Foreign Direct Investment Chapter Sixteen Eitman, Stonehill, & Moffett October 2, 20151Chapter 16 -...

Foreign Direct Investment

Chapter SixteenEitman, Stonehill, & Moffett

April 19, 2023 1Chapter 16 - Foreign Direct Investment

Absolute advantage (Smith)

Absoluteland 0.2 productive units to produce 1 X 0.3 productive units to produce 1 Y

Relativeland 0.4 productive units to produce 1 X 0.5 productive units to produce 1 Y

Absoluteland has absolute advantage in the production of both X and Y

April 19, 2023 Chapter 16 - Foreign Direct Investment

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Relative Advantage (Ricardo) Absoluteland

The X price of Y is 0.67 The Y price of X is 1.5

Relativeland The X price of Y is 0.8 The Y price of X is 1.25

Relative advantage Absoluteland in X Relativeland in Y


3

The world price of X and Y

Perfect world Absoluteland specializes in Y

World X price of Y is between 0.67 and 0.8 Relativeland specializes in X

World Y price of X is between 1.25 and 1.5

Actual price Evolution of trade will determine a

common world price


4

Reasons for investment

markets raw materials production cost reduction technology transfers reduction of political risk


Government interference

Full employment policies Tax breaks for automobile manufacturers

Economic development Bombadier

Essential industries protected Agriculture

Defence related industries Boeing, McDonald/Douglas in the U.S.


6

Factors of production mobile

Capital Very efficient world-wide capital markets Flows of capital large Multinationals easily transfer production

Technology Intellectual property is very hard to protect

Labor Illegal immigrants Immigration policy


7

Factors of production substituted

Capital for labor (capital investment) Labor for capital (outsourcing) Technology transfers

Through subsidiaries Through joint ventures


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Economies of scale & scope

scale economies production finance research & development transportation purchasing marketing

scope economies finance marketing


Product & factor markets

new product markets barriers to entry reduction of barriers

factor markets labour money & capital technology goods resource


Defensive investments

product cycle - cigarette industry declining N. America, steady-state market in

Europe, increasing Eastern Europe, Asia

follow the leader - China conventional wisdom, huge market horizontal or vertical integration

zero-sum game in home markets growth leads to destructive competition

knowledge transfers


Modes of investment

Production at home and exporting joint venture merger licensing agreement management contract


Production at home, exporting

Advantages Control Less risk

Political risk

Disadvantages High cost of labor Transaction and operating exposure


13

Joint Venture

Advantages partner has country specific knowledge

markets, politics, regulation politicians prefer local ownership Less transaction or operating exposure

Disadvantages lack of control

financing, transfer pricing, strategy valuation is difficult Potential translation exposure


Mergers & Acquisitions

Advantages economies of scale & scope reduces operating exposure obtain technology Obtain markets Transaction, operating exposure lower

Disadvantages divergent corporate cultures political opposition valuation is difficult Potential translation exposure


Strategic alliances

Advantages exchanging stock marketing agreements cost sharing agreements

Disadvantages Little control


Licensing

Advantages No investment costs Partner with knowledge of local markets

disadvantages cash flow & transfer of knowledge may create competitor


17

Political risk

change in rules which lead to reallocation of resources tax rules ownership rules/capital controls

restrictions of foreign ownership exchange controls

change in political structure which portends reallocation of resources


Macro risks

expropriation government seizure of property valuation

book?? Market?? exchange rates??

time value of money civil strife

investment in Yugoslavia, Russia?? antagonistic governments

for US Iran , Cuba ??


Micro risks - Government Policy Goals employment policies resource reallocation

taxes transfers

trade policies protectionism balance of payments exchange rate policy

economic development


Barriers

limitations to trade quotas, embargoes, licensing, domestic content

administrative restrictions fees, tariffs, deposit requirements, tax

adjustments

non-economic discrimination quality standards, environmental, health

direct government interference procurement, export subsidies, domestic

subsidies


Non-economic goal conflicts

economic emperialism African economies

national security concerns U.S. concern

corruption & nepotism South, Central America, Africa, Asia

xenophobia Asian economies


Assessing Political risk

political stability probability of change direction change would take

firm specific negotiating terms operating strategies to mitigate risk


Foreign Direct Investment Chapter Sixteen Eitman, Stonehill, & Moffett October 2, 20151Chapter 16 -...

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