Global Business 3e

Chapter 6
Investing Abroad Directly

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LEARNING OBJECTIVES
After studying this chapter, you should be able to:
6-1 use the resource-based and institution-based views to
answer why foreign direct investment (FDI) takes place.
6-2 understand how FDI results in ownership, location, and
internalization (OLI) advantages.
6-3 identify different political views on FDI based on an
understanding of its benefits and costs to host and home
countries.
6-4 participate in two leading debates concerning FDI.
6-5 draw implications for action.

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FDI VOCABULARY
Foreign direct investment (FDI)
Putting money in activities that control and manage
value-added activities in other countries
Multinational enterprise (MNE)
Firms that engage in FDI
Foreign portfolio investment (FPI)
Holding securities, such as stocks and bonds, of
companies in countries outside one’s own but does
not entail the active management of foreign assets
Management control rights
Authority to appoint key managers and establish
control mechanisms © 2014 Cengage Learning. All Rights
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HORIZONTAL AND VERTICAL FDI
Horizontal FDI
Producing the same products or offering the same
services in a host country as firms do at home
Vertical FDI
Firm moves upstream or downstream in different
value chain stages in a host country through FDI

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UPSTREAM AND DOWNSTREAM
VERTICAL FDI

Upstream vertical FDI

Using FDI in an earlier activity in the value
chain
Downstream vertical FDI
Using FDI in an later activity in the value chain

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FDI FLOW AND STOCK
FDI flow
Amount of FDI moving in a given period (usually a
year) in a certain direction

FDI inflow
FDI moving into a country in a year

FDI outflow
FDI moving out of a country in a year

FDI stock
Total accumulation of inbound FDI in a country or
outbound FDI from a country © 2014 Cengage Learning. All Rights
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WHY FIRMS BECOME MNEs
BY ENGAGING IN FDI

OLI advantages
Quest for ownership (O) advantages, location (L) advantages, and
internalization (I) advantages

Ownership
MNEs’ possession and leveraging of certain valuable, rare, hard-
to-imitate, and organizationally embedded (VRIO) assets
overseas

? Can you name some OLI advantages for a

familiar firm? © 2014 Cengage Learning. All Rights
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OLI ADVANTAGES

Location
Features unique to a place, such as its natural or labor
resources or its location near particular markets, that
provide certain advantages to firms doing business
there

Internalization
Replacement of cross-border markets (such as
exporting and importing) with one firm (the MNE)
locating and operating in two or more countries

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OLI ADVANTAGES

Licensing
Selling technology or intellectual property for a fee

Market imperfection (market failure)

Imperfect rules governing international transactions

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FDI VS LICENSING

Dissemination risk
Possibility of unauthorized diffusion of
firm-specific know-how

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LOCATION

Agglomeration
Clustering of economic activities in certain
locations
Knowledge spillover
Diffusion of knowledge from one firm to
others among closely located firms that
attempt to hire individuals from competitors

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LOCATION

Location advantages refer to the advantages

one firm obtains when operating in a
location due to its firm-specific capabilities

Oligopoly
An industry dominated by a small
number of players

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OVERCOMING MARKET FAILURE
THROUGH FDI

Intrafirm trade
Transactions occur between two
subsidiaries in two countries controlled
by the same MNE

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POLITICAL VIEWS ON FDI

Radical view
Treats FDI as an instrument of imperialism and a
vehicle for exploiting domestic resources, industries,
and people by foreign capitalists and firms

Free market view

Unrestricted by government Intervention FDI will
enable countries to tap into their absolute or
comparative advantages by specializing in the
production of certain goods and services

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POLITICAL VIEWS ON FDI

Pragmatic nationalism
Considering both the pros and cons of FDI and
approving FDI only when its benefits
outweigh its costs

? What is your opinion of FDI?

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BENEFITS AND COSTS OF FDI TO
HOST COUNTRIES

Technology spillover
Domestic diffusion of foreign technical knowledge and
processes

Demonstration effect
Local rivals, after observing foreign technology, may
recognize its feasibility and strive to imitate

Contagion (imitation) effect

Local rivals, after observing foreign technology, may
recognize its feasibility and strive to imitate
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HOW MNEs AND HOST
GOVERNMENTS BARGAIN

Bargaining power
Ability to extract favorable outcome from
negotiations due to one party’s strengths

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HOW MNEs AND HOST
GOVERNMENTS BARGAIN
Obsolescing bargain
Requirements of a deal previously struck between an MNE
and a host government is changed after the initial FDI entry

Expropriation
Confiscating foreign assets

Sunk cost
Already invested sums

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SOVEREIGN WEALTH FUNDS
Sovereign wealth fund (SWF)
State-owned investment fund composed of
financial assets such as stocks, bonds, real
estate, or other financial instruments funded by
foreign exchange assets

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