1 Lectures 29-31: Foreign Direct Investment Determinants of FDI Evaluation of FDI Effects of FDI

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Lectures 29-31: Foreign Direct Investment

Determinants of FDIEvaluation of FDIEffects of FDI

2 Fall 2007 NU-FAST Zahid Siddique

What in it?

• Trade theories concentrate on why countries export & import and what?– Don’t explain why firms

• make FDI instead of exporting domestic goods• sell foreign firms the right to produce its goods,

use its process or brand for licensing fee– Often export and FDI are regarded substitutes by

firms• Important issues involve:

– factors influencing FDI decisions– FDI and imperialism debate– effects of FDI on both countries


FDI

• Foreign direct investment (FDI) occurs when a firm invests directly in production facilities in a foreign country– FDI implies control, else it is portfolio investment (PI)

• PI is investment in foreign financial instruments– Govt. sets arbitrary ownership-minimums for reporting

statistics and policy making (usually 10%-25%)– Must differentiate b/w flow & stock of FDI

• Flow is amount of FDI undertaken over a given period of time– outflow: flow of FDI out of a country– inflow: flow of FDI into a country

• Stock is total accumulated value of foreign owned assets at some given point in time


Acquisition Vs Establishment

• FDI takes two major forms– establishment of a wholly new operation in a foreign

country (called Greenfield investment)– acquiring/merging with existing firm in foreign country

• Normally, FDI happens in the form of acquisition b/c: – it is easy to execute– firms have valuable strategic assets; e.g. brand

loyalty, consumer relationships, distributional channels• less risky and costly to acquire them than to build

– efficiency may be improved by transferring capital, technology and management skills

• May take two dimensions– Horizontal FDI: investment in same industry as at

home– Vertical FDI: investment in input-providing industry or

output-selling industry for domestic production


Horizontal FDI and internalization theory

• Why firms go for FDI despite that:– it is expansive and risky compared to

exporting/licensing• expensive b/c acquiring resources abroad needs

resources• risky b/c of cultural differences

• One reason is avoiding transportation cost– However, economists don’t weigh it highly as it is out

of their standard mantra of ‘market mechanism’• Justification of ‘Market imperfections’ is what they prefer

to explain this phenomenon• Imperfections arise due to

i. Barriers against exports• decrease the profitability of exporting relative to

FDI



ii. Barriers against sale of ‘know-how’ (expertise)– technological, marketing & management ‘know-how’

build competitive advantage (or asset) for firms• the larger the market-size, the larger the potential

for profitability arising due to them– One easy way to transfer this ‘know-how’ is licensing

• Rule: make FDI only if transfer of ‘know-how’ difficult

– Many difficulties according to economists• licensing may means giving away your asset to

your potential competitor (e.g. Pizza Next)• licensing does not allow tight control over

production process which– may be required to benefit from input cost

differences producing parts at different locations– or may be for maintaining company’s strategies



• some aspects can’t be transferred via licensing; e.g. marketing and management skills can’t be codified

• Some other reasons are also advanced to explain FDI– Product life cycle

• already discussed in trade theory– Location specific advantages

• Porter’s diamond roots– Strategic behavior of firms

• Go through them yourself


Horizontal FDI: the decision tree

Transportation costs and trade

barriers

Is know-how amenable to

licensing?

Tight control over operation

needed?

Can know-how be protected?

Exports

Licensing

FDI

FDI

FDI

Low

No

Yes

No

High

Yes

No

Yes

Sources of Market

imperfections


FDI—good or bad

• Making value-judgment presumes ‘some criterion’– Basis of ‘decision criterion’ changes policy guide

• Marxists Vs Social democratic critiques of markets• Orthodox Vs revisionist evaluation of capitalism

• Evaluation on the desirability of FDI depends largely upon ideological underpinning of state officials– Four broader perspectives

• Radicals: Marxists roots• Liberals: Free market roots• Pragmatic nationalists: social democratic roots• Islamists: Revisionists and orthodox

• Let’s highlight their important features


1) Radicals—left to globalization

• Marxists and Liberals are arch rivals on the role of ‘private property’ in economic development– Liberals: no development strategy can go without

private property and, hence, it is ‘good’• policy: insulate private property

– Marxists: private property is the source of economic exploitation and, hence, is ‘evil’• policy: abolish private property

• Conduct of FDI makes firm ‘multi-national enterprise' (MNE)

• Since almost all MNE work on the principle of ‘private property’– FDI is seen as tool for the promotion and domination

of this property form at global level—i.e. materializes imperialistic agenda of liberal capitalism


1) Radicals—left to globalization

• Marxists charge MNE for:– exploiting host country cheap labor– extracting profits to their home countries– keeping control over technology to keep LDC dependent– lobbying and corrupting political officials

• Extreme Radical opposes acceptance of FDI by host country as it leads to economic ‘domination’ and not of ‘development’– Nationalize if any MNE exist in the country

• This view dominated b/w 1940s-1980s– has lost loyalty mainly after fall of USSR and partially due

to poor economic performance of socialist economies• Radicals offer merely instrumental critique of capitalism

– FDI is barrier to the realization of freedom and equality– Have no alternative plan of life other than ‘modernity’


2) Liberals: agents of globalization

• Base their argument on superiority of – Smith’s free market order, and– Ricardo’s comparative advantage for efficient allocation

of resources• To them, FDI is a means to this end at global level

– hence favor Globalization• Countries face foreign pressure as they assume increasing

subordination in globalization for– deregulation—limiting state restrictions in business, and– Privatization—shifting ownership from public to private

agents• Dichotomy: ‘capital is global’ but ‘countries want its hold

nationally’– Solution: make your home land a ‘market place’ for

capital– This is what is meant by Globalization


• Proponents of globalization take economic plea– results in lower prices of goods and services– stimulates economic growth– raises incomes of consumers– creates new job avenues

• Critics take a multi-dimensional approach– job loss in industries attacked by foreign competition– downward pressure on wages of unskilled labour– environmental degradation– cultural imperialism of global media and multinationals– political hegemony of America

• Receive article from photo-state shop– Emma Aisbett (2005), “why are critics so convinced

that globalization is bad for the Poor?”

Globalization: pros and cons


• An unintended result of globalization is glocalization—i.e. think globally but act locally– Globalization: looking at similarities– Glocalization: looking at differences

• Interaction among cultures revealed value of ‘differences’• Multiculturalism is presented as solution to this problem

– we should enjoy differences b/c we can’t rationally prove any conception of good and culture superior to others

– all ways of life be treated and given equally opportunities

• However, it is fallacious both in theory and practice– multiculturalism presumes an over-riding rule

• which is ‘Human Rights framework’– subordinates all ways of life to capitalistic way of life

• Conflicting ways of life can’t flourish together

From Globalization to Glocalization


3) Pragmatic nationalists

• Pragmatism is an epistemology according to which: – truth is relative– what matters is the effects of an action—i.e. ‘truth’ is

what works to achieve desired ends• Pragmatic nationalists don’t take ideological position,

rather evaluate benefits & costs of FDI– maximize national benefits and minimize costs out of

FDI going case by case• Allow FDI only if benefits outweigh costs

– Block FDI that harms indigenous industry– Court FDI that is in national interest

• Tax breaks• Subsidies


Summary

Ideology Characteristics Host-Govt. Policy

Radicals Marxist rootsView MNEs instrument of imperialist agenda

Prohibit FDINationalize foreign owned MNEs

Liberals Neoclassical economic rootsView MNEs instrument for efficient allocation of resources

Allow free movement of FDIMake home country ‘market’ for global capitalPragmatic

nationalistsView FDI having both benefits and costs

Resist FDI if costs outweigh benefitsBargain for greater national benefitsOffer incentives


Islamists: Revisionist fallacy Vs Orthodox legacy

• Revisionists seek to Islamize all western discourses; whether economic, social or political– disagree on number and extent of issues to be Islamized

• Fail to see historicity of western civilization; i.e. capitalism– regard it universal and historically necessary

phenomenon• Since, to them, market is a natural and neutral order of life

– can’t oppose FDI, except on pragmatic grounds• endorse ‘Muslim nationalism’—viewing Islam as a

means for the progress and domination of Muslims– or may take a ‘cultural plea’ against FDI

• Their fallacy is to ‘view Islam in context of capitalism’—i.e. Islam = capitalism or Socialism with some + & -– not view Islam an independent civilization

• Can’t apprehend how the objectives of Shariah ( الشريعه صد ( مقاare hampered by the domination of capitalism via MNEs



• Since orthodox equate capitalism with Jahilya and regard Islam an independent civilization– FDI is seen as means for domination of capitalist Jahilya– MNEs promote and sustain capitalistic way of life by

universalizing ‘for-profit business enterprise’ and ‘utility hunting consumption attitude’

• Domination of capitalism corrupts Islamic society at all levels– In individual sphere: eliminate possibilities for flourishing

of Islamic individuality—one characterized by زهد (self-denial) and فنا (self-annihilation)

– In social sphere: marginalize collectivities based on love, co-operation and religious ties

– In state sphere: instrumentalize state-powers for capital accumulation and desire-fulfillment agency• trio makes organic-whole—can’t perpetuate in isolation






Back to Science: ‘knowledge of buying and selling’

• FDI has both positive as well as negative sides• Benefits of FDI include:

– Transfer of Resources (capital, technology, skills)– Employment effects

• more jobs created in case of Greenfield investment– but jobs also lost due to shut down of home

industry• links more negative in case of acquisition b/c

MNEs reduce work force to restructure operation– Balance of Payment Effect

• to be discussed in next topic– Growth effects

• ‘economic theory’ shows positive relation b/w FDI and growth


Back to Science: ‘knowledge of buying and selling’

• Cost-side comprises:– Hampering of competition

• MNEs force domestic firms out of business by drawing resources from elsewhere to subsidize its production

• may also monopolize production by merging two firms together after acquiring them

– Loss of national sovereignty• country losses economic independence as major

economic decisions are left to foreigners who have no loyalty to host country

Documents

1 Lectures 29-31: Foreign Direct Investment Determinants of FDI Evaluation of FDI Effects of FDI