UNSW Business School/ Banking and Finance

FINS2622 Session 2 2017

Week 9
FDI (inwards from developed markets to
Asian markets)
Foreign Direct Investment (FDI)

Definition: FDI is acquisition abroad of plant and equipment

Reasons:
1. Product and factor market imperfection
MNCs have intangible capital (trademarks, patents,
organizational skills); if embedded in product without
adaptation export. Examples

If this capital can be written down and transmitted

objectively licensing. Examples
If those aspects of this asset cant be unbundled and sold
separately setting up foreign affiliates; hence FDI.

Product and factor (land/labour/capital) imperfections mean

that an MNC (say based in Australia) would be better off
setting up plant and factory in say Vietnam because no
local (Vietnamese) is able to produce.
Other considerations that favour FDI:

An Asia Pacific country prefers FDI because it generates

domestic employment and consumption. Examples
An Asia Pacific country may restrict imports by means of
policies such as tariff. So FDI is the way to circumvent
such restrictions
FDI may take the forms of:
Vertical integration: Why?
Horizontal FDI: Why?

Against such advantages of product and factor

imperfections: local firms have an inherent cost
advantages. Examples
Thus comparative advantages eventually erode. Examples:
imitated by local firms
International portfolio investment

Foreign investor buy/sell equities/bonds in Asian markets

A way to explain why in some cases international portfolio

investment is preferred and in other cases FDI is
preferred:
PV of investment = I/r
If r is different among countries this justifies portfolio
investment
If I is different among countries this justifies FDI
In addition to product and factor imperfections that justify
FDI:
Financial Market Imperfection is another comparative
advantage
A MNC diversifies on behalf of its shareholders.
One reason may be low correlation of an Asian Pacific
country, say Vietnam, with its home base, say Australia .
MNC may have better access to internal financial markets
hence lower cost of borrowing.
Discuss
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