2.3 Foreign direct investment and multinational corporations
4 min read•august 15, 2024
(FDI) is a key driver of globalization, allowing companies to expand internationally. It involves cross-border investments in foreign businesses, taking various forms like greenfield projects, acquisitions, and joint ventures.
Multinational corporations (MNCs) use FDI strategies to access new markets, resources, and efficiencies. This impacts both home and host countries, influencing economic growth, employment, and global competitiveness.
Foreign Direct Investment: Definition and Forms
Types of FDI Investments
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Factors Affecting Investment Decision of FDI Enterprises in Thanh Hoa Province, Vietnam View original
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Foreign direct investment (FDI) involves cross-border investments made by an entity in one country into a business or asset in another country, establishing a lasting interest and control
Greenfield investments entail building new operational facilities from the ground up in a foreign country
Brownfield investments involve purchasing or leasing existing facilities to launch new production
Mergers and acquisitions (M&As) occur when a company purchases an existing foreign company or merges with it
Joint ventures represent a collaborative form of FDI where two or more companies from different countries form a new entity
FDI Classifications and Ownership Structures
replicates home country activities in a host country (opening a similar factory abroad)
moves different stages of production to various countries (sourcing raw materials from one country, manufacturing in another)
Ownership in FDI ranges from minority stakes to wholly-owned subsidiaries, affecting control and risk levels
(less than 50% ownership)
(more than 50% but less than 100% ownership)
(100% ownership)
Determinants of FDI by Multinational Corporations
Market and Resource Factors
aims to access new markets or expand existing market share in foreign countries
Driven by market size (population, GDP)
Growth potential (emerging economies)
Consumer preferences (localization of products)
secures access to natural resources, raw materials, or specific labor skills
assessment evaluates stability and policy changes in host countries
Currency hedging protects against exchange rate fluctuations
Diversification across markets and industries mitigates country-specific risks
Balancing short-term profitability with long-term strategic positioning in global markets
Key Terms to Review (34)
Brownfield investment: Brownfield investment refers to the process of acquiring and developing previously used or abandoned industrial sites, which may be contaminated or require cleanup. This type of investment is essential for revitalizing urban areas, fostering economic growth, and promoting sustainable development while addressing environmental concerns.
Corporate Social Responsibility: Corporate Social Responsibility (CSR) is a business model in which companies integrate social and environmental concerns into their operations and interactions with stakeholders. CSR reflects the idea that businesses should not only focus on profit but also consider their impact on society, the environment, and the economy, promoting sustainable practices and ethical decision-making.
Currency risk: Currency risk refers to the potential financial loss that arises from fluctuations in exchange rates, affecting the value of investments and cash flows in foreign currencies. This risk is particularly relevant for businesses and investors engaged in foreign direct investment, as it can impact profitability and the overall success of multinational operations. Understanding currency risk is crucial for managing investments across different countries and markets, as it can influence decisions on where to invest and how to hedge against potential losses.
Economic liberalization: Economic liberalization refers to the process of reducing government regulations and restrictions on economic activities to promote free-market principles. This includes policies that encourage foreign investment, trade, and competition, allowing businesses to operate with minimal interference. By fostering an open economic environment, countries aim to enhance growth, attract foreign direct investment, and support the expansion of multinational corporations.
Efficiency-seeking fdi: Efficiency-seeking foreign direct investment (FDI) refers to investments made by multinational corporations (MNCs) in foreign countries with the aim of reducing production costs and increasing operational efficiencies. This type of FDI is often driven by the desire to capitalize on lower labor costs, favorable tax regimes, or advanced technologies available in host countries. By optimizing their production processes through strategic location choices, firms can enhance their competitiveness in global markets.
Exchange rates: Exchange rates are the value of one currency in relation to another, determining how much of one currency can be exchanged for another. They play a crucial role in international trade and finance, affecting everything from the cost of imports and exports to the profitability of foreign direct investments. Fluctuations in exchange rates can influence economic stability, corporate strategies, and investment decisions, making them a vital component in the landscape of global finance.
Foreign direct investment: Foreign direct investment (FDI) refers to the investment made by a company or individual in one country in business interests located in another country. This usually involves acquiring assets, establishing business operations, or expanding existing operations abroad, and plays a critical role in shaping economic relationships and development globally.
Greenfield investment: Greenfield investment refers to a type of foreign direct investment where a company builds a new facility from the ground up in a foreign country. This approach allows companies to establish their operations and brand presence in a new market without the constraints of existing structures or assets. It is particularly significant in the context of multinational corporations as it demonstrates their commitment to long-term investment in a host country.
Horizontal FDI: Horizontal foreign direct investment (FDI) occurs when a company invests in a foreign country by establishing or acquiring a similar business at the same stage of production. This type of investment allows multinational corporations to expand their market reach, increase their competitiveness, and capitalize on new opportunities while maintaining similar operational activities across different geographical locations.
Intellectual Property Protection: Intellectual property protection refers to the legal rights that are granted to creators and inventors to safeguard their original works, inventions, and brands from unauthorized use or reproduction. This protection encourages innovation and creativity by allowing individuals and companies to reap the benefits of their inventions, which is especially important in the context of foreign direct investment and multinational corporations as they often rely on unique products and technologies to maintain a competitive edge in global markets.
International Monetary Fund: The International Monetary Fund (IMF) is an international organization established in 1944 to promote global monetary cooperation, secure financial stability, facilitate international trade, and reduce poverty around the world. The IMF provides financial assistance, policy advice, and technical assistance to its member countries, especially during economic crises, connecting its mission to the broader goals of human development and economic stability.
Investment treaties: Investment treaties are international agreements designed to protect and promote foreign direct investment by establishing legally binding rights and obligations between the host country and the investor's home country. These treaties aim to provide a framework that reduces risks associated with investing abroad, such as expropriation, discrimination, and unfair treatment, thereby encouraging multinational corporations to invest in different countries.
Job creation: Job creation refers to the process of generating new employment opportunities, typically resulting from economic growth, investments, or the establishment of new businesses. It plays a crucial role in reducing unemployment rates and improving the overall economic stability of a region. Job creation is often influenced by foreign direct investment (FDI) and the activities of multinational corporations (MNCs), as these entities can introduce capital, technology, and expertise that lead to the development of new industries and job opportunities.
Joint venture: A joint venture is a business arrangement in which two or more parties agree to pool their resources to accomplish a specific task or project while remaining independent entities. This collaboration allows companies to share risks, costs, and expertise, making it particularly attractive for foreign direct investment and multinational corporations looking to enter new markets or develop new products.
Local Content Requirements: Local content requirements are regulations that stipulate a certain percentage of a product must be produced using domestic resources or labor. These rules are often implemented by governments to promote local industries, create jobs, and reduce dependency on foreign goods. By enforcing these requirements, governments aim to stimulate economic growth while also attracting foreign direct investment.
Majority stake: A majority stake refers to the ownership of more than 50% of a company's shares, granting the shareholder significant control over the company's decisions and operations. This level of ownership allows an investor, often a multinational corporation, to influence or dictate corporate policies, appoint board members, and make strategic decisions that can affect the company's direction and performance.
Market-seeking fdi: Market-seeking foreign direct investment (FDI) refers to investments made by companies in foreign countries with the primary goal of accessing new markets and increasing their sales. This type of FDI often involves establishing production facilities, distribution networks, or retail outlets in the host country to better serve local consumers and respond to local demand.
Merger and acquisition: A merger and acquisition refers to the process where two companies either combine to form a single entity (merger) or one company purchases another (acquisition). This strategic decision is often made to enhance market share, gain access to new markets, or achieve economies of scale, playing a critical role in the growth and development of multinational corporations and influencing global foreign direct investment.
Minority stake: A minority stake refers to owning less than 50% of a company's equity, giving the investor limited influence over the company's operations and decisions. This type of investment can be strategic for multinational corporations looking to enter new markets or establish partnerships without full control. While a minority stake does not grant controlling interest, it can still provide valuable insights and benefits in the context of foreign direct investment.
Multinational enterprise: A multinational enterprise (MNE) is a corporation that manages production or delivers services in more than one country, operating on a global scale while being headquartered in its home country. These firms engage in foreign direct investment, establishing subsidiaries or branches in different nations to optimize their operations, access new markets, and enhance competitiveness. MNEs play a significant role in shaping international trade and investment flows, influencing global economic policies and practices.
Oli Paradigm: The OLI Paradigm, developed by John Dunning, is a framework that explains why multinational corporations (MNCs) choose to engage in foreign direct investment (FDI) rather than export or license their products. It consists of three key components: Ownership advantages, Location advantages, and Internalization advantages, which together provide insights into the strategic decisions made by MNCs when entering foreign markets.
Political Risk: Political risk refers to the potential for losses or adverse impacts on investments and operations due to political instability or changes in the political environment of a country. This can encompass government actions, regulatory changes, social unrest, or geopolitical tensions that could affect multinational corporations and their foreign direct investments. Understanding political risk is crucial for companies operating globally, as it directly influences their strategic decisions and overall success.
Political Stability: Political stability refers to the enduring condition of a government where there is consistent adherence to established rules and norms, allowing for a predictable and functional political environment. This stability is crucial for fostering investor confidence, promoting economic growth, and encouraging foreign direct investment, as investors are more likely to commit resources in countries where the political landscape is stable and predictable.
Regulatory environment: The regulatory environment refers to the framework of laws, regulations, and policies that govern business operations within a specific country or region. It shapes how multinational corporations operate, influencing their strategies regarding foreign direct investment, compliance, and risk management. A favorable regulatory environment can facilitate smoother market entry for businesses, while a restrictive one may create barriers that hinder investment and operational efficiency.
Resource-seeking fdi: Resource-seeking foreign direct investment (FDI) refers to the investments made by multinational corporations to acquire or access natural resources in a host country. This type of FDI is driven by the need for companies to secure essential inputs for their production processes, such as minerals, oil, and agricultural products, in order to enhance their competitiveness and sustain their operations globally.
Strategic asset-seeking fdi: Strategic asset-seeking foreign direct investment (FDI) refers to investments made by multinational corporations with the primary goal of acquiring valuable resources, capabilities, or technologies that can enhance their competitive advantage. This type of FDI is often pursued to gain access to advanced knowledge, unique skills, or critical intellectual property that cannot be easily replicated or developed internally.
Tax policies: Tax policies refer to the laws and regulations established by governments that dictate how taxes are levied, collected, and managed. These policies play a crucial role in shaping economic behavior, influencing both domestic and international investment decisions. In the context of foreign direct investment and multinational corporations, tax policies can significantly impact where companies choose to invest, how they structure their operations, and their overall financial performance.
Technology transfer: Technology transfer is the process of sharing or disseminating technology, knowledge, and skills between individuals, organizations, or countries to enhance productivity and innovation. This transfer can occur through various means, such as foreign direct investment, joint ventures, licensing agreements, and research collaborations. It's essential for fostering economic development and facilitating sustainable practices, especially in contexts where developing nations seek to adopt advanced technologies to improve their industries and environmental outcomes.
Trade agreements: Trade agreements are formal pacts between countries that establish the rules and regulations governing trade between them. These agreements can reduce or eliminate tariffs, quotas, and other trade barriers to facilitate international commerce, impacting economic relationships and shaping the behavior of multinational corporations and foreign direct investment.
Trade barriers: Trade barriers are government-imposed restrictions on international trade that can take various forms, such as tariffs, quotas, and non-tariff barriers. They are often used to protect domestic industries from foreign competition, regulate the flow of goods, or achieve economic and political goals. Understanding trade barriers is essential for analyzing how they impact interregional cooperation and the strategies of multinational corporations in foreign markets.
Transnational corporation: A transnational corporation (TNC) is a large company that operates in multiple countries, managing production and delivering goods or services across national borders. These corporations often have a centralized head office that coordinates global operations while adapting to local markets. TNCs play a key role in shaping global value chains and production networks, as they leverage foreign direct investment to establish subsidiaries, joint ventures, or partnerships in various countries.
Vertical fdi: Vertical foreign direct investment (FDI) refers to investments made by a company in a foreign market that involves the acquisition of assets or operations at different stages of production within the same industry. This type of investment can either be backward, where a company invests in suppliers, or forward, where it invests in distribution channels. Vertical FDI is a strategic move for multinational corporations looking to enhance their supply chains, reduce costs, and gain greater control over their production processes.
Wholly-owned subsidiary: A wholly-owned subsidiary is a company that is completely owned by another parent company, with 100% of its shares held by the parent. This arrangement allows the parent company to maintain full control over the subsidiary's operations, management, and strategic direction. Wholly-owned subsidiaries are commonly established through foreign direct investment, enabling multinational corporations to expand into new markets while minimizing risk.
World Bank: The World Bank is an international financial institution that provides loans and grants to the governments of poorer countries for the purpose of pursuing capital projects. It aims to reduce poverty, promote sustainable economic development, and improve living standards through financial and technical assistance.