Foreign Direct Investment

1
Foreign Direct Investment

• Team 1
• Daisy Gonzales
• Chris Green
• Hoyoung Jung

2
Foreign Direct Investment

• def Investment by transnational corporations or
  multinational enterprises in foreign countries in
  order to control assets and manage production
  activities in those countries.

3
Foreign Direct Investment

• def
• Long term investment of a parent enterprise
  from home economy into a subsidiary, affiliate,
  or branch enterprise in a foreign host economy.

4
Foreign Direct Investment

• MNE A firm with assets and activities in more
  than one country (and which is thus engaged in
  FDI).
• Subsidiary (or affiliate) a firm that is
  controlled (owned) for a significant degree by
  another firm (the parent).
• Parent firm a firm that controls a significant
  degree of assets of another firm (the
  subsidiary).
• Home country country from which the MNE
  originates.
• Host country country in which a foreign direct
  investment is made.

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Country A (e.g. the Netherlands)
Country B (e.g. Malaysia)
MNE
Subsidiary
Parent firm
Philips N.V.
Philips Malaysia Bhd.
FDI
Host country
Home country
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History of Foreign Investment
Many well-developed countries pose the argument
that in order for a developing nation to succeed
in economic development, they must do as they
did implement policies to welcome foreign
investors and use free trade.

7
The United States in FDI

• Early economic development 1st World War
• - U.S. is the Worlds largest importer of
  foreign capital
• Sparked widespread concern with many Americans
  with
• - absentee management
• - foreign domination of the American economy
• We have no horror of FOREIGN CAPITALif
  subjected to American management. Niles Weekly
  Register
• Large number of federal and state legislation
  were enacted to ensure that FDI did not lead to
  loss of national control in key sectors of the
  economy.

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The United States in FDI

• Five areas of Federal Legislation
• 1. Navigation
• a navigation monopoly for US ships for coastwise
  trade was imposed in 1817 by Congress
• 2. Finance
• In the First Bank of the USA, only resident
  shareholders could vote and only American
  citizens could become a director.
• The 1864 National Bank Act also required that
  the directors of national (as opposed to state)
  banks had to be Americans.

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The United States in FDI

• Five areas of Federal Legislation
• 3. Land
• an 1885 resolution passed by the New Hampshire
  legislature read American soil is for
  Americans, and should be exclusively owned and
  controlled by American citizens.
• The 1887 federal Alien Property Act prohibited
  the ownership of land by aliens or by companies
  more than 20 owned by aliens in the territories
  (as opposed to the states), where land
  speculation was particularly rampant.

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The United States in FDI

• Five areas of Federal Legislation
• 4. Natural Resources
• Federal mining laws in 1866, 1870, and 1872
  restricted mining rights to US citizens and
  companies incorporated in the USA.
• In 1878, a timber law was enacted, permitting
  only US residents to log on public land.
• 5. Manufacturing
• The 1885 contract labor law prohibited the
  import of foreign workers

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The United States in FDI

• State Legislation
• State laws were more hostile to foreign
  investment than federal law
• Foreign investment banned in some states
• some state laws taxed foreign companies more
  heavily than the American ones

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The United States in FDI

• Results
• The U.S. supported foreign investment with many
  provisions to limit control of the foreign
  nation.
• None of todays developed countries pursued Free
  Trade Policy that they are so eager to impose on
  the now developing countries.
• Developed countries imposed strict regulation of
  foreign investment when they were the net
  recipients.

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Economy of Developing Nations

• Developing nations are those that have either low
  or middle level per capita incomes have
  underdeveloped capital markets and/or are not
  industrialized.
• These countries are undergoing many changing
  conditions and radical reforms such as
  technological innovation.
• Developing countries are becoming more attractive
  arenas for investment.

14
Foreign Direct Investment
15
FDI Inflows

• Higher in riskier countries
• -countries with low credit ratings for sovereign
  debt
• Higher in countries where the quality of
  institutions is lower.

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Factors affecting FDI inflows

• Fundamentals
• Market size
• Good infrastructure public spending
• Low wage / high skill labor force
• Technological capability
• Capital markets etc.
• Host-government policies
• Rule of law and low levels of corruption

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FDI Outflows

• 1990-2002

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Multinational Enterprises

• Do they crowd in investments or displace domestic
  producers or pre-empting their investment
  opportunities?

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MNE

• FDI may crowd out domestic investment
• MNEs may displace domestic firms
• Crowding In Vs. Crowding Out

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Crowding In

• If FDI enters into an already competitive
  domestic environment
• Placement of FDI
• Into developed sector of economy
• Into underdeveloped sector of economy
• Incumbent firms are likely to be displaced

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Crowding Out

• Merger Acquisitions do nothing for the domestic
  firm
• Raising interest rates may displace investment

22
Potential Risks

• Country Risk
• Exchange Rate Risk
• Transfer of Control
• FDI Reversals
• Adverse Selection Fire Sales
• Leverage
• Reflects weakness

23
Transfer of Control

• Corporate governance mechanism
• -Foreign investors can exercise management and
  control over host country firms.
• Question arises
• Do the foreign investors have special competence
  to run the firm better or is it simply because
  they have money and the locals do not?

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FDI Reversals

• Bad Cholesterol
• Driven by Short Term Effects
• Good Cholesterol

25
Adverse Selection

• Informational advantage of foreign firms
• Foreign direct investors tend to have
  high-productivity firms
• May lead to over investment

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Excessive Leverage

• Heavily leveraged owing to borrowing in domestic
  credit market
• Therefore, the fraction of domestic investment
  actually financed by foreign savings is small

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Reflects Weakness

• FDI is more likely to take place in countries
  with missing or inefficient markets.
• Foreign investors will prefer to operate directly
  instead of relying on
• -local financial markets
• -suppliers
• -legal arrangements

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Host Country Problems With FDI

• MNEs become more powerful.
• - Drives out local competitors
• (Can prevent the development of local
  competitors)
• Profits brought home hurts (debit) a hosts
  capital account
• (may not stay in the country for investment)
• Parts imported for assembly hurt trade balance
• Can affect sovereignty and national defense

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Home Country Problems with FDI

• Negative effect on Balance of Payments
• Initial capital outflow
• MNE uses foreign subsidiary
  to sell back to home market
• MNE uses foreign subsidiary
  as a substitute for direct exports
• Potential loss of jobs

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Effects on Domestic Markets

• In high tariff or non tariff barrier protected
  markets FDI strengthens lobbying efforts to
  perpetuate the existing misallocation of
  resources.
• Loss of domestic competition through
  consolidation of domestic producers
• -Takeovers
• -Corporate failures

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Group Opinion

• Developing nations should limit Foreign Direct
  Investment

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How Can Countries Limit FDI?

• Limit capital outflows (Home)
• Manipulate tax code to encourage domestic
  investment (Home)
• Political restrictions on investing in certain
  countries (Home)

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How Can Countries Limit FDI?

• Ownership restraints (Host)
• Performance requirements (Host)
• Local content
• Information transfer
• Local participation in management

34
Policy Recommendations

• Developing countries should concentrate on
  improving the environment for investment both
  domestic and foreign and the functioning
  markets.

35
Policy Recommendations

• Concentrate on developing credible enforcement
  mechanisms instead of trying to get more FDI.

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Questions?