Transcript Foreign Direct Investment

Foreign Direct Investment and
Political Risk
International Financial Management
Dr. A. DeMaskey
1
Learning Objectives
 How
do firms become multinational?
 Why do firms locate production overseas?
 What is country risk? Political risk?
 How do we measure political risk?
2
How Do Firms Become
MNCs?
 Exporting/Importing

Low Risk/Low Return
Strategy (early phase)
 Licensing
(intermediate phase)
 Franchising
 Joint Ventures
 Acquisitions
 De
Novo Start Up

High Risk/High Return
Strategy (advanced phase)
Foreign Direct Investment
3
Global Trends in FDI
 Total
annual worldwide FDI flows of $830 billion
 FDI Outflows
– Strong preference to invest in developed countries
– Biggest targets are U.K. and Germany
– Comparative advantages
 FDI
Inflows
– U.S. is an attractive source of FDI
– Other popular destinations include China, Mexico, and
Spain
– Locational advantages
4
Why Do Firms Invest
Overseas?
 Market
Imperfections (Kindleberger (1969)
and Hymer (1975))
 Imperfections in
– Product Markets
– Factor Markets
– Capital Markets
5
Key Factors in Locating
Production Overseas
 Trade
Barriers
 Imperfect Labor Markets
 Intangible Assets
Market Failure Imperfections
 Vertical integration
 Product Life Cycle
 Capital Market Imperfections
6
Hourly Labor Costs in the
Manufacturing Sector (2001)
Germany
$23.04
U.S.
$20.67
Belgium
$20.25
Japan
$19.52
Sweden
$18.41
France
$16.70
U.K.
$15.75
Canada
$15.70
Korea
$7.53
Hong Kong
$5.47
Mexico
$1.70
China
$0.60
Indondesia
$0.22
7
Political Risk and FDI
 Risk
of loss to the parent firm due to
adverse political developments in the host
country.
– Outright expropriation
– Unexpected changes in tax laws
8
Types of Political Risk
 Depending
on
incidence:
– Macro risk
– Micro risk
 Depending
on
manner:
– Transfer risk
– Operational risk
– Control risk
9
Examples of Political Risk
 China
 Cuba
in 1949
in 1960
 Egypt
in the early 1950s
10
Key Factors in
Political Risk Analysis







Host country’s political and government
system
Track records of political parties and their
relative strength
Integration into the world system
Host country’s ethnic and religious stability
Regional security
Key economic indicators
Capital flight
POR
Index
11
Measuring Political Risk
 In-house
experts
 Outside experts;
– Morgan Stanley provides in-depth analysis of
country/political risks
– Euromoney provides country ratings by
 Political
risk
 Credit risk
 Economic performance
12
Economic and Political Factors
Underlying Country Risk
 Fiscal
irresponsibility
 Monetary instability
 Controlled exchange rate system
 Wasteful government spending
 Quality of natural, human, and financial resources
 Adjustment to external shocks
 Market-oriented vs. statist policies
13
Useful Web Sites for
Assessing Country Risk
 What
are the political and financial outlook
for various countries?
– Consult the Country Commercial Guides
prepared by embassy staff at
http://www.usatrade.gov/website/ccg.nsf/ccgho
mepage?openform.
– Refer to the CIA’s World Factbook at
http://www.odci.gov/.
– Visit http://biz.yahoo.com/ifc/
More …
14
Useful Web Sites for
Assessing Country Risk
 How
risky is your country? Look up:
– http://www.worldbank.org/data/wdi2001/pdfs/t
ab5_2.pdf
– http://www.prsgroup.com/icrg/icrg.html
– http://www.institutionalinvestoronline.com/
– http://www.euromoney.com/
– http://www.moodys.com/moodys/cust/loadBus
Line.asp?busLine=sovereign
– http://www.standardpoor.com/
15