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Chapter 08 - Foreign Direct Investment
8-1
Foreign Direct Investment
Learning objectives
• Explain the different theories of
FDI.
• Understand how political
ideology shapes a government’s
attitudes towards FDI.
• Identify the implications for
managers of the theory and
government policies associated
with FDI.
The focus of this chapter is foreign direct
investment (FDI). The growth of foreign direct
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,
restrictions on FDI in the retail sector. Several
global retailers have tried to make headway into
India’s retail sector with mixed results. The closing
case describes Walmart’s investment in Japan.
Walmart’s initial venture into Japan has been
8
7
Chapter 08 - Foreign Direct Investment
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OUTLINE OF CHAPTER 8: FOREIGN DIRECT INVESTMENT
Opening Case: Foreign Retailers in India
Introduction
Foreign Direct Investment in the World Economy
Country Focus: Foreign Direct Investment in China
Theories of Foreign Direct Investment
Management Focus: Foreign Direct Investment by Cemex
Political Ideology and Foreign Direct Investment
The Radical View
Management Focus: DP World and the United States
Benefits and Costs of FDI
Host-Country Benefits
Government Policy Instruments and FDI
Home-Country Policies
Host-Country Policies
International Institutions and the Liberalization of FDI
Focus on Managerial Implications
The Theory of FDI
Government Policy
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CLASSROOM DISCUSSION POINT
Ask students for examples of foreign firms that have invested in the U.S. Jot them down
on the board.
OPENING CASE: Foreign Retailers in India
The opening case explores the intense debate in India about the wisdom of relaxing the
country’s restrictions on FDI in the retail sector. Barely 6% of India’s $500 billion dollar
retail sector takes place in organized establishments; the remainder takes place in small
shops typically run by individuals or households. Discussion of the case can revolve
around the following questions:
1. How would global companies help India reduce its expensive logistics expenditures?
2. Why have Indian farmers emerged as strong advocates of FDI? How would this
investment help them get their crops to market faster?
3. Several years ago, Walmart opened up wholesale stores in India in a joint venture with
Bharti, an Indian conglomerate. With 20 stores in operation, the joint venture has
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
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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 and 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.
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.
The flow of FDI refers to the amount of FDI undertaken over a given time period, while
the stock of FDI refers to the total accumulated value of foreign-owned assets at a given
time. Outflows of FDI are the flows of FDI out of a country, and inflows of FDI are the
flows of FDI into a country.
Slides 8-5 through 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.
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Slides 8-11 and 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 8-17 and 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.
According to the eclectic paradigm, in addition to the various factors discussed earlier, it
is important to consider:
• location-specific advantages - that arise from using resource endowments or
Slides 8-19 and 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.
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Recently, there has been a strong shift toward the free market stance creating:
• a surge in FDI worldwide
• an increase in the volume of FDI in countries with newly liberalized regimes
Slides 8-23 and 8-24 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.
Slides 8-26 and 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.
To encourage inward FDI, governments offer incentives to foreign firms to invest in their
countries, while they restrict inward FDI through ownership restraints and performance
requirements.
Chapter 08 - Foreign Direct Investment
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.
CRITICAL THINKING AND DISCUSSION QUESTIONS
QUESTION 1: In 2008, inward FDI accounted for some 63.7% of gross fixed capital
formation in Ireland, but only 4.1% in Japan (gross fixed capital formation refers to
investments in fixed assets such as factories, warehouses, and retail stores). What do you
think explains this 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
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
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QUESTION 3: What are the strengths of the eclectic theory of FDI? Can you see any
shortcomings? How does the eclectic theory influence management practice?
ANSWER: Championed by British economist John Dunning, the eclectic theory of FDI
focuses on location-specific advantages in explaining the rationale and direction of FDI.
QUESTION 4: 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?
ANSWER 4:
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
either need to license a local company or make an investment in the market directly.
QUESTION 5: You are the international manager of a US business that has just
developed 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
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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 5: 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.
CLOSING CASE: Walmart in Japan
Summary
The closing case explores Walmart’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.
Walmart, taking advantage of this shift in policy, acquired a large Japanese retailer in
QUESTION 1: Why, historically, has the level of FDI in Japan been so low?
ANSWER 1: Government regulations have made it difficult for foreign companies to
invest in Japan. Until the 1994, Japanese law made it all but impossible for foreign
Chapter 08 - Foreign Direct Investment
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QUESTION 2: What are the potential benefits to the Japanese economy of greater FDI?
ANSWER 2: Foreign firms can bring competition to Japan where local companies may
QUESTION 3: How might the entry of Walmart into the Japanese retail sector benefit
that sector? Who could lose as a result of Walmart’s entry?
ANSWER 3: Walmart saw the opportunity to help restructure Japan’s retail sector by
boosting productivity, gaining market share, and increasing overall profits. The
QUESTION 4: Why has it been so hard for Walmart to make a profit in Japan? What
might the company have done differently in its early years in Japan?
ANSWER 4: Using its low-priced strategy early on, Walmart brought in cheap Chinese
goods to their Japanese stores, which were perceived by local consumers as poor quality
QUESTION 5: Why did Walmart announce in late 2012 that it would expand its
operations in Japan after opening no new stores in four years?
ANSWER 5: The company has finally adapted to the Japanese retail market, for example,
creating special products that appear to the aging population. Also, Walmart has been
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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: British Foreign Secretary: ‘We Should Be in Europe, But Not Taken
Over by Europe’
Run Time: 8:30
Abstract: This video explores the reaction to Britain’s recent rejection of a debt
resolution agreement for the European Union, and the future of the country within the
trading bloc.
Key Concepts: economic integration, political union, European Union, euro, global
economy, political economy, globalization, global monetary system, global capital
markets
Notes: Britain’s recent decision to reject an agreement aimed at fixing the debt crisis in
Europe and preventing future problems prompted mixed reactions. Some felt that in
This is not the first time that Britain has stood apart from the majority in the European
Union failing to support or adopt policies that could have a negative impact on the
country. Indeed, Britain was one of just two nations that opted out of monetary union in
1993. At that time, Britain raised concerns that participating in the Euro Zone would
compromise its sovereignty and ability to set its own course, something it was not willing
Chapter 08 - Foreign Direct Investment
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Some however, wonder whether Britain’s decision signals its intent to emphasize its own
interests over those of the European Union bloc. This attitude of course would run
Discussion Questions and Answers
1. Discuss the basic idea behind economic integration. What is the European Union?
What advantages does it offer its members? How does Britain’s approach to the euro and
now to debt resolution within the bloc fit into the concept?
Answer: The European Union is an economic and political union. As such, there is free
trade between member countries, a common policy toward non-members, free movement
2. Is Britain isolating itself by not agreeing to work with the rest of the European Union
or is it protecting itself and its sovereignty? Could Britain actually emerge stronger as a
result of this decision?
3. British Foreign Secretary William Hague has stated that Britain should be part of
Europe, but be taken over by Europe. What did he mean by this? Do you agree with
him? Why or why not?
Answer: Many students may argue that Britain sees many of the problems with debt and
financial uncertainty within the European Union as the result irresponsible decisions
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4. Britain, along with France and Germany, were founding members of the European
Union. Consider how the bloc might change if Britain is indeed isolated after its recent
rejection of the fiscal deal.
Answer: Many students will probably note that Germany and France are powerful forces
within the European Union, although not always on the same page. Some may wonder
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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.
Key Words
❖ Ethics and social responsibility
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.
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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?
INCORPORATING globalEDGE™ EXERCISES
Exercise 1
The World Investment Report published annually by UNCTAD provides a summary of
recent trends in FDI as well as quick access to comprehensive investment statistics.
Identify the table of largest transnational corporations from developing and transition
Exercise 1 Answer
Search phrase: largest transnational corporations
Resource Name: UNCTAD: Largest Transnational Corporations
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globalEDGE Category: Rankings
Additional Info:
The ranking of the largest transnational corporations in the world is an annex to the
Exercise 2
An integral part of successful foreign direct investment (FDI) is to understand the target
market opportunities as well as the nature of the risk inherent in possible investment
Exercise 2 Answer
Search phrase: Multilateral Investment Guarantee Agency
Resource Name: Multilateral Investment Guarantee Agency (MIGA)
Additional Info:
The Water and Wastewater Sector Brief can be reached in two ways: (1) By visiting the
Sectors section, choosing Infrastructure, and then clicking on the Water Sector Brief
under that section. (2) Visiting the Resources section, choosing Briefs and Case Studies
on the left menu, and then clicking on the Water link.
