International Investments Ing. Jana Šimáková, Ph.D. simakova@opf.slu.cz •Commercial loans –Primarily take the form of bank loans issued to foreign businesses or governments •Official flows –Generally refer to the forms of development assistance that developed nations give to developing ones •Foreign direct investment –International investment in which the investor obtains a lasting interest in an enterprise in another country •Foreign portfolio investment –Investment more easily traded, may be less permanent, and do not represent a controlling stake in an enterprise • Principal Categories of International Investment (BoP approach) International Investments •Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market in a foreign country •FDI is investment in which the investor obtains a lasting interest in an enterprise in another country •Technically, the threshold for FDI is ownership of “10 percent or more of the ordinary shares or voting power” of a business entity (according to IMF) •Once a firm undertakes FDI it becomes a multinational enterprise •FDI includes all kinds of capital contributions, such as the purchases of stocks, as well as the reinvestment of earnings by a wholly owned company incorporated abroad and the lending of funds to a foreign subsidiary or branch Definition of Foreign Direct Investment International Investments •Hungry Dragon Toys, a Chinese company, is sitting on a lot of cash. The company’s board of directors decides to take some of that money and purchase Cooperative Chemical, a plastics company in New Jersey. Hungry Dragon, a foreign investor, now owns a U.S. subsidiary company. Hungry Dragon’s ownership of Cooperative Chemical is substantial and more likely to be long term. Hungry Dragon is unlikely to sell if the U.S. economy faces a temporary downturn. •Hence, we consider this investment as FDI. FDI is considered as relatively stable form of international investment. Questions and Applications International Investments •Cross-border transactions and positions involving equity or debt securities, other than those included in direct investment or reserve assets •The characteristic feature of portfolio investment is their negotiability –Their legal ownership is readily transferable from one unit to another unit Negotiable instruments are designed to be traded on organized markets •Can be bought and sold, which makes them an efficient, flexible way of raising and investing money •Comes from many diverse sources such as a small company’s pension or through mutual funds held by individuals •Factors affecting portfolio investments – Tax rates on interest or dividends; interest rates; exchange rates Definition of Portfolio Investment International Investments •John Yamashita, a Japanese citizen, purchases one hundred shares of stock in General Motors (GM). John now owns part of a U.S. corporation, the shares of which are part of his personal investment portfolio. John is eligible to receive dividend payments from GM, participate in shareholder decisions, or sell the stock for a profit/loss. John’s share of GM is very minor, and his chief concern is not the long-term profitability of the company but the short-term value of his stock. He might therefore sell his share quickly if the share price goes up or down significantly. •Hence, we consider this investment as portfolio investment. Portfolio investment is usually more volatile than FDI. Questions and Applications International Investments •??? What are the principal differences between foreign direct investments and portfolio investments??? Questions and Applications International Investments Distinction between Direct and Portfolio Investment International Investments Foreign direct investment Foreign portfolio investment Long-term investment Generally short-term investment Investment in physical assets Investment in financial assets Aim is to increase enterprise capacity or productivity or change management control Aim is to increase capital availability Leads to technology transfer, access to markets and management inputs Results in only capital inflows Flows into the primary market Flows into the secondary market Does not tend to be speculative Tends to be speculative Direct impact on employment and wages No direct impact on employment and wages Abiding interest in management Fleeting interest in management Composition of Private Capital Flows (bil. USD) International Investments •Acquisition of existing company –Purchase an existing company in the foreign country (brownfield investment) –Can be done through privatization, sell of to competitor, or merger –E.g. Starbucks purchases an existing UK firm “British Coffee” and sells coffee/tea/desserts under the name “Starbucks” – •Establishment of new company –Usually in the form of greenfield investment –Set up a new company “from the ground up” in the foreign country –E.g. Hyundai invests money in Czechia and builds a new plant to produce cars – Forms of Foreign Direct Investment International Investments •Subsidiary –Company in the foreign country is entirely controlled/owned by one single company –Full competencies and decision power –Usually slightly different name than maternal company –Independent book-keeping, profit taxed in host country •Branch –Organizational unit in the maternal company‘s structure –Limited competencies and decision power –Similar name like maternal company –Unified book-keeping with maternal company, profit taxed in home country – – – Forms of Foreign Direct Investment International Investments •Joint venture –Occurs when two or more companies together form a new company in the host country –Each of the participants is responsible for profits, losses and costs associated with it –The venture is its own entity, separate and apart from the participants' other business interests –In the international context, usually occurs when one (or more) foreign company and one (or more) local company join to form a new company – – Forms of Foreign Direct Investment International Investments •Revenue-related motives –Attract new sources of demand –Enter profitable markets –Exploit monopolistic advantages –React to trade restrictions –Diversify internationally •Cost-related motives –Fully benefit from economies of scale –Use foreign factors of production –Use foreign raw materials –Use foreign technology –React to exchange rate movements •Selfish managerial motives Motives for Foreign Direct Investments International Investments Possible means of Using FDI to Achieve Benefits International Investments •??? How MNC make decision about industry where to realize the foreign direct investment??? Questions and Applications International Investments •Investment in the “same” industry as a firm operates in at home •Reasons for horizontal FDI –Transportation costs –Market imperfections •Impediments to exporting •Impediments to sale of know-how –Strategic behavior –Product life cycle –Location specific advantages – Horizontal Foreign Direct Investment International Investments •Investment in a downstream supplier (backward) or upstream purchaser (forward) as compared to the business that the firm operates in its home country –Backward investment is more common than forward •Reasons for vertical foreign direct investment –Strategic behavior –Market imperfections •Impediments to know-how •Investments in specialized assets – Vertical Foreign Direct Investment International Investments •Investment in a business that is unrelated to existing company‘s business –Since it involves entering an inustry in which investor has n previous experience, it often takes form of a joint venture with a company already operating in the industry. •Reasons for foreign direct investments –Diversification –Strategic behaviour – – Conglomerate Foreign Direct Investment International Investments Foreign Direct Investment Inflows 1980-2008 (bil. USD) International Investments Foreign Direct Investment Inflows 2008-2019 (bil. USD) International Investments FDI inflows - global FDI Inflows by Region 2014-2016 (bil. USD) International Investments FDI Inflows by Component 2007-2016 (in %) International Investments FDI Inflows top 15 Host and Home Economies (bil. USD) International Investments •Radical view –“Imperialist” extraction of host country wealth –Implication: Always bad for the host country •Free market –Different countries have different comparative advantages; best to allow countries to engage activities for which they do so most efficiently –Implication: Always good when countries are specializing in activities for which they have a comparative advantage •Pragmatic nationalism –Belief that FDI has costs and benefits, and whether to engage in FDI depends on whether the benefits exceed the cost Political Economy of Foreign Direct Investment International Investments •??? What are the costs and benefits to the host country??? Questions and Applications International Investments •Resource transfer effects –Capital: MNC invests capital in foreign markets –Technology: Research supports that MNCs do transfer technology when they invest in a foreign country –Management: When MNCs invest and manage in a foreign country, they often transfer management skills to the host country’s workforce – •Employment effects –MNCs, by investing in foreign countries, can create employment opportunities for the local workforce –But: Acquisition vs. Greenfield Investment Benefits to the Host Country International Investments •Balance of payments effects –FDI can have beneficial and negative effects on a country’s balance of payment. •Initial capital inflow •Substitute for imports •Inflow of payments from export of goods and services • •Effect on competition –Efficient functioning of markets require adequate level of competition between producers Benefits to the Host Country International Investments •Adverse effects on competition –MNCs may have “too much” power and kill off competition – •Adverse effects on balance of payments –After initial inflow of capital, subsequent outflow of capital from the earnings of the FDI –FDI may import inputs from abroad – •National sovereignty and autonomy –Key decisions that affect the host country’s economy may be made by a foreign parent that has no real commitment to the host country Costs to the Host Country International Investments •Benefits –Stream of income from foreign earnings –FDI may import intermediate goods or inputs for production from the home country, creating jobs –MNCs may learn skills from exposure to foreign countries •Costs –Initial capital outflow (but often set off by future stream of foreign earnings) –Current account suffers if FDI is to serve home market from low-cost production location –Current account suffers if FDI is a substitute for direct export –FDI a substitute for domestic production Benefits and Costs to the Home Country International Investments •Tax breaks on the income earned there •Rentfree land and buildings •Low-interest loans •Subsidized energy •Reduced environmental regulations •etc. • •The degree to which a government will offer such incentives depends on the extent to which the MNC’s FDI will benefit that country. Incentives to Encourage FDI by Host Country International Investments •Protective Barriers •“Red Tape” Barriers •Industry Barriers •Environmental Barriers •Regulatory Barriers •Ethical Differences •Political Instability • Barriers of FDI by Host Country International Investments Labor Costs in the EU International Investments International Labor Costs International Investments Productivity of Labor International Investments Annual Working Hours (2012) International Investments Corporate Tax Rates (Combined) in OECD Countries (2015) International Investments Following Business Partners in Automobile Industry International Investments •Economical expectations and reality •Success of economical proposals of government •Political instability and terrorism •Foreign conflicts •Corruption in government •Importance of army and church in politics •Power of legal tradition •Conflicts between nationalities and minorities, civic war •Development of political system •Quality of bureaucratic system Foreign Direct Investment Risks – Political International Investments •Insolvency or unfavorable structure of debt •Delay of payable supplying loans •Governments non acceptation of its liabilities •Losses of foreign exchange control •Expropriation of private investments •Inflation risk •Ratio of debt service to annual export •Covering of one month import by net foreign currency reserves •Payment discipline of importers •Share of goods and services export on current balance amount •Percentage difference between official and „black“ exchange rate • Foreign Direct Investment Risks – Economic and Financial International Investments A.T. Kearney FDI confidence index International Investments Ernst &Young FDI Attractiveness in Europe International Investments •???What about FDI in your home country??? • •Find the development of FDI in your home country in the last 5 years. What are the net inflows/outflows of FDI there? What are current trends in development of FDI there? What are major determinants of FDI there? Questions and Applications International Investments THANK YOU FOR YOUR ATTENTION J