Ing. Tom Dud, PhD.

Structure of the presentation

FDI theories introduciton and main questions FDI theories on macro level Development theories of FDI

FDI theories on micro level

Eclectic FDI theory (OLI theory)

The basic questions of FDI theories (6W+H)

Who? (is the investor)
What? (kind of FDI) Why? (are we investing) Where? (is the FDI going)

When? (do we invest)

How? (the mode of entry)

FDI theories on macro level

Capital market theory One of the oldest theories of FDI (60s) FDI is determined by interest rates
Dynamic macroeconomic FDI theory FDI are a long term function of TNC strategies The timing of the investment depends on the changes in the macroeconomic environment hysteresis effect

FDI theories on macro level

FDI theory based on exchange rates Analyses the relationship of FDI flows and exchange rate changes FDI as a tool of exchange rate risk reduction
FDI theory based on economic geography Explores the factors influencing the creation of international production clusters Innovation as a determinant of FDI Greta Garbo effect

FDI theories on macro level

Gravity approach to FDI The closer two countries are (geographically, economically, culturally ...) the higher will be the FDI flows between these countries
FDI theories based on istitutional analysis Explores the importance of the institutional framework on the FDI flows Political stability key factor

Life cycle theory

Raymond Vernon 1966
It can be used to analyse the relationship of product

life cycle and possible FDI flows

FDI can be seen mostly in the phases of maturity and

decline

The conclusions of this theory are questionable

nowadays

Japanese FDI theories

Were initially developed in the 70s of the last century
Main representant Terumoto Ozawa

He analysed the relationship of FDI, competitiveness and

economic development based on the ideas of Michael Porter

He identified three main phases of development when he

analysed the waves of FDI inflow and outflow from a country

Japanese FDI theories

I. phase of economic growth The country is underdeveloped and is targeted by foreign companies wanting to use its potential advantages (especially low labour costs) Almost no outgoing FDI
II. Phase of economic growth New FDI is drawn by the growing internal markets and by the growing standards of living Outgoing FDI are motivated by the raising labour costs

Japanese FDI theories

III. Phase of economic growth The competitivness of the country is based on innovation The incoming and outgoing FDI are motivated by market factors and technological factors

Five Stage Theory - John Dunning

Stage 1 Low incoming FDI, but foreign companies are beginning to discover the advantages of the country No outgoing FDI no specific advantages owned by the domestic firms
Stage 2 Growing incoming FDI do the advantages of the country especially the low labour costs The standards of living are rising which is drawing more foreign companies to the country Still low outgoing FDI

Five Stage Theory - John Dunning

Stage 3 Still strong incoming FDI, but their nature is changing due to the rising wages The outgoing FDI are taking off as domestic companies are getting stronger and develop their competitive advantages
Stage 4 Strong outgoing FDI seeking advantages abroad (low labour costs)

Five Stage Theory - John Dunning

Stage 5 Investment decisions are based on the strategies of TNCs The flows of outgoing and incoming FDI come into equilibrium

Incoming and outgoing FDI in China between 2001-2004

70000 60000 50000 40000 30000 20000 1 0000 0 -1 0000 2001 2002 2003 2004 FDI inflow FDI outflow

Incoming and outgoing FDI in South Korea between 2001-2004

8000 7000 6000 5000 4000 3000 2000 1 000 0 2001 2002 2003 2004 FDI inflow FDI outflow

Incoming and outgoing FDI in Japan between 2001-2004

40000 35000 30000 25000 20000 1 5000 1 0000 5000 0 2001 2002 2003 2004 FDI inflow FDI outflow

FDI theories on micro level

Existence of firm specific advantages (Hymer) Access to raw materials Economies of scale Intangible assets such as trade names, patents, superior management etc Reduced transaction costs when replacing an arm's length transaction in the market by an internal firm transaction
FDI and oligopolistic markets In oligopolistic markets the companies follow the actions of the market leader Mutual threats game theory

FDI theories on micro level

Theory of internalisation Due to market imperfections, there may be several reasons why a firm wants to make use of its monopolistic advantage itself (or organise an activity itself) Buckley and Casson (influenced by Coase), suggested that a firm overcomes market imperfections by creating its own market - internalisation
he theory of internalisation was long regarded as a

theory of why FDI occurs By internalising across national boundaries, a firm becomes multinational

Eclectic FDI theory John Dunning

John Dunning attempts to integrate a variety of

strands of thinking
He draws partly on macroeconomic theory and trade,

as well as microeconomic theory and firm behavior (industrial economics)

O = Ownership advantages
Some firms have a firm specific capital known as knowledge capital: Human capital (managers), patents, technologies, brand, reputation This capital can be replicated in different countries without losing its value, and easily transferred within the firm without high transaction costs

L Localization advantages
Producing close to final consumers or downstream

customers

Saving transport costs Obtaining cheap inputs Jumping trade barriers Provide services (for most services production and delivery

have to be contemporaneous)

OLI approach - conclusions

The eclectic, or OLI paradigm, suggests that the

greater the O and I advantages possessed by firms and the more the L advantages of creating, acquiring (or augmenting) and exploiting these advantages from a location outside its home country, the more FDI will be undertaken Where firms possess substantial O and I advantages but the L advantages favor the home country, then domestic investment will be preferred to FDI and foreign markets will be supplies by exports

I internalization advantages
Why don't a firm just sign a contract with a

subcontractor (external agent) in a foreign country? Because contracting out is risky: it implies transferring the specific capital outside the firm and revealing the proprietary information (e.g. how to use the technology or the patent). Problem:
If the agent interrupts the contract it can use the

technology to compete with the mother company In the case of brands/reputation: if the agent damages the brand reputation

4 types of FDI derived from OLI theory

The typology of FDI was developed by Jere Behrman to

explain the different objectives of FDI:

Resource seeking FDI Market seeking FDI Efficiency seeking (global sourcing FDI) Strategic asset/capabilities seeking FDI

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Resource seeking FDI

To seek and secure natural resources e.g. minerals, raw materials, or lower labor costs for the investing company
For example, a German company opening a

plant in Slovakia to produce and re-export to Germany

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Market seeking FDI

To identify and exploit new markets for the firms` finished products
Unique possibility for some type of services for which production and distribution have to be contemporaneous (telecom, water supply, energy supply) Automotive TNCs have invested heavily in China

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Efficiency seeking FDI

To restructure its existing investments so as to achieve an efficient allocation of international economic activity of the firms
International specialization whereby firms seek to

benefit from differences in product and factor prices and to diversify risk Global sourcing resource saving and improved efficiency by rationalizing the structure of their global activities. Undertaken primarily by network based MNCs with global sourcing operations.
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Strategic asset/capabilities seeking FDI

MNCs pursue strategic operations through the

purchase of existing firms and/or assets in order to protect O specific advantages in order to sustain or advance its global competitive position
Acquisition of key established local firms Acquisition of local capabilities including R&D, knowledge

and human capital Acquisition of market knowledge Pre empting market entrance by competitors Pre empting the acquisition by local firms by competitors
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