Download of FDI - Karl Aiginger

MGTECON 580: Class 4
Foreign Direct Investment:
a tool for sustained competitive advantage
and/or for technology diffusion
Definition: acquisition of controlling assets of a
firm in another country
FDI in perspective is one alternative strategy to
internationalize:
- exports
- licensing
- sourcing abroad
- distribution subsidiary
- production subsidiary
Relation to location theory:
One step more complicated
Different functions at different location
Centrifugal versus centripetal forces; transport costs
1
The firm perspective and the
country view
Strategic importance for firms
Lowering costs
Increasing market share
Diversification
Acquiring strategic assets
Securing long-run profitability
Old style firm vs. new
Old: one region, one country
production and demand overlap
New: optimizing jointly production,
transport, marketing, sourcing
The policy issue (country perspective)
There are usually arguments against both types:
- Inward investment (IDI) implies “Foreign dominance”
specifically in sophisticated, strategic industries
- Inward investment implies “development trap”
if only low-skill industries come in
- “Investing abroad” implies employment loss
2
Technicalities and indicators
Investment vs. stocks
Flows in a year, stocks accumulated
Acquisition value vs. net addition to stock
Buying price (investment) in % of national (physical)
investment
Alternative indicator: capital stock in % to GNP
Investment is recorded (via National Bank)
Divestment often not, if bankruptcy
Sales of a firm can comprise:
Sales = SHD + SHF + SAF + SAH
Sales at home for domestic market
Sales at home for foreign market
Sales abroad for foreign market
Sales abroad for home market
3
The many faces (types) of FDI
According to activity
• Production
• Upward activities (sourcing)
• Distribution, logistic
• Research
• Headquarters
According to investment mode
• Greenfield investment
• Merger/acquisition
• Joint venture
Note: portfolio investment (small shares) is not FDI
According to motives
• Cost-driven
• Market-driven (serve better the market)
• Infrastructure-driven (business environment)
According to trade effect
• Import substituting
• Export increasing
According to financial transaction
• Equity capital (share)
• Reinvested earnings
• Intra-company loans
According to firm’s internal structure
• Horizontal FDI
•Duplicating plans to get rid of tariffs and trade costs
•In principle substitute to exports
• Vertical FDI
•Part of the supply chain is “outsourced”
•In principle complement to exports
• Horizontal FDI
•Duplicating plans to get rid of tariffs and trade costs
•In principle substitute to exports
• Conglomerate
4
The eclectic OLI Model
by John Dunning
The basic theoretical challenge
• Indigenous, domestic firms should have a priori advantage
• Knowledge of environment
• Distance HQ -- production site
What compensates this advantage
• Ownership advantages: firm-specific knowledge
• Patents, expertise of organization and learning
• Location advantages: cheaper/better inputs
• Internalization advantages
• Better use inside the firm than through the market (licensing and
pricing)
OLI paradigm: you need all three
5
Other determinants of FDI
Rate of return difference
FDI goes in countries with higher expected return
Portfolio diversification: investments to diversify risks
Market size attracts investment
Product cycle explanation
Each product passes three phases:
1st phase: invention
in developed country
2nd phase: growth period
exports
3rd phase: maturity
FDI
Oligopolistic interaction
•
Investment is a commitment
Which puts other firms in worse position
•
Other strategic factors
Defend markets, get foothold, complementing,
committing
Internal financing: free cash flow looks for opportunities
Policy related determinants: better business conditions
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Five Stage Theory: Net FDI
depends on stages of
development, by John Dunning
Stage 1: No location bound asset
• At least no created ones, ev. Natural resources
• Prediction: Neither IDI nor ADI
Stage 2: Inward FDI attracted by cheap inputs or
resources
• Possibly government helps (involuntarily) with import taxes
• Outward investment starts, but well behind inward
• Prediction: FID-deficit
Stage 3: Upcoming ownership advantages: ADI rises
faster than IDI
• Surpluses with poor countries, deficits with rich ones
• Prediction: FDI stock becomes balanced
Stage 4: Ownership advantages and search for low
cost production sites
• Further push outward investment up to maximum surplus
• Intra-industry production specialization (following IIT shares)
• Prediction: high-surplus of ADI, both flows increasing
Stage 5: Firms become globalized and nationalities
blurred (Dunning-Narula, p8)
• But there can be instable positions (fluctuations, vicious and virtuous circles)
• Prediction: Net positions equalize again
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Empirics of FDI
Stylized fact 1: FDI growth higher than trade and GNP
growth
Hierarchy of dynamics 1985 - 97: (UNCTAD FDI/TNC Database
Nominal GDP
7%
Trade by
9%
FDI inflow 18%
Stylized fact 2: Significant share of trade is intra-firm
trade
1998 - 30% of world trade is trade in commodities within firms (Yeats p.16)
Stylized fact 3: FDI is investment of developed countries
in developed countries
High share from neighbors
Much intra EU
A lot from US
18% of employees in EU work in MNE
8.6% owned by non-EU parents
7% in US parents
Stylized fact 4: There are industry differences
High FDI sectors are
R&D intensive
Skill intensive
Technically sophisticated, differentiated
Peak of US firm shares in Europe
Optical and medical instruments
17%
Transportation
14%
Chemicals
12%
Telecom
10%
Peak of EU in US are
Chemicals
36%
Glass, stone
18%
Electronics
14%
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Stylized fact 5: In bilateral investment EU has a
substantial surplus, high overlap
US firms in EU are responsible for 22% of EU imports from US and 19% of
EU exports to US
EU firms in US are responsible for 28% of US imports from EU and 12% of
US exports to EU
Interpretations: EU “needs more home input”
35% of EU and 47% of US imports (share of bilateral flows)
Stylized fact 6: Developing countries are recipient: IDI:
ADI=4:1
Stylized fact 7: Developing countries receive minority of
FDI (30%)
However, relative to GDP now more (2.4%) than developed 1.3% (p13)
Stylized fact 8: EU is net investor in FDI, as well as a net
export in trade
Stylized fact 9: US are marginally a net investor in FDI,
net importer in trade
Stylized fact 10: Japan is a net investor, though with low
flows and less surplus than in trade
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Does actual pattern of FDI follow
Five Stage Theory?
Deficit in stage 2 is empirically shown
• FDI deficit in developing countries
• And in GR, P, SP
Increasing outward investment in stage 3 also
• But to different extent
• Deficit depends on natural resources vs. firm specific advantages
Country specific persistency in phase 4
• See European countries:
• UK and Switzerland have persistent investment surplus
• Austria a persistent deficit (never a surplus in between)…
Equalization in phase 5 is open question
• US has still a surplus (decreasing)
• Japan has a large non-decreasing surplus
What is behind?
• High wage in Switzerland
• Financial center, research and other attractions for headquarters
• Headquarters move only for significant cost-service differences
10
Inward and outward investment
across countries
Inward and Outward investment across countries
108.3
97.5
100.0
73.9
65.7
50.7
50.0
50.1
49.8
47.4
32.7
26.8
20.921.5
14.5
11.2 9.2
24.7
17.1
18.9
13.7
16.4
15.8
29.9
26.8
20.519.0
11.113.0
10.6
9.4
i
U
K
U
SA
Sw
e
Sw
ed
Po
r
Sp
N
r
G
Fr
G
e
en
SF
D
A
B&
L
Ita
0.4
0.0
Inward
Outward
21.2
17.7
Ire
Inward/Outward
150.0
Country 1999 FDI stocks as percentage of GDP
Conclusions:
FDI activists in Europe: UK, Netherlands,
Sweden, D,F,SF,S,I
These are all big 4 plus the Nordic
FDI receivers all south (exception Italy)
plus Austria (A-D); Belgium (B:NI)11
Sp less than expected see SP-P
The impact of FDI on economic
development
Positive:
• Quickest import of technology and management
• High productivity, cheap products
• Learning to catch up in skills
Negative:
• Host country may get second best technology
• Development trap (MNE invest in industry with low future potential)
• Plants not fitting into endogenous development
• Footloose industries stay only as long as costs are low
• Outside steering of development, dictated by headquarter
Important for a positive contribution to host country:
• Linkages, Learning, Upgrading as shown in the Irish example
• Open for inward FDI plus upgrading infrastructure
And inviting firms to upgrade plant
• Focus on linkages
•On learning
•On small local firms interrelating with MNE
12
Empirical facts about
behavior of MNE
Labor-intensive sectors dominate
Capital-intensive sectors
Human capital-intensive industries underrepresented
Many IDI have few linkages (insolated firms)
MNE plants have high productivity
Fast growing
Technology transfer, however, not own research
Countries pursuing export lead perform better
Than countries relying on import substitution strategies
13
The impact of FDI on economic
development
The rationale for FDI
• Lowering costs (road to cost leadership)
• Increasing market share (size, barriers to entry, strategic advantage
• Diversification (new market, distributing fixed costs of firm specific asset or
capability)
• Acquiring strategic assets (innovative capacity of foreign firm, country)
• Long-run profitability
Chances
• To evade the eternal threat of profit dissipation (the need for markets)
• To reduce costs (the need of evading high costs)
• To increase world market share (the need of top 3 position)
• To shift into fast growing countries
• To acquire strategic assets and capabilities (IT, knowledge)
Risks
• Specific country risk (political, legal)
• Difference in culture and corporate governance
• Different scheme of wages, social contributions, taxes
• Danger that competitive advantage can not be transferred, sustained
• Danger that resources will be diverted from investing into sustaining
competitive advantage
• Specific problem of control (size, distance)
And organization (decentralization, centralization, divisional,
functional)
14
The implementation in formal mode
(A1)
FDI:
fixed cost at headquarter (once): F
lower variable costs (relative to domestic
firms): c.q, c<c*
set up costs at each location: n.f
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