left with no other choice.
Google is not alone in its battle with the Chinese government. Other Internet companies
like Twitter, Facebook, and YouTube are also blocked, and some twenty other companies
were also attacked at the same time as Google. Now, one is left to wonder what the cost
of operating in China really is.
Discussion Questions
1. Consider the ethics involved in Google’s decision to initially enter, and then later exit,
China. Why do you think Google agreed to censor its search results in China? Do you
agree with its decision to move its operations to Hong Kong?
2. What does Google’s decision to move its operations out of China mean to Chinese
citizens? Did Google have a moral obligation to maintain its operations in the country?
What were the social consequences of Google’s decision to pull out?
3. Reflect on the need for country risk assessments and discuss the risks involved in
entering a market where the government is hostile to foreign companies. How should
firms assess the risk involved? What variables do you think Google considered when
entering China?
4. What can other companies considering entering China learn from Google’s experience
in the market?
INCORPORATING globalEDGE™ EXERCISES
Use the globalEDGE™ site {http://globalEDGE.msu.edu/} to complete the following
exercises:
Exercise 1
The World Investment Report published annually by UNCTAD provides quick electronic
access to comprehensive statistics on the operations of the largest transnational
corporations. Gather a list of the top 10 non-financial transnational corporations from
developing countries. Provide a summary of the countries and industries represented. Do
you notice any common traits from your analysis?
Exercise 2
An integral part of successful foreign direct investment (FDI) is to understand the target
market as well as the nature of the possible investment sector. As such, your energy
company is seeking FDI opportunities in Jordan. The Multilaterial Investment Guarantee
Agency has been identified as a resource to examine the energy industry internationally.
Chapter 08 – Foreign Direct Investment
8-15
Based on the information available at this resource, prepare a report indicating recent and
important trends relevant to a possible FDI venture in Jordan.
Answers to Exercises
Exercise 1
The data source can be accessed by searching the term “World Investment Report” at
http://globaledge.msu.edu/ResourceDesk/. The link to the World Investment Report is
Exercise 2
The FDI.net website provides FDI information for emerging markets around the world.
This resource can be accessed by searching “Multilaterial Investment Guarantee Agency”