8.2 Theories and Patterns of Foreign Direct Investment

Foreign Direct Investment (FDI) is a key driver of global economic integration. It involves companies or individuals investing in businesses abroad, establishing lasting control. FDI differs from portfolio investment and requires at least 10% ownership.

Theories like Dunning's OLI Framework explain FDI motivations. These include market-seeking, resource-seeking, efficiency-seeking, and strategic asset-seeking investments. Global FDI patterns show developed economies as major players, with emerging markets gaining importance.

Foreign Direct Investment (FDI)

Concept of foreign direct investment

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• FDI occurs when a company or individual from one country invests in business interests located in another country
• Establishes a lasting interest and significant degree of control over the foreign enterprise
• Differs from portfolio investment, which involves purchasing securities without active management or control (stocks, bonds)
• Minimum 10% ownership stake is typically required for an investment to be considered FDI (IMF, OECD)
• Enables investors to access new markets, resources, and strategic assets abroad (technology, brands)

Theories behind FDI motivations

• Dunning's Eclectic Paradigm (OLI Framework) explains FDI based on three advantages:
  1. Ownership advantages: Firm-specific advantages that enable MNCs to compete in foreign markets (brand reputation, proprietary technology)
  2. Location advantages: Country-specific advantages that attract FDI (large market size, abundant natural resources, favorable tax policies)
  3. Internalization advantages: Benefits of maintaining control over foreign operations rather than outsourcing or licensing (protect intellectual property, ensure quality control)
• Market-Seeking FDI aims to access new markets or expand market share in foreign countries
  • Driven by factors such as market size, growth potential, and consumer preferences (rising middle class, untapped demand)
• Resource-Seeking FDI secures access to natural resources, raw materials, or low-cost labor abroad
  • Motivated by the availability and cost of resources in the host country (oil reserves, mineral deposits, cheap labor)
• Efficiency-Seeking FDI optimizes production processes by exploiting differences in factor costs across countries
  • Involves relocating production to countries with lower labor, energy, or other input costs (offshoring manufacturing to China, Vietnam)
• Strategic Asset-Seeking FDI acquires strategic assets, such as technology, brands, or intellectual property, through cross-border investments
  • Enhances the firm's global competitiveness and innovation capabilities (acquiring a foreign tech startup, buying a well-known brand)

Global patterns of FDI flows

• Developed economies have traditionally been the largest source and recipient of FDI (US, EU, Japan)
  • Intra-regional FDI flows are significant, particularly within North America (US-Canada) and Europe (EU single market)
• Emerging economies are capturing an increasing share of global FDI inflows and outflows
  • China has become a major FDI recipient and is increasingly an important source of outward FDI (Belt and Road Initiative)
  • Other Asian countries (India, ASEAN) are attracting more FDI in manufacturing and services
• Sectoral patterns show a shift towards services and knowledge-intensive industries
  • Services sector accounts for a growing share of global FDI (finance, telecommunications, business services)
  • Manufacturing remains a key target of FDI, focusing on efficiency-seeking and market-seeking investments (automotive, electronics)
  • Primary sector continues to attract FDI in extractive industries (oil and gas, mining, agriculture)

Determinants of FDI decisions

• Economic factors play a crucial role in attracting FDI:
  1. Market size and growth potential (large consumer base, expanding middle class)
  2. Labor costs and productivity (skilled workforce, competitive wages)
  3. Infrastructure quality (reliable transportation networks, modern telecommunications)
  4. Macroeconomic stability (low inflation, stable exchange rates)
• Political and institutional factors shape the investment climate:
  1. Political stability and low risk of expropriation or nationalization
  2. Favorable government policies and regulations (tax incentives, streamlined procedures)
  3. Strong intellectual property rights protection (patents, trademarks)
  4. Low levels of corruption and good governance (rule of law, transparency)
• Social and cultural factors influence the ease of doing business:
  1. Language and cultural proximity (shared values, business practices)
  2. Availability of human capital and skills (educated workforce, training programs)
  3. Entrepreneurial culture and innovation ecosystem (startups, research centers)
• Agglomeration economies attract FDI through positive externalities:
  1. Presence of industry clusters and networks (Silicon Valley for tech, Detroit for automotive)
  2. Spillover effects and knowledge transfer (learning from nearby firms, collaborations)
  3. Availability of specialized suppliers and services (input providers, logistics)