7.3 Foreign direct investment and multinational corporations
5 min read•august 15, 2024
(FDI) is a key driver of globalization, involving companies investing in businesses abroad. It comes in different forms like horizontal, vertical, and , each serving unique purposes for expanding operations internationally.
Companies engage in FDI for various reasons, including market access, resource acquisition, and efficiency gains. While FDI can boost economic growth in host countries, it may also lead to job losses in home countries and create dependencies on foreign capital.
Foreign Direct Investment: Definition and Types
Definition and Key Characteristics
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- Foreign direct investment (FDI) is an investment made by a company or individual in one country into business interests located in another country
- FDI involves establishing business operations or acquiring business assets in a foreign country with the aim of establishing a lasting interest
- Key characteristics of FDI include long-term commitment, control over the invested enterprise, and transfer of resources such as capital, technology, and management skills
Types of Foreign Direct Investment
- occurs when a company carries out the same activities abroad as at home
- Examples include opening multiple stores or service centers in foreign countries (McDonald's, Starbucks)
- Horizontal FDI allows companies to replicate their successful business models in new markets
- takes place when different stages of activities are added abroad
- Companies may establish manufacturing plants in foreign countries to take advantage of lower operating costs (labor, raw materials)
- Vertical FDI often involves the fragmentation of production processes across different countries
- Conglomerate FDI involves the diversification of FDI into an unrelated business abroad
- Companies may use FDI to open a new business in a foreign country that is not directly connected to its core business
- Conglomerate FDI allows companies to diversify their portfolio and reduce risk by investing in different sectors or industries
Motivations for Foreign Direct Investment
Market-Seeking and Resource-Seeking FDI
- aims to enter new markets or expand in existing ones by investing in a foreign country
- Driven by factors such as market size, growth potential, and consumer purchasing power
- Companies may establish local subsidiaries or acquire existing firms to gain access to new customers (Walmart's expansion into international markets)
- is motivated by the desire to acquire specific resources that are available in a foreign country
- Resources may include natural resources (oil, minerals), raw materials, or low-cost labor
- Companies invest in foreign countries to secure access to these resources and reduce production costs (mining companies investing in resource-rich countries)
Efficiency-Seeking and Strategic Asset-Seeking FDI
- seeks to increase efficiency by taking advantage of lower costs or economies of scale in a foreign country
- Companies may establish production facilities or outsource services to countries with lower labor or operational costs (Apple's manufacturing in China)
- Efficiency-seeking FDI allows companies to optimize their global production networks and improve competitiveness
- is driven by the desire to acquire strategic assets through investment in a foreign company
- Strategic assets may include advanced technology, intellectual property, brand names, or distribution networks
- Companies engage in strategic asset-seeking FDI to enhance their capabilities and gain competitive advantages (pharmaceutical companies acquiring biotech firms for their drug pipelines)
Impact of Foreign Direct Investment on Economies
Economic Growth and Development in Host Countries
- FDI can stimulate economic growth in the host country by increasing , creating jobs, and boosting exports
- Foreign investments bring in new capital that can be used to finance infrastructure projects, expand production capacities, and develop new industries
- FDI creates employment opportunities in the host country, both directly through the foreign-invested enterprises and indirectly through spillover effects on local businesses
- Increased exports from foreign-invested enterprises can improve the host country's trade balance and generate foreign exchange earnings
- Host countries can benefit from increased generated by the economic activities of foreign investors
- Tax revenues can be used to fund public services, such as education, healthcare, and social welfare programs
- FDI can also contribute to infrastructure development in the host country, as foreign investors may finance the construction of roads, ports, and telecommunications networks
Potential Drawbacks for Home and Host Countries
- Home countries may experience job losses and reduced tax revenues as companies shift production and investment abroad
- Efficiency-seeking FDI, in particular, may lead to the relocation of jobs from the home country to lower-cost host countries
- The loss of jobs and tax revenues can have negative impacts on the home country's economy and social welfare
- Repatriation of profits earned by multinational corporations in host countries can lead to a net outflow of capital over time
- Multinational corporations may transfer profits back to their home countries through dividends, royalties, or transfer pricing
- The outflow of capital can reduce the resources available for reinvestment and development in the host country
- Host countries may become overly dependent on foreign investments, leaving them vulnerable to economic shocks or policy changes in the home countries of multinational corporations
Multinational Corporations: Technology Transfer and Knowledge Spillovers
Channels of Technology Transfer
- Multinational corporations often possess advanced technologies and knowledge that can be transferred to host country firms through various channels
- allow local firms to use the technologies and intellectual property of multinational corporations in exchange for royalties or fees
- between multinational corporations and local firms facilitate the sharing of technologies, management practices, and market knowledge
- , where local firms serve as suppliers to multinational corporations, can lead to the transfer of technical and quality control standards
- The presence of multinational corporations can create , as local firms observe and imitate the technologies and practices used by foreign investors
- Local firms may adopt new production methods, management techniques, or marketing strategies based on the examples set by multinational corporations
- Demonstration effects can lead to productivity gains and improved competitiveness among local firms
Factors Influencing Knowledge Spillovers
- The extent of and depends on various factors:
- of local firms refers to their ability to recognize, assimilate, and apply new technologies and knowledge
- Level of in the host country can influence the willingness of multinational corporations to transfer cutting-edge technologies
- Nature of the investment, such as wholly-owned subsidiaries vs. joint ventures, can affect the degree of technology transfer and knowledge sharing
- Multinational corporations may invest in (R&D) activities in host countries
- R&D investments can lead to the creation of new knowledge and technologies that can benefit local industries
- Collaboration between multinational corporations and local universities or research institutions can foster innovation and knowledge spillovers
- In some cases, multinational corporations may limit technology transfer to protect their competitive advantage
- Corporations may use intellectual property rights, such as patents and trade secrets, to prevent the diffusion of core technologies to local competitors
- Restrictive practices, such as prohibiting local employees from working for competitors, can hinder the spread of knowledge and skills in the host country
Key Terms to Review (29)
Absorptive capacity: Absorptive capacity refers to the ability of an organization or country to recognize, assimilate, and apply new external knowledge. This concept is crucial in understanding how multinational corporations (MNCs) leverage foreign direct investment (FDI) to enhance their operational efficiencies and innovate. A strong absorptive capacity enables entities to not only absorb new information but also to adapt it effectively to their existing frameworks, thereby fostering growth and competitive advantage in a globalized economy.
Bilateral Investment Treaties: Bilateral investment treaties (BITs) are agreements between two countries that establish the terms and conditions for private investment by nationals and companies from one country in the other country. These treaties aim to promote and protect foreign investments by providing legal guarantees, such as fair treatment, protection from expropriation, and mechanisms for dispute resolution. BITs are crucial in the context of foreign direct investment as they help to create a stable environment for multinational corporations to operate across borders.
Capital Formation: Capital formation refers to the process of building up the capital stock of a country through investing in physical assets such as machinery, infrastructure, and technology. This process is crucial as it leads to economic growth and increases productivity. The accumulation of capital enables businesses to expand their operations, innovate, and improve efficiency, which is particularly relevant in the context of foreign direct investment and the activities of multinational corporations.
Conglomerate fdi: Conglomerate foreign direct investment (FDI) refers to investments made by multinational corporations in different industries or sectors that are not related to their existing business operations. This strategy allows firms to diversify their operations, reduce risks, and tap into new markets. By investing in unrelated businesses, companies can leverage their capital, management expertise, and technological advancements to create value and enhance their global presence.
Demonstration Effects: Demonstration effects refer to the social and economic influences that arise when the actions, behaviors, or successes of one entity inspire or motivate others to follow suit. This concept is particularly relevant in the context of foreign direct investment (FDI) and multinational corporations (MNCs), as the presence and practices of these companies can showcase new technologies, management techniques, and business models that local firms might adopt to enhance their competitiveness and efficiency.
Efficiency-seeking fdi: Efficiency-seeking foreign direct investment (FDI) occurs when companies invest in foreign markets to optimize their production processes and reduce operational costs. This type of FDI aims to leverage advantages like lower labor costs, access to advanced technologies, and proximity to key markets, allowing firms to enhance their overall efficiency and competitiveness.
Export boosting: Export boosting refers to strategies and policies implemented by countries to enhance their export performance, making their goods and services more competitive in international markets. This can involve providing incentives to local businesses, investing in infrastructure, or negotiating trade agreements that lower tariffs and other barriers. These efforts aim to increase a country's share in global trade and improve its balance of payments.
Foreign direct investment: Foreign direct investment (FDI) refers to the investment made by a company or individual in one country in business interests in another country, typically by acquiring assets or establishing business operations. FDI is a vital component of globalization, influencing economic geography as it affects capital flows, job creation, and regional development.
Foreign ownership restrictions: Foreign ownership restrictions are regulations imposed by a country that limit the percentage of ownership foreign entities can have in local businesses or industries. These restrictions can impact foreign direct investment by controlling how much influence and control external investors can have over domestic companies, affecting the landscape for multinational corporations and their operations in various countries.
Horizontal FDI: Horizontal foreign direct investment (FDI) occurs when a multinational corporation (MNC) invests in the same industry in a foreign country as it operates in its home country. This type of investment allows companies to expand their production and services internationally, catering to local markets while maintaining their original business model. It helps MNCs to achieve economies of scale, diversify market presence, and enhance competitive advantage.
Intellectual property protection: Intellectual property protection refers to the legal rights granted to individuals or organizations for their creations, inventions, and innovations, ensuring that they can control and profit from their intellectual efforts. This protection is essential for fostering creativity and innovation, especially in the context of foreign direct investment and multinational corporations, as it provides a framework for safeguarding proprietary technologies, trademarks, and trade secrets. A strong intellectual property regime encourages companies to invest in research and development, knowing that their innovations will be legally protected from unauthorized use or reproduction.
Inward fdi: Inward foreign direct investment (FDI) refers to investments made by foreign entities into a country's economy, where these investors acquire ownership or control of assets, production facilities, or business operations. This type of investment is vital for economic growth as it brings in capital, technology, and expertise, which can help boost local industries and create jobs. Inward FDI often results in multinational corporations establishing a presence in the host country, leading to increased competition and innovation.
Job creation: Job creation refers to the process of generating new employment opportunities within an economy, often as a result of various economic activities and investments. It is crucial for economic growth, reducing unemployment rates, and improving overall living standards in a region. Job creation is often associated with foreign direct investment (FDI) and the activities of multinational corporations, which can stimulate local economies by establishing new businesses or expanding existing ones.
John Dunning: John Dunning is a renowned economist known for his work on international business and foreign direct investment (FDI). He introduced the OLI framework, which highlights three key factors—Ownership, Location, and Internalization—that influence a firm's decision to invest abroad. His research has significantly shaped the understanding of multinational corporations (MNCs) and their strategies in global markets.
Joint ventures: Joint ventures are strategic partnerships where two or more parties come together to undertake a specific business project, sharing resources, risks, and profits. These arrangements are often formed by companies looking to expand their market presence, reduce costs, or leverage each other’s strengths while maintaining their individual identities. This collaborative approach is particularly significant in the context of foreign direct investment, as it allows multinational corporations to enter new markets with local knowledge and shared investment.
Knowledge Spillovers: Knowledge spillovers refer to the unintended and informal exchange of knowledge and ideas that occurs when individuals or firms interact, leading to enhanced innovation and productivity. This phenomenon often takes place in regions where firms are clustered together, as proximity allows for easier communication and collaboration, enabling the sharing of insights and expertise that can benefit others in the same area. Knowledge spillovers play a crucial role in economic development, driving competitiveness and fostering new industries.
Licensing agreements: Licensing agreements are legal contracts that allow one party to use another party's intellectual property, such as patents, trademarks, or technology, under specified conditions. These agreements play a crucial role in facilitating foreign direct investment by enabling multinational corporations to enter new markets while minimizing risks and costs associated with establishing a physical presence. Through licensing, companies can expand their brand presence, leverage local expertise, and adapt products to fit regional markets without the full commitment of direct investment.
Market-seeking fdi: Market-seeking foreign direct investment (FDI) refers to investments made by companies in foreign markets to access new customers and increase their market share. This type of FDI typically occurs when businesses aim to expand their operations into countries where they can find a growing demand for their products or services. Market-seeking FDI plays a crucial role in helping multinational corporations penetrate and thrive in new geographical areas.
Multinational corporation: A multinational corporation (MNC) is a company that operates in multiple countries, managing production or delivering services in more than one nation. These corporations often have a centralized head office in one country while leveraging resources, labor, and markets globally to optimize their operations. MNCs play a significant role in foreign direct investment as they invest directly in facilities and assets across borders, impacting local economies and global trade patterns.
Outward fdi: Outward foreign direct investment (FDI) refers to the investment made by a resident entity in one country into business interests in another country. This form of investment often involves the acquisition or establishment of assets such as production facilities, subsidiaries, or joint ventures abroad, reflecting the global expansion strategies of companies. Outward FDI plays a significant role in shaping international trade relationships and contributes to the economic growth of both the investing and host countries.
Research and development: Research and development (R&D) refers to the systematic investigation and innovative activities undertaken by organizations to create new products, improve existing products, or advance technologies. R&D is critical for fostering innovation and maintaining a competitive edge, especially for multinational corporations that invest in various markets to adapt their offerings to local needs and preferences.
Resource-seeking fdi: Resource-seeking foreign direct investment (FDI) refers to investments made by companies in foreign countries specifically to acquire natural resources or raw materials that are essential for their production processes. This type of investment is driven by the need to secure a stable supply of critical inputs, often in response to resource scarcity in the investor's home country or to take advantage of more favorable conditions abroad. By establishing operations in resource-rich countries, multinational corporations can enhance their competitiveness and reduce operational costs.
Saskia Sassen: Saskia Sassen is a prominent sociologist and geographer known for her work on globalization, migration, and the role of cities in the global economy. She has particularly focused on how foreign direct investment and multinational corporations shape urban landscapes and influence socio-economic dynamics. Additionally, her research addresses the impacts of brain drain and brain gain in relation to skilled migration, emphasizing how these phenomena affect both sending and receiving countries.
Strategic asset-seeking fdi: Strategic asset-seeking foreign direct investment (FDI) refers to the type of investment made by multinational corporations to acquire and control valuable assets, such as technology, brand names, and skilled personnel, in foreign markets. This strategy aims to enhance a firm's competitive advantage and facilitate access to resources that are crucial for long-term growth and sustainability in a globalized economy.
Supplier relationships: Supplier relationships refer to the interactions and connections between businesses and their suppliers, encompassing communication, collaboration, and negotiation throughout the supply chain. These relationships are crucial for ensuring that companies receive high-quality materials and services in a timely manner, which directly impacts production efficiency and overall business success. Strong supplier relationships can lead to better pricing, improved quality, and innovation as both parties work together toward shared goals.
Tax revenues: Tax revenues are the income generated by governments through the taxation of individuals and businesses. This financial resource is crucial for funding public services, infrastructure, and various government programs. In the context of foreign direct investment and multinational corporations, tax revenues play a significant role in shaping economic policies and attracting foreign investments.
Technology transfer: Technology transfer refers to the process of sharing or disseminating technological innovations and knowledge from one organization, country, or sector to another. This process is crucial for fostering innovation and economic growth, especially in a globalized economy, as it allows for the spread of new ideas, techniques, and products that can enhance productivity and competitiveness.
Transnational Corporation: A transnational corporation (TNC) is a large company that operates in multiple countries, managing production or delivering services in more than one nation. These corporations often have a centralized head office where they coordinate global management but maintain various operational branches across different countries to optimize efficiency and profits. TNCs play a significant role in foreign direct investment by facilitating capital flow and technology transfer between nations, contributing to global economic integration.
Vertical FDI: Vertical foreign direct investment (FDI) occurs when a multinational corporation invests in different stages of production in a foreign country, either by acquiring or establishing facilities for upstream or downstream activities. This type of investment is essential for firms to control their supply chain, reduce costs, and enhance efficiency across various levels of production, which can provide a competitive advantage in global markets.