What is Foreign Direct

Investment (FDI)?
 A source of capital and investment
involving foreign control of
production

 A source of exploitation?

 A channel of technology transfer

and industrial development?
What is FDI…?
 Foreign direct investment (FDI) is defined
as a long-term investment by a foreign direct
investor in an enterprise resident in an
economy other than that in which the foreign
direct investor is based.
 The FDI relationship, consists of a parent
enterprise and a foreign affiliate which
together form a transnational corporation
(TNC).
 In order to qualify as FDI the investment must
afford the parent enterprise control over its
foreign affiliate.
 The UN defines control in this case as owning
10% or more of the ordinary shares or voting
power of an incorporated firm or its equivalent
for an unincorporated firm.
Types of FDI
 Greenfield investment: direct
investment in new facilities or the expansion
of existing facilities.
 Greenfield investments are the primary target
of a host nation’s promotional efforts because
they create new production capacity and jobs,
transfer technology and know-how, and can
lead to linkages to the global marketplace.
 downside of Greenfield investment is that
profits from production do not feed back into
the local economy, but instead to the
multinational's home economy. This is in
contrast to local industries whose profits flow
back into the domestic economy to promote
growth.
Types of FDI
Continued……….
 Mergers and Acquisition

transfers of existing assets from

local firms to foreign firms takes
place; the primary type of FDI.
 Cross-border mergers occur when
the assets and operation of firms
from different countries are
combined to establish a new legal
entity.
Types of FDI
Continued……….
 Horizontal Foreign Direct Investment:
investment in the same industry abroad
as a firm operates in at home.
 Vertical Foreign Direct Investment:
Takes two forms:
 1) backward vertical FDI: where an
industry abroad provides inputs for a firm's
domestic production process
 2) forward vertical FDI: in which an
industry abroad sells the outputs of a firm's
domestic production
Types of FDI based on the
motives of the investing firm
 Resource Seeking: Investments which seek
to acquire factors of production that are more
efficient than those obtainable in the home
economy of the firm.
 In some cases, these resources may not be
available in the home economy at all (e.g.
cheap labor and natural resources).
 This typifies FDI into developing countries, for
example seeking natural resources in the
Middle East and Africa, or cheap labor in
Southeast Asia and Eastern Europe.
 Market Seeking: Investments which aim at
either penetrating new markets or maintaining
existing ones.

 Efficiency Seeking: Investments
which firms hope will increase their
efficiency by exploiting the benefits of
economies of scale and scope, and also
those of common ownership.
 It is suggested that this type of FDI
comes after either resource or market
seeking investments have been realized,
with the expectation that it further
increases the profitability of the firm.
 Typically, this type of FDI is mostly
widely practiced between developed
economies; especially those within
closely integrated markets (e.g. the EU).
Global Trends……..

 Concentrated in the USA, Japan and Western

Europe
 FDI of developed countries in 1998:
 Inflows: USD 460 billion
 Outflows: USD 595 billion
 Top five host countries:
 China
 Brazil
 Mexico
 Singapore
 Indonesia
had 55% of FDI inflows to developing
countries in 1998
Attractiveness as FDI
Destination

 Strong and stable government

 Pro-active government policies
 Investor-friendly and transparent decision making
process
 Sound diversified industrial infrastructure
 Comfortable power situation
 Abundant skilled manpower
 Harmonious industrial relations
 Quality work culture
 Peaceful life
 Incentive packages
 Cosmopolitan composition
 Fluent English
 Chennai ranked second-best by BT Gallup Survey of
Best Cities to do Business (Dec. 2001)
Dollar Flows to Asia

160000
140000
120000
100000 2001
2002
80000
2003
60000 2004
40000 2005
20000
0
Asia
Dollar Flows to Asia

40000
35000
30000
25000 2001
20000 2002
15000 2003
2004
10000
2005
5000
0
China Hong India S Korea Taiwan
Kong
Dollar Flows Growth Rate

90
80
70
60
50
40
30 Growth %
20
10
0
-10
China Hong India S Korea Taiwan
Kong
FDI Inflow

3
India
2

0
2003-04 2004-05 2005-06
April-September

4.5
4
3.5
3
2.5
2 India
1.5
1
0.5
0
2005-06 2006-07
Advantages of FDI in
India…
 Domestic Investment
 Advantages
 FDI encourages domestic investment by
providing:
 New markets
 Demand for inputs
 New technology
 Labor is mobile and often moves from
multinational firms to domestic firms
 Increased competition makes markets more
efficient
 Investments in new sectors simulates the
growth of new industry and new products
 Employment Generation and Labor
Skills
 Foreign firms generate hundreds
or thousands of jobs
 They generate employment in
suppliers
 Technology
 Advantages
 Foreign firms bring new technology
 Increased productivity of labor and capital
 Improved product standardization
 Reduced error rates
 Foreign firms invest in new technology
 Upgrades overall stock of capital
 More efficient in raising and using financial resources
 Unrestricted access to parent company's technology
 Access to tacit knowledge
 Export Competitiveness
 Advantages
 Dominant technologies brought in by
foreign companies makes products
suitable for export
 Foreign technology increases production,
reduces error rates and improves quality
 Foreign firms have strong distribution
and marketing facilities
 Foreign firms have brand names that
help exports
Disadvantages of FDI in
India…
Domestic Investment
 Disadvantages
 FDI crowds out domestic investment by:
 Being a monopolistic competitor
 Raises demand for money
 Raises interest rates
 Foreign firms have more:
 Advertising power
 Ability to dominate the market
 Predatory pricing to prevent entry
 Financial inflows raise the exchange rates,
making exports unattractive
 Technology
 Disadvantages
 Technology brought may be inappropriate
 The technology may be too capital-intensive
 Pollution-intensive technologies may be
exported from countries where they are
banned
 Sometimes, external transactions allow
foreign technology to be acquired more
cheaply, especially if the technology is
mature
 Environment
 Disadvantages
 Foreign firms operating in regions
where rules are non-existent or not
enforced have greatly exceeded
emissions and effluent levels allowed in
their home countries
 Foreign firms have exercised significant
political influence to prevent the
imposition of rules regarding the
environment
Some of the major
pitfalls….
 FDI flows have simply enabled trans-
national giants like Coke and Pepsi to
set up monopolies in highly profitable
sectors where Indian business concerns
were already meeting the requirements
of the market. Coke and Pepsi, with
their monopolistic stranglehold on the
bottling and distribution chain have
wiped out niche producers; consumers
have less choice than they did before,
and must pay more. Neither have these
companies brought in any valuable new
technology.
Contd …..
 Highly controversial Enron
Power project

 The Emerging Telecom

Scandal

 FDI has come in the form of

speculative investments in
India's stock market
Conclusion……….

 Foreign firms do generate technological

development in the host country
 Crowding out is not a major problem
 Host countries should enforce environmental
regulations
 This will not make foreign firms leave the
country, as the cost of conforming to
regulations is much lower than the difference in
cost of labor
 Benefits in increased:
 Competition
 Efficiency
 Innovation