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Foreign Direct Investment

Foreign Direct Investment. Discussion Section February 16, 2007 Brian Chen. Agenda. Administrative Index cards Starbucks FDI case due Word on section participation Review Political Economy of FDI Concepts/Definitions

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Foreign Direct Investment

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  1. Foreign Direct Investment Discussion Section February 16, 2007 Brian Chen

  2. Agenda • Administrative • Index cards • Starbucks FDI case due • Word on section participation • Review • Political Economy of FDI • Concepts/Definitions • Application: Chinese Corporations Law relating to wholly foreign-owned enterprises • Foreign Direct Investment • (Time permitting) • Concepts/Definitions

  3. Review • International Trade • “Chicago school” economists tend to favor free trade • But there are political and economic grounds to governments to intervene to check absolute free trade • These tools include: • Tariffs, subsidies, quotas, administrative policies, local content requirement, antidumping policies • Boeing v. Airbus • Both received government subsidies: One direct, one indirect, and the question is whether one form is worse than the other • Also, there may be room to argue whether there are acceptable political and economic grounds for government intervention in these industries

  4. Chapter 8 • The Political Economy of Foreign Direct Investment

  5. Political Economy of FDI: Outline • Three Views • Radical View • “Imperialist” extraction of host country wealth • Implication: Always bad for the host country • Free Market • Different countries have different comparative advantages; best to allow countries to engage activities for which they do so most efficiently • Implication: Always good when countries are specializing in activities for which they have a comparative advantage • Pragmatic Nationalism • Belief that FDI has costs and benefits, and whether to engage in FDI depends on whether the benefits exceed the cost • What are the costs and benefits to the host country? • Benefits • Costs

  6. FDI: Benefits to the Host Country • Resource Transfer Effects • Capital • MNE invests capital in foreign markets • Technology • Research supports that MNEs do transfer technology when they invest in a foreign country • Management • When MNEs invest and manage in a foreign country, they often transfer management skills to the host country’s workforce • Employment Effects • MNEs, by investing in foreign countries, can create employment opportunities for the local workforce • But: Acquisition vs. Greenfield Investment • Balance of Payment Effects • Balance of Payment: A country’s balance-of-payment is the difference between the payments to and receipts from other countries • FDI can have beneficial and negative effects on a country’s balance of payment. We look at the beneficial effects next • Effect on Competition • Efficient functioning of markets require adequate level of competition between producers

  7. FDI: Benefits to Host Country’s Balance of Payment • Initial Capital Inflow • When a company invests in a foreign country, it brings capital into that country • Substitute for Imports • To the extent that the goods/services produced by the FDI substitute for imported goods/services, there is a positive effect on B-of-P • Inflow of payments from export of goods and services • To the extent that the goods/services produced by the FDI are exported to another country, there is a positive effect on the host country’s B-of-P

  8. FDI: Costs to Host Countries • Adverse Effects on Competition • MNEs may have “too much” power and kill off competition • Adverse Effects on Balance of Payments • After initial inflow of capital, subsequent outflow of capital from the earnings of the FDI • FDI may import inputs from abroad • National Sovereignty and Autonomy • Key decisions that affect the host country’s economy may be made by a foreign parent that has no real commitment to the host country

  9. FDI: Benefits & Costs to Home Country • Benefits • Stream of income from foreign earnings • FDI may import intermediate goods or inputs for production from the home country, creating jobs • MNEs may learn skills from exposure to foreign countries • Costs • Balance of payment: • Initial capital outflow (but often set off by future stream of foreign earnings) • Current account suffers if FDI is to serve home market from low-cost production location • Current account suffers if FDI is a substitute for direct export • Employment effects: • FDI a substitute for domestic production (e.g., Etch-A-Sketch)

  10. Government Policy Instruments and FDI: Host Country Policies • Encouraging Inward FDI • Tax concessions • Low-interest loans • Grants • Subsidies • Restricting Inward FDI • Ownership restraints • Exclusion from certain industries • Why do so? • To protect national interest (defense, etc) • To facilitate resource-transfer • Performance requirements • Local content, exports, technology transfer, and local participation in top management

  11. Government Policy Instruments and FDI: Home Country Policies • Encouraging Outward FDI • Insurance programs to cover major types of foreign investment risks • Special funds or banks to make government loans • Political influence to persuade host countries to relax restrictions on inbound FDI • Restricting Outward FDI • Limit capital outflows • Manipulate tax rules to encourage investment at home • Outright prohibition from investing in certain countries

  12. Chinese Law on WOFC • What type of FDI did Starbucks engage in (in Thailand)? • Acquisition? Greenfield? • Horizontal? Vertical? • Wholly owned subsidiary? Joint Venture? • Suppose Starbucks invested in China instead, with the same facts. Does this law apply to your firm? • What are the articles of law that protect the host country? • What are they trying to protect? • What are the article of law that protect the foreign investor? • Why are they important to you? • How would you judge China’s WOFC law? • Does it subscribe to the Radical View, the Free Market View, or the National Pragmatism View? • Why do you say so?

  13. Chapter 7 • Foreign Direct Investment

  14. FDI: Definition • What is FDI? • FDI occurs when a firm invests directly in facilities to produce and/or market a product in a foreign country • Examples: • Motorola sets up a plant in China to manufacture cell phones • Starbuck purchases an existing UK firm, “British Coffee,” to sell coffee, tea and desserts in the UK • Volkswagen and two Chinese joint venture partners Shanghai Automotive Industry Corporation (SAIC) and First Automotive Works (FAW) open their newly built gearbox plant in Shanghai "Volkswagen Transmission (Shanghai) Co. Ltd" • Alternatives to FDI • Licensing; Direct Export

  15. FDI: Forms • Forms of FDI • Acquisitions • Purchase an existing company in the foreign country • Greenfield Investments • Set up a new company “from the ground up” in the foreign country • Examples: • Motorola investments money in China and builds a new plant to produce cell phones • Starbucks purchases an existing UK firm “British Coffee” and sells coffee/tea/desserts under the name “Starbucks”

  16. FDI: Forms (II) • Forms of FDI (II) • Wholly Owned Subsidiary • Occurs when the company in the foreign country is entirely controlled/owned by one single company. • Motorola’s company that manufactures cell phones in China • Starbuck’s acquisition that sells coffee/tea/desserts in the UK • Joint Ventures • Occurs when two or more companies together form a new company in the host country • In the international context, usually occurs when one (or more) foreign company and one (or more) local company join to form a new company • Volkswagon + Shanghai Automotive Industry Corporation (SAIC) + First Automotive Works (FAW)

  17. FDI: Horizontal vs. Vertical • Horizontal vs. Vertical Direct Investment • Horizontal • Investment in the “same” industry as a firm operates in at home • Examples: • Starbucks and its international expansion • MacDonald’s and its international expansion • Vertical • Investment in a downstream supplier (backward) or upstream purchaser (forward) as compared to the business that the firm operates in its home country • Examples: • Backward: Volkswagon + SAIC + FAW to produce gearbox (an input to Volkswagon’s home operation) • Forward: Less common. Volkswagon’s acquisitions of dealers in the US (Volkswagon “sold” cars to the dealers in the US. I.e., Volkswagon sold the output of its home country operations to the US dealers that it acquired)

  18. Why Horizontal FDI? • Transportation Costs • Market Imperfections • Impediments to exporting • Impediments to Sale of Know-How • Strategic Behavior • Product Life Cycle • Location Specific Advantages

  19. Why Vertical FDI? • Strategic Behavior • Market Imperfections • Impediments to Know-How • Investment in Specialized Assets

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