Fdi

Main Determinants of Foreign Direct Investment (FDI) Location and Strategies employed by Transnational Corporations to maximise the net advantages of their locational decisions.

Introduction:

In the past few decades, the most important development has been of increasing internationalisation and globalisation of economic activities. Internationalisation is not a new thing, some commodities have been traded internationally since centuries, however the production process (plant, firm and industry) was always organised within the national economies. Today the world economy has changed dramatically, whereas a few centuries ago only a few products were traded internationally today, everything one can imagine of is involved in international trade. Production processes are no longer restricted by national boundaries, firms are setting up productive facilities overseas through Foreign Direct Investment. The most important indicator of the changing global map is Foreign Direct Investment. (Dicken, 1998)

FDI plays a significant and key role in global business. Companies may choose FDI as way to enter new markets and provide access to new marketing channels, cheaper production facilities, new technology, skilled labour force and finance. It is not only beneficial to the firm investing, but also the host receiving investment benefits from it through the transfer of capital, new technology and management skills and as such can provides a strong boost for economic development.

As per FDI Daniels, et.al. (2004) FDI can be defined as, a direct investment which gives the investor a controlling interest in a foreign company also known as FDI. It does not include portfolio investment as it is considered as indirect investment. Over time the definition of FDI has been expanded to include direct acquisition of a foreign firm, investment in a joint venture or strategic alliance with a local firm, construction of a building and licensing of intellectual property.

The advancements in technology and reduction in communications costs globally has made managements of foreign investments much easier than in the past. Also favourable investment policies and regulatory environment including favourable trade policy and tariff liberalisation and easing of the restrictions on foreign investment have probably been the most significant factors in the expanded role of FDI. Today FDI is not the domain of large companies only a lot of small and medium enterprises also hold direct investments aboard in the form of real estate, but since large companies hold investments in larger facilities and operate in many countries they have a higher FDI.

(http://www.going-global.com/articles/understanding_foreign_direct_investment.htm)

As per current statistics inflows of FDI have been substantial in 2005. FDI reached 916 billion in the year 2005 an increase of 29 % from the previous year of 2004 where it increased by 27 %, however this increase is much less than FDI in the peak year of 2000. (http://www.unctad.org/en/docs/wir2006_en.pdf).

Mergers & Acquisitions have been one of the key factors for the rise of FDI, though much of the M & A have been concentrated in financial services, insurance, life sciences, telecommunications and media. Since 190 M & A has risen from $ 600 billion in 1990 to $ 600 billion in 2002 and largely as a result of them, the 100 largest MNEs increased their foreign assets by 20% in 2000, foreign employment by 19% and sales by 15%. (Wall and Rees, 2004)

Determinants of FDI Location

(Taggart & McDermott, 1993) analysed why is FDI concentrated in some type of industries, and dominated by large firms oligopolistic markets, why are only few countries the source of the FDI, why are only a few countries the recipients of FDI, why are investments made by countries in one another quite often within the same industries.

One obvious reason for companies investing in a foreign country would be an estimated higher present value of future profits from establishing production facility in a foreign country as against the existing options available to the firm e.g. exporting to a foreign country. (Wall & Rees, 2004).

A prominent feature of today's world is the increasingly global nature of competition, firms not only competing with national firms but with firms from across the world, hence the pursuit is for global profits. Profit is the difference between Revenue (the income received by the firm from selling its goods and services and Cost (the expense of the firm to distribute its products and services) thus profit can be increased either by maximising Revenue or by reducing costs. Firms may also have other motives apart form profit like some firms may like to expand their market size, to become an industry leader or simply just to become bigger. However the pursuit for profit remains the prime motive for FDI. FDI decision is a complex one which may be influenced by social relationships within and outside the firm and for which there are a whole range of determining factors Some approaches seek to identify these determining factors for FDI. (Dicken, 1998)

Early theories like the Comparative advantage theory by David Ricardo in1817 and Factor Endowment Theory by Heckscher-Ohlin in 1933, have tried to explain why trade takes place between nations but one of the pioneering studies for factors determining FDI has been by Hymer in the 1960s. Hymer drew inspiration from the industrial organisation theory. He assumed that in serving a particular market, domestic firms would have an intrinsic advantage over the foreign firms. As per Hymer's argument domestic firms would have a better understanding of the local business environment, nature of the market, government policies and regulations. Given such a situation Hymer argued that a foreign firm would invest or produce in that market only of it possessed some firm specific advantages (example economies of scale, better technology, marketing skills like advertising strength and brand name) which would offset the advantages of the domestic firms. Thus his study focused

on the firm and emphasized the importance of market imperfections in stimulating International Production. (Dicken, 1998)

Another International Trade Theory was developed by R. Vernon of Harvard Business School in 1966 to establish the reasons for international production and trade known as the "Product Life Cycle". It was based on the assumption that products go through four stages in their life cycle namely of Introduction, Growth, Maturity and Decline and the location of production varies internationally,