This chapteris concerned with foreign direct investment (FDI). Foreign direct investment occurs when a firm invests directly in facilities to produce and/or market a product in a foreign country. Once a firmundertakes FDI, it becomes a multinational enterprise.
FDI takes two main forms. The first is a green-field investment, which involves the establishment of a wholly new operation in a foreign country.The second involves acquiring or merging with an existing firm in the foreign country. Note that acquisitions can be a minority, majority, or full outright stake.
Also, there is an importantdistinction between FDI and foreign portfolio investment (FPI). Foreign portfolio investment is investment by individuals, firms, or public bodies in foreign financial instruments. FPI does not involve taking asignificant equity stake in a foreign business entity.
The central objective in the Chapter will be to identify the economic rationale that underlies foreign direct investment. Firms often viewexports and FDI as substitutes for each other. This Chapter attempts to understand the conditions under which firms prefer FDI to exporting. Various theories regarding these conditions will be reviewed.These theories also need to explain why it is preferable for a firm to engage in FDI rather than licensing. Licensing occurs when a domestic firm, the licensor, licenses to a foreign firm, thelicensee, the right to produce its product, to use its production processes, or to use its brand name or trademark. In return for giving the licensee these rights, the licensor collects royalty fees on everyunit the licensee sells or on total licensee revenues. The advantages claimed for licensing over FDI is that the licensor does not have to pay for opening a foreign market, nor does the licensor...