Lecture 6 - Foreign direct investments and MNEs Flashcards
Define Foreign Direct Investment FDI
= Significant amount of ownership in a foreign-based enterprise to gain management control. Defined by the UN as involving an equity stake of 10% or more in a foreign-based enterprise.
Define Foreign Portfolio Investments FPI
=Investment in a portfolio of foreign securities such as stocks and bond that do not entail the active management of foreign assets.
Define:
1) FDI flow
2) FDI inflow
3) FDI outflow
1) Amount of FDI capital moving in a given period in a certain direction
2) Inflow = FDI moving into a country
3) Outflow = FDI moving out of a country
Define FDI stock
= Total accumulation of inbound or outbound FDI in/from a country at a certain point in time
What is an MNE and what is it not?
= A firm that engages in FDI
A non-MNE = a firm that does business abroad but via:
-Exporting
-Licensing
-Outsourcing and engages in FPI
Define Horizontal FDI
= Duplicates its home country based activities at the same value chain stage in a host country
Define Vertical FDI
=When a firm through FDI moves upstream or downstream in different value chain stages in a host country
What is the OLI paradigm and what does it consist of?
A theoretical framework explaining why firms engage in FDIs through 3 aspects:
-Ownership or firm-specific advantages
-Location
-Internalization advantages
OLI paradigm:
Define ownership/ firm specific advantages
Defined as resources or capabilities of the firm that:
-Are transferrable across borders and enable firms to achieve competitive advantage abroad
What 4 ownership advantages do EMNEs have?
1) Capabilities in managing large-scale, labor intensive operations in multiple countries
2) Experience in operating in highly volatile and imperfect institutional environments
3) Access to vast home country markets that is attractive for foreign investors
4) Preferential access to resources controlled by the government
OLI paradigm: ‘
Define location advantages and the 4 areas they stem from
= Advantages bound to a specific location.
1) Markets
-Size and growth of consumer demand
-Protectionism i.e. tariffs
-Transportation costs
-Proximity to key clients
2) Resources
-Human resources
-Natural resources
3) Agglomeration
-Clustering of economic activities in certain locations that creates:
-Knowledge spillovers
-Access to qualified labor force
-Access to specialized suppliers and buyers
4) Institutions
-Formal and informal
-Political stability and security
-Tax system, financial incentives
-Culture/language
What is internalization advantages and what leads to transaction costs?
= Advantages of using an asset within the firm rather than selling or licensing it.
Advantage to replace external market relationships with relationships internal to the firm across borders.
FDI overcomes market failures through internalization
These advantages arise because firms incur transaction cost arising from:
1) Asset specificity - requiring investment very specific to a business relationship
2) Information asymmetry - hard to monitor the process
3) Dissemination risk - knowledge goes out of the firm
4) Tacit knowledge transfer - knowledge is too complex to transfer properly
What are the 2 alternatives to FDIs and when should they be used?
1) Exporting
2) Contracting via licensing:
-Granting a foreign entity the right to produce and sell the firm’s product in return for royalty fee for each unit sold.
Should be used if there is no internalization advantages
When should firms:
1) Remain domestic
2) Produce at home and export
3) Export/license
4) Engage in FDI
1) If it does not have ownership/ firm-specific advantages
2) If it has ownership/ firm-specific advantages but no location advantages of moving abroad
3) If it has ownership/ firm-specific advantages and location advantages but no internalization advantages
4) If it has:
-ownership/ firm-specific advantages
-Location advantages
-Internalization advantages
What are the potential positive and potential negative effect of FDI in host countries for:
1) Consumers
2) Suppliers
3) Competitors
4) Workers
5) Government
6) Natural environment
1) Consumers
-Access to international quality products and brands
-Lower prices due to scale of economics and competition
-Reduces variety of traditional local brands
-Monopoly prices when an MNE dominates the market
2) Suppliers
-Technological transfer enhancing productivity
-Opportunity to become an international supplier
-Crowding out by international sourcing
3) Competitors
-Technology spillovers enable learning
-Competition may trigger upgrading and innovation
-Crowding out by overwhelming competition
4) Workers
-Employment opportunities
-Typically higher labor standards
-Training and knowledge transfer
-Often less labor-intensive production than local firms
5) Government
-Tax revenue
-Economic growth
-Costs of subsidies and other incentives
6) Natural environment
-MNEs often have higher environmental standards than local firms
-May locate highly pollution activities in places with less stringent regulation
