International Business – Week #4 Lecture 2

Foreign Direct Investment

This lecture begins by sorting out the complex vocabulary related to foreign direct investment (FDI): foreign portfolio investment (FPI), horizontal, vertical, upstream, downstream, flow, and stock. We also distinguish a multinational enterprise (MNE) from a non-MNE. The discussion then turns to the advantages of FDI, including ownership, location, and internalization advantages. We then turn to the realities of FDI, including different political views on FDI and its benefits and costs to both the home and host countries.

The term Foreign Direct Investment (FDI) refers to the direct investment in activities that control and manage value creation in other countries. This is in contrast to Foreign Portfolio Investment (FPI), which is the holding of stocks and securities in foreign companies with no active management. Essentially, FPI is foreign indirect investment. FDI is the distinctive factor of all MNEs.

As with most other business activities, FDI takes place because its benefits outweigh its costs. The primary benefits of FDI can be summed up as OLI Advantages – ownership, location and internalization.

In contrast to FPI, FDI provide a significant ownership stake in a foreign company or asset, which provides the MNE with management control rights. Many firms prefer the higher level of control that FDI provides over other options, as this reduces the risk of firm-specific knowledge being spread to competitors, leads to tighter control of foreign operations, and allows for easier transfer of knowledge.

Internalization refers to the replacement of cross-border market relationships with one firm (the MNE) owning, controlling and managing activities in two or more countries. By replacing an external market transaction with an internal activity, the firm is able to reduce opportunism and makes that activity more efficient, which in turn reduces the costs of international transactions and helps avoid market failure.

Location advantage refers the advantages that an MNE enjoys because of the area in which it operates. These advantages not only stem from features that are particular to a certain region, but also from agglomeration, the clustering of economic activity within a certain location. It is important to remember that location advantages originate not only from the location of a firm, but also from firm-specific capabilities.

Now, to continue on with this unit, please view the video presentation, and read the chapters assigned. Then respond to the Discussion Questions with an initial post and two responses to others in the class. You will also be responsible for all the assignments, case studies assigned to each unit. I look forward to your participation in the discussion threads and assignments.