doc. Ing. Tomáš Dudáš, PhD.

Structure of the presentation

 FDI theories – introduction and main questions

 FDI theories on macro level

 Development theories of FDI

 FDI theories on micro level

 Eclectic FDI theory (OLI theory)

The basic questions of FDI theories (5W+H)
 Who? (is the investor)

 What? (kind of FDI)

 Why? (are we investing)

 Where? (is the FDI going)

 When? (do we invest)

 How? (the mode of entry)

FDI theories on macro level
 Capital market theory
 One of the oldest theories of FDI (60s)
 FDI is determined by interest rates

 Dynamic macroeconomic FDI theory

 FDI are a long term function of TNC strategies
 The timing of the investment depends on the changes in
the macroeconomic environment
 „hysteresis effect“
FDI theories on macro level
 FDI theory based on exchange rates
 Analyses the relationship of FDI flows and exchange rate
changes
 FDI as a tool of exchange rate risk reduction

 FDI theory based on economic geography

 Explores the factors influencing the creation of
international production clusters
 Innovation as a determinant of FDI – „Greta Garbo
effect“
FDI theories on macro level
 Gravity approach to FDI
 The closer two countries are (geographically,
economically, culturally ...) the higher will be the FDI
flows between these countries

 FDI theories based on istitutional analysis

 Explores the importance of the institutional framework
on the FDI flows
 Political stability – key factor
Life cycle theory
 Raymond Vernon – 1966

 It can be used to analyse the relationship of product

life cycle and possible FDI flows
 FDI can be seen mostly in the phases of maturity and
decline

 The conclusions of this theory are questionable

nowadays
Japanese FDI theories
 Were initially developed in the 70s of the last century

 Main representant – Terumoto Ozawa

 He analysed the relationship of FDI, competitiveness and

economic development based on the ideas of Michael
Porter

 He identified three main phases of development when he

analysed the waves of FDI inflow and outflow from a
country
Japanese FDI theories
 I. phase of economic growth
 The country is underdeveloped and is targeted by
foreign companies wanting to use its potential
advantages (especially low labour costs)
 Almost no outgoing FDI

 II. Phase of economic growth

 New FDI is drawn by the growing internal markets and
by the growing standards of living
 Outgoing FDI are motivated by the raising labour costs
Japanese FDI theories
 III. Phase of economic growth
 The competitivness of the country is based on
innovation
 The incoming and outgoing FDI are motivated by
market factors and technological factors
Five Stage Theory - John Dunning

 Stage 1
 Low incoming FDI, but foreign companies are beginning to
discover the advantages of the country
 No outgoing FDI – no specific advantages owned by the
domestic firms

 Stage 2
 Growing incoming FDI do the advantages of the country -
especially the low labour costs
 The standards of living are rising which is drawing more
foreign companies to the country
 Still low outgoing FDI
Five Stage Theory - John Dunning
 Stage 3
 Still strong incoming FDI, but their nature is changing
due to the rising wages
 The outgoing FDI are taking off as domestic companies
are getting stronger and develop their competitive
advantages

 Stage 4
 Strong outgoing FDI seeking advantages abroad (low
labour costs)
Five Stage Theory - John Dunning

 Stage 5
 Investment decisions are based on the strategies of
TNCs
 The flows of outgoing and incoming FDI come into
equilibrium
Incoming and outgoing FDI in China between
2001-2004

70000
60000
50000
40000
30000 FDI inflow
FDI outflow
20000
10000
0
-10000
2001 2002 2003 2004
Incoming and outgoing FDI in South Korea between 2001-2004

8000
7000
6000
5000
4000 FDI inflow
FDI outflow
3000
2000
1000
0
2001 2002 2003 2004
Incoming and outgoing FDI in Japan between
2001-2004

40000
35000
30000
25000
20000 FDI inflow
FDI outflow
15000
10000
5000
0
2001 2002 2003 2004
FDI theories on micro level
 Existence of firm specific advantages (Hymer)
 Access to raw materials
 Economies of scale
 Intangible assets such as trade names, patents, superior
management etc
 Reduced transaction costs when replacing an arm's length
transaction in the market by an internal firm transaction

 FDI and oligopolistic markets

 In oligopolistic markets the companies follow the actions of
the market leader
 Mutual threats – game theory
FDI theories on micro level
 Theory of internalisation
 Due to market imperfections, there may be several
reasons why a firm wants to make use of its
monopolistic advantage itself (or organise an activity
itself)
 Buckley and Casson (influenced by Coase), suggested
that a firm overcomes market imperfections by creating
its own market - internalisation
 The theory of internalisation was long regarded as a theory of
why FDI occurs
 By internalising across national boundaries, a firm becomes
multinational
Eclectic FDI theory – John Dunning
 John Dunning attempts to integrate a variety of
strands of thinking

 He draws partly on macroeconomic theory and trade,

as well as microeconomic theory and firm behavior
(industrial economics)
 O = Ownership advantages
 Some firms have a firm specific capital known as
knowledge capital: Human capital (managers),
patents, technologies, brand, reputation…

 This capital can be replicated in different countries

without losing its value, and easily transferred
within the firm without high transaction costs
 L – Localization advantages
 Producing close to final consumers or downstream
customers

 Saving transport costs

 Obtaining cheap inputs

 Jumping trade barriers

 Provide services (for most services production and delivery

have to be contemporaneous)
I – internalization advantages
 Why don't a firm just sign a contract with a
subcontractor (external agent) in a foreign country?
 Because contracting out is risky: it implies transferring
the specific capital outside the firm and revealing the
proprietary information (e.g. how to use the
technology or the patent).
 Problem:
 If the agent interrupts the contract it can use the
technology to compete with the mother company
 In the case of brands/reputation: if the agent damages
the brand reputation
OLI approach - conclusions
 The eclectic, or OLI paradigm, suggests that the
greater the O and I advantages possessed by firms and
the more the L advantages of creating, acquiring (or
augmenting) and exploiting these advantages from a
location outside its home country, the more FDI will
be undertaken
 Where firms possess substantial O and I advantages
but the L advantages favor the home country, then
domestic investment will be preferred to FDI and
foreign markets will be supplies by exports
4 types of FDI derived from OLI theory

 The typology of FDI was developed by Jere Behrman to

explain the different objectives of FDI:
 Resource seeking FDI
 Market seeking FDI
 Efficiency seeking (global sourcing FDI)
 Strategic asset/capabilities seeking FDI

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Resource seeking FDI
 To seek and secure natural resources e.g.
minerals, raw materials, or lower labor costs for
the investing company
 For example, a German company opening a
plant in Slovakia to produce and re-export to
Germany

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Market seeking FDI
 To identify and exploit new markets for the firms`
finished products
 Unique possibility for some type of services for
which production and distribution have to be
contemporaneous (telecom, water supply, energy
supply)
 Automotive TNCs have invested heavily in China

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Efficiency seeking FDI
 To restructure its existing investments so as to
achieve an efficient allocation of international
economic activity of the firms
 International specialization whereby firms seek to
benefit from differences in product and factor prices and
to diversify risk
 Global sourcing – resource saving and improved
efficiency by rationalizing the structure of their global
activities. Undertaken primarily by network based
MNCs with global sourcing operations.

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Strategic asset/capabilities seeking FDI
 MNCs pursue strategic operations through the
purchase of existing firms and/or assets in order to
protect O specific advantages in order to sustain or
advance its global competitive position
 Acquisition of key established local firms
 Acquisition of local capabilities including R&D, knowledge
and human capital
 Acquisition of market knowledge
 Pre empting market entrance by competitors
 Pre empting the acquisition by local firms by competitors

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