Chapter 8 – Foreign Direct Investment

 

 

Multiple Choice Questions

 

FROM AN ECONOMIC STANDPOINT, WHY DO PRODUCTION FACTORS MOVE FROM ONE COUNTRY TO ANOTHER?

 

1.      From an economic standpoint, production factors generally move internationally from:

a.       countries where there is a relative abundance of the factors to countries where there is a relative scarcity.  (difficult, page 238)

b.      countries where there is a relative scarcity of the factors to countries where there is a relative abundance.

c.       net importing countries to net exporting countries.

d.      countries with big populations to countries with small populations.

 

2.      Companies and private individuals primarily transfer capital because of:

a.        cultural differences that exist among nations.

b.        differences in expected return.  (moderate, page 238)

c.        technology being more abundant in high-income countries.

d.        labor being cheaper in developing countries.

 

3.      Which of the following statements regarding the international mobility of production factors is FALSE?

a.       Short-term capital is generally more mobile than long-term capital.

b.      Investors feel more certain about short-term political and economic conditions in a foreign country than about long-term ones.

c.       All capital movements occur because of investors’ perception of risk and expected returns on capital. (difficult, page 238)

d.      Non-profit organizations donate money abroad to relieve worrisome economic and social conditions.

 

EXPLAIN THE RELATIONSHIP BETWEEN INTERNATIONAL TRADE AND FACTOR MOBILITY FROM THE STANDPOINT OF COST REDUCTION.

 

4.   Which of the following statements is true concerning the relationship between international trade and international factor mobility?

a.       International trade always results in greater production efficiency than international factor mobility.

b.      International factor mobility always results in greater production efficiency than international trade.

c.       International factor mobility may stimulate trade, but not vice versa.

d.      Both international trade and international factor mobility may increase global efficiency.  (difficult, page 242)

 

5.      Which of the following statements regarding the complementarity of international trade and factor movements is FALSE?

a.      When companies make direct investments abroad, the investments always decrease exports from their home countries. (difficult, page 242)

b.      About one-third of world trade (exports) is among controlled entities, i.e., between parent companies and their subsidiaries or among companies’ subsidiaries.

c.       Domestic operating units may export materials and components to their foreign facilities for use in a finished product.

d.      A foreign facility may produce part of the product line while serving as a sales agent for exports of its parent’s other products.


 

6.      Which of the following statements regarding the complementarity of international trade and factor movements is TRUE?

a.       International capital mobility decreases world trade.

b.      Although international capital movements may lead to foreign production, these same movements may stimulate exports from the capital exporting country. (difficult, page 242)

c.       The international mobility of people is for political rather than economic reasons.

d.      If free trade existed, there would be no pressure for international factor mobility.

 

DEFINE DIRECT INVESTMENT

 

7.      For direct investment to take place, ______________ must accompany the investment; otherwise it is a portfolio investment.

a.       money

b.      labor

c.       control (moderate, page 242)

d.      technology

 

8.      If ownership in a foreign direct investment is widely dispersed, then:

a.       a large ownership percentage is required to establish control of managerial decision making.

b.      there is a tendency for employee cultures and religious beliefs to be similar to those in the home country of the foreign investor.

c.       natural resources in the home country will automatically become more expensive.

d.      a small percentage of the holdings may be sufficient to establish control of managerial decision making. (difficult, page 242)

 

9.      Governments usually define direct investment as an ownership share of at least ________________ of the voting stock in a foreign enterprise.

a.      10% or 25% (moderate, page 242)

b.      33% or 50%

c.       51% or 75%

d.      100%

 

10.   When a foreign investor has sufficient ownership to control an operation, that operation is a:

a.       portfolio investment.

b.      foreign direct investment. (moderate, page 242)

c.       multinational company.

d.      transnational operation.

 

WHY ARE GOVERNMENTS CONCERNED ABOUT WHETHER A FOREIGN INVESTMENT IS CONTROLLED BY THE PARENT?

 

11.    Governments are concerned about foreign control of companies because:

a.       they lose their ability to enact import restrictions.

b.      they often require  religious conversion as a requisite for employment.

c.       decisions of national importance may be made abroad. (moderate, page 243)

d.      these companies pay no local taxes.

 

12.    Which of the following is NOT a decision made by a foreign direct investor that might concern a host-government?

a.       personnel staffing

b.      export prices from the host country

c.       the retention and payout of a subsidiary’s profits

d.      import tariffs imposed on the product being imported back to the home country (difficult, page 243)

 

13.   Host country governments are usually most concerned about foreign ownership of a:

a.      direct investment.  (moderate, page 243)

b.      portfolio investment.

c.       trademark.

d.      patent.

 

ACCORDING TO THE APPROPRIABILITY THEORY AND INTERNALIZATION THEORY, WHY WOULD COMPANIES WANT TO CONTROL THEIR FOREIGN OPERATIONS?

 

14.    Companies receiving vital resources from other organizations can use them to undermine the competitive position of the foreign company transferring them. Denying rivals access to resources is called the:

a.       absolute advantage theory

b.      appropriability theory (moderate, page 243)

c.       comparative advantage theory

d.      compatibility theory

 

15.    Which of the following theories best represents the following example? Bridgestone was hesitant to transfer either product technology, such as its SuperFiller radials, or process technology, such as its mold changeover methods, to other companies.

a.       absolute advantage theory

b.      comparative advantage theory

c.       appropriability theory (difficult, page 243)

d.      compatibility theory

 

16.    The control through self-handling of operations (internal to the organization) is known as:

a.       externalization

b.      domestication

c.       privatization

d.      internalization (moderate, page 243)

 

17.    Which of the following terms best represents the following example? Intel found that transferring technology to independent motherboard manufacturers in Taiwan was too slow, so it moved into Taiwan with its own production facility.

a.      internalization (moderate, page 243)

b.      externalization

c.       domestication

d.      privatization

 

18.   Which of the following is NOT, at times, an advantage of internalization?

a.       A company’s owned operation is usually easier to control.

b.      A company may decrease the capital it invests. (moderate, page 243)

c.       It is often faster to transfer technology to one’s own foreign operation.

d.      A company can avoid the costly process of negotiating and enforcing an agreement with another company.


HOW DO TRANSPORTION COSTS, PLANT CAPACITY UTILIZATION, AND SCALE OF PROCESS TECHNOLOGY INFLUENCE COMPANIES’ PRODUCTION LOCATIONS TO SERVE FOREIGN MARKETS?

 

19.    ________________ raises costs so much that it becomes impractical to export some products.

a.       Factor mobility

b.      Import quotas

c.       Transportation (moderate, page 244)

d.      Subsidies

 

20.        20.    In which of the following examples would companies most likely produce abroad to serve foreign markets rather than exporting to those markets?

a.       Transport costs are low, and the company has excess production capacity.

b.      The company has excess capacity, and process technology favors large-scale production.

c.       Transport costs are low, and process technology favors large-scale production.

d.      Transport costs are high, and process technology favors small-scale production. (difficult, page 244)

 

21.    A company may delay making a foreign direct investment in a country with lower production costs because its average cost per unit ________________ until it reaches full capacity.

a.      decreases (easy, page 244)

b.      increases

c.       does not change

d.      fluctuates intensely

 

22.    In which of the following types of technologies would a company’s exports most likely reduce average cost per unit by spreading fixed costs over more units of output?

a.       small-scale process technology

b.      large-scale process technology (moderate, page 245)

c.       variable-scale product technology

d.      fixed-scale product technology

 

WHAT IS THE RELATIONSHIP BETWEEN COUNTRY-MARKET SIZE AND IMPORT RESTRICTIONS AS A MOTIVATOR FOR FOREIGN DIRECT INVESTMENT?

 

23.    ________________ have been highly influential in enticing automobile producers to locate in Brazil because of its large market.

a.       Export trade restrictions

b.      Export quotas

c.       Import trade restrictions (moderate, page 245)

d.      Quality standards

 

24.       When the United States removed tariffs on goods originating in Mexico, but not in Taiwan, some Taiwanese companies shifted their production to Mexico to serve the U.S. market.  The Taiwanese companies’ response would be an example of:

a.       trade creation.

b.      economic integration.

c.       vertical integration.

d.      trade diversion. (moderate, page 245)

 

25.    The ________________ a product has to be altered for the foreign market, the ________________ it is that production will shift abroad.

a.      more, more likely (moderate, page 145)

b.      less, more likely

c.       more, less likely

d.      less, more probable

 

26.        Both China and Jamaica have import restrictions on automobiles, yet more automobile companies have responded by making foreign direct investments in China than in Jamaica.  The likely cause of the greater amount of investment in China is:

a.       the fact that Jamaicans drive on the left side of the road.

b.      the larger size of the Chinese market.  (difficult, page 245)

c.       the lower cost of labor in China.

d.      higher transportation cost from the United States to China than to Jamaica.

 

27.        Import restrictions by Central American countries have attracted more foreign direct investment in the pharmaceutical industry than in the automobile industry.  A likely reason for the difference by industrial sector is:

a.       more restrictions on pharmaceuticals than on automobiles.

b.      that pharmaceuticals are a necessity, whereas automobiles are discretionary.

c.       more efficiency for small scale pharmaceutical than for automobile production. (difficult, page 245)

d.      higher transport costs as a percentage of pharmaceutical than automobile value.

 

HOW/WHY MIGHT THE COUNTRY-OF-ORIGIN OF A PRODUCT INFLUENCE COMPANIES TO ENGAGE IN FOREIGN DIRECT INVESTMENT?

 

28.    The campaign by the American Fiber, Textiles, and Apparel Coalitions to push “Crafted with Pride in the U.S.A.” is an example of which of the following country-of-origin effects?

a.       delivery risk

b.      privatization

c.       product quality

d.      nationalism (moderate, page 245)

 

29.    Consumers sometimes prefer domestically-produced goods because of all of the following EXCEPT:

a.      a belief that foreign cultures are inferior (moderate, page 245)

b.      nationalism

c.       a belief that domestically produced products are better

d.      a fear than foreign-made goods may not be delivered on time

 

30.   When consumers prefer domestically produced goods, there is an incentive for foreign companies to:

a.       export to the market.

b.      produce within that market. (moderate, page 245)

c.       alter their products to fit the taste of those consumers.

d.      integrate vertically.

 

WHAT ADVANTAGES MIGHT COMPANIES GAIN THROUGH INTERNATIONAL VERTICAL INTEGRATION?

 

31.    ________________ is a company’s control of a product through its  different stages—from raw materials through production to its final distribution.

a.       Horizontal integration

b.      Rationalized production

c.       Vertical integration (moderate, page 246)

d.      Factor mobility

 

32.    When raw materials and markets are located in different countries, companies have an incentive to:

a.       integrate horizontally.

b.      take advantage of country-of-origin preferences.

c.       engage in trade diversion.

d.      integrate vertically.  (moderate, page 246)

 

33.    Most international vertical integration is:

a.      supply-oriented. (moderate, page 246)

b.      demand-oriented.

c.       price-oriented.

d.      labor-oriented.

 

WHAT IS RATIONALIZED PRODUCTION?  WHAT ADVANTAGES MIGHT COMPANIES GAIN THROUGH RATIONALIZED PRODUCTION?

 

34.    In rationalized production, different components or portions of a product line are made in different parts of the world. The advantages are come from ________________ and ________________.

a.       factor-cost differences, short production runs

b.      factor-cost differences, long production runs (moderate, page 247)

c.       cultural differences, long production runs

d.      cultural differences, short production runs

 

35.    When companies produce different components or different portions of their product line in different parts of the world to take advantage of national cost differences, this is known as:

a.       partial production.

b.      economies of scale.

c.       rationalized production. (moderate, page 247)

d.      vertically integrated  production.

 

36.    In a situation where semi-finished goods are exported from the United States to Mexico for the labor-intensive portion of the production, such as sewing car seats for GM or building TV cabinets for Panasonic, this is known as:

a.       partial production.

b.      trade creation.

c.       trade diversion.

d.      rationalized production. (moderate, page 247)

 

HOW MIGHT GOVERNMENT INCENTIVES INFLUENCE COMPANIES TO MAKE FOREIGN DIRECT INVESTMENTS?

 

37.    All of the following are government incentives that encourage direct investment by foreign companies EXCEPT:

a.      restrictions on exports (easy, page 249)

b.      restrictions on imports

c.       offering of tax concessions

d.      offering of subsidies

 

38.    Home country governments give incentives to their companies to make direct investment in order to do all of the following EXCEPT:

a.       gain supplies of strategic resources

b.      promote dumping of products in industrialized countries (moderate, page 249)

c.       develop spheres of influence

d.      maintain spheres of influence

 

39.   Government incentives to attract foreign direct investment sometimes influence companies because they:

a.       are less concerned about appropriability.

b.      encourage trade as opposed to factor mobility.

c.       result in lower company operating costs.  (moderate, page 249)

d.      overcome adverse country-of-origin effects.

 

COMPARE THE ADVANTAGES OF MAKING A FOREIGN DIRECT INVESTMENT BY BUYING AN EXISTING FACILITY ABROAD VERSUS STARTING UP A NEW FACILITY ABROAD.

 

40.    All of the following may be advantages of acquiring an existing foreign operation as opposed to a start-up foreign operation EXCEPT:

a.       avoiding start-up problems

b.      easier financing through local banks

c.       adding no further capacity to the market

d.      guaranteed profits from the initial acquisition (moderate, page 251)

 

41.    Companies may choose to build a new facility abroad as opposed to acquiring an existing one for all of the following reasons EXCEPT:

a.      to avoid start-up problems (easy, page 251)

b.      no desired company is available for acquisition

c.       an existing facility may have problems that will carry-over to the new owners

d.      a start-up  may be easier to finance through local development banks

 

42.    Which of the following is NOT a reason companies seek acquisitions instead of choosing to build abroad?

a.       Through acquisitions, a company may gain the goodwill and brand identification important to the marketing of mass consumer products.

b.      Local governments often encourage acquisitions because they want fewer competitors and more foreign domination in the market. (difficult, page 251)

c.       A company that depends substantially on local financing rather than on the transfer of capital may find it easier to gain access to local capital through an acquisition.

d.      Local capital suppliers may be more familiar with an ongoing operation than with the foreign enterprise.

 

WHY DO MOST FOREIGN DIRECT INVESTMENTS ORIGINATE FROM AND GO TO DEVELOPED COUNTRIES?

 

43.    All of the following are reasons most FDI occurs in developed countries EXCEPT:

a.       they have the biggest markets

b.      they have the lowest perceived risk

c.       they encourage the  cultural and religious diversity that FDI brings (moderate, page 253)

d.      they have the least discrimination toward foreign companies

 

44.    The industrial nations, through ________________, are committed to liberalizing direct investment among their members.

a.       the European Union

b.      the North American Free Trade Agreement

c.       the United Nations

d.      the Organization for Economic Cooperation and Development (moderate, page 253)

 

45.   Most foreign direct investment originates in ____________and goes to ___________.

a.      developed countries, developed countries  (moderate, page 253)

b.      developed countries, developing countries

c.       developing countries, developing countries

d.      developing countries, developed countries


 

WHAT SECTOR HAS RECENTLY ACCOUNTED FOR THE FASTEST GROWTH IN FOREIGN DIRECT INVESTMENT?

 

46.    The highest recent growth in FDI has been in which of the following sectors?

a.       automobile

b.      services (moderate, page 254)

c.       telecommunications

d.      computer hardware

 

47.    Which of the following statements regarding the economic sectors of FDI is FALSE?

a.       Trends in the distribution of FDI by economic sector generally conform to long-term economic changes in the home and host countries.

b.      FDI in the service sector, especially in banking and finance, has grown rapidly in recent years.

c.       Over time, the portion of FDI accounted for in the raw materials sector (e.g., mining, smelting, and petroleum) has increased.  (difficult, page 254)

d.      FDI in technology-intensive manufacturing has been increasing as a portion of total FDI.

 

48.        Which of the following sectors has been growing most rapidly as a portion of global FDI?

a.       agriculture

b.      raw materials

c.       manufacturing

d.      services  (easy, page 254)

 

Essay Questions

 

49.    From an economic standpoint, why do production factors move from one country to another?

 

Answer

Capital, especially short-term capital, is the most internationally mobile production factor. Companies and private individuals primarily transfer capital because of differences in expected return. Short-term capital is more mobile than long-term capital, especially direct investment, because there is more apt to be an active market through which investors can quickly buy foreign holdings and sell them if they want to transfer capital back home or to another country. Furthermore, investors feel more certain about short-term political and economic conditions in a foreign country than about long term ones. People are also internationally mobile. Unlike funds that can be cheaply transferred by wire, people must usually incur high transportation costs to work in another country. If they move legally, they must get immigration papers, and most countries give these sparingly. Finally, they may have to learn another language and adjust to a different culture away from their families and friends who serve as their customary support groups.  

(moderate, page 238)

 

50.    Explain the relationship between international trade and factor mobility from the standpoint of cost reduction.

 

Answer

Factor movement is an alternative to trade that may or may not be a more efficient allocation of resources.  If trade could not occur and production factors could not move internationally, a country would have to either forgo consuming certain goods or produce them differently, which in either case would usually result in decreased worldwide output and higher prices.  In some cases, however, the inability to gain sufficient access to foreign production factors may stimulate efficient methods of substitution, such as the development of alternatives for traditional production methods.

(moderate, page 240)


 

51.    In a short essay, discuss how transportation, trade restrictions, country-of-origin effects, and changes in comparative costs affect companies’ sales.

 

         Answer

a.       Transportation – When companies add the cost of transportation to product costs, some products become impractical to ship over great distances. A few of these products are newspapers, margarine, dynamite, and soft drinks. For the companies that make these products, it is necessary to produce abroad if they are to sell abroad.

b.      Trade restrictions – Governments restrict imports. Thus, companies may find they must produce in a foreign country if they are to sell there. Governmental trade restrictions often favor big companies that can afford to commit large amounts of resources abroad, making foreign competitiveness more difficult for small companies that can afford only exportation as a means of serving foreign markets.

c.       Country-of-origin effects – Government-imposed legal measures are not the only trade barriers to otherwise competitive goods. Consumer desires also may dictate limitations. Consumers may prefer to buy goods produced in their own country rather than another. Or, they may believe that goods from a given country are superior, therefore preferring those countries’ products. They may also fear that service and replacement parts for imported products will be difficult to obtain.

d.      Changes in comparative costs – A company may export successfully because its home country has a cost advantage. The home country cost advantage depends on the prices and productivity of the individual production factors, the size of the company’s operations, the cost of transporting finished goods, and any regulations on how to produce.

         (difficult, page 241)

 

52.    In a short essay, define direct investment.

 

Answer

For direct investment to take place, control must accompany the investment.  Otherwise, it is a portfolio investment.  If ownership is widely dispersed, then a small percentage of the holdings may be sufficient to establish control of managerial decision making.  However, even 100% share does not guarantee control.  If a government dictates whom a foreign company can hire, what the company must sell at a specified price, and how the company must distribute its earnings, then control belongs to the government.  [Say something about how governments use 10% or 25% as an arbitrary figure to define direct investment.]

(moderate, page 242)

 

53.    In a short essay, discuss the concerns that a foreign government and an investing company would have regarding the control of an FDI, citing examples to support your answer.

 

         Answer

a.       Governmental concern – Many critics of FDI worry that the host country’s national interest will suffer somewhat if a multinational company makes decisions from afar on the basis of its own global or national objectives. For example, GM, a U.S. company, owns a 100% interest in Vauxhall Motors in the United Kingdom. Such control means that GM’s corporate management in the United States can make decisions about personnel staffing, export prices, and the retention and payout of Vauxhall’s profits. This level of control concerns the British public because decisions that directly affect the British economy can come from the United States.

b.      Investor concern – Control is also important to foreign companies. They are reluctant to transfer vital resources—capital, patents, trademarks, and management know-how—to another organization that can make all its operating decisions independently. The company receiving these resources can use them to undermine the competitive position of the foreign company transferring them. For example, Bridgestone was hesitant to transfer either product technology, such as its SuperFiller radials, or process technology, such as its mold changeover methods, to other companies. Its management was well aware of how acquired technology can be used to competitive advantage.

         (moderate, page 242)

 

54.    According to the appropriability theory an internalization theory, why would companies want to control their foreign operations?

 

         Answer

         Control is important to foreign companies since they may want to do what is best for their global operations, rather than what is best for the operations of a specific country.  Companies are reluctant to transfer vital resources—capital, patents, trademarks, and management know-how—to another organization that can make all its operating decisions independently.  The company receiving these resources can use them to undermine the competitive position of the foreign company transferring them.  The idea of denying rivals access to resources is called the appropriability theory. The control through self-handling of operations (internal to the organization) is internalization.

(moderate, page 243)

 

55.    How do transportation costs, plant capacity utilization, and scale of process technology influence companies’ production locations (home versus foreign country) to serve foreign markets?

 

         Answer

 

a.       Transportation costs – When companies add the cost of transportation to production costs some products become impractical to ship over great distances.  For these companies, it is necessary to produce abroad if they are to sell abroad. 

b.      Plant capacity utilization – As long as a company has excess capacity, it may compete effectively in limited export markets despite high transportation costs.This ability might occur if domestic sales cover fixed operating expenses, enabling the company to set foreign prices on the basis of variable rather than full costs.

c.       Scale of process technology – The manufacture of some products necessitates a high fixed capital cost for plant and equipment.  For such products, the cost per unit drops significantly as output increases.  Companies can export large amounts of such products because the cost savings from scale economies overcome added transportation costs.

(moderate, page 244)

 

56.    What is the relationship between country-market size and import restrictions as a motivator for foreign direct investment?

 

         Answer

         Managers must view import barriers along with other factors, such as the market size of the country imposing the barriers.  For example, import trade restrictions have been highly influential in enticing automobile producers to locate in Brazil because of its large market.  Removing trade restrictions among a group of countries also may attract direct investment, possibly because the expanded market may justify scale economies and possibly because the output from a new location can be feasibly exported.

(easy, page 245)

 

57.    In a short essay, discuss the various reasons consumers may prefer to buy goods produced in their own country.

 

         Answer

a.       Nationalism – In many countries, companies have instituted promotional campaigns to persuade people to buy locally produced goods. A specific example is the campaign by the American Fiber, Textiles, and Apparel Coalitions to push “Crafted with Pride in the U.S.A.”

b.      Product image – Although products may be identical, consumers often view their quality differently on the basis of the country of origin.

c.       Delivery risk – Many consumers fear that service and replacement parts for foreign-made goods may be difficult to obtain from abroad. Industrial consumers often prefer to pay a higher price to a nearby producer in order to minimize the risk of nondelivery due to distance and strikes.

         (moderate page 245)


 

58.    What advantages might companies gain through international vertical integration?

 

         Answer

         As products and their marketing become more complicated, companies need to combine resources that are located in more than one country. Advantages of vertical integration may accrue to a company through either market-oriented or supply-oriented investments in other countries. Companies from industrial countries are more apt to have the resources necessary to invest in emerging economies than are companies from emerging economies to invest in industrial countries. Companies may also gain certain economies through vertical integration. Because supply and/or markets are more assured, a company may be able to carry smaller inventories and spend less on promotion. By buying and selling within the family of companies, the foreign direct investor also has considerably greater flexibility in shifting funds, taxes, and profits among countries.

         (easy, page 246)

 

59.    What is rationalized production?  What advantages might companies gain though rationalized production?

 

         Answer

         Rationalized production – Some companies produce different components or different portions of their product line in different parts of the world to take advantage of low labor costs, capital, and raw materials. This is rationalized production. As is the case with vertical integration, companies choose to own the production facilities in the different countries because of the need for a tight relationship to ensure a smooth production flow. Another possible advantage is smoother earnings when exchange rates fluctuate.

         (moderate, page 247)

 

60.    In a short essay, explain the product life cycle theory.

 

         Answer

         The product life cycle theory shows how, for market and cost reasons, product often moves from one country to another as a product moves through its life cycle. During the introductory stage, production occurs in only one (usually industrial) country. During the growth stage, production moves to other industrial countries, and the original producer may decide to invest in production facilities in those foreign countries to earn profits there. In the mature stage, production shifts largely to emerging economies, and the same company may decide to control operations there as well.

         (easy, page 247)

 

61.    Companies may reduce risks by operating internationally, such as through sales diversification. In a short essay, discuss the specific reasons to use FDI to minimize risk.

 

         Answer

a.       Following customers – Many companies sell abroad indirectly. They sell products, components, or services domestically, which then become embodied in a product or service that their domestic customer exports. For example, Bridgestone sells tires to Toyota and Honda, which in turn exports cars (including the tires) to foreign markets. In such cases, the indirect exporters commonly follow their customers when those customers make direct investments. Bridgestone decided to make automobile tires in the United States in order to continue selling to Honda and Toyota once those companies initiated U.S. production.

b.      Preventing competitor’s advantage – If only one company establishes a direct investment, it will have an advantage over its competitors by garnering a larger market, spreading its R&D costs, and making a profit it can reinvest elsewhere. Once one company decides to produce in the market, competitors are prone to follow quickly rather than let that company gain advantages. The company’s decision to invest depends not so much on the benefits it gains but rather on what it could lose by not entering the field.

c.       political motives – FDI sometimes depends on countries’ political motives to reduce security risk.

         (difficult, page 248)

 

62.    There are two ways companies can invest in a foreign country. They can either acquire an interest in an existing operation, or construct new facilities. In a short essay, describe the advantages and disadvantages of each alternative.

 

         Answer

a.       Reasons for buying – There are many reasons for seeking acquisitions. One is the difficulty of transferring some resource to a foreign operation or acquiring that resource locally for a new facility. Personnel are a resource that foreign companies find it difficult to hire, especially if local unemployment is low. Instead of paying higher compensation that competitors do to entice employees away from their old jobs, a company can buy an existing company, which gives the buyer not only labor and management but also an existing organizational structure. Through acquisitions, a company may also gain the good will and brand identification important to the marketing of mass consumer products, especially if the cost and risk of breaking in a new brand are high. Further, a company that depends substantially on local financing rather than on the transfer of capital may find it easier to gain access to local capital through an acquisition. Local capital suppliers may be more familiar with an ongoing operation than with the foreign enterprise. In addition, a foreign company may acquire an existing company through an exchange of stock, which circumvents home-country exchange controls.

b.      Reasons for building – Although acquisitions offer advantages, a potential investor will not necessarily be able to realize them. Companies frequently make foreign investments where there is little or no competition, so finding a company to buy may be difficult. In addition, local governments may prevent acquisitions because they want more competitors in the market and fear market dominance by foreign enterprises. Even if acquisitions are available, they are less likely to succeed than start-up operations. The acquired companies might have substantial problems. Further, the managers in the acquiring and acquired companies may not work well together. Finally, a foreign company may find local financing easier to obtain if it builds facilities, particularly if it plans to tap development banks for part of its financial requirements.

         (moderate, page 251)

 

63.    Why do most foreign direct investments originate from and go to developed countries?

 

         Answer

a.       Location of ownership – The industrial countries account for a little over 90% of all direct investment outflows. This is understandable, since more companies from those countries are likely to have the capital, technology, and managerial skills needed to invest abroad. Nevertheless, hundreds of firms from emerging economies have FDIs, although the holdings from individual emerging economy investors remain small compared to investments from industrial nations. During much of the post-World War II period, the United States was the dominant investor. However, its share has been falling as the share from other industrial countries, especially the United Kingdom and Japan, has increased. Recently, FDI has been flowing more rapidly into the United States than from it.

b.      Location of investment – The largest investors in the United States are the United Kingdom and Japan, accounting in 1998 for about 19% and 16%, respectively, of FDI there. The largest locations of U.S.-owned FDI in 1998 were in the United Kingdom, Canada, and the Netherlands. The major recipients of FDI are developed countries, which received about 71% of the world’s total in 1998.

(moderate, page 253)

 

64.    What sector has recently accounted for the fastest growth in foreign direct investment?

 

         Answer

         Economic sector of investment – Trends in the distribution of FDI generally conform to long-term economic changes in the home and host countries. Over time, the portion of FDI accounted for in the raw materials sector that includes mining, smelting, and petroleum has declined. The portion in manufacturing, especially resource-based production, grew steadily from the 1920s to the early 1970s but has since stabilized. In the 1980s and 1990s, FDI in the service sector grew rapidly, as did FDI in technology-intensive manufacturing.

         (moderate, page 254)


 

65.    In a short essay, discuss market-seeking direct investments and resource-seeking investments and the type of strategy most appropriate for each investment.

 

         Answer

         Market-seeking direct investments are those that take place because companies must produce within the markets they serve (because of high cost of transportation or trade restrictions). Market-seeking direct investments generally favor multidomestic strategies. Direct investments that are motivated by consumer or competitor moves are more likely to be global or transnational strategies. Resource-seeking investments to bring about vertical integration or rationalized production usually entail global or transnational strategies as well. Direct investment, because of its implied control, permits companies to make decisions to maximize global performance. When they depend instead on licensing or foreign production contracts, the interests of their partner companies may constrain their ability to implement global strategies.

         (moderate)