Understanding Foreign Direct Investment.docx
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Understanding Foreign Direct Investment.docx
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UnderstandingForeignDirectInvestment
UnderstandingForeignDirectInvestment(FDI)
Definition
Foreigndirectinvestment(FDI)playsanextraordinaryandgrowingroleinglobalbusiness.Itcanprovideafirmwithnewmarketsandmarketingchannels,cheaperproductionfacilities,accesstonewtechnology,products,skillsandfinancing.Forahostcountryortheforeignfirmwhichreceivestheinvestment,itcanprovideasourceofnewtechnologies,capital,processes,products,organizationaltechnologiesandmanagementskills,andassuchcanprovideastrongimpetustoeconomicdevelopment. Foreigndirectinvestment,initsclassicdefinition,isdefinedasacompanyfromonecountrymakingaphysicalinvestmentintobuildingafactoryinanothercountry.Thedirectinvestmentinbuildings,machineryandequipmentisincontrastwithmakingaportfolioinvestment,whichisconsideredanindirectinvestment.Inrecentyears,givenrapidgrowthandchangeinglobalinvestmentpatterns,thedefinitionhasbeenbroadenedtoincludetheacquisitionofalastingmanagementinterestinacompanyorenterpriseoutsidetheinvestingfirm’shomecountry.Assuch,itmaytakemanyforms,suchasadirectacquisitionofaforeignfirm,constructionofafacility,orinvestmentinajointventureorstrategicalliancewithalocalfirmwithattendantinputoftechnology,licensingofintellectualproperty, Inthepastdecade,FDIhascometoplayamajorroleintheinternationalizationofbusiness.Reactingtochangesintechnology,growingliberalizationofthenationalregulatoryframeworkgoverninginvestmentinenterprises,andchangesincapitalmarketsprofoundchangeshaveoccurredinthesize,scopeandmethodsofFDI.Newinformationtechnologysystems,declineinglobalcommunicationcostshavemademanagementofforeigninvestmentsfareasierthaninthepast.Theseachangeintradeandinvestmentpoliciesandtheregulatoryenvironmentgloballyinthepastdecade,includingtradepolicyandtariffliberalization,easingofrestrictionsonforeigninvestmentandacquisitioninmanynations,andthederegulationandprivitazationofmanyindustries,hasprobablybeenbeenthemostsignificantcatalystforFDI’sexpandedrole.
Themostprofoundeffecthasbeenseenindevelopingcountries,whereyearlyforeigndirectinvestmentflowshaveincreasedfromanaverageoflessthan$10billioninthe1970’stoayearlyaverageoflessthan$20billioninthe1980’s,toexplodeinthe1990sfrom$26.7billionin1990to$179billionin1998and$208billionin1999andnowcomprisealargeportionofglobalFDI..Drivenbymergersandacquisitionsandinternationalizationofproductioninarangeofindustries,FDIintodevelopedcountrieslastyearroseto$636billion,from$481billionin1998(Source:
UNCTAD)
Proponentsofforeigninvestmentpointoutthattheexchangeofinvestmentflowsbenefitsboththehomecountry(thecountryfromwhichtheinvestmentoriginates)andthehostcountry(thedestinationoftheinvestment).OpponentsofFDInotethatmultinationalconglomeratesareabletowieldgreatpoweroversmallerandweakereconomiesandcandriveoutmuchlocalcompetition.Thetruthliessomewhereinthemiddle.
Forsmallandmediumsizedcompanies,FDIrepresentsanopportunitytobecomemoreactivelyinvolvedininternationalbusinessactivities.Inthepast15years,theclassicdefinitionofFDIasnotedabovehaschangedconsiderably.Thisnotionofachangeintheclassicdefinition,however,mustbekeptinthepropercontext.Veryclearly,over2/3ofdirectforeigninvestmentisstillmadeintheformoffixtures,machinery,equipmentandbuildings.Moreover,largermultinationalcorporationsandconglomeratesstillmaketheoverwhelmingpercentageofFDI.But,withtheadventoftheInternet,theincreasingroleoftechnology,looseningofdirectinvestmentrestrictionsinmanymarketsanddecreasingcommunicationcostsmeansthatnewer,non-traditionalformsofinvestmentwillplayanimportantroleinthefuture. Manygovernments,especiallyinindustrializedanddevelopednations,payverycloseattentiontoforeigndirectinvestmentbecausetheinvestmentflowsintoandoutoftheireconomiescananddoeshaveasignificantimpact. IntheUnitedStates,theBureauofEconomicAnalysis,asectionoftheU.S.DepartmentofCommerce,isresponsibleforcollectingeconomicdataabouttheeconomyincludinginformationaboutforeigndirectinvestmentflows. Monitoringthisdataisveryhelpfulintryingtodeterminetheimpactofsuchinvestmentsontheoveralleconomy,butisespeciallyhelpfulinevaluatingindustrysegments.Stateandlocalgovernmentswatchcloselybecausetheywanttotracktheirforeigninvestmentattractionprogramsforsuccessfuloutcomes.
HowHasFDIChangedinthePastDecade?
Asmentionedabove,theoverwhelmingmajorityofforeigndirectinvestmentismadeintheformoffixtures,machinery,equipmentandbuildings.Thisinvestmentisachievedoraccomplishedmostlyviamergers&acquisitions.Inthecaseoftraditionalmanufacturing,thishasbeentheprimarymechanismforinvestmentandithasbeenheretoforeveryefficient.Withinthepastdecade,however,therehasbeenadramaticincreaseinthenumberoftechnologystartupsandthis,togetherwiththeriseinprominenceofInternetusage,hasfosteredincreasingchangesinforeigninvestmentpatterns.Manyofthesehightechstartupsareverysmallcompaniesthathavegrownoutofresearch&developmentprojectsoftenaffiliatedwithmajoruniversitiesandwithsomegovernmentsponsorship.Unliketraditionalmanufacturers,manyofthesecompaniesdonotrequirehugemanufacturingplantsandimmensewarehousestostoreinventory.Anotherfactortoconsideristhenumberofcompanieswhoseprimaryproductisanintellectualpropertyrightsuchasasoftwareprogramorasoftware-basedtechnologyorprocess.Companiessuchasthesecanbehousedalmostanywhereandthereforemakingacapitalinvestmentinthemdoesnotrequirehugeoutlaysforfixtures,machineryandplants.
Inmanycases,largecompaniesstillplayadominantroleininvestmentactivitiesinsmall,hightechorientedcompanies.However,unlikeinthepast,theselargercompaniesarenotnecessarilyacquiringsmallercompaniesoutright.Thereareseveralreasonsforthis,butthemostimportantoneismostlikelytheriskassociatedwithsuchhightechventures.Inthecaseofmatureindustries,theproductsarewelldefined.Themanufacturerusuallywantstogetclosertoitsforeignmarketorwantstocircumventsometradebarrierbymakingadirectforeigninvestment.Themajorriskhereisthatyoudonotsellenoughoftheproductthatyoumanufactured.However,youhaveaddedadditionalcapacityandinthecaseofmultinationalcorporationsthiscapacitycanbeusedinavarietyofways.
Hightechventurestendtohavelongerincubationperiods.Thatis,theproducttendstorequiresignificantdevelopmenttime.Inthecaseofsoftwareandotherintellectualpropertytypeproducts,theproductisconstantlychangingevenbeforeithitsthemarketplace.Thismakestheinvestmentdecisionmorecomplicated.Whenyouinvestinfixturesandmachinery,youknowwhattherealandbookvalueofyourinvestmentwillbe.Whenyouinvestinahightechventure,thereisalwaysanelementofuncertainty.Unfortunately,therecentspateoffailuresisquiteillustrativeofthispoint.
Therefore,theexpandedroleoftechnologyandintellectualpropertyhaschangedtheforeigndirectinvestmentplayingfield.Companiesarestillmotivatedtomakeforeigninvestments,butbecauseofthevagariesoftechnologyinvestments,theyarenowfindingnewvehiclestoaccomplishtheirgoals.Considerthefollowing:
Licensingandtechnologytransfer.Licensingandtechtransferhavebeenessentialinpromotingcollaborationbetweentheacademicandbusinesscommunities.Eversincelegalhurdleswereremovedthatalloweduniversitiestoholdtitletoresearchanddevelopmentdoneintheirlabs,licensingagreementshavehelpedturnedrawtechnologyintofinishedproductsthatareviableincompetitivemarketplaces.WithsomehelpfromavarietyofgovernmentagenciesintheformofgrantsforR&Daswellasotherfinancialassistanceforsuchthingsasincubatorprograms,oncetimidcollegeresearchersarenowsteppingoutandbecomingcuttingedgeentrepreneurs.Thesestrategicallianceshavehadaseriousimpactinseveralhightechindustries,includingbutnotlimitedto:
medicalandagriculturalbiotechnology,computersoftwareengineering,telecommunications,advancedmaterialsprocessing,ceramics,thinmaterialsprocessing,photonics,digitalmultimediaproductionandpublishing,opticsandimagingandroboticsandautomation.Industryclustersarenowgrowinguparoundtheuniversitylabswheretheirderivativetechnologieswerefirstdiscoveredandnurtured.Licensingagreementsallowcompaniestotakefulladvantageofnewandexcitingtechnologieswhilelimitingtheiroverallrisktoroyaltypaymentsuntilaparticulartechnologyisfullydevelopedandthusreadytoputnewproductsintothemanufacturingpipeline.
Reciprocaldistributionagreements.Actually,thistypeofstrategicallianceismoretrade-based,butinaveryrealsenseitdoesinfactrepresentatypeofdirectinvestment.Basically,twocompanies,usuallywithinthesameoraffiliatedindustries,agreetoactasanationaldistributorforeachother’sproducts.Theclassicalexampleistobefoundinthefurnitureindustry.AU.S.-basedmanufactureroftablessignsareciprocaldistributionagreementwithaSpanish-basedmanufacturerofchairs.Bothcompaniesgaindirectaccesstotheother’sdistributionnetworkwithouthavingt
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