The thought of FDI is non new. There are extended sums of literature aiming the topic. This chapter will supply a brief literature reappraisal of theories turn toing some of the chief FDI theories. It will besides turn to the chief theories used in the arrested development analysis.
Introduction to Key Concepts:
Before explicating the chief theories, an debut to the different entry schemes available to a company when come ining a new market will be given. There are two general ways for a house to derive entree to a new market, either by equity or non-equity attacks.
A common manner to derive entree to a market is to put up a joint venture with a local house. A joint venture can be described as a company owned by two or more concern parties. Puting up a joint venture with a company in the foreign state is a really common manner to derive entree to a new market. The chief benefits with a joint venture are the entree to knowledge of the foreign market from the other and by sharing costs and hazards ( Hill, 2010 ) .
When a house wants entire control alternatively of puting up a joint venture, it ‘s normally done in two basic ways ; by a greenfield investing or as a amalgamation and acquisition ( M & A ; A ) with an bing house in the foreign state. A greenfield investing is when the company establishes a new mill in the foreign state in an country where no old installations exist. It establishes its ain subordinate in the state. The startup clip is longer when doing a greenfield investing compared to an M & A ; A trade, but hosts possible long term benefits for the house as it can organize the company after its ain corporate civilization, penchants and demands. An M & A ; A make the procedure of constitution in the foreign state faster, as a local house is acquired. In add-on to being able to put up the concern in a short period of clip, the house is likely to hold cognition of local civilization and concern environment ( Hill, 2010 ) .
There are two common ways to derive entree to a foreign market without having equity in a foreign house. The first manner is to export. When exporting, the company can take advantage of house specific assets, international experience and by enabling economic systems of graduated table. On the other manus, an exporting house faces challenges such as trade duties, transit costs and non being able to work the low pay states, hence non bring forthing as cost efficaciously as possible. The 2nd possibility is licencing, which gives a licensor permission to bring forth or sell the merchandise in return for a royalty fee. This attack is cost effectual and by and large entails less hazard than other attacks. The negative side of licensing is chiefly the hazard of losing control of its rational belongings. The benefits gained from economic systems of graduated table are besides lost ( Hill, 2010 ) .
Main FDI Theories
There are many theories turn toing FDI. Among the earliest theories turn toing the affair was Kindleberger ( 1969 ) , who attempted to explicate FDI through market imperfectnesss. His general premise was that there is no such thing as a perfect market. Harmonizing to Hymer ( 1976 ) , a company must possess some firm-specific advantages in order to countervail the domestic company ‘s advantage ( civilization, linguistic communication, local web, etc. ) . Through the old ages, several ways of obtaining this sort of advantages has been presented. They include, but are non limited to: low rewards ( Grubel, 1968 ) , holding entree to natural resources used in production ( Lall and Streeten, 1977 ) , holding buttockss to superior engineering and selling ( Caves, 1971 ) , etc. By utilizing its advantages, a MNC can make a state of affairs of oligopolistic or monopolistic competition. In the literature of FDI, there is a general consensus about FDI holding a positive impact on the technological development of a state ( Wang, Blomstrom, 1992 ; Moosa, 2002 ) and the economic growing that follow.
The Product Life Cycle Theory
This theory is by and large seen as the first major theory turn toing the principle behind FDI. In his work, Vernon ( 1966 ) criticized old theories merely turn toing the cost of factors of production. Alternatively, he addresses the function cognition and communications as of import factors in the procedure of developing and bring forthing new merchandises. He outlines three phases a merchandise typically goes through – the invention stage, the adulthood stage and the standardisation stage. In the invention stage, demand for the merchandise emanates chiefly from the domestic market. The monetary value is inelastic, doing the monetary value high. As the merchandise matures, it enters the international market. In this stage, there is an increased demand from foreign states. Foreign rivals are besides get downing to copy the merchandise at this stage. To remain competitory, the exporting house is forced to put up subordinates in the targeted states. At this phase, the drive force for FDI is to cut down production costs, therefore keep backing or increasing its competitory advantage. At the last phase, full economic system of graduated tables is achieved by the company. This by standardisation of its merchandises and by traveling production to low pay states, i.e. former importers become exporters.
The Internalization Theory
Welch and Luostarinen ( 1988 ) describe internationalisation as “ the procedure of increasing engagement in international operations ” . It was foremost propounded by Buckley and Casson ( 1976 ) , and is another of the major FDI theories. It inquiries the premises made in neoclassical economic sciences such as perfect competition and entree to full information. The general focal point of this theory is that a company prefers an internal internalisation procedure, instead than with an external opposite number. The chief advantage of maintaining a procedure internal in this theory is due to clip slowdown, monetary value dialogues and supply uncertainness. An illustration of this construct would be a company utilizing a specific production factor intensely, get a manufacturer of this factor, therefore taking the supply uncertainness. An exemplifying illustration of this event would be a paper-producer geting a wood-supplier alternatively of purchasing wood on the market. A well-known theoretical account turn toing the procedure of internalisation is the Uppsala internationalisation procedure theoretical account, formulated in 1977 by the two Swedish economic experts Johanson and Vahlne by making empirical observations on Swedish fabrication houses. It describes how a house bit by bit increases its engagement in foreign states as a procedure go oning on a bit-by-bit footing, instead than through big initial foreign investings ( Johanson, Vahlne, 1977 ) . The internalisation procedure was found to hold a few key characteristics. The house started with deriving experience from the foreign markets by exporting to nearby states, so bit by bit traveling to more distant states. With increased volumes, gross revenues subordinates are established. The last phase is to set up ain production in the state, such as a greenfield investing.
The internalisation theory has been examined in several plants, such as Dunning ( 1977 ) , Rugman ( 1986 ) , Casson ( 2000 ) and Henisz ( 2003 ) . The internalisation theory is found to be a superior explanatory tool, but with a few defects. The chief issue found by Henisz was FDI flows to countries dominated by a few MNCs non happening in the anticipations of the theoretical account. He states that “ the theory must be expanded to include institutional foibles ” .
OLI Eclectic paradigm
One of the most influential findings in respect to international production was John Dunnings OLI Eclectic paradigm ( Dunning, 1977 ) . The theoretical account is used to explicate the motivations behind FDI. He found that three advantages must be present in order for FDIs to happen, viz. Ownership ( house specific assets or resources ) , Location ( features of a specific state ) and Internalization ( ability to internalise the ownership and location advantages ) .
His findings concluded that a company with a competitory advantage over companies from another state has an ownership advantage ( O ) . These advantages are frequently defined as holding entree to firm-specific, income-generating assets entirely held by that company. These assets could be engineering, capital, cognition, etc. ( Tormenting, 1977 ) . The localisation advantage ( L ) comes from the specific features of a state, where the company believe that its concern would be more profitable. If such advantages are found in a state, the company will set up production the state alternatively of exporting or licencing to foreign houses. The state specific advantages include factors such as natural resources, substructure, labour costs and authorities policy ( Dunning, 1977 ) . The 3rd advantage needed for FDI is the internalisation advantage ( I ) . In order for a house to work its advantages in the foreign state, it must be able to internalise its ownership advantages in order to run expeditiously in the foreign environment. The chief point stated is that a company is better of working its cognition and assets internally instead than turning to an external portion ( Dunning, 2001 ) , as maintaining processes internal gives the company advantages by holding control of its concern, market and trade name image.
Motivations and Drivers for FDI
Behind every investing is a motivation. For the interest of understanding why a company chose to put in foreign states, a theoretical account used by Tormenting ( 1993 ) will be used. Harmonizing to him, FDI can be segmented into four different types, with a specific motivation behind each.
Market-seeking FDI – the ground behind an investing here is due to the size of a specific market and every bit good as its hereafter growing potency. In add-on, advantages such as being closer to the market, therefore obtaining better market cognition every bit good as closer contact with clients and providers.
Resource-seeking FDI – occur when a house set up entree to a specific resource needed in production that might be rare, expensive or non-existent domestically. Those resources might be natural stuffs, natural resources, low pay labour, etc.
Efficiency-seeking FDI – taking advantage of handiness, costs of factors or economic systems of graduated table
Strategic asset-seeking FDI – normally high tech houses seeking to get assets
Lall and Streeten ( 1977 ) alternatively use five major forces for MNCs to prefer FDI over exports.
FDI has cost advantages as exportation is both clip consuming and cost money
Trade barriers can do FDI more attractive
In order to better function its clients, a MNC can set up a subordinate
As explained by the crown-in consequence, one MNC investment in a state will force its rivals to make the same
The merchandise life rhythm, looking for cheaper production, can besides promote FDI.
Market size – Normally seen as the most of import driver of market oriented FDI. Normally measured as GDP or GDP per capita ( Zang, 2000 )
Labor costs – The most relevant driver in resource oriented FDI. Normally measured as the quality of the human capital ( Zang, 2000 )
Political hazard – Stability in the political environment is by and large seen as a driver playing a major function in pulling inward FDI ( Lankes, Venables, 1996 )
Government inducement policies and trade openness – Governments actively seeking to pull foreign investors have a positive correlativity with pulling FDI ( Shapior, Globerman, 2003 )
Geographical and cultural intimacy – States located near to the beginning market will by and large pull more FDI as shown in Grosse and Trevino, ( 1996 )
Infrastructure – More developed substructure means better production and distribution possibilities and therefore bring forthing more FDI ( Li, 2005 )
Interest rate and rising prices – Despite research findings done by Li, ( 2005 ) demoing an undistinguished relation between rising prices and FDI influx, involvement rates and rising prices is by and large seen as holding a negative consequence on pulling FDI as it might increase labour, production and cost of capital.
Agglomeration economic systems – Research on states with a important sum of FDI indicates that a larger sum of investings increases the opportunities for others to follow ( Tseng, Zebregs, 2002 )