CHAPTER 3: ECONOMIC ASPECTS OF FOREIGN DIRECT INVESTMENT

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Official Flows FOREIGN AID

Private Flows

FDI FPI Private loans

ODA OA OOFs

PRIVATE FLOWS

Foreign direct investment (FDI)

Foreign portfolio investment (FPI)

(International) private loans (IPL)

3.1. FDI definition

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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)

IMF &

OECD

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Direct investors : individuals; incorporated or unincorporated private or public enterprises; associated groups of individuals or enterprises; governments or government agencies; or estates, trusts, or other organizations that own () direct investment enterprises in economies other than those in which the direct investors reside.

Direct investment enterprise : in which a direct investor owns 10 percent or more of the ordinary shares or voting power

HOME COUNTRY

HOST COUNTRY DIRECT

INVESTOR

DIRECT INVESTMENT ENTERPRISE

FOREIGN DIRECT INVESTMENT

Lasting interest: - long-term relationship - Significant degree of

management ( >= 10%)

FDI Definition (cont.)

Vu Chi Loc (1997):

Foreign direct investment is the category of international investment that an investor in one country invest the whole or a substantial part of a project's capital amount in another country to control or join in controlling activities of that project.

FDI Characteristics

A voice in management

Threshold-equity ownership

- OECD (IMF)

- UNCTAD

- Vietnam

FDI Characteristics (cont.)

Return of investors

Technology transfer

Types of FDIodes

Linkages:

Horizontal FDI:: share the same product lines.

E.g: Lenovo & IBMs PC Division

P&G & Gillette (2005, $57b)

Types of FDI (linkages)

Vertical FDI:: in one value chain.

-Forward integration: downstream integration.

E.g: Walt Disney & ABC Television (1996)

-Backward integration: upstream integration.

E.g: Apple & Intel (2006)

Supplier Producer Distributor

Types of FDI (linkages)

Conglomerate FDI:: no common business areas. E.g: Phillip Morris & General Foods

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Types of FDI (cont.)

Perspectives of host country:

+ Import-substituting FDI

+ Export-increasing FDI

+ Government-initiated FDI

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Modes of FDI entry

Greenfield vs. M&A

Greenfield (UNCTAD): undertaken to set up a new production venture in a host country

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Modes of FDI entry (cont.)

M & A:

- UNCTAD: transfer of assets from domestic to foreigner investors by merge with or acquire an existing local firm in the host country.

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TNC MNC

???

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TNC - Definition

Dunning (1993):

A TNC is an enterprise that engages in FDI and owns or controls value-adding activities in more than 1 country.

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TNC Inclusion

- Parent enterprise

- Foreign affiliate + Subsidiary

+ Associate

+ Branch

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TNC Inclusion (cont.)

Parent enterprise controls assets of other entities

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TNC Inclusion (cont.)

Foreign affiliate

. incorporated or unincorporated

. ownership of 10%

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TNC Inclusion (cont.)

Foreign affiliate

Subsidiary

Incorporated

Parent entity: . 50% voting power . Appoint or remove a majority of the members of the administrative,

management or supervisory body

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TNC Inclusion (cont.)

Foreign affiliate

Associate

Incorporated

Parent entity:

10% X < 50% voting power

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TNC Inclusion (cont.)

Foreign affiliate

Branch

Unincorporated

Parent entity: wholly or joinly own

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TNC Measurement

- Performance: Investment expenditures, sales, assets, employment, output, exports

- No. of TNC: parent and foreign affiliates

Measurement of FDI

FDI flows vs. FDI stocks

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FDI Components

Equity capital

Reinvested earnings

Other capital (Intra-company loans)

Conclusion FDI is:...

Lasting interest direct investment relationship

Control-effective voice in the management

The threshold equity ownership

FDI differs from other forms of international investment

FDI is made inside investing firm

Transfer not only capital but also other assets and resources across borders

FDI effects

Positive effects vs. Negative effects

Possible positive effects

Provide capital

Finance their investments projects better and often cheaper

Create new jobs

Possible positive effects

Bring new technologies

Provide better access to foreign markets

Possible positive effects

Help to change the economic structure of the target country

Crowding in effect

Improve the business environment

Foreign corporations usually have a positive effects on the trade balance

Possible positive effects

Improve the environmental

conditions

Increase the level of wages

Possible negative effects

Monopoly threat

Crowding out effect

Possible negative effects

May cut working positions

May lead to increased imports

Possible negative effects

Repatriation of the profits can be

stressful on the balance of payments

The high growth of wages in FDI

firms can influence a similar growth

in the domestic corporations

which are not able to cover

this growth with the growth of

productivity

Possible negative effects

Transfer pricing

Possible negative effects

Possible environmental damage

Incentive tourism

FPI Definitions

IMF, Balance of Payment:

Portfolio investment is the category of international investment that covers investment in equity and debt securities, excluding any such instruments that are classified as direct investment or reserve assets

FPI Definitions (cont.)

Vu Chi Loc (1997), Foreign Investment:

Foreign portfolio investment is the category of international investment that an investor in one country buy securities of enterprises in another country equal to or below a certain threshold to gain profit but not control those security issuers.

FPI Characteristics

- No voice in management Sornarajah (2004)

UNCTAD

- Return of investors

FPI Characteristics (cont.)

- Less stable

- No technology transfer

IPL Definitions

Vu Chi Loc (1997), Foreign Investment:

International Private Loan is the category of international indirect investment that investors lend their money and gain profits

via interest.

IPL Characteristics

- Relation between investors and recipients

- Usage right of invested money

- Return of investor

FDI vs. FPI?

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FDI vs. FPI (foreign portfolio investment)

FDI (investing in production) Motive: profit from production

Control of foreign affiliate

Contribution: a package of assets (capital, technology, etc.)

Time horizon: long

Stability: relatively stable

Investors: TNCs, producers of goods and services

Statistical definition: more than 10% of equity stake in a foreign company

FPI (buying shares of a company) Dividend or a capital gain

No control

Only capital

Sometimes very short

Volatile, sensitive to financial turmoil

Financial institutions, institutional investors, etc.

Equal or less than 10% of equity stake

FPI can be useful. It simply performs different functions