CCGL 9019
Economic Globalization:
Issues and Challenges
4. FDI and MNCs
An Oscar Winner
◼ https://www.imdb.com/video/vi4081433625?playlistId=tt
9351980&ref_=tt_ov_vi (American Factory)
Foreign Investment
◼ Direct investment
◼ have influence and control over the company in which
investment is made
◼ OECD definition is 10% ownership or more
◼ green field vs. brown field
◼ Portfolio investment
◼ indirect, hands-off
◼ easier to go in and pull out
◼ This file (File 5) focuses on direct investment, while
portfolio investment is discussed in File 4
Multinational Corporations
◼ Multinational corporations, transnational corporations,
stateless corporations
◼ A long history – the first multinationals are colonial
enterprises
◼ One of the first major MNCs was East India Company
(formed in 1600) which was later involved in the opium
trade to China
◼ Note that there may not be capital flow associated with
FDI if the funds are raised in the host country
Motives of Going Overseas
◼ To exploit economies of scale
◼ Firms with superior technology or brand name can get
more returns from larger-scale production (as most of the
fixed costs are already paid, e.g., Coca-Cola)
◼ Such MNCs tend to be large corporations
◼ To save production and distribution costs
◼ To gain market access
◼ To make use of source-specific technologies and
resources in the host economy
Welcoming Foreign Direct Investment
◼ Considerations by the recipient economies
◼ technology transfer
◼ job creation
◼ other spillover effects (e.g., infrastructure, deeper financial
markets)
Foreign Investment
◼ It might be thought that FDI would flow from rich to poor
economies, first because rich economies have more
money, and second because the marginal product of
capital in poor economies is considered to be higher
◼ However, lots of FDI flows are from rich to rich
economies, and some are from poor to rich economies
◼ The US used to receive the largest amount of FDI
inflows, due to the expected returns and political stability
there, etc., but it was overtaken by China in 2020
◼ Recall that diminishing marginal productivity assumes
other things are the same, including technology – but
technology is not constant, especially in the US
Some FDI Data from the World Bank
◼ https://data.worldbank.org/indicator/BX.KLT.DINV.CD.WD
◼ https://data.worldbank.org/indicator/BX.KLT.DINV.WD.GD.
ZS
◼ https://data.worldbank.org/indicator/BX.KLT.DINV.CD.WD
?locations=XP-XM-XD
◼ https://data.worldbank.org/indicator/BX.KLT.DINV.WD.GD.
ZS?locations=XP-XM-XD
◼ https://data.worldbank.org/indicator/BX.KLT.DINV.CD.WD
?locations=CN-US
◼ https://data.worldbank.org/indicator/BX.KLT.DINV.WD.GD.
ZS?locations=CN-US
Modes of Going Overseas
◼ When a firm goes overseas, it can do the following
◼ Non-equity modes
◼ exporting
◼ licensing
◼ franchising
◼ contract provision
◼ Equity modes
◼ joint ventures
◼ fully owned subsidiaries
Non-equity Modes
◼ Exporting
◼ low risk – little investment is involved, and it is easy to exit
◼ need good and reliable distribution channels
◼ could face trade barriers such as tariff and quota
◼ Licensing (e.g., Microsoft Office software)
◼ gives a firm in a host country the right to produce and sell
a product for a specified period for a fee
◼ low risk, and an an easy way to “enter” a country that has
trade barriers or cultural differences
◼ but lack of control of the licensee, e.g., over product
quality, so the brand name may be tarnished
Non-equity Modes
◼ Licensing (cont.)
◼ difficult to monitor the licensee, e.g., its revenue, which
could be tied to the fee (royalty)
◼ the licensee may acquire the expertise and turn itself into
a competitor
◼ Franchising (e.g., McDonald’s, Subway, 7-11)
◼ like licensing but more comprehensive – involves a whole
package of trademark, products, services, operating
principles, etc., in order to create the impression of a
worldwide company and to ensure similar quality of the
products
Non-equity Modes
◼ Contract provision (outsourcing)
◼ Take Nike as an example – it does its design, product
development and marketing, but contracts out the
manufacturing of shoes and clothing to Asia
◼ there is no local ownership of manufacturing in Asia
◼ can produce according to demand
◼ dependent on the manufacturers so there there is the
issue of quality control
◼ given the big name of Nike, there is pressure to
investigate worker conditions etc., even it does not hire
workers itself: https://www.huffpost.com/entry/nike-
indonesia_n_2481236
Equity Modes
◼ International joint ventures (IJVs)
◼ MNC and one or more local partner
◼ Sometimes this is the only form of equity entry – a local
partner is needed for MNC to operate in the host economy
◼ Even if a local partner is not needed, the MNC may still
want to enter as IJV since the local partner can provide
local market knowledge, access to distribution networks,
natural resources, and make the MNC an insider in the
host economy
◼ IJVs provides rapid entry and risk sharing
◼ Need to negotiate equity shares, management roles and
other details
Equity Modes
◼ International joint ventures (cont.)
◼ There could be diverging expectations, objectives and
interests, etc. between the partners
◼ The MNC is usually the stronger partner in terms of
technology and management skills – the local partner
may find the MNC over-protective of its technology, while
the MNC may not trust its local partner
◼ The local partner may be the local government, which has
other objectives (such as creating jobs in the city) while
the MNC focuses on maximizing profit from the IJV
Equity Modes
◼ Fully owned subsidiaries – the MNC can enter the host
economy by M&A (mergers and acquisitions), or as a
new start-up
◼ M&A advantages: rapid entry into a market, access to
established product lines, distribution channels and an
insider status
◼ M&A has been the dominant form of FDI flows
◼ But there could be difficulties integrating the acquisition
into the culture and overall strategy of the MNC
◼ And, even with due diligence, the acquirer may still not
fully understand what is acquired (asymmetric
information)
Equity Modes
◼ Start-ups (green field investment)
◼ There is no need to integrate different cultures
◼ This has the highest risk of all modes, especially in
countries with strong nationalistic attitudes
◼ It takes a long time to establish the company overseas
China Equity JVs
◼ Equity JVs are similar to joint ventures abroad
◼ Foreign participation in some industries (including
certain types of mining, auto manufacturing, and medical
institutions) is limited to a minority stake
◼ Equity can be contributed in the form of foreign
currency, equipment, buildings and even intangible
assets, provided their value is recognized by both the
approving authorities and the local partner
China Contractual JVs
◼ Contractual JVs, or co-operative JVs, allow for profit
distribution according to a formula specified in the
contract instead of according to equity shares
◼ This structure is most useful for companies that need
flexibility in the allocation of returns, such as
infrastructure projects
◼ One possible model is for the Chinese partner to make a
limited-equity investment, has little say in management
and receives a fixed periodic payment
China Contractual JVs
◼ Another possible model is the foreign partner is allowed
to retain a disproportionate share of the profits for a
fixed number of years, after which most or all profits go
to the Chinese partner
◼ This might be used in large infrastructure projects where
foreign companies need to recoup their investment fast
and are willing to forego long-term profits
Why Enter as Joint Ventures in China
◼ Lack of viable options: a JV is often the only investment
vehicle permitted for some industries, though the list of
industries requiring JVs has shrunk considerably with
WTO accession
◼ Real-estate acquisition: a JV makes it possible for a
foreign company to acquire prime land in China such as
central business districts – in many cases, land is the
sole asset of value contributed by the Chinese partner
◼ Guanxi or brand: The most valuable contribution of the
Chinese partner in a JV may be in its network of
connections, sales and distribution clientele, or its
strength as a brand name
Joint Venture Disadvantages
◼ Inflexibility: JV operations are governed by the initial JV
investment contract, which is quite difficult to change
◼ Changes in the contract require a unanimous vote of the
board of directors, which includes representatives of
both the local and foreign partners, plus government
approval
◼ JVs are thus slow to adapt to changes in market
conditions, and as Chinese markets become more
competitive this may be increasingly problematic
◼ Difficulties in expanding investment: while foreign
investors want to expand operation, the Chinese
partners may not be able to contribute new resources
Joint Venture Disadvantages
◼ Conflict of interest between partners: the strategic
outlook and management philosophies of Chinese and
foreign JV partners may differ
◼ While foreign companies are driven by profit, local
partners may have to address various demands and
responsibilities, e.g., to keep their workforce employed
◼ Even when the interests of the two sides coincide, there
could still be disagreement on strategy or management
control
Percentage of Realized Investment
10%
20%
30%
40%
50%
60%
70%
80%
90%
0%
1979-82
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
Equity Joint Venture
1995
1996
1997
1998
1999
2000
2001
Joint Development Projects
2002
Figure 17.3 Modes of FDI in China
2003
2004
2005
2006
Contractual JV
Wholly Foreign Owned
2007
2008
2009
WFOEs
◼ WFOEs are no longer bound by as many restrictions as
before and their access to the domestic market has
improved significantly
◼ Yet the government continues to steer foreign investors
into areas where foreign funds and expertise are needed
◼ In sectors where output far exceeds demand, or where
they are deemed sensitive, the government restricts
investment structures
◼ Thus, certain industries are open to WFOEs while others
are restricted to JVs
WFOE Advantages
◼ Complete management control: no need to lose control
over critical functions to a partner with fewer skills or too
many competing demands
◼ Simpler establishment procedures: the negotiation and
approval process is usually quicker without a partner
◼ Easier to exit: a JV can only be liquidated prematurely
on the agreement of both parties or through court order
◼ Flexibility of location: a WFOE is not constrained in its
choice of site and are free to build on green field land,
while JVs are usually located wherever the local partner
happens to have an existing plant
◼ Protection of intellectual property
WFOE Disadvantages
◼ Acceptability by the local governments: many officials,
especially those in inland areas, still prefer a JV so that
locals can be involved
◼ Lack of a Chinese “protector” who can negotiate with the
bureaucracy: this is becoming less of a drawback as
administrative measures are codified more clearly, and
foreign companies establish government relations
departments or outsource this function to public relations
firms
◼ Inability to obtain stock market listing: JVs may convert
to joint-stock companies and issue shares on the
Shenzhen and Shanghai stock exchanges, not WFOEs
Multinational Corporations
◼ MNCs are firms that own a significant equity share –
typically 50% or more – of another company operating in
a foreign country
◼ They are the major players behind globalization
◼ They account for about half of the world’s industrial
output and about 2/3 of world trade
◼ Foreign investment and trade has become intertwined
because of MNCs: some 35% to 45% of global trade is
intra-firm trade
Multinational Corporations
◼ The next slide show trends that are familiar
◼ As FDIs are carried out primarily by MNCs, the top curve
shows MNC investment activities overseas
◼ The recent growth of FDI has far outpaced the growth of
trade and income
◼ Before 1985, GDP, exports and FDI similar trends
◼ For 1985-99, while worldwide real GDP increased at a
rate of 2.5% a year and worldwide exports by 5.6%,
worldwide real FDI inflows increased by nearly 18% --
the third wave of globalization
Origins of MNCs and FDI
◼ FDI originates predominantly from advanced countries
◼ Between 1998-2000, 93% of outward FDI flows
originated in an advanced country
◼ The US is the world’s largest foreign investor, while the
EU as a whole accounts for 71% of all outward FDI
Origins of MNCs and FDI
◼ At the turn of the century, of the world’s largest 500
MNCs, a total of 434 are from the US, EU and Japan
◼ These 434 MNCs carry out half of total world trade,
often in the form of intra-company sales between
subsidiaries
◼ Most MNCs have strong national identity: GE from the
US, Toyota from Japan, etc.
◼ It is not just the brand name; the shares of the MNCs are
also mostly held by the home nationals and most of the
board members are domestic residents
Destinations of MNCs and FDI
◼ FDI naturally goes with the MNCs even though there
can be FDI without MNCs or vice versa
◼ Developed countries receive the majority of the FDIs, so
MNCs have their presence in the developed world
◼ Within the foreign countries, MNCs cluster
geographically around areas with well-developed
infrastructures including suppliers, skills and innovative
capabilities (California and New York in the US, the
coastal regions in China)
MNCs Compared to Domestic Companies
◼ MNCs can exploit economies of scale in production and
development due to their size
◼ Their global presence means more exposure to new
ideas and opportunities
◼ Their location in many countries can be used as a
bargaining chip in obtaining favorable conditions from
governments that are anxious to preserve inward
investment and jobs
◼ Yet a large size could also lead to slowness and
bureaucracy
MNCs Compared to Domestic Companies
◼ Domestic companies have a customer base which is
familiar with their brands, and MNCs have to overcome
such local loyalty without invoking nationalistic reaction
◼ The local companies also have developed supply chain
relations that may involve long-term contractual
relationships that effectively preclude newcomers
◼ This has been a major barrier for companies entering the
Japanese market
MNCs Compared to Domestic Companies
◼ Depending on the attitude of the government, the local
regulators may tend to discriminate against foreign
firms, which may be significantly more investigated,
audited, and prosecuted
◼ Even in the US which officially commits to applying the
same ‘national treatment’ to foreign companies, it has
been documented that ‘foreign subsidiaries face more
labor lawsuit judgments than their domestic counterparts
MNCs Compared to Domestic Companies
◼ Domestic companies have the general advantage of
better information about their economy, language, laws
and politics, e.g., workers’ responses to company
policies, or labor union resistance, consumer behavior,
etc.
◼ To overcome these disadvantages, MNCs must possess
some unique capability in order to survive and do well,
such as advanced technological expertise, marketing
competencies or scale economies
◼ They also have to be continuously adaptive and
responsive to local conditions
MNCs Compared to Domestic Companies
◼ MNCs are on average larger than domestic firms in the
host economies even in the developed world, as
measured by the number of employees, turnover or
value added
◼ MNCs also have higher labor productivity
◼ This is partly the result of the sectors they are in,
compared to the economy as a whole
MNC Performance Overseas
◼ MNCs are not necessarily successful
◼ The Templeton Global Performance Index shows that in
1998, the foreign activities of the world’s largest MNCs
accounted for 36% of their assets, 39% of revenues, but
only 27% of their profits
◼ Over 60% of MNCs had lower profitability abroad than at
home (e.g., HSBC)
◼ The report concludes that many MNCs are not
particularly good at managing their foreign activities,
particularly in regard to digesting acquisitions
MNCs in Manufacturing vs. Services
◼ Advantages of MNCs in manufacturing appear to be
more obvious than in services
◼ In manufacturing, the value chain can be divided across
many locations to better spread costs
◼ Some processes can be located to low-cost countries,
while R&D can be located where there is specialized
competencies
◼ For services, much of the value is generated locally and
is also difficult to spread around
◼ Services have to be tailored to each client
MNCs in Manufacturing vs. Services
◼ Yet, the share of services in foreign direct investments
(FDI) has risen significantly, particularly in
telecommunications, utilities, investment banking,
business consulting, accountancy and legal services
◼ Recall the rise of trade in services discussed before
◼ The share of services in FDI now accounts for about half
of inward FDI stock in the world
Multinationals: Positives
◼ http://cep.lse.ac.uk/pubs/download/CP167.pdf
◼ MNCs often bring technologies, skills and financial
resources
◼ For the host country, MNCs create employment and
usually pay higher wages than local firms
◼ They are fast in taking advantage of new opportunities
◼ They often offer better employment conditions and
product qualities than domestic firms
Multinationals: Positives
◼ MNCs are relatively large, have competitive power in the
market and bargaining power in policy, particularly in
smaller developing countries
◼ They are global players that can circumvent local
regulations more easily than domestic firms
◼ They are able to move activities between their plants at
relatively low cost, removing benefits as rapidly as they
deliver them
Multinationals: Negatives
◼ They produce standardized products massively,
jeopardizing product variety
◼ There is the concern that MNCs shift polluting
production to developing countries, especially when their
home country tightens up regulation
◼ Given that MNCs are on the whole more productive and
so generate more global income, but who get the
benefits (next slide)
Distribution Effects
◼ MNCs may hire local workers and generate income, but
they also compete away some local firms and reduce
jobs
◼ Yet there is evidence that the eliminated local firms tend
to be the more inefficient ones – the released resources
can be diverted into better uses
◼ There is also technology transfer that enhance the
productivity of some of the local firms
◼ But there is also the concern that MNCs channel profits
out of the host country instead of reinvesting there
At the Macroeconomic Level
◼ To the extent that MNCs increase investments in the
host country, they also promote growth
◼ To the extent that economic growth is essential for
poverty reduction, MNC activities contribute to less
poverty
