IB 150 Midterm: Review2

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Review 2 for IB 150
Foreign Direct Investment
What is Foreign Direct Investment (FDI)?
Foreign direct investment occurs whenever a firm establishes a controlling interest in a
business entity based in another country by acquiring ownership of more than 50% of the
entity’s entire stock
Practically, the U.S. Department of Commerce deems an investment FDI whenever a
U.S. citizen, organization, or affiliated group takes an interest of 10% or more in a foreign
entity
Different ideologies toward FDI.
Political Ideology Toward FDI
The Radical View
Popular from WWII into the 1980’s
Marxist roots: MNE considered a tool for imperialist domination
Prohibition of FDI
Nationalization of MNE (multinational enterprises) subsidiaries, ex: Venezuela
makes american oil companies to sell their products to a Venezuelan oil company or
confiscate the product
Practiced mainly in
Eastern Europe
China
India, and other socialist countries
In recession in the 1990’s
The Free-Market View
Multinationals viewed as an instrument for dispersing production and flow of
goods & services in the most efficient manner
Classical economic roots (Adam Smith)
Explained by the market imperfection theory
No restrictions on FDI
Practiced mainly in advanced and some developing countries, e.g., \U.S., U.K.,
Holland, Hong Kong, Singapore
The Pragmatic Nationalist View
FDI viewed as having both benefits and costs
Lies in between the radical and the free-market views
Governments should pursue policies designed to maximize the national benefits
and minimize the national costs of FDI:
Restrict FDI when costs outweigh benefits
Court beneficial FDI by offering incentives
Practiced in most countries
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Different effects caused by FDI to the investor country or the recipient country
Benefits of FDI to Host or Recipient Country
Resource-transfer effect
Capital inflow - in substantial amounts
Technology is brought in: critical to economic development of host country
Management expertise: increase the productive use of the host country’s
resources
Employment effect
Direct job creation in FDI created businesses
Indirect job creation - in supply & distribution chains of such businesses
Balance of payment effect
Capital account inflow (FDI) can offset current account deficits in the recipient
country’s balance of payment
FDI firms’ products can replace a country’s foreign imports: import substitution
effect
Reduction of imports, which reduces trade deficit
Exports by FDI firms
Increase of exports, which increases trade surplus
Costs of FDI to Host Country
Adverse effect on competition
FDI firms usually more competitive
Infant industry concerns: domestic industry can’t compete with FDI firms
Adverse impact on Balance of Payment
Subsequent outflow of earnings by FDI firms
FDI firms’ import of foreign inputs
National sovereignty and autonomy
Potential loss of economic independence
“Economic ransom” by FDI firms
A naïve view given the current world economic interdependence
Benefits and Costs of FDI to Home (Investor) Country
Benefits:
BOP effect: inward flow of earnings from FDI
Employment effect: from higher home country export of equipment and other
capital goods
Reverse resource transfer effect: skills learned and transferred back home
Costs:
BOP effect:
Initial capital outflow
FDI serving home market: “offshore production”
FDI creates export substitution
Employment effect: “export of jobs”
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The current and historical volume of the investment, and stock and flow of FDI
FDI Growth in the World Economy: Some Facts
FDI Outflow of $25 billion in 1975 increased to $644 billion in 1998, $1,149 billion in
2000;
90% are from developed countries, U.S. MNCs account for 12 % in 2000
Developed countries received 79% of FDI in 2000, U.S. received 22% of global FDI
inflows.
FDI Flow from all countries increased 1000%, trade 91%, world output 27% from 1984 to
1998
FDI Stock increased to $3.5 trillion by 1997
60,000 parent MNEs with 500,000 foreign affiliates produced $11 trillion sales, or 25%
of global output
FDI growing faster than world trade and GDP
Historical Changes in the Recipients of FDI
From 1986 to 1990, developing nations were the recipients of about 16 % of all FDI. By
1994, it increased to 41 %
China’s total stock of FDI increased from $6.25 billion in 1980 to $346.7 billion in 1999,
and to $1.3 trillion in 2013.
This is due to the rapid economic progress of many developing nations and their
adoption of economic liberalization policies, which lowered barriers to FDI
There has also been a rise in the inflows of FDI into the United States. Two leading
investors in the U.S. were the British and the Japanese
The motivation for FDI: seeking markets, self-handling, following competitors, etc.
Regional Integration
What is Regional Economic Integration?
Agreements among geographically proximate countries to reduce/remove tariff and non-tariff
barriers to enable free flows of:
Goods
Services
Factors of production: labor and capital
Reasons for forming regional integrations: cultural, political, geographical, economic, etc.
Economic reasons
Enlargement of market and opportunities
Complementary of economies
Political reasons
Political amenability within group
Linkages of economies create interdependencies that reduce the potential for violent
conflict
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