Transcript Slide 1

Outline
•
••
Global Trends in FDI
Why
Why Do
Do Firms
Firms Invest
Invest Overseas?
Overseas?
– Trade Barriers
• Cross-Border Mergers and Acquisitions
– Imperfect Labor Markets
• Political
Risk
and FDI
– Intangible
Assets
– Vertical Integration
– Product Life Cycle
– Shareholder Diversification
• Cross-Border Mergers and Acquisitions
• Political Risk and FDI
Global Trends in FDI
• Several developed nations are the sources
of FDI outflows.
– About 90% of total world-wide FDI comes
from the developed world.
• Both developing and developed nations
are the recipient of inflows of FDI.
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22.2
19.4
60.3
40.4
50.4
28.6
36.9
16.4
30.7
11.5
22.9
1.8
8.6
13.2
13.4
64.9
80
42.7
100
99.6
120
47.2
46.8
29.3
29.2
60
2.8
8.4
7
140
Inflows
116.8
160
149.9
148.8
Average Annual FDI (in Billions)
1999-2004
Outflows
0
Why Do Firms Invest Overseas?
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Trade Barriers
Labor Market Imperfections
Intangible Assets
Vertical Integration
Product Life Cycle
Shareholder Diversification
Trade Barriers
• Government action leads to market
imperfections.
• Tariffs, quotas, and other restrictions on
the free flow of goods, services and
people.
• Trade Barriers can also arise naturally due
to high transportation costs, particularly for
low value-to-weight goods.
Labor Market Imperfections
• Among all factor markets, the labor market
is the least perfect.
– Recall that the factors of production are land,
labor, capital, and entrepreneurial ability.
• If there exist restrictions on the flow of
workers across borders, then labor
services can be underpriced relative to
productivity.
– The restrictions may be immigration barriers
or simply social preferences.
Labor Market Costs Around the
World (2001)
Persistent wage
differentials across
countries exist.
This is one on the
main reasons
MNCs are making
substantial FDIs in
less developed
nations.
Country
Germany
U.S.
Japan
Israel
Taiwan
Mexico
Hourly Cost
$31.25
$21.97
$20.09
$11.73
$5.84
$2.48
U.S. Department of Labor, Bureau of Labor Statistics
Vertical Integration
• MNCs may undertake FDI in countries
where inputs are available in order to
secure the supply of inputs at a stable
accounting price.
• Vertical integration may be backward or
forward:
– Backward: e.g. a furniture maker buying a
logging company.
– Forward: e.g. a U.S. auto maker buying a
Japanese auto dealership.
Product Life Cycle
• U.S. firms develop new products in the
developed world for the domestic market,
and then markets expand overseas.
• FDI takes place when product maturity hits
and cost becomes an increasingly
important consideration for the MNC.
Product Life Cycle
Quantity
The U.S.
New product
Quantity
Less advanced
countries
exports
imports
Maturing product
Standardized product
exports
imports
New product
Maturing product
Standardized product
Product Life Cycle
• It should be noted that the Product Life
Cycle theory was developed in the 1960s
when the U.S. was the unquestioned
leader in R&D and product innovation.
• Increasingly product innovations are taking
place outside the United States as well,
and new products are being introduced
simultaneously in many advanced
countries.
• Production facilities may be located in
multiple countries from product inception.
Shareholder Diversification
• Diversification might reduce risks such as
– Exchange rate risk
– Political risks
– Risks of disruption to transportation, labor or
other inputs
• But how many of these risks are nonsystematic (and hence risks that
shareholders can deal with by diversifying
their own portfolios)?
Cross-Border Mergers &
Acquisitions
• Greenfield Investment
– Building new facilities from the ground up.
• Cross-Border Acquisition
– Purchase of existing business.
– Cross-Border Acquisition represents 40-50%
of FDI flows.
• Cross-border acquisitions are a politically
sensitive issue:
– Greenfield investment is usually welcome.
– Cross-border acquisition is often unwelcome.
Top 10 Cross-Border M&A Deals
1998-2003
Year ($
b)
Acquirer
Hom Target
e
Host
2000
202.8 Vodafone AirTouch
PLC
U.K.
Mannesmann AG
German
y
1999
60.3 Vodafone Group
PLC
U.K.
AirTouch
U.S.
1998
48.2 British Petroleum Co. U.K.
Amoco
U.S.
France
Orange PLC
U.K.
2000
46 France Telecom SA
1998
40.5 Daimler-Benz AG
German
y
Chrysler Corp.
U.S.
2000
40.4 Vivendi SA
France
Seagram Co. LTD
Canada
1999
34.6 Zeneca Group PLC
U.K.
Astra AB
Sweden
1999
32.6 Mannesmann AG
German
y
Orange PLC
U.K.
Political Risk and FDI
• Unquestionably this is the biggest risk
when investing abroad.
• “Does the foreign government uphold the
rule of law?” is a more important question
than normative judgements about the
appropriateness of the foreign
government’s existing legislation.
• A big source of risk is the non-enforcement
of contracts.
Measuring Political Risk
• Integration into the world system.
– North Korea, Iraq, Libya are examples of
isolationist countries unlikely to observe the rules
of the game.
• Ethnic and religious stability.
– Look at the recent civil war in Bosnia.
• Regional security
– Kuwait is a nice enough country, but it’s in a
rough neighborhood.
Political Risk and FDI
• Macro Risk
– All foreign operations put at risk due to
adverse political developments.
• Micro Risk
– Selected foreign operations put at risk due to
adverse political developments.
Political Risk
• Transfer Risk
– Uncertainty regarding cross-border flows of
capital.
• Operational Risk
– Uncertainty regarding host countries policies
on firm’s operations.
• Control Risk
– Uncertainty regarding expropriation.
Measuring Political Risk
• The host country’s political and government
system.
– A country with too many political parties and
frequent changes of government is risky.
• Track records of political parties their relative
strength.
– If the socialist party is likely to win the next
election, watch out.
Measuring Political Risk
• Integration into the world system.
– North Korea, Iraq, Libya are examples of
isolationist countries unlikely to observe the rules
of the game.
• Ethnic and religious stability.
– Look at the recent civil war in Bosnia.
• Regional security
– Kuwait is a nice enough country, but it’s in a
rough neighborhood.
Measuring Political Risk
• Key economic indicators
– Political risk is not entirely independent of
economic risk.
– Severe income inequality and deteriorating living
standards can cause major political disruptions.
– In 2002, Argentina’s protracted economic
recession led to the freezing of bank deposits,
street riots, and three changes of the country’s
presidency in as many months.
Hedging Political Risk
• Geographic diversification
– Simply put, don’t put all of your eggs in one
basket.
• Minimize exposure
– Form joint ventures with local companies.
• Local government may be less inclined to
expropriate assets from their own citizens.
– Join a consortium of international companies
to undertake FDI.
• Local government may be less inclined to
expropriate assets from a variety of countries all at
once.
Hedging Political Risk
• Insurance
– The Overseas Private Investment
Corporation (OPIC) a U.S. government
federally owned organization, offers
insurance against:
1. The inconvertibility of foreign currencies.
2. Expropriation of U.S.-owned assets.
3. Destruction of U.S.-owned physical properties due
to war, revolution, and other violent political events
in foreign countries.
4. Loss of business income due to political violence