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FOREIGN DIRECT INVESTMENT

BY:CHARU KHARBANDA(31) ATTINDER SINGH(48) ARSHIA KALRA(55)

MEANING

Means investment for establishment of a new enterprise in foreign country either as a branch or as a subsidiary and acquisition of an overseas business enterprise.

THEORIES OF FDI
MAC DOUGALL-KEMP HYPOTHESIS INDUSTRIAL ORGANISATION THEORY LOCATION SPECIFIC THEORY PRODUCT CYCLE THEORY INTERNALISATION APPROACH ECLECTIC PARADIGM CURRENCY BASED APPROACHES POLITICO ECONOMIC THEORIES MODIFIED THEORIES FOR THIRD WORLD FIRMS

MAC DOUGALL-KEMP THEORY


It was developed by MacDougall(1958) and elaborated by Kemp(1964) FDI moves from a capital abundant economy to a capital scarce one till the marginal productivity of capital is equal in both the countries. This leads to improvement in efficiency in the use of resources which leads ultimately to an increase in welfare.

INDUSTRIAL ORGANISATION THEORY


This theory is based on the assumption of the imperfect market and was propounded by Hymer(1976) An MNC with technology moves to different countries to supply innovated product making in turn ample gains According to this a MNC is a typical oligopolistic firm that possesses some sort of superiority and that looks for control in an imperfect market with a view to maximising profits by trensmitting the advantages more effectively fro one unit to another irrespective of their geographical distance.

This theory gives answer to the question why we do FDI.The answer is its advantages.The advantages are:Product differentiation Marketing skills Proprietory technology Managerial skills Beter access to capital Economies of scale Govt imposed market distortion

LOCATION SPECIFIC THEORY


Given by Hood and Young in 1979 and it gives answer to the question where to do FDI? Hood and Young stressed on locational factors.They argue that since real wage cost varies among countries,firms with low cost technology move to low wage countries The availability of cheap and abundant raw material encourages the MNC to invest in a particular country

PRODUCT CYCLE THEORY


It was given by Raymond vernon in 1966 which gives answer to when,why and where to do FDI Basically there are 4 stages 1. INNOVATION STAGE 2. MATURING PRODUCT STAGE 3. STANDARDISED PRODUCT STAGE 4. DEMATURING STAGE INNOVATION STAGE is characterised with quite newness of product having price inelastic demand

MATURING PRODUCT STAGE appears when the proct turns price elastic along with similar product in the market.Rivals increase and firm decide to set up a subsidiary
STANDARDISED PRODUCT STAGE with greater price competitiveness motivates firm to start production in a low cost location where cheap labour is available DEMATURING STAGE breaks down product standardisation with sophisticated models of the product being manufactured in high income countries.

INTERNALISATION APPROACH
Buckley and Casson n 1976 too assume market imperfection but imperfection in their view is related to the transaction cost that is involved in the intra firm transfer of intermediate products such as knowledge or expertise. In an international firm,technology developed at one unit is passed on to other units normally free of charge This means that transaction cost in respect of intra firm transfer of technology is almost zero whereas such costs in respect of technology transfer to other firms is usually exorbitantly high.

ELECTIC PARADIGM
It was given by Dunning in 1980 and revised in 1993 It is a combination of industrial organisation theory,internalisation theory and location specific theory It postulates that at any given time,the stock of foreign assets owned by a MNC is determined by a combination of firm specific or ownership advantage(O),the extent of location bound endowments(L),and extent to which these advantages are marketed within various units of the firm(I)

CURRENCY BASED APPROACHES


There are 3 approaches I. ALIBER(1971)postulates that internalisation of firms can be explained in terms of relative strength of different countries. II. FROOT & STEIN(1989) viewed that depreciation in the real value of currency of a country lowers the wealth of domestic residents vis a vis the wealth of the foreign residents III. CAVES(1988) mentions influence of exchange rate in 2 ways:cost & revenue capital gains

POLITICO-ECONOMIC THEORIES
According to Fatehi-Sedah & Safizedah(1989) political stability in the host countries leads to foreign investment therein. A firm moves from a politically unstable country to a politically stable country.

MODIFIED THEORIES FOR THIRD WORLD FIRMS

Developing country firms too possess firm specific advantages on account of modification of technology

COST AND BENEFITS OF FDI

1.
2. 3. 4. 5.

BENEFITS TO THE HOST COUNRY Availabiliy of scarce factors of production Improvement in balance of payments Building of economic and social infrastructure Fostering of economic linkages Strenghtening of the government budget

COST TO HOST COUNTRY


1.

2. 3. 4. 5. 6.

Strained balance of payment following reverse flow Dependence on the import technology Employment of expatriates Inappropriate technology Unhealthy competition Cultural and political interference

BENEFITS TO HOME COUNTRY


1.

2.
3. 4. 5.

Availability of raw material Improvement in balance of payment Employment generation Revenue to the government Improved political relations

COST TO THE HOME COUNTRY


1.

2.

Undesired outflow of factors of production Possibility of conflict with the host country government

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