Foreign Direct InvestmentIntroduction

Ivar Bredesen

Associate Professor, Oslo University College

Direct Foreign Investment and the Multinationals

What do we mean by Foreign Direct Investment, FDI

Who are the major sources and recipients of FDI How is FDI financed? What are the entry modes of FDI?

Definitions

Multinational Enterprises (MNEs) are firms which own a significant equity share (typically 50 % or more) of another company operating in a foreign country

The most common definition of FDI is related to the compilation Balance on Payment accounts and has been originally provided by IMF (1993) and subsequently endorsed by the OECD (1996). It is based on the ideas of lasting interest and influence on management

OECD – IMF Definition

“Foreign direct investment reflects the objective of obtaining a lasting interest by a resident entity in one economy (‘‘direct investor’’) in an entity resident in an economy other than that of the investor (‘‘direct investment enterprise’’). The lasting interest implies the existence of a long-term relationship between the direct investor and the enterprise and a significant degree of influence on the management of the enterprise. Direct investment involves both the initial transaction between the two entities and all subsequent capital transactions between them and among affiliated enterprises, both incorporated and unincorporated."  

UNSNA Definition

The United Nations System of National Accounts focuses on the concept of control.

Foreign Controlled enterprises include subsidiaries with more than 50% owned by a foreign parent. Associates of which foreign ownership is 10-50% [...] may be included or excluded by individual countries according to their qualitative assessment of foreign control."

FDI vs. Portfolio Investment

FDI is different from portfolio investment, which can de divested easily and do not have a significant influence on the management of the firm

Thus, to create, acquire or expand a foreign subsidiary, MNCs undertake FDI

FDI - preliminaries

Home country (outward FDI) vs. Host country (inward FDI) – both flows are registered in the balance of payments

Flows are measured every given time interval, stocks are the sum of flows

Horizontal FDI – same sector, arises to access the markets for example due to some restrictions on exporting to the same market

Vertical FDI – upstream/downstream integration of suppliers or customers in order to take advantage of international factor price differentials

Macro vs. Micro

We get information on FDI from Macroeconomic data (GDP, Balance of Payments etc) Microeconomic data at the firm level (employment,

sales for every firm etc)

Models of FDI should be consistent with some of these facts

Are MNCs important?

In 2004, there are about 70 000 MNCs with 690 000 foreign affiliates

The most “multinationalised” countries in the world are Belgium, Luxembourg and Hong Kong, and India is among the lowest

MNE activity

How do we measure MNE activity? FDI flows per year FDI stock Foreign sales of FDI FDI as a share of capital formation

FDi Inflows 1980 - 2004

FDI share of gross fixed capital formation

FDI/Exports ratio

Indicators of FDI

FDI flows by regions (2003 and 2004)

FDI in Poland

FDI as a share of GFCF

Main entry modes

Main modes of entry Merger and Acquisitions

( M & A) is the most common modality in developed economies

Greenfield Investments (GF) dominate in developing nations, partly due to restrictions on M&A activities

FDI - preliminaries

It is sometimes of interest to split flows into components Equity capital Reinvested earnings Intra-company loans

FDI components

FDI inflows – top 20 economies

What does micro data tell us?

There are large differences across industries in the degree to which production and sales are accounted for by MNCs

In particular, MNCs tend to be of greater importance in technology intensive industries, with indicators such as High level of R&D/sales ratios Large share of professional and technical workers in their

work force Products which are new or technically complex High level of product differentiation or advertising