UK Essays: Custom Essays Writers

Free Essays - Free Management Essays

Changes In Foreign Direct Investment

Foreign direct investment (FDI) has increased rapidly, during the last century along with increasing internationalisation of the economy, as well as during the last decade.

Yet, the competitive advantages of today's businesses are increasingly said to be generated by co-operation and alliances as opposed to integration, and outsourcing or market exchanges as opposed to investment.

Summary

This essay therefore discusses whether or not the increasing direct investment will keep on growing, or if other alternatives will become more attractive. In order to provide such a discussion, a description of recent trends in flows and motives of FDI is first provided.

The changes in both directions and motives provide some indications that foreign direct investment will continue to grow, largely due to increasing cross-border mergers and acquisitions.

The text begins with briefly describing the overall increase in FDI during the last decade. It then moves on to describing primarily geographical flows in FDI, and briefly industry specific flows. Based on these facts and recent literature, motives are then described and discussed, after which future trends in flows and motives are discussed.

1 Introduction

Foreign direct investment (FDI) has increased rapidly, not only during the last century along with increasing internationalisation of the economy, but also during the last decade.

For instance, in 1998, global FDI inflows increased for the seventh consecutive year. Seemingly unaffected by the Asian financial crisis, they increased by 19% to a new record level of $400 billion, while outflows reached $424 billion. The capital base of international production in 1997, including capital for direct investment purposes drawn from sources other than trans-national corporations was estimated to have increased by $1.6 trillion in 1997. And since the early 1980s, world FDI flows, now attributable to almost 54,000 trans-national corporations, have grown faster than either world trade or world output. During 1980-97, global FDI outflows increased at an average of about 13% a year, compared with average rates of 7% both for world exports of goods and services and for world GDP (current prices) during 1980-96.

Yet, the competitive advantages of today's businesses are more often than not, said to be generated by co-operation and alliances as opposed to integration, and outsourcing or market exchanges as opposed to investment. Investment is often said to be moderate in firms with quick responsiveness, flexibility and the competitive edge to pursue rapid changes on markets. Why then, does foreign direct investment continue to increase? How can it be that FDI has continued to grow in a decade of outsourcing and disintegration? These are among the questions raised in this text.

The actual flows of capital constitute another interesting issue to analyse. Much of the literature focuses on the implications for the host country. This is obviously an important part of the debate, since countries go through lengths to create incentives for FDI, and this clearly affects the level and directions of FDI. However, in view of the reasoning above, and the increasing trend of strategic alliances and outsourcing, it is also important to look at the issue from another angle: i.e. what is in it for the investor? This discussion has to be included, not only because of the value of comparing it to other forms of market entry, but as a means of evaluating whether or not countries' attempts to attract investors are justifiable, or if the attempts are minute in the context.

This text will therefore describe and discuss recent trends in investment flows in order to estimate whether these are likely to continue. The paper will thus also examine the reasons for investing and aims to provide a discussion of the future attractiveness of FDI-methods compared to other methods. To enable such an analysis, the discussion begins an examination of the major changes in trends in FDI flows during the 1990s. Then follows a discussion of recent motives in FDI, after which a few thoughts on future FDI will be provided.

1.1 Objectives

To identify and summarise major trends and flows in FDI during the 1990s, primarily between countries/regions, and briefly on industry level, in order to identify any recent major changes or trends. Based on past and present motives for FDI, to provide a discussion whether the current patterns and trends will continue or if they will take new directions.

2 Geographical Trends in FDI

2.1 Inflows

Large declines in FDI, for instance to East Asia and Latin have recently been highlighted. The recession in Japan, the decline in market size (expressed in foreign currency) and reduced growth prospects has been said to lower FDI flows. It needs to be considered however, that investment in these areas is still significant, and that FDI has been much more resilient than other forms of private capital flows in response to the recent financial crisis. In addition, FDI flows were relatively stable to 4 of the 5 East Asian countries most affected by the crisis. The only exception was Indonesia, where FDI flows dropped to $1.3 billion in 1998, compared with $4.7 billion in 1997. Exchange rate depreciations, declines in asset values, a more attractive domestic policy environment, and the opportunity to profit from corporate restructuring tended to support FDI flows.

Furthermore, even if declines in FDI flows to East Asia have been given much attention, these investments still remain significant comparatively. The share of world FDI inflow going to South, East and South-East Asia fluctuated between 20% and 24% in 1994 to 1997. Compared to the whole of Asia, which accounted for 21.7% of world FDI inflows in 1997, inflows to South, East and South-East Asia are immense, as they amounted to 20.6%. China has emerged as the largest regional recipient of inflows, followed by Singapore and other economies in the region. The rate of FDI inflows to China declined however, to 11% in 1997 from an average of 147% between 1992 and 1993.

The slowing down of fresh inflows of FDI to certain East Asian host economies was predicted, as countries in the region needed to adjust to current economic difficulties, but some experts believe inflows are likely to resume pace once the adjustment period is over. In relation to the above, it deserves to be mentioned that developing countries (by definition Asia, Africa, Latin America and the Caribbean, Developing Europe and The Pacific) received around 37-39% yearly in 1994 to 1997 (with a drop in 1995, to 31.9%).

When seen in perspective, the increase of flows to developing countries becomes clear; developing countries accounted for two-thirds of the rise in global FDI flows from the late 1980s to the 1990s. It is in flows of inward FDI that developing countries have made the biggest gains over the 1990s. Their respective value of these, as well as shares of global inflows, increased noticeably: from $34 billion in 1990 (17% of global inflows) to $149 billion in 1997 (37% of global inflows).

Developed countries received around a yearly 60% of FDI inflows in the same period, with Western Europe accounting for the biggest part (normally around half of the total amount of investment flowing to developed countries), and the US the second biggest (an increase from 18.6% in 1994 to 22.7% in 1997). Flows to Japan never breached the one-percent level, the highest proportion was in 1997 when FDI inflows reached 0.8%. It is interesting to note that the $3 billion invested in Japan actually was a record figure, but still low compared to other developed economies. Continued strong economic growth in the United States, improved economic performance in many Western European countries, along with the mergers and acquisitions boom, were largely responsible for the acceleration of inflows to developed countries in 1997. The increase was almost a fifth over 1996, $233 billion. The United States received $91 billion in inflows, which was more than a fifth of global inflows, and they invested $115 billion abroad during 1997. Among the countries within the EU, the United Kingdom received $37 billion in 1997, which was just under 10%.

Central and Eastern Europe do not account for any significant parts of FDI inflows. However, this is where the biggest relative increase can be detected. These areas reached 4.6% in 1997, compared to 2.4% in 1995.[15] Largely, the explanation lies in the increasing privatisation. This continued to be an important source of FDI in 1998, particularly in Eastern Europe (as well as Latin America). The economies of Central and Eastern Europe consequently broke their stagnating FDI trend in 1997 by receiving record FDI flows of $19 billion, 44% more than in 1996. This was the first year the region as a whole registered a positive GDP growth rate in recent years. The Russian federation was the leading recipient.

2.2 Outflows

Unsurprisingly, the largest share of FDI comes from developed countries. These have consistently contributed with around 85% of FDI outflows during the last few years. Of these, Western Europe accounts for the largest share with up to half of the total flows from developed countries (the EU typically contributed with 42-45% of developed countries' share of FDI outflow). Outflows from the EU were $180 billion in 1997, and new attention to European integration encouraged by the expected arrival of the Euro in 1999 led to a surge in the share of investment directed to member countries. The two other members of the triad, The US and Japan, accounted for 27% and 6.1% of world FDI outflows respectively in 1997 (which represents no major changes compared to the years leading up to this).

Most of the substantial increase in FDI in East Asia described in the previous section comes from the United States. With respect to both absolute amounts and relative global shares, US firms have invested substantial and increasing sums throughout most of the region. At the same time, intra-regional FDI, originating largely in Japan and the Asian NIEs, has grown still more quickly in recent years.

Again, the increase in the numbers representing Central and Eastern Europe show the relatively biggest changes. These areas do still not however, contribute with more than 0.8% of world FDI outflows.

The investment flow from developing countries was 14.4% of total FDI outflows in 1997, most of which came from Asia (12%) or more specifically South, East and South-East Asia (11.8%). Again, no significant changes can be seen during the preceding years.

Considering the amount of investment flows that developed countries provide, it is not surprising that developed countries share of inward and outward FDI stock, even if it is being eroded, dominate the global picture. These account for more than two-thirds of the world inward FDI stock and 90% of the outward stock. The erosion of developed countries' share of inward stock is highlighted by the fact that developing countries accounted for nearly a third of the global inward FDI stock in 1997, increasing from one-fifth in 1990.

The following sections will briefly describe the particular types of investments made in the main regions discussed.

2.3 Sector and industry specific FDI

Services vs manufacturing. Services can be said to have accounted for the creation of the largest share of FDI of major trading nations throughout the 1990s (i.e. this is particularly true for developed countries). The proportion of services in FDI was between 46% and 66% of the total stock in the early 1990s. This can be compared to the 33-53% in the mid- 1980s. Furthermore, it has been said that this trend is likely to continue.

Industries
In the case of services, finance is the biggest source of FDI inflow in developed countries, and transport, storage and communications is the biggest source in South, East and South-East Asia.

In developed countries, chemicals and chemical products, by far account for the biggest share of FDI inflows, followed by machinery and equipment. Chemicals and chemical products also account for the largest share of FDI inflows in South, East and South-East Asia.

The investments in Central and Eastern Europe present a difference between the leading recipient, the Russian Federation, and the rest of the region. In the Russian Federation, investment mainly occurred within natural resources and infrastructure development, whereas in the other economies, most of the FDI growth occurred in manufacturing and services.

After establishing where the investment comes from and where it goes to, the discussion will now move on to discussing why this is the case. More specifically, investors' motives will be described and analysed.

3 General Motives for FDI

In general, FDI occurs when firms combine their ownership-specific advantages with the host country's location-specific advantages through internalisation, i.e. through intra-firm rather than arm's-length transactions. Three broad issues determine where companies invest: the policies of host countries, the proactive measures countries implement to promote investment, and the characteristics of their economies. The relative importance of different location-specific FDI determinants depends on the motive and type of investment, the industry in question, and the size and the strategy of the investor. Different motives, for example, can translate into different location patterns depending on the investor's strategy.

Why does the level of foreign direct investment continue to increase? A direct investment is undoubtedly difficult to reverse. And considering the vast literature on co-operative solutions, such as e.g. strategic alliances and outsourcing, as well as the increasing emphasis on flexibility in the management of organisations of today one might be forgiven for believing that these forms of market entries would increase more rapidly. Well-recognised authors within the field of FDI are also beginning to emphasise the role of flexibility in multinational enterprises. Buckley and Casson, for instance, say flexibility is identified as the hallmark of recent modelling of the multinational enterprise, and that the focus on flexibility is a response to the rationalisation and restructuring of international business. The same authors continue with arguing that "the new dynamic agenda", among other things, focuses on uncertainty and market volatility, flexibility and the value of real options, co-operation through networks and organisational change. In addition, the desire for flexibility discourages integration, as it is seen as better to subcontract or to franchise sales. Similarly dis-integration becomes encouraged.

One explanation is obviously that if flexibility were costless, then all organisations could build in unlimited flexibility at the outset. In practice, the greater the flexibility, the higher the transaction costs become.

Other commonly used, and perhaps obvious explanations for FDI include market access, the size of markets, tax evasion and cheap inputs. However, in view of the recent trends discussed above, it is still interesting to estimate whether FDI will continue to increase, and if so, why.

3.1 Changing motives in FDI

Mergers and acquisitions have become an increasingly important vehicle for FDI to developing countries. The share of developing countries in global majority-owned, cross border M&A sales rose to 19 percent in 1997, compared with 5 percent in 1991. World-wide cross-border M&As, mostly in banking, insurance, chemicals pharmaceuticals and telecommunications, were aimed at the global restructuring or strategic positioning of firms and experienced a surge in 1997. Valued at $236 billion, majority owned M&As represented nearly three-fifths of global FDI inflows in 1997, increasing from almost a half in 1996. Many of the 1997 M&As were large and 58 of them were each worth more than $1 billion. The United States, followed by the United Kingdom, France and Germany, accounted for the biggest share of the large M&As. Developed countries accounted for about 90% of the world-wide majority-owned M&A purchases. These deals are not only a major driver of FDI inflows for developed countries, but also highlight the current strategies of trans-national corporations, divesting non-core activities and strengthening competitive advantages through acquisitions in core activities. Strategies like these have also been facilitated by liberalisation and deregulation.

The resources sought seem to have changed towards more intangible ones over the years. For instance, Chen and Chen argue that network linkages drive and facilitate FDI. They drive FDI because investors can gain access to strategic assets in a foreign country via network connections. They facilitate FDI because, via network connections, investors can overcome entry barriers to establish themselves in a foreign market, and can reduce transaction costs when running cross-country operations. Furthermore, network linkages may complement or supplant the weakness of firm-specific capabilities. With regards to the earlier discussion on the flexibility of firms, this also has implications for firm-specific competitive advantage. When a firm's best alternative is to invest directly, it is imperative that flexibility is achieved in other ways than via e.g. sub-contracting. Consequently, imaginative employees and charismatic leaders will have to be recruited. Strengths like these can be achieved either by moving the intangible assets in question from existing locations or "acquiring" them. If, for instance, a multinational enterprise is seeking flexibility in the range of products it produces it will therefore be encouraged to seek out locations with a versatile labour force. In addition, flexibility is not just an aspect of corporate strategy, but a component of location advantage too. Such location advantage depends among other things on supplier networks and their degree of trust, the nature of local institutions and local culture. The above argument of a move towards an emphasis on intangible assets in FDI is supported by the fact that, as discussed earlier, services account for the largest share of FDI. Examples would include the recently growing number of merging banks. These obviously fall into the largest FDI sector; "services", but also into the top service industry; financial services. The manufacturing industries described can also be said to be relatively knowledge intensive.

To develop the reasoning on intangible assets, it has also been argued that many times the perceived advantages of FDI are company specific. In other words, companies seek to acquire advantages such as reputation, skills and other resources that there, in effect, are no markets for. M&As thus become the only method of expansion available. Similarly, it has been said that one major purpose of FDI is to move the investing firm's (already existing) intangible assets, and that many of the explanations of the 1970s and 1980s need to be modified as firm-specific assets have become mobile across natural boundaries.

Another example of the changing priorities is the view on more tangible advantages such as e.g. labour costs. The countries receiving the largest share of the surge in FDI flows had more open policy regimes, large markets, and relatively high incomes. No low-income country is among the top 10 recipients (even if FDI flows account for a large share of total capital flows to many of the low-income oil and mineral producers).[38] It seems that the advantage of cheap labour has dropped down the list of reasons and motives for direct investment.

The Future of FDI and its Motives

Evidence indicates that the occurrence of cross-border mergers and acquisitions will continue to grow, thus keeping FDI at a high level. Dunning,[39] for instance, highlights a new trend (when comparing FDI in the 1990s with the 1970s) in strategic asset seeking. He argues that there is a "growing geographical dispersion of knowledge-based assets, and need of firms to harness such assets from foreign locations", and that this fact "makes a more important motive for FDI". Furthermore, there are opportunities offered, often by particular subnational spatial units, for exchange of localised tacit knowledge, ideas and interactive learning. There is thus a growing importance of intangible assets, particularly intellectual capital, and of the need of companies to tie together and exploit these assets from a variety of locations. The role of location-bound assets is also changing, as investors look for complements to their own core competencies.

Another issue suggesting continued growth in FDI is represented by the example of the increasing investment in East Asia. This has enabled transnational corporations to source, not only inexpensive, but also increasingly skilled East Asian labour. As a result, by almost any measure United States FDI in East Asia has increased substantially in recent years. In absolute terms, the total stock of United States FDI in the region grew from approximately $300 million in 1950 to about $14 billion in 1980, after which it increased to an estimated $95billion by 1995.

The increasing privatisation, which continued to be an important source of FDI in 1998, is likely to persist. Privatisation is also a trend that is likely to continue, especially in Eastern Europe, where efforts are made to harmonise with the rest of Europe. As a result there may be further M&As in the area. Earlier research suggests that the behaviour of MNEs is responsive to European institutional changes. As mentioned earlier FDI levels in Western Europe have been high, and if Eastern Europe continues to adapt to EU policies we might experience further upsurge in FDI in this area.

Many of the new motives for FDI represent areas or issues that cannot be solved with less than direct investment. Markets rarely or never exist for intangible assets, and it is a widely known economic fact that, were imperfections on markets prevail, internalisation will take place.

Back to: Management Essays

Conclusions

Developed countries play a large part in the increasing world FDI flows. Recent upswings can be seen in developing countries, however. Central and Eastern Europe and East Asia, particularly China accounts for significant increases. Estimates indicate that foreign direct investment levels will continue to increase.

Services, especially financial, are paramount in the increasing world FDI flows. In manufacturing, chemicals and chemical products account for large shares of flows. This is typical of the more knowledge-intensive investments made.

Future FDI might begin to even more move towards areas with skilled labour. Evidence from the heavy investment in China suggests that investors do not only want cheap labour, but skill as well. Further evidence can be found in the type of investments made around the world. Services account for the largest part of FDI, and often investors are looking for intangible assets such as e.g. knowledge or know-how. This is highlighted by the growing number of cross-border mergers and acquisitions.

Part of the reason for the increasing cross-border investment is mergers and acquisitions. Reasons for M&As in turn, include: movement or harnessing of intangible assets, incorporation of skills and competencies, strategic positioning, risk reduction and efforts to increase profits. Another part of the reason for the upsurge in M&As is liberalisation and deregulation of markets. This is likely to contribute towards a continued growth in FDI flows. Firm-specific assets like the above, have become increasingly mobile.

More Management Essays...

Do you need some more research material? We have hundreds of free essays available in our online resource library - essays not just on management but from all the major subject areas...

Please note: The above essays and dissertations were written by students and then submitted to us to display and help others. Thanks to all the students who have submitted their work to us.