International Finance - APIIT SD India

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					international Finance

Asst. Prof. Vishal Kumar
                 Chapter - 4
          Foreign Direct Investment

üExplain the motivations behind making FDI

üEvaluates the costs & benefits of FDI from the view point of host & home country

üDescribes the various FDI startegies

üControlling of MNC’s operations   Overview of Management

The three letters FDI stands for Foreign Direct Investment.

In simple words, FDI is any investment made by a foreign
  country in another country.

FDI usually happens in developing countries by countries
  that have surplus liquid money in hand.

An example for FDI is by US in China & India.

                        Overview of Management
             Types of FDI

• Horizontal FDI - A multinational firm (MNE) enters a
  foreign country to produce the same type of products
  that it produces at home.

• Vertical FDI - a multinational firm enters a foreign
  market to produce intermediate goods to be used in their
  final products.

                        Overview of Management
                Benefits of FDI

Benefits to the Host Country                Benefits to the Home Country

Ø Availability of scarce factors of               ØAvailability of raw material
   production                                     ØImprovement in BOP
Ø Improvement in the BOP                          ØEmployment generation
Ø Building of economic & social                   ØRevenue to the government
   infrastructure                                 ØImproved political relations
Ø Fostering of economic linkages

Ø Strengthening of the Govt.

                               Overview of Management
                 Costs of FDI

Costs to the Host Country                Costs to the Home Country
Ø Strained BOP following reverse               ØUndesired outflow of factors of
   flow – Ex:- India                           production

Ø Dependence on the import of                  ØPossibility of conflict with the
   technology                                  host country government

Ø Employment of expatriates

Ø Inappropriate technology

Ø Unhealthy competition

Ø Cultural & political interference

                             Overview of Management
           Strategy for FDI

Following are the strategy for FDI

Ø Firm – Specific Strategy

Ø Cost – Economizing Strategy

Ø Strategy of Entering in New Areas

Ø Joint – Venture with a Rival Firm

Ø Investment Mode Strategy : Merger versus GI

                        Overview of Management
                Theories of FDI

Following are the theories of FDI:

Ø MacDougall – Kemp Hypothesis             Ø The Eclectic Paradigm

Ø Industrial Organization Theory           Ø Currency Based Approach

Ø Location – Specific Theory               Ø Politico Economic Theory

Ø Product Cycle Theory                     Ø Modified Theory for Third World

Ø Internalization Approach                       Firms

                                Overview of Management
MacDougall – Kemp Hypothesis

  Developed by G.D.A. MacDougall (1958) and subsequently
    elaborated by M.C. Kemp (1964)


  Ø Two-country model

  Ø Price of capital = marginal productivity

  Explanation:- FDI moves from a capital abundant country to a
    capital scarce country and in this way the marginal
    productivity of capital tends to equalize between the two
                            Overview of Management
Industrial Organization Theory

Based on an oligopolistic or imperfect market in which the
  investing firm operates.

It was propounded by Hymer (1976)

He says that an MNC with superior technology moves to
  different countries to supply innovated product making
  in turn ample gains.
Example European Firm invested in USA

                         Overview of Management
   Location – Specific Theory

Developed by Hood and Young (1979)

Ø Real wage cost varies among countries.

  Therefore, firms with low cost technology move to low
  wage countries

Ø Availability of cheap and abundant raw material that
  encourages the MNCs to invest in the county with
  abundant raw material.

                       Overview of Management
      Product Cycle Theory

Hymer explained “why” foreign investment takes place.
  Hood and Young explained “where” foreign investment
  takes place.

It was Raymond Vernon (1966) who added “when” to “why”
  and “where”, based on data obtained from US corporate

Reymond Vernon’s theory is known as the product cycle

                      Overview of Management
       Product Cycle Theory

Vernon feels that most products follow a life cycle that is
  divided into three stages.

1) Innovation Stage

2) Maturing Product Stage

3) Standardized Product Stage

Ø Dematuring Stage (Ex. Television set – USA – Japan )

                         Overview of Management
     Internalization Approach

Internalization theory asks why business transactions take
  place within a firm (hierarchy) rather than between
  independent firms in a market

Buckley and Casson suggested that a firm overcomes
  market imperfections by creating its own market.

Here, market imperfection is related to transaction cost
  that is involved in the intra-firm transfer of intermediate
  products such as knowledge or expertise

                        Overview of Management
        Eclectic Paradigm

Dunning’s eclectic paradigm is a combination of
  the major imperfect market-based theories of
  FDI, that is,

Ø Ownership Advantage or Industrial organization

Ø Location-specific theory

Ø Internalization theory,
                     Overview of Management
          Eclectic Paradigm

Foreign investment will be greater where the O-L-I configuration is
more propounded.
                           Overview of Management
   Currency Based Approach

There are three theories based on this approach.

One such theory developed by Aliber (1971)

Acc. to Aliber, a firm moves from a strong currency country
  to a weak currency country.

Another theory has been developed by Froot & Stein (1989)

It is about effect of exchange rate change on the wealth of
  domestic firm as well as foreign firm.

                        Overview of Management
   Currency Based Approach

Third theory has been propounded by Caves (1988).

He mentions a couple of channels through which exchange
  rate influences FDI.

Ø Cost & revenue

Ø Capital gains

                         Overview of Management
     Politico-Economic Theories

Modified Theories For Third World Firm

               Overview of Management
Overview of Management

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