Vertical FDI

12 Key excerpts on "Vertical FDI"

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  International Financial Operations

  Arbitrage, Hedging, Speculation, Financing and Investment

  • I. Moosa(Author)
  • 2003(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Vertical FDI, on the other hand, is undertaken for the purpose of exploiting raw materials (backward Vertical FDI) or to be nearer to consumers through the acquisition of distribution outlets (forward Vertical FDI). From the perspective of the host country, FDI can be classified into (i) import-substituting FDI, (ii) export-increasing FDI and (iii) government-initi- ated FDI. Import-substituting FDI involves the production of goods previ- ously imported by the host country, necessarily implying that imports by the host country and exports by the investing firm will decline. This type of FDI is likely to be determined by the size of the host country’s market, transportation costs and trade barriers. Export-increasing FDI, on the other hand, is moti- vated by the desire to seek new sources of input, such as raw materials and intermediate goods. This kind of FDI is export-increasing in the sense that the host country will increase its exports of raw materials and intermediate prod- ucts to other countries, where the investing firm and its subsidiaries are located. Government-initiated FDI may be triggered, for example, when a government offers incentives to foreign investors in an attempt to eliminate a balance of payments deficit. FDI may also be classified into expansionary and defensive types. Expan- sionary FDI seeks to exploit firm-specific advantages in the host country. This type of FDI has the additional benefit of contributing to sales growth of the investing firm at home and abroad. On the other hand, defensive FDI seeks cheap labour in the host country with the objective of reducing the cost of production. FDI may take one of three forms: greenfield investment, cross-border mergers and acquisitions (M&As), and joint ventures. Greenfield investment occurs when the investing firm establishes new production, distribution or other facilities in the host country.

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  Foreign Direct Investment and Development in Vietnam

  Policy Implications

  • Pham Hoang Mai(Author)
  • 2003(Publication Date)
  • ISEAS Publishing

    (Publisher)

  4 Foreign Direct Investment and Development in Vietnam © 2004 Institute of Southeast Asian Studies, Singapore 2 Theoretical Overview of FDI While FDI is acknowledged as a significant form of capital in many developing economies, often constituting a large proportion of gross national investment, its socio-economic impact is hotly debated. This chapter reviews the various, often oppositional, theories about the nature, origins and patterns of transnational FDI flows. In addition, this chapter analyzes the role of government in influencing the effects of FDI on recipient economies. The arguments presented here set the background for this book’s analysis of the impact of the first decade of FDI flows in Vietnam, between 1988 and 1998. Definitions There are several ways to define foreign direct investment. According to the International Monetary Fund, FDI includes: • new equity purchased or acquired by parent companies in overseas firms they are considered to control (including the establishment of new subsidiaries); • reinvestment of earnings by controlled firms; and • intra-company loans from parent companies to controlled firms. (Graham and Krugman 1993, p. 16). The United Nations defines FDI as “an investment involving a long term relationship and reflecting a lasting interest of a resident entity (individual or business) in one economy (direct investor) in an entity resident in an economy other than that of the investor (host country)” (United Nations 1992 cited in Lindblad 1997, p. 1). In general, FDI has been defined as the long-term investment made by non-residents of a host country through the creation or acquisition of capital assets in the host country. FDI implies the ownership of capital assets large enough to have full or partial control of the enterprise and a physical presence by foreign firms or individuals (Gillis et al. 1992, 4 Reproduced from FDI and Development in Vietnam, by Pham Hoang Mai (Singapore: Institute of Southeast Asian Studies, 2004).

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  The Princeton Encyclopedia of the World Economy. (Two volume set)

  • Kenneth A. Reinert, Ramkishen Rajan, Amy Joycelyn Glass, Lewis S. Davis, Kenneth A. Reinert, Ramkishen Rajan, Amy Joycelyn Glass, Lewis S. Davis, Kenneth Reinert, Ramkishen Rajan, Amy Glass, Lewis Davis(Authors)
  • 2010(Publication Date)
  • Princeton University Press

    (Publisher)

  headquarter services . Although this is clearly a multidimensional factor, it is common to model it in terms of a single index of firm productivity. The most sophisticated treatment along these lines is found in work on heterogeneous firms by Helpman, Melitz, and Yeaple (2004), which combines the simplest version of the horizontal motive for FDI (to be discussed later in this article) with the assumption that firms differ in their productivities. A potential firm must pay a sunk cost to determine its productivity, and when this is revealed, active firms sort themselves into different modes of production. Low-productivity firms produce only for the home market; medium-productivity firms choose to pay the fixed costs of exporting; but only the most productive firms choose to pay the higher fixed costs of engaging in FDI. These predictions are consistent with the evidence. As a further contribution, the paper derives from the model the prediction that industries with greater firm heterogeneity will have relatively more firms engaged in FDI and shows that this prediction is confirmed by the data. This work and others like it do not explore, however, why firm productivities differ in the first place. Prior investment in research and development (both process and product) and in marketing presumably account for the disproportionately greater productivity of most MNEs.

  Location While international trade theory has tended to take ownership advantages for granted or else to model them in fairly obvious ways, rather more attention has been devoted to exploring alternative motives for MNEs to locate abroad. A key issue that has attracted much attention is the distinction between “horizontal” and “vertical” FDI. Horizontal FDI occurs when a firm locates a plant abroad in order to improve its market access to foreign consumers. In its purest form, this simply replicates its domestic production facilities at a foreign location. Vertical FDI, by contrast, is not primarily or even necessarily aimed at production for sale in the foreign market, but rather seeks to take advantage of lower production costs there. Since in almost all cases the parent firm retains its headquarters in the home country, and the firm-specific or ownership advantages can be seen as generating a flow of headquarter services to the host-country plant, there is a sense in which all FDI is vertical. Nevertheless, the distinction between market-access and cost motives for FDI is an important one.

  The horizontal motive for FDI reflects what Brainard (1997) has called a “proximity-concentration trade-off”: building a local plant saves on trade costs and so has the advantage of proximity; but it loses the benefits of concentrating production in the firm’s home plant. Let π *(t *) denote the operating profits that a potential MNE can earn from selling in a foreign market subject to per unit trade costs t * (which can include both tariffs and transportation costs). These operating profits are decreasing in t *: higher trade costs reduce operating profits. Constructing a local plant avoids the trade costs, leading to higher operating profits of π *(0); however, it requires an additional fixed cost f . Hence the trade-cost-jumping gain, the difference between the total profits from FDI, ΠF , and those from exporting, ΠX

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  Multinational Firms in the World Economy

  • Giorgio Barba Navaretti, Anthony J. Venables(Authors)
  • 2020(Publication Date)
  • Princeton University Press

    (Publisher)

  6 Determinants of FDI: the Evidence We have identified two distinct reasons why a firm would want to invest abroad. One is to supply a market directly through an affiliate (horizontal investment (HFDI), as discussed in Chapter 3). The other is to find low-cost locations for parts of the production process (vertical investment (VFDI), as discussed in Chapter 4). In each case a firm faces trade-offs in its investment decision. Avoiding trade costs through HFDI implies foregoing economies of scale, as production is distributed across several plants. Exploiting international differences in factor prices through VFDI means incurring costs of geographically disintegrating production. Theory suggests factors that are important in these trade-offs; some of these factors are firm or industry specific (e.g. the importance of economies of scale), some are country characteristics (e.g. market size or factor prices), and often it is the interaction of these firm and country characteristics. This chapter is devoted to empirically testing the hypotheses suggested by theory and to measuring the quantitative importance of different factors in determining MNE activity. 6.1 A General Framework Theory comes up with a number of predictions on how firm, industry and country characteristics influence the investment decision. These predictions are summarized in Table 2.3 and derived in Chapters 3 and 4. Some of the main ones are that HFDI will take place when gains in trade costs and strategic advantage are large relative to the fixed cost of setting up a new plant. We therefore expect to find MNEs mainly among firms that can spread assets across several plants at little cost, i.e. when firm-level economies of scale are large relative to plant-level economies of scale. VFDI is predicted to occur when factor cost savings are large relative to the costs of fragmenting activities in several locations.

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  Liberalizing Financial Services and Foreign Direct Investment

  Developing a Framework for Commercial Banking FDI

  • L. Páez(Author)
  • 2011(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  2 Correspondingly, a definition of FDI will reflect these statistical and legal discrepancies. Nonetheless, a concept that has had grow- ing acceptance in an important number of countries is the OECD Benchmark definition. This definition is consistent with the IMF Balance of Payments Manual and has also been systematically taken up by the United Nations Conference for Trade and Development (UNCTAD) in its World Investment Report. 3 The OECD defines foreign direct investment as follows: Foreign direct investment reflects the objective of obtaining a last- ing interest by a resident entity in one economy (“direct investor”) Understanding FDI 9 in an entity resident in an economy other than that of the investor (“direct investment enterprise”). The lasting interest implies the existence of a long-term relationship between the direct inves- tor and the enterprise and a significant degree of influence on the management of the enterprise. Direct investment involves both the initial transaction between the two entities and all sub- sequent capital transactions between them and among affiliated enterprises, both incorporated and unincorporated. 4 As the word foreign denotes, foreign direct investment is a cross-bor- der transfer of capital from a source to a host country. In essence, FDI reflects an interest on behalf of the “direct investor” to seek establishment in the host country through a “direct investment enterprise.” Further, this interest is accompanied by the objective to exercise some form of control over the investment, since the investor holds “a significant degree of influence on the management of the enterprise.” Two important considerations arise in the context of this defini- tion. First, how much FDI is required to qualify establishment of an enterprise as a direct investment enterprise? Second, to what extent does the direct investor have an influence over the enterprise management? These questions can be answered when ownership control is addressed.

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  The Economics of UK-EU Relations

  From the Treaty of Rome to the Vote for Brexit

  • Nauro F. Campos, Fabrizio Coricelli, Nauro F. Campos, Fabrizio Coricelli(Authors)
  • 2017(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Traditionally, international trade has focused on final goods and was driven by the exploitation of mutual comparative advantage. In the last two or three decades, international trade has increasingly focused on trade in parts and components (instead of final goods) and has been increasingly driven by domestic absorptive capacity. Deep integration has contributed to the emergence of global value chains (Amador and di Mauro 2015) in which production is spread across various countries or, to put it differ- ently, to a larger role for intra-industry trade. UNCTAD (WIR 2016) estimates that 60% of global trade is in intermediate goods and services. There is an enormous literature on the impact of FDI on the host economy (see Bruno et al. 2017), which attests to the importance of these factor flows for national economic performance. As we have noted, FDI matters because the entry of foreign firms in the domestic market increases competition and shores up technological innovation both in terms of product and process (Alfaro et al. 2004). It also puts pressure simultaneously on their direct domestic competitors in the host econ- omy, as well as on upstream and downstream firms (Javorcic 2004; Mastromarco and Simar 2015). Importantly, FDI entails the diffusion of frontier management practices (Bloom et al. 2012). FDI is often con- ceived as being more resilient than other international capital flows (portfolio investment, for instance) and may exhibit important comple- mentarity patterns not only with respect to international trade, but also with other elements of financial globalization. 142 R.L. Bruno et al. To understand the nature of the phenomenon and how institutions of economic integration might influence FDI, it is useful to distinguish between horizontal and vertical effects of FDI.

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  Trading Spaces

  Foreign Direct Investment Regulation, 1970–2000

  • Sonal S. Pandya(Author)
  • 2013(Publication Date)
  • Cambridge University Press

    (Publisher)

  This specialization has increased cross-border trade of inter- mediate production inputs. Intrafirm trade is vertical trade that occurs between foreign affiliates of the same multinational firm. In 2000, intrafirm trade as a percentage of total U.S. trade grew to more than 80 percent; there are similar estimates of vertical trade for other industrialized countries. 20 To illustrate, consider Mexico’s maquiladoras, manufacturing facilities that 19 This refers to cross-border trade in services rather than the more general meaning of “trade in services” enshrined in the WTO’s General Agreement on Trade in Services. Technology has made some inroads in weakening these constraints on cross-border trade, but they continue to hold for most services. 20 See Bernard, Jensen, and Schott (2009, 537–538) for U.S. estimates; Hummels, Ishii, and Yi (2001) for descriptions of OECD trade patterns. FDI 36 import production inputs, primarily from the United States, on a tariff- free basis, and produce exclusively for export back to the U.S. market. This arrangement allows U.S. firms to take advantage of lower production costs in Mexico. Many developing countries have created similar programs to attract export-oriented investments. Export-oriented FDI grew with the passage of the U.S.-Canada Free Trade Agreement, which later expanded into the North American Free Trade Agreement to include Mexico. As trade costs have declined, export-oriented investments became more appealing to multinational firms. Trade costs are all of the transactions costs associated with cross-border trade including transport costs (e.g. shipping, insurance) and policies like trade restrictions that raise the cost of prod- ucts sold in foreign markets. Figure 2.2 shows that the growth in worldwide trade preceded growth in total FDI inflows. The panels divided by country income level demonstrate that the trend is consistent across all income lev- els.

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  Foreign Direct Investment

  Theory, Evidence and Practice

  • I. Moosa(Author)
  • 2002(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Moreover, production in the foreign country invariably requires the import of intermediate products from the 84 Foreign Direct Investment home country (and hence exports). This argument also applies to imports by the home country. If a foreign subsidiary can produce goods more cheaply abroad and export them to the home country, this obviously means that FDI leads to increasing imports by the home country. There is now a consensus that whether trade and FDI are comple- ments or substitutes depends on whether FDI is horizontal ± as in Markusen (1984), or vertical ± as in Helpman (1984). Whether FDI is horizontal or vertical depends on various country characteristics. For example, if countries have significantly different factor endowments, then Vertical FDI dominates. On the other hand, horizontal FDI dominates if countries are similar in size and relative endowments, and if trade costs are moderate to high. Markusen et al. (1996) tried to predict the relationship between FDI and country characteristics. Naturally, it seems that the same criteria would determine whether FDI and trade are complements or substitutes. But why would this relationship exist? In horizontal FDI, firms serve foreign markets by setting up plants there to provide identical goods (Markusen, 1984). Hence, exports from the source country to the host country will decline, implying that they are substitutes. In Vertical FDI, MNCs separate different production stages geograph- ically across countries, to take advantage of lower factor prices (Help- man, 1984). Specifically, the unskilled-labour-intensive stages of production are located in a low-wage country. In this case, there will be an increase in the exports of final products from the host country (the cheap labour country), while there is also an increase in the exports of intermediate products by the MNC (from the source coun- try) to the host country where the subsidiary is located.

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  The Political Economy of Japanese Foreign Direct Investment in the US and the UK

  Multinationals, Subnational Regions and the Investment Location Decision

  • C. Aaron(Author)
  • 1998(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  23 'Vertical integration occurs . . . because the parties prefer it to the alternative state of arm's-length transactions. The vertically integrated firm internalizes a market for an intermediate product, just as the horizontal [MNC] inter- nalizes markets for intangible assets.' 24 In particular, vertical inte- gration allows firms to maximize profits through transfer pricing practices. Given the declining importance of labour and raw ma- terial costs, the transactional cost approach, although apparently less locationally specific than the least-cost approach, in fact sug- gests a location more central to the market, where the firm enjoys better access and potential economies of scale whilst continuing to benefit from internalization per se. In any case, Caves concludes that 'the behaviour of horizontal [MNCs] cannot be fully under- stood without recognizing the complementary vertical aspects of their domestic and foreign operations'. 25 50 The Political Economy of Japanese FDI in the UK and the US A second type of FDI identified by Strange is that which seeks to secure access to customers in foreign countries. 26 This may oc- cur where exporting is difficult due, for example, to excessive transport costs, or because customers require local sourcing of components and/or the ability to request immediate design modifications. Strange adds that there is no shift in comparative advantage either to or from the host country in this case. The clearest example is of com- panies undertaking an investment in order to supply specific final product manufacturers. The issue of transport costs 27 has, however, far deeper implica- tions for the location of FDI than simply being a motivation for local production by supplier companies. The costs involved in sup- plying and responding to the needs of consumers as well as busi- ness customers extend far beyond those of physically transporting products to their market.

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  Foreign Direct Investment in Transitional Economies

  A Case Study of China and Poland

  • Kenneth A. Loparo, Michael Du Pont(Authors)
  • 2000(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Therefore production on a smaller scale will be encouraged, favouring assembly technologies that do not require large fixed investments likely to be found abroad (Flamm and Grunwald, 1985); although still seemingly under the aegis of an individual company, albeit one that is changing its shape, size and organisational design (Yongwoong and Simon, 1994). THE TRADITIONAL VIEW There are two major schools of thought concerning FDI. The con- ventional school, pioneered by Hymer (1960) and Caves (1974), states that FDI is undertaken only by firms that possess some intangible asset. These firms invest in a foreign country in order to exploit the firm-specific ownership advantage embodied in the intangible asset. FDI is, therefore, seen as an aggressive action to extract economic rent from a foreign market (Tain-Jy Chen, Yin-Hwa Ku and Meng- Chun Liu, 1994). The other school, represented by Vernon and Kojima, portrays FDI as a defensive action undertaken by firms to protect their export market which is either threatened by competitors in the local market (Vernon, 1966) or damaged by unfavourable developments in macro- economic conditions at home (Kojima, 1973), such as wage increases and/or currency appreciation. `Defensive' FDI is often made in low- wage countries where cheap labour enables investors to reduce their production costs in order to restore international competitiveness. `Aggressive' FDI may be made in any countries where local produc- tion is seen as the best way to enter the market. If both types of FDI exist in the real world, it is empirically difficult to distinguish one from the other because actual FDI may be undertaken for a mixture of 9 Theory and Evidence on FDI reasons including market exploitation and labour-seeking motives.

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  Plugging into Production Networks

  Industrialization Strategy in Less Developed Southeast Asian Countries

  • Ikuo Kuroiwa(Author)
  • 2009(Publication Date)
  • ISEAS Publishing

    (Publisher)

  FDI and Economic Integration in Vietnam 203 of the market. Labour market conditions also suggest that foreign investors play quite an important role in training skilled workers and this role needs to be taken into account when making policy regarding human resource development. • There are still problems associated with the transfer of technology and equipment through FDI. The technical level of the FDI sector in Vietnam in general is higher than that of the domestic sector. However, it is not always the case that foreign investors bring in new and more advanced technology. In some cases, they have actually brought in obsolete technology and equipment, even to the point of not utilizing existing machines and technology, resulting in low productivity, environmentally harmful waste, and destruction of the environment. This situation not only reduces competitiveness of companies and enterprises but also creates unwanted serious environmental problems. 32 Thus, behind the statistical figures of FDI capital inflows, it is important to take into account the issue of quality in FDI when aiming for sustainable development. In investment projects there is often a trade-off between short-term growth and the objectives of long-term development. • Although the introduction of capital into the domestic market through FDI is the norm, there are FDI projects that borrowed from the domestic banks to finance their investment capital and increased their capital from this source during their operation. Since 1992, when the second revised Law on FDI allowed FDI projects to open foreign and domestic currency accounts in any bank in the domestic market, many FDI projects increased their capital by borrowing from these institutions. Therefore, not all FDI capital is of foreign origin and real foreign investment capital flows in fact may be less than the published statistics. This situation cannot be ruled out when assessing the impact of FDI in terms of capital formation.

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  Mergers and Acquisitions as the Pillar of Foreign Direct Investment

  • A. Bitzenis, V. A. Vlachos, P. Papadimitriou, A. Bitzenis, V. A. Vlachos, P. Papadimitriou(Authors)
  • 2012(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  ● Many firms also follow their competitors, in order to exploit the latter’s experiences by following their successful steps and avoiding their mistakes (follow the competition). ● Firms in the financial industry such as banks and insurance firms follow their clients into the host country in order: (1) not to allow their clients to hire a local firm or another MNE that might in time take up their operations in the home country as well and (2) to exploit the ready-to-use clients in foreign markets. ● For firms that utilize raw materials that are supplied by only a given number of suppliers, an FDI project may come by following the expansion of suppliers, which open the way for their clients to follow (follow the supplier). ● The growing trend of globalization exerts pressure on firms to undertake FDI in many countries in order to secure their physical presence in most of them and establish themselves as economic giants. In many cases, the selection of the region is done according to the fashion trend of the time, which points out which regions are profitable or offer investment and privatization opportunities—for example, Central and South America, Asia, Central and Eastern Europe, and the Commonwealth of Independent States (CIS) countries. ● Firms may acquire assets (by making a joint venture or an M&A, and so forth) from a local firm in a host country for (a) the purpose of increasing market share in the global market, or (b) to decrease global competition (to become a global leader) in the specific indus- try/sector ( decrease competition or weaken the competition), or (c) for a geographical dispersion of knowledged-based assets from for- eign locations. ● A firm may decide to undertake FDI if it finds a market where no foreign firm from the same industry has any operations (first mover advantage).

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