BUSE 608

International Business
KAAU, 2011-12

Topic 6: FDI: Home and Host Country Perspective

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Learning outcomes
Understand the terms, forms and trends of FDI Analyse the pros and cons of FDI for home and host countrys perspective Understand how countries (host) negotiate with MNCs to attract FDI Theoretical and explanations of FDI policies adopted by host countries FDI: is it good or bad for the country?

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An exercise:
Subsidise Daimler Netherlands Dont Subsidise 5 -10

Daimler Close plant Netherlands

-15 -25

Keep plant open

Daimler Netherlands

-5 0

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Foreign Direct Investment (FDI)

Definition
An investment in a foreign operation which results in: managerial participation and effective control The setting up of a new overseas operation (GFI) or as a form of international inter-firm co-operation that involves a significant equity stake in, or effective management control of, host country enterprise
Significant??? Effective control??? Minimum 10% equity participation The traditional route to growth for most MNCs

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FDI and IMES

Routes:
Green-field, acquisition, JVs, ISA (customer base, govt regulations, economies of scale, market potentials, protection of technologic know-how, etc.) FDI PI
Export Franchising Acquisitions Wholly-owned subsidiary

Licensing

JVs

Partly-owned subsidiary

Equity participation

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FDI Terms
Flow of FDI, outflow and inflow of FDI, Stock of FDI, Host/Home country, Foreign subsidiary, MNCs
Host Country

MNE Home Country

Philips Malaysia Bhd.

Philips N.V

FDI

Parent firm

Subsidiary

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Types of FDI
Horizontal FDI Vertical FDI (Backward vertical FDI, Forward
vertical FDI)

Conglomerate FDI
Other Industries
Supplier Industry

BVfdi

Hfdi
FVfdi
Showrooms After sale services

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FDI growth (1982-2000)

700 600 500 400 300 200 100 0

Exports FDI

1 600 1 400 1 200 1 000 800 600 400 200 Developed countries Developing countries Central and Eastern Europe 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 World

Uneven Downturn in Developing Countries

Inflows of FDI to developing countries, 1995-2002, by region
$ billions

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

Luxembourg United States 120 63 40 31 29 26 25 18 18 0 20 40 60 80 100 120

154

250

France
Developing countries
200

United Kingdom
Asia and the Pacific

150

Japan Canada

100

Netherlands
Latin America/Caribbean

50

Germany
China LDCs Africa

Spain Hong Kong, China

1995

1996

1997

1998

1999

2000

2001

2002

Source:

UNCTAD, World Investment Report 2003. FDI Policies for Development: National and International Perspectives

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Inward FDI stock

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Multinational companies (MNCs)

A MNC is a firm that owns and manages production facilities in three or more countries
The US is by far the largest home country of MNCs as well as the largest host country of foreign MNCs.

Theoretical explanations Practical/strategic explanations

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MNCs structure (Philips, 2002)

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Access to markets
Limits to export potential
Nature of the product/service, government regulations, customer demands, change in relative costs

Market considerations
Size/growth of market, following customers, following competitors

BUT
Market access restrictions
Licensing requirements Outright prohibitions >> military industries, mass media, air and land transport, banking and finance, telecommunication

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Access to factors of production

Labour
Cost Productivity

Technology/knowledge/skills Capital, Raw materials BUT

Performance requirements >> technology transfer to local partners, exports, employments, local contents

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Host countries perspective

Mostly from developed countries MNCs 20%

80%

Developed Countries
100%

0%

Mostly American, British and Japanese

Developing Countries

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Costs & benefits of FDI to hosts

Resource transfer Employment Balance of payment Competition and economic growth

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Main theoretical views

The Radical View
MNCs seen as instruments of imperialist domination, exploiting developing countries to the exclusive benefit of their home countries, so against FDI.

The Free Market

MNCs seen as instrument of dispersing production of goods and services to the most efficient locations around the world, so for FDI

Pragmatic Nationalism
MNCs seen as bringing benefits and cost, with encouragement offered to FDI perceived to offer significant gains to the host country, so for FDI but with conditions

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Spillovers:
Locals benefit from the presence of MNCs without paying the full price Several possible channels: Demonstration effects. copying MNCs Training of employees who may leave the MNCs for jobs in local firms Forward and backward linkages MNC entry may stimulate competition, efficiency, and development MNCs often enter industries where entry barriers for local firms are high BUT. spillovers are not automatic. Efforts are determined by the local environment Technological capability and labour skills, level of competition, trade policy

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MNC negotiation with Host countries

The context of negotiation the Four Cs
Establishing new plant in Mexico

Common Interests Negotiation Process

Conflicting Interests

Proportion of posts procured locally, no of jobs created, proportion of output exported

Reaching a decision which benefit both parties

Compromise

Criteria

IBM: profits + 100 ownership Govt: employment, technology transfer, BOP

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Determinants of bargaining power

Bargaining power of Firm High Firms time horizon Long Low Short

Comparable alternatives open to firm Value placed by host government on investment

Many

Few

High

Low

Bargaining power of the Govt

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Summary
When a company makes more than 30% investment in foreign operations, it is said to have made FDI Trends show that FDI has increased tremendously in comparison to other foreign market entry strategies In order to get maximum advantages from FDI, countries have to negotiate with MNCs on the basis of what they can offer Countries often compete to attract FDI by offering numerous incentives to MNCs The overall view is that FDI is good for the country, if it is controlled properly

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Reading list
This lecture is based on Hill, Chapter 8 Additional readings:
Waldkirch, A. 2003. Vertical FDI? A Host Country Perspective. Oregon University working paper series. Mattooy, A., Olarreagaz, M., and Saggix, K. 2002. Mode of foreign entry, technology transfer, and FDI policy. University seminar paper.

Related Case Study:

FDI in South Africa

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