Foreign Direct

Investment
 Volkswagen
Produces 8 million cars a year
Modular production strategy
Special protection in Germany

Copyright 2014 Pearson Education, Inc.

7-2
 Foreign Direct Investment
(FDI)

Purchase of physical assets or

significant amount of ownership
of a company in another country
in order to gain some measure of
management control

By contrast, portfolio investment

does not involve obtaining a
degree of control in a company
 Yearly FDI Inflows

Source: Based on World Investment Report (Geneva, Switzerland: UNCTAD), various years.
Reasons for FDI Growth

Increasing
globalization

International mergers
and acquisitions
Value of Cross-Border M&As

Source: Based on World Investment Report (Geneva, Switzerland: UNCTAD), various years.
 Worldwide FDI Flows

World FDI inflows 82,000 multinationals

Developed (49%), developing (45%)

European Union: 28% of world FDI

Developing nations
China and India attract most FDI
with
All of Africa: 2.8% of world FDI 810,000 affiliates
 Discussion Question

What is the
difference between
foreign direct
investment and
portfolio
investment?
 Answer to Discussion
Question
Foreign direct investment is the
purchase of physical assets or a
significant amount of the
ownership of a company in
another country to gain a
measure of management
control.
Portfolio investment does not
involve obtaining a degree of
control in a company.
 International Product Life
Cycle
A company begins by exporting its product and later undertakes
foreign direct investment as a product moves through its life cycle

Source: Raymond Vernon and Louis T. Wells, Jr., The Economic Environment of International Business, 5th ed. (Upper Saddle River, N.J.: Prentice
Hall, 1991), p. 85.

Copyright 2014 Pearson Education, Inc.

7 - 10
Market Imperfections
(Internalization)
A company undertakes FDI to
internalize a transaction that
is made inefficient because of
a market imperfection

Trade barriers
(e.g., tariffs)

Unique advantage
(e.g., special
knowledge)
 Eclectic Theory

FDI when location, ownership, and internalization

advantages combine to make a location appealing

Location Ownership Internalization

advantage advantage advantage
(optimal location) (special asset) (efficiency)
 Balance of Payments
National accounting system that records all payments to entities
in other countries and all receipts coming into the nation

Current account Capital account

The import and export of The purchase or sale of

goods and services,
income receipts on
assets abroad, and
income payments on
foreign assets inside the
country
assets (including assets
such as property and
shares of common stock
in a company)
U.S. Balance of Payments
 Discussion Question

What do we mean
by a countrys
balance of
payments and
what is its
usefulness?
 Answer to Discussion
Question
A countrys balance of payments is
a national accounting system that
records all payments to entities in
other countries and all receipts
coming into the nation.
The system helps monitor a
countrys flows of goods, services,
income, and asset transfers
between itself and other nations.
The balance of payments position
sends warning signals about trade
deficits with other nations.
 Host Intervention I

Initial FDI boosts economy

Balance of Payments FDI may decrease imports

+
FDI may generate exports
 Host Intervention II

Access technology
Obtain resources
and benefits Access management skills
+
Create employment
 Home Intervention

Remove national resources

Eliminate export markets
Eliminate domestic jobs

+ Improve competitiveness
+ Eliminate low-wage jobs
Host Promotion Methods

Financial incentives
Low or waived taxes
Low-interest loans

Infrastructure benefits
Better seaports, roads,
and telecom networks
Host Restriction Methods

Ownership restrictions
Prohibit investment in
industries or businesses

Performance demands
Local content requirements
Export targets
Technology transfers
 Home Promotion Methods

Insurance on Loans and loan Special tax

assets abroad guarantees treaties

Tax breaks on profits Persuade other nations

earned abroad to accept FDI
Home Restriction Methods

Higher taxes on
foreign income

Sanctions that
prohibit investing