3. Foreign direct investment and multinational enterprises

1. COURSE: Globalisation and multinational enterprises 3. Foreign direct investment and multinational enterprises

2. What matters… • Where do you trade? (No. and type of markets) • Who trades with you? (size and technological development of yr partners) • What do you trade? (hi-tech, low-tech, type of services) • HOW DO YOU TRADE? (export, MNE,…) Access to • Markets (size, growth) • resources, cheaper inputs • knowledge, innovation cooperation

3. Motivation discussion • Foreign direct investment has been one of the key features of globalisation along with the actual activities of MNCs in the host-country markets • What are the driving forces of globalisation? • What are the expected consequences of FDI flows and multinational activity? • How important are MNCs in global trade? • How important are FDI/MNC in the times of economic crises?

4. Outline • Definition of FDI • Definition of multinational enterprises • Descriptive statistics • Dynamics and trends of FDI • Causes and consequences

5. Definitions • “a category of international investment that indicates an intention to acquire a lasting interest in an enterprise operating in another economy. It covers all financial transactions between the investing enterprise and its subsidiaries abroad” (European Commission) • “an investment involving a long-term relationship and reflecting a lasting interest and control of a resident entity in one economy in an enterprise resident in an economy other than that of the investor” (UN)

6. Definitions • practical definition: usually ownership of at least 10% of the ordinary shares of a foreign establishment (UN, IMF, EU, US) • “A multinational enterprise is one that owns/controls and manages production establishments located in at least two countries” (Caves, 1996)

7. Definitions • What is not FDI? • non-equity investments (debt) • Portfolio investment: investment involves the exchange of equity with the aim of attaining a return on the invested capital, not to achieve any form of control • Licensing production/technology rights to another company abroad • Strategic alliances

8. Types of foreign direct investment • By activity • horizontal FDI • similar plants at the same stage of the production process located in different national markets • “market seeking investment” • vertical FDI • plants produce at adjacent stages of a vertically related set of production processes • “natural resource seeking investment” • diversified FDI • plants’ outputs are not related to each other • risk diversification

9. Types of foreign direct investment • By investment strategy • greenfield investment • market entry by establishing a completely new plant • mergers and acquisition • market entry by acquiring an existing plant • joint venture • market entry by forming a new enterprise with a foreign partner

10. Components of FDI flows inflow outflow Foreign affiliate Parent Parent sells, or reduces its stake in, an existing affiliate Parent establishes, or increases its stake in an existing affiliate Equity Capital Affiliate repays part or all of a loan received from parent Parent extends a loan to its affiliate Source: US Bureau of Economic Analysis Intercompany debt Affiliate extends a loan to its parent Parent repays part or all of a loan received from its affiliate Affiliate suffers losses, or pays dividends to its parent in excess of the parent’s share of that profit Reinvested Earnings Affiliate earns profit and does not pay dividends in excess of the parent’s share

11. Measurement of FDI • Measuring FDI through the balance of payments (capital account) • Capital transfer between parent and foreign affiliate • Issue of ultimate ownership is problematic

12. Who is the “owner”? Country A Country B owns Firm 1 Firm 2 Country C owns Firm 3

13. Other measures • Activities of MNEs • sales, value added, employment, assets, numbers • direct measure of activity by foreign affiliate • overestimate foreign influence as affiliates may be only partly foreign owned • Measures of M&As • Transnationality Index

14. Descriptive statistics FDI inflows, global and by groups of economies, 1980-2008

15. Selected indicators of FDI and international production, 1982-2008

16. Descriptive statistics • Global FDI reached an all time high in 2007 (previous high was in year 2000), but decline substantially in 2008, prolong declining in 2009 • 2007: Compared to 2006, FDI experienced a 30% growth rate in US dollar terms and a 23% increase in terms of local currencies; • 2008; a decline of globalFDI flows by 29% in developed econimies but growth in CIS (26%) & CEE (17%), 2009 30%-50% fallin developed, up to 30% in developing • A recovery in 2010, an acceleration expected in 2011; • Profitability of MNCs also increase greatly in 2007, (since 2002), but decreased in 2008 and in 2009 • Mostly MNCs retained good financial health despite a crysis in the world financial markets

20. Descriptive statistics • Strong economic growth and availability of credit before 2008 allow for an increase in cross-border M&A activity, huge decrease afterwards

22. M&As declined  • Equity investments • Lower profits • Lower reinvestred earnings • Repayment od external loans; intra-company loans declined or turned negative

23. Key factors impacting on FDI WhileGreenfield FDI data cannot be compared directly with official FDI flows data(fDi Inteligence unit) - Greenfield data tracks the totalamount companies are investing overseas, not only the proportion which crosses-borders as FDI flows - the factors impacting on global FDI are broadly the same: • At macro-level, FDI is closely correlated to GDP and GDP growth, a decline in GDP growth has been associated in world recessions with a decline in FDI • Decline in the volume and value of M&A deals has a major impact on overall FDI numbers. Decline in stock markets results in deal values being lower. A lower volume of M&A deals over time also reduces Greenfield FDI as less firms become foreign-owned • The financial crisis reduces funding sources available for all FDI

24. Global FDI trends – Greenfield projects • Most governments around the world measure their success in attracting FDI by the number of projects they attract • Productive capital investment and job creation only take place if new projects are attracted or current projects are expanded • Project numbers peaked in Q2 2008 and have decline since Source: fDi Markets database from fDi Intelligence, Financial Times Ltd

25. Global FDI trends – Greenfield investment • Trends in the capital investment by companies in their new and existing subsidiaries overseas broadly mirrors that of FDI project trends • However, we can see that capital investment has declined much more steeply in the recession than project numbers • Q3 2009 was the first quarter showing recovery in investment Source: fDi Markets database from fDi Intelligence, Financial Times Ltd

26. Global FDI trends – projects in 09 vs 08 • At the start of 2009, the FT forecast a 14-15% decline in Greenfield FDI projects in 2009. The actual is 17% Source: fDi Markets database from fDi Intelligence, Financial Times Ltd

27. Global FDI trends – investment in 09 vs 08 • There has been a 36% decline in Greenfield capital investment YTD • This is driven by the decline in capital intensive construction projects • However, there has still been $0.75 trillion of Greenfield FDI YTD Source: fDi Markets database from fDi Intelligence, Financial Times Ltd

28. Global FDI trends – job creation in 09 vs 08 • There has also been a 36% decline in Greenfield FDI jobs YTD, driven by major declines in the global manufacturing and construction sectors • Note that there still has been 2 million new jobs announced in 2009 Source: fDi Markets database from fDi Intelligence, Financial Times Ltd

29. Regional trends – Greenfield projects • Decline in FDI most markets • Biggest decline in Rest of Europe - by 40% Source: fDi Markets database from fDi Intelligence, Financial Times Ltd

30. Regional trends – Greenfield investment • Decline in all markets • Biggest decline in Rest of Europe and Africa • Smallest decline in LAC Source: fDi Markets database from fDi Intelligence, Financial Times Ltd

31. Regional trends

35. MNEs • World’s largest TNCs • In 2005, 2006 and 2007 100 of the largest TNCs accounted for 10%, 16% and 12%, respectively, of the estimated foreign assets, sales and employment of all TNCs across the world • Geographical shift • FDI has shifted in sectoral composition towards service sectors, most notably telecommunications, electricity and water services • Many TNCs have lately become involved in infrastructure development since those sectors have been liberalised.

36. Regional decomposition • Investors based in non-OECD countries now account for 25% of international M&A activity, up from 4% in 2000 • FDI into the OECD area has declined by almost 70% over the past 2 years. OECD, March,2010

38. Sectoral decomposition

39. Sectoral decomposition

40. Transnationality index • Composed of three ratios • foreign assets/total assets • foreign sales/total sales • foreign employment/total employment • measures the degree of international involvement from a number of perspectives: • Operations of the firm; • Stakeholders ; • Spatial organisation of management. • Internationalization index • Ratio of TNC’s foreign to total affiliates • Index of Geographical Spreading

42. Transnationality index

44. Motivation

45. Number of parent corporations and foreign affiliates in economy Source: WIR 2003

46. Motivation

47. Determinants of FDI • Firm characteristics why a firm would choose to servicea foreign market through affiliate production, rather than other options such as exporting orlicensing arrangements; • Intangible assets (R&D intensity and advertising intensity serve as proxies) • Country and industry-level characteristics why does a firm choose a specific market/specific country

48. Determinants of FDI • Country and industry-level characteristics • Changes in the bilateral level of exchange rates (depretiation increases FDI); • Exchange rate variability (exchange rate uncertainty reduces FDI); • Taxes (higher taxes discourage FDI), depending on the type of taxes

49. Determinants of FDI • Institutions quality of institutions as a determinant of the quantity of FDI inflows • protection of property rights; • price of doing business; • administrative restrictions • Institutions are difficult to measure and effects of different institutions are difficult to disentangle. • trade protection higher trade protection leads to more foreign direct investment (tariff-jumping FDI);

50. Determinants of FDI • trade effects FDI is either considered a substitute or there is a natural progression from arms-length trade to foreign-based production demand in foreign markets increases • gravity determinants • distance; • size of the foreign markets and the domestic market; • platfrom FDI