MIKE O.

MOORES1 LECTURE2 (George Washington University) ON FOREIGN

DIRECT INVESTMENT

One of the striking aspects of economic globalization in the west a couple of

decades has been the rising importance of foreign direct investment. And I want to
use this video to discuss some of the basic ideas behind foreign direct investment some motivations, the few of the upside but also the downside, risks associated
with undertaking foreign direct investment.
First, we must make sure we understand what FDI means. Thats when a
multinational corporation has facilities in another country over which it has control.
Now, what do we mean by control? The standard definition is if a company or
individual (but typically a company) owns more than 10% of the value of a foreign
company. It is assumed to have at least some control (significant influence) and that
is considered direct investment. That is opposed to portfolio investment. So mutual
funds for example will own individual shares (maybe a lot of individual shares) of a
company. But until they reach the 10 % minimum, which is ultimately arbitrary, it is
considered portfolio investment. Above 10%, it is foreign direct investment.
One thing to note here is a multinational doesnt have to fully own the foreign
company. It doesnt have to have 50% control. It is anything over 10%. So in any of
the official statistics, anything over 10% is considered FDI.
Now, there is outward foreign direct investment. So for example if a US
multinational invest in Mexico or in China (so it is owning firms outside the US), that
is considered US outward FDI. From Chinese standpoint that would be inward FDI.
FDI is controversial. In large part, developing countries sometimes worry about
multinational corporations having more control over the activities inside the
economy. In developed world, there is worry about offshoring of activities by
multinational corporations. Theres controversy on both sides. I should finally say, in
terms of introduction, that FDI can occur by a merger with a foreign entity, it could
be acquiring an existing company and finally you have this concept of whats called
green field investment that is an entirely new company or factory setup. So you
have mergers, acquisitions and green field investments. All they get slumped into
standard FDI statistics but they have distinct attributes.
So why would a multinational corporation acquire assets abroad? (Multinational
corporations often choose between exporting and undertaking FDI. FDI is a more
long-lasting commitment.) Some of the major motivations. One is proximities to a
1 Michael Moore is a professor of Economics and International Affairs at the George
Washington Universitys Elliot School of International Affairs and Department of
Economics. His areas of expertise include International trade theory and policy,
antidumping, and the World Trade Organization.
2 https://www.youtube.com/watch?v=4NBzBS0jZkc

foreign market. If a US company wants to serve the Chinese market, they can save
transportation cost by setting up an affiliate in China. You also sometimes have it
done as an export platform so you setup in China in order to export back into the US
or other parts of Asia or wherever. But it is access or proximity to a market you want
to serve.
Certainly, access to raw materials is a motivation. If a Chinese company requires a
mine in Africa to develop iron orb or petroleum, then that is access to raw material.
Maybe access to lower labor costs if youve got reduced cost of workers. But be
careful about that because its just about lower wages, its about lower labor costs.
If you have lower wages but your workers are not very productive so your costs are
higher because they dont product that much, that is not really a motivation You
might also have lower cost of environmental regulation.
Tariff-jumping- it is a broader concept than just tariff. Lets say US wants to serve
India or Brazil. If the US Auto company wants to sell in Brazil, they have to pay
tariffs at the border. But if they set up shop inside of Brazil set up a factory inside
Brazil, then they could potentially avoid the tariffs by undertaking activities within
that country. (NOTE: Higher tariffs on final goods are sometimes accompanied by
low tariffs on inputs. This can help encourage FDI by those making the final good.)
Now this is sometimes a motivation for countries to divert production potentially
into their home market.
There are also sometimes specific advantages that a multinational corporation
would have there some expertise that they have that a domestic firm in the host
country does not share. They may have the ability to have higher profits associated
with the activities inside the country which puts them in a great advantage vis--vis
the domestic rivals.
Well, all of these motivations are basically one way or another about having higher
profits, higher rate of return inside the developing market or the host market than
you have at home. But I want to emphasize that it is multifaceted. It is not just one
of these factors; it is a combination of these things. And not one of these is
dispositive.