3' Foreign direct investment and multinational enterprises

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3. Foreign direct investment and multinational
enterprises

• Globalisation and multinational enterprises

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Outline

• Descriptive statistics
• Definition of FDI
• Definition of multinational enterprises
• Dynamics of FDI
• Causes and consequences

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Motivation

• Foreign direct investment has been one of the key
  features of globalisation along with the actual
  activities of MNCs in the host-country markets
• What are the driving forces of globalisation?
• What are the expected consequences of FDI flows
  and multinational activity?

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Descriptive statistics
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Descriptive statistics

• Global FDI reached an all time high in 2007
  (previous high was in year 2000), but is said to
  decline substantially in 2008
• Compared to 2006, FDI experienced a 30 growth
  rate in US dollar terms and a 23 increase in
  terms of local currencies
• Profitability of MNCs also increase greatly in
  2007, whereby it followed a trend set since 2002
• Mostly MNCs retained good financial health
  despite a crysis in the world financial markets

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Descriptive statistics
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Descriptive statistics

• Strong economic growth and availability of credit
  allow for an increase in cross-border MA
  activity

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Motivation
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Motivation (source WIR, 2006)

• 5 largest recepients of FDI are the UK, US,
  France, Netherlands and Canada

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Motivation

• Worlds largest TNCs
• In 2005, 2006 and 2007 100 of the largest TNCs
  accounted for 10, 16 and 12, respectively, of
  the estimated foreign assets, sales and
  employment of all TNCs across the world
• FDI has shifted in sectoral composition towards
  service sectors, most notably telecommunications,
  electricity and water services
• Many TNCs have lately become involved in
  infrastructure development since those sectors
  have been liberalised.

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Regional decomposition
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Sectoral decomposition
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Sectoral decomposition
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Transnationality index

• Composed of three ratios
• foreign assets/total assets
• foreign sales/total sales
• foreign employment/total employment
• Internationalization index
• Ratio of TNCs foreign to total affiliates

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Transnationality index
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Motivation
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Number of parent corporations and foreign
affiliates in economy
Source WIR 2003
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Motivation
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Motivation

• Transationality index measures the degree of
  international involvement from a number of
  perspectives
• Operations of the firm
• Stakeholders
• Spatial organisation of management.
• Composite index of three measures
• Foreign assets to total assets ratio
• Foreign sales to total sales ratio
• Foreign employment to total employment.

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Foreign direct investment in Slovenia
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Foreign direct investment in Slovenia
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Definitions

• a category of international investment that
  indicates an intention to acquire a lasting
  interest in an enterprise operating in another
  economy. It covers all financial transactions
  between the investing enterprise and its
  subsidiaries abroad (European Commission)
• an investment involving a long-term relationship
  and reflecting a lasting interest and control of
  a resident entity in one economy in an enterprise
  resident in an economy other than that of the
  investor (UN)

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Definitions

• practical definition usually ownership of at
  least 10 of the ordinary shares of a foreign
  establishment (UN, IMF, EU, US)
• A multinational enterprise is one that
  owns/controls and manages production
  establishments located in at least two countries
  (Caves, 1996)

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Definitions

• What is not FDI?
• non-equity investments (debt)
• Portfolio investment investment involves the
  exchange of equity with the aim of attaining a
  return on the invested capital, not to achieve
  any form of control
• Licensing production/technology rights to another
  company abroad
• Strategic alliances

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Types of foreign direct investment

• By activity
• horizontal FDI
• similar plants at the same stage of the
  production process located in different national
  markets
• market seeking investment
• vertical FDI
• plants produce at adjacent stages of a vertically
  related set of production processes
• natural resource seeking investment
• diversified FDI
• plants outputs are not related to each other
• risk diversification

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Types of foreign direct investment

• By investment strategy
• greenfield investment
• market entry by establishing a completely new
  plant
• mergers and acquisition
• market entry by acquiring an existing plant
• joint venture
• market entry by forming a new enterprise with a
  foreign partner

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Measurement of FDI

• Measuring FDI through the balance of payments
  (capital account)
• Capital transfer between parent and foreign
  affiliate
• Issue of ultimate ownership is problematic

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Who is the owner?
Country A
Country B
owns
Firm 1
Firm 2
Country C
owns
Firm 3
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Components of FDI flows
inflow
outflow
Foreign affiliate
Parent
Parent sells, or reduces its stake in, an
existing affiliate
Parent establishes, or increases its stake in an
existing affiliate
Equity Capital
Affiliate repays part or all of a loan received
from parent
Parent extends a loan to its affiliate
Source US Bureau of Economic Analysis
Intercompany debt
Affiliate extends a loan to its parent
Parent repays part or all of a loan received from
its affiliate
Affiliate suffers losses, or pays dividends to
its parent in excess of the parents share of
that profit
Reinvested Earnings
Affiliate earns profit and does not pay dividends
in excess of the parents share
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Other measures

• Activities of MNEs
• sales, value added, employment, assets, numbers
• direct measure of activity by foreign affiliate
• overestimate foreign influence as affiliates may
  be only partly foreign owned
• Measures of MAs

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Determinants of FDI

• Firm characteristics why a firm would choose to
  service a foreign market through affiliate
  production, rather than other options such as
  exporting or licensing arrangements
• Intangible assets (RD intensity and advertising
  intensity serve as proxies)
• Country and industry-level characteristics why
  does a firm choose a specific market/specific
  country

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Determinants of FDI

• Country and industry-level characteristics
• Changes in the bilateral level of exchange rates
  (depretiation increases FDI)
• Exchange rate variability (exchange rate
  uncertainty reduces FDI)
• Taxes (higher taxes discourage FDI), depending on
  the type of taxes

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Determinants of FDI

• Institutions quality of institutions as a
  determinant of the quantity of FDI inflows
• protection of property rights
• price of doing business
• administrative restrictions
• Institutions are difficult to measure and effects
  of different institutions are difficult to
  disentangle.
• trade protection higher trade protection leads to
  more foreign direct investment (tariff-jumping
  FDI)

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Determinants of FDI

• trade effects FDI is either considered a
  substitute or there is a natural progression from
  arms-length trade to foreign-based production
  demand in foreign markets increases
• gravity determinants
• distance
• size of the foreign markets and the domestic
  market
• platfrom FDI

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The role of multinational enterprises

• Compared with domestic firms
• Are larger in terms of employment
• Larger in terms of revenue
• Export more
• Import more
• More capital intensive
• Invest more
• Pay higher wages.

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The role of multinational enterprises (Source
Kiyota, Urata 2005)
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The role of multinational enterprises (Source
Kiyota, Urata 2005)
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Activity of multinationals
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Employment and wages in MNCs (case of Ireland)
Source Figini, Görg, 1998
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Employment and wages in MNCs (case of Sweden)
Source Heyman et al, 2006
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