F oreign Direct Investment

1. ForeignDirect Investment Chapter 8 Md. Afnan Hossain Lecturer, School of Business & Economics

2. What Is FDI? Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market in a foreign country Once a firm undertakes FDI it becomes a multinational enterprise FDI can be: Greenfield investments - the establishment of a wholly new operation in a foreign country Acquisitions or Mergers with existing firms in the foreign country Acquisitions can involve: A minority stake (10%-49%) A majority stake (50%-99%) A full outright stake (100%) 2

3. What Is FDI? The flow of FDI - the amount of FDI undertaken over a given time period Outflows of FDI are the flows of FDI out of a country Inflows of FDI are the flows of FDI into a country The stock of FDI - the total accumulated value of foreign-owned assets at a given time • Both the flow and stock of FDI have increased over the last 30 years Most FDI is still targeted towards developed nations United States, Japan, and the EU

4. Figure 1: FDI Outflows 1982-2010 ($ billions) Trends In FDI

5. Figure 2: FDI Inflows by Region 1995-2010 ($ billion)

6. Figure 3: FDI Inflows 2005-2014 ($ billion) The members of the G20 are: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Republic of Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey, the United Kingdom, the United States and the European Union.

7. FDI Trend of Bangladesh • Bharti Airtel acquired Abu Dhabi Group’s Warid Telecom in Bangladesh for $300 million. • In September 2004, Orascom Telecom Holdings purchased 100% of the shares of Sheba Telecom (Pvt.) Ltd. for US$ 60 million (‘Sheba’, which was a Bangladesh and Malaysia joint venture). Orascom is now known as Global Telecom Holding. • Sanofi , GSK in Bangladesh (MNCs in Pharmaceutical sector). • HSBC, Unilever BD, BAT (MNCs in Bangladesh). • Launched in 1997, Grameenphone was the first Telenor venture in the Asian Telecom market. • Bangladesh does not have an extensive outward FDI industry. According to UNCTAD data, FDI outflows from Bangladesh are below $0.1 billion. • In Middle East, Bangladesh is seeking to increase economic ties with Saudi Arabia by investing in ceramics, pharmaceuticals and leather products. • Bangladesh has invested in Sudan in the pharmaceutical industry.

8. Sector wise FDI Inflow: Bangladesh

9. Sources of FDI • Since World War II, the U.S. has been the largest source country for FDI • The United Kingdom, the Netherlands, France, Germany, and Japan are other important source countries • together, these countries account for 56% of all FDI outflows from 1998-2006, and 61% of the total global stock of FDI in 2007

10. SOURCES OF FDI Figure 4: Cumulative FDI Outflows 1998-2007 ($ billions)

11. Arguments Against FDI Over Exporting or Licensing • Exporting involves producing goods at home and then shipping them to the receiving country for sale. Usually done by native sales agent. • Licensing involves granting a foreign entity (the licensee) the right to produce and sell the firm’s product in return for a royalty fee on every unit sold. • Cons of FDI over exporting or licensing: • FDI is expensive- cost of establishment or acquisition • FDI is risky- cultural, political and economical situation of the host country (firm might not know the rules of the game in the host country)

12. Logics Supporting FDI Over Exporting Limitations of Exports Transportation Cost: Transportation costs increases the cost of products that have low value-to-weight ratio - FDI is preferable E.g. CEMEX (cement), soft drinks, etc. Transportation cost will be a little percentage of production cost for products that have high value-to-weight ratio. –Export is preferable E.g.electronic components, personal computers, medical equipment, computer software, etc.

13. Logics Supporting FDI Over Exporting Limitations of Exports Trade Barriers: FDI can also increase due to increased threats of trade barriers such as import tariffs and import quotas. Exporting will decrease profitability. • E.g.during the 1980s and 1990s, protectionist threat by the US Congress via import quotas on Japanese cars increased FDI flow to USA by Japanese auto companies 13

14. Logics Supporting FDI Over Licensing Limitations of Licensing Market Imperfection Approach • Licensing has drawbacks: • Licensing may result in firms giving away valuable technological know-how to potential foreign competitor. E.g.RCA color television (USA)-Matsushita and Sony (Japan) • The firm’s lack of tight control over manufacturing, marketing and strategy in a foreign country that are required to maximize their market share and profitability.

15. The Pattern of FDI Observation suggests that firms in the same industry often undertake FDI around the same time and direct their investment activities toward certain locations. Strategic Behavior • This theory suggests that FDI flows are a reflection of strategic rivalry between firms in the global marketplace. Knickerbocker looked at the relationship between FDI and rivalry in oligopolistic industry (imitative behavior). E.g.Honda invested in the US and Europe. Toyota and Nissan also follow suit. • Multipoint competition: This arises when two or more enterprises encounter each other in different regional markets, national markets or industries. E.g.Kodak & Fuji Photo Film Co.; Coke & Pepsi Co.

16. The Pattern of FDI Product Life Cycle Theory Vernon’s theory suggest that firm undertake FDI at a particular stage in the life cycle of a product they have pioneered. Firms do invest in a foreign country when demand in that country will support local production and they do invest in low cost locations when cost pressure become intense. E.g. Xerox introduced photocopier in the US, then set up production facilities in Japan (Fuji-Xerox) and UK (Rank-Xerox)

17. The Pattern of FDI The Eclectic Paradigm Proponent: British economist John Dunning Location factor affects the direction or pattern of FDI. By location-specific advantage, Dunning means advantages that arise from using resource endowments or assets that are tied to particular foreign location and that firms find valuable to combine with their own assets (technological, managerial or marketing know-how capabilities). Examples:US investment in labor intensive RMG industries based in India, China & Bangladesh; European & Japanese firms invest in the Silicon Valley region of California.

18. How Does FDI Benefit The Host Country • There are four main benefits of inward FDI for a host country • Resource transfer effects - FDI brings capital, technology, and management resources • Employment effects - FDI can bring jobs • Balance of payments effects - FDI can help a country to achieve a current account surplus • Effects on competition and economic growth - greenfield investments increase the level of competition in a market, driving down prices and improving the welfare of consumers • can lead to increased productivity growth, product and process innovation, and greater economic growth 18

19. What Are The Costs of FDI To The Host Country Inward FDI has three main costs: Adverse effects of FDI on competition within the host nation - subsidiaries of foreign MNEs may have greater economic power than indigenous competitors because they may be part of a larger international organization. Adverse effects on the balance of payments - when a foreign subsidiary imports a substantial number of its inputs from abroad, there is a debit on the current account of the host country’s balance of payments. Perceived loss of national sovereignty and autonomy - decisions that affect the host country will be made by a foreign parent that has no real commitment to the host country, and over which the host country’s government has no real control.

20. How Does FDI Benefit the Home Country The benefits of FDI for the home country include The effect on the capital account of the home country’s balance of payments from the inward flow of foreign earnings The employment effects that arise from outward FDI The gains from learning valuable skills from foreign markets that can subsequently be transferred back to the home country

21. What Are The Costs Of FDI To The Home Country • The home country’s balance of payments can suffer • from the initial capital outflow required to finance the FDI • if the purpose of the FDI is to serve the home market from a low cost labor location • if the FDI is a substitute for direct exports • Employment may also be negatively affected if the FDI is a substitute for domestic production

22. What Does FDI Mean For Managers • Managers need to consider what trade theory implies about FDI, and the link between government policy and FDI • The direction of FDI can be explained through the location-specific advantages argument associated with John Dunning • A host government’s attitude toward FDI is an important variable in decisions about where to locate foreign production facilities and where to make a foreign direct investment