Published on November 16, 2007
Why Do Companies Invest Overseas?: Why Do Companies Invest Overseas? Krishna G Iyer Department of Applied and International Economics Massey University, Palmerston North. Outline of the Presentation: Outline of the Presentation Define overseas/foreign investment. Types of foreign investment. Foreign direct investment and Multinational Enterprises. Statistical highlights: Macro-level Data. What drives FDI – Micro factors. Shareholder portfolio diversification. Revenue related objectives. Cost related objectives. Trojan Horse Theory. Incentives and Barriers to FDI. Conclusion. Types of Investment: Types of Investment Foreign Direct Investment (FDI) – Multinational Enterprise (MNE). Foreign Portfolio Investment (FPI) Other Foreign Investment (OFI) Relative Importance (USA): Relative Importance (USA) Relative Importance (USA): Relative Importance (USA) Relative Importance (NZ): Relative Importance (NZ) Relative Importance (NZ): Relative Importance (NZ) Growth Rates: Growth Rates FDI as share of GDP: FDI as share of GDP FDII and FDIO Flows as Percentage of GDP (1980-2004) FDI – Who Invests: FDI – Who Invests FDI – Who Hosts: FDI – Who Hosts The China Story: The China Story The Micro-Story: Why do firms invest overseas?: The Micro-Story: Why do firms invest overseas? Shareholder Diversification Services. Revenue Related Motives. Cost Related Motives. Trojan Horse Theory. Shareholder diversification services: Shareholder diversification services Don’t put all your eggs in one basket. International Stock Market Correlations are low – thus portfolio risk might converge to the systematic risk. FDI provides indirect diversification services. Little empirical evidence favoring this thesis. In any case, reducing barriers to FPI makes this motive, if it ever existed, less important. Revenue Related Motives: Revenue Related Motives New markets. Enter markets with superior profits. Exploit intangible assets. Reacting to trade barriers. International business diversification. New Markets: New Markets Establish a subsidiary or acquire a competitor – Greenfield Investments / joint ventures / cross-border mergers and acquisitions. E.g. Blockbuster Entertainment Corp. – entering the rest of the OECD. Coca-Cola and Pepsi in China and India. FORD, HP, IBM. YUM Brands – KFC Franchises. Firm Level Surveys indicates access to new markets as the primary determinant of FDI (PC - Australia). Markets with superior profits: Markets with superior profits MNE’s are attracted to markets with superior profits. When profit margins are squeezed in the domestic market – foreign markets may be worth exploring. Related to the Product Life Cycle theory of Vernon (1966). Entry may trigger a price war and defeat the purpose of FDI – E.g. the Mobile Phone Industry in Asia and more recently India. Joint Ventures may then be preferred. Exploit Intangible Assets: Exploit Intangible Assets Comparative advantage of MNE’s off-setting the inherent disadvantages vis-à-vis domestic firms. The intangible assets may take the form of technology, marketing know-how, superior R&D capabilities, brand name and recognition. Hard to package and sell intangible assets to foreign firms. Further, property rights are difficult to establish and protect in foreign countries – So FDI emerges, often, as the best way to exploit intangible assets. The Coca-Cola Story in India. Reacting to Existing/Potential Trade Barriers: Reacting to Existing/Potential Trade Barriers Transportation costs. Circumvent trade barriers – E.g. Japanese televisions in US. Pre-empt trade barriers – E.g. Japanese automobiles in US. Surge of FDI in Mexico (NAFTA) and Spain and newer members of EU. International Business Diversification: International Business Diversification Reducing overall risk via international diversification – low correlation once again the key. The Enron Story. Cost Related Motives: Cost Related Motives Exploiting economies of scale. Access to raw materials / inputs. Labor market imperfection. Exchange Rate Movements. Exploiting Economies of Scale: Exploiting Economies of Scale Lower average cost per unit resulting from increased production. Also relates to the revenue related objective of exploiting intangible assets. E.g. Consolidation of US MNEs in Europe since the Single European Act. Specific examples include: General Motors – Poland, Peugeot – Czech Republic, Toyota – Slovakia, Audi – Hungary, Renault – Romania, Volkswagen – Slovenia. Access to raw materials / inputs: Access to raw materials / inputs Transportation costs – bulky raw materials. Ensuring inputs supply stability. E.g. SKF the Swedish ball-bearing manufacturer. Labor Market Imperfection: Labor Market Imperfection Labor services in a country can be severely under-priced relative to its productivity. Labor is not perfectly mobile across countries. Surging FDI in Mexico, China, India, Thailand, Indonesia, Malaysia often attributed to low cost of labor. Revisiting examples: General Motors – Poland, Peugeot – Czech Republic, Toyota – Slovakia, Audi – Hungary, Renault – Romania, Volkswagen – Slovenia (Spain – Germany Link). Surge of FDI in Mexico (NAFTA) and Spain (EU). How divergent are labor costs?: How divergent are labor costs? Exchange Rate Movements: Exchange Rate Movements Undervalued currency may encourage FDI since initial outlay is likely to be low. Empirical evidence is not clear. Trojan Horse Hypothesis: Trojan Horse Hypothesis Has been the hot topic over the last few years. Rising Sun – the book by Michael Crichton has several references to this theory. To revisit the Trojan Horse Story. Trojan Computer Virus – and now Trojan FDI. Van Pottelsberghe and Lichtenberg (1996, 1998 and 2001) say FDI is essentially driven by the desire to acquire technology. At the aggregate level, almost no evidence is found. But what does the market say? Average Wealth Gains from Cross-Border Acquisitions: Foreign Acquisitions of US Firms (Eun et al. 1996): Average Wealth Gains from Cross-Border Acquisitions: Foreign Acquisitions of US Firms (Eun et al. 1996) Returning to the macro level - Incentives for FDI: Returning to the macro level - Incentives for FDI Widely held view that FDI offers substantial benefits for host economies – technology, employment, export revenue, consumer choice, increased competition etc. Empirical evidence is ambiguous. Incentives include tax breaks, rent-free land and buildings, low interest loans, subsidized energy, reduced environmental regulations. Classic examples – Finland and Ireland 1990s. With tax breaks there is always the possibility of round tripping – China and India are examples. Incentives must be carefully weighed – easy to go overboard. Barriers to FDI: Barriers to FDI Barriers placed by Government agencies. E.g. France, Australia. Japan has a historically imposed barriers on acquisitions. Restricted Ownership rules in several developing countries – can be effectively used to reduce political risk of FDI. Conditions – Employment related conditions (American Universities in the Middle East), Acquisition of Inputs from local sources e.g. Mexico, Export conditions, E.g. Spain, etc. Red Tape / Corruption. Conclusion: Conclusion Large and Increasing Magnitudes of FDI – a trend certain to continue in the future. Why do firms undertake FDI? Is it beneficial for host and source economies? What sort of incentives are being offered? What kind of barriers exist? Weighing the Costs and Benefits.