Foreign Direct Investment

1
Foreign Direct Investment

• Chapter Sixteen
• Eitman, Stonehill, Moffett

2
Absolute advantage (Smith)

• Absoluteland
• 0.2 productive units to produce 1 X
• 0.3 productive units to produce 1 Y
• Relativeland
• 0.4 productive units to produce 1 X
• 0.5 productive units to produce 1 Y
• Absoluteland has absolute advantage in the
  production of both X and Y

3
Relative Advantage (Ricardo)

• Absoluteland
• The X price of Y is 0.67
• The Y price of X is 1.5
• Relativeland
• The X price of Y is 0.8
• The Y price of X is 1.25
• Relative advantage
• Absoluteland in X
• Relativeland in Y

4
The world price of X and Y

• Perfect world
• Absoluteland specializes in Y
• World X price of Y is between 0.67 and 0.8
• Relativeland specializes in X
• World Y price of X is between 1.25 and 1.5
• Actual price
• Evolution of trade will determine a common world
  price

5
Reasons for investment

• markets
• raw materials
• production cost reduction
• technology transfers
• reduction of political risk

6
Government interference

• Full employment policies
• Tax breaks for automobile manufacturers
• Economic development
• Bombadier
• Essential industries protected
• Agriculture
• Defence related industries
• Boeing, McDonald/Douglas in the U.S.

7
Factors of production mobile

• Capital
• Very efficient world-wide capital markets
• Flows of capital large
• Multinationals easily transfer production
• Technology
• Intellectual property is very hard to protect
• Labor
• Illegal immigrants
• Immigration policy

8
Factors of production substituted

• Capital for labor (capital investment)
• Labor for capital (outsourcing)
• Technology transfers
• Through subsidiaries
• Through joint ventures

9
Economies of scale scope

• scale economies
• production
• finance
• research development
• transportation
• purchasing
• marketing
• scope economies
• finance
• marketing

10
Product factor markets

• new product markets
• barriers to entry
• reduction of barriers
• factor markets
• labour
• money capital
• technology
• goods
• resource

11
Defensive investments

• product cycle - cigarette industry
• declining N. America, steady-state market in
  Europe, increasing Eastern Europe, Asia
• follow the leader - China
• conventional wisdom, huge market
• horizontal or vertical integration
• zero-sum game in home markets
• growth leads to destructive competition
• knowledge transfers

12
Modes of investment

• Production at home and exporting
• joint venture
• merger
• licensing agreement
• management contract

13
Production at home, exporting

• Advantages
• Control
• Less risk
• Political risk
• Disadvantages
• High cost of labor
• Transaction and operating exposure

14
Joint Venture

• Advantages
• partner has country specific knowledge
• markets, politics, regulation
• politicians prefer local ownership
• Less transaction or operating exposure
• Disadvantages
• lack of control
• financing, transfer pricing, strategy
• valuation is difficult
• Potential translation exposure

15
Mergers Acquisitions

• Advantages
• economies of scale scope
• reduces operating exposure
• obtain technology
• Obtain markets
• Transaction, operating exposure lower
• Disadvantages
• divergent corporate cultures
• political opposition
• valuation is difficult
• Potential translation exposure

16
Strategic alliances

• Advantages
• exchanging stock
• marketing agreements
• cost sharing agreements
• Disadvantages
• Little control

17
Licensing

• Advantages
• No investment costs
• Partner with knowledge of local markets
• disadvantages
• cash flow transfer of knowledge
• may create competitor

18
Political risk

• change in rules which lead to reallocation of
  resources
• tax rules
• ownership rules/capital controls
• restrictions of foreign ownership
• exchange controls
• change in political structure which portends
  reallocation of resources

19
Macro risks

• expropriation
• government seizure of property
• valuation
• book?? Market??
• exchange rates??
• time value of money
• civil strife
• investment in Yugoslavia, Russia??
• antagonistic governments
• for US Iran , Cuba ??

20
Micro risks - Government Policy Goals

• employment policies
• resource reallocation
• taxes
• transfers
• trade policies
• protectionism
• balance of payments
• exchange rate policy
• economic development

21
Barriers

• limitations to trade
• quotas, embargoes, licensing, domestic content
• administrative restrictions
• fees, tariffs, deposit requirements, tax
  adjustments
• non-economic discrimination
• quality standards, environmental, health
• direct government interference
• procurement, export subsidies, domestic subsidies

22
Non-economic goal conflicts

• economic emperialism
• African economies
• national security concerns
• U.S. concern
• corruption nepotism
• South, Central America, Africa, Asia
• xenophobia
• Asian economies

23
Assessing Political risk

• political stability
• probability of change
• direction change would take
• firm specific
• negotiating terms
• operating strategies to mitigate risk