Foreign Direct Investment

There are several reasons why a company may grow via FDI and become a multinational, and often in making the decision financial considerations are outweighed by strategic reasons. The common reasons quoted for FDI are listed below, but you should note that there is often more than one reason why a firm may decide to invest overseas.

  • The provision of raw materials (e.g. oil, minerals) -many MNCs base part of their operations in the location of their raw materials, for cost or logistic reasons, or in order to comply with the political and legislative wishes of the host government.
  • The provision of cheap and productive sources of labour is a reason given for many MNCs locating in the Far East and Mexico.
  • Location in the market for the company’s goods, e.g. several Japanese car firms have located in Europe in order to supply the EU markets.
  • Location in centers of knowledge, e.g. several Japanese and European companies have purchased firms in the US in order to gain access to technological knowledge in the field of electronics. An example of a firm investing in Britain for this reason are the plans of Microsoft to establish facilities in Cambridge.
  • To permit diversification opportunities not available in the country’s domestic markets.
  • To allow growth if there are limited opportunities for the firm “at home”; such growth can take the form of diversification, or horizontal or vertical integration.
  • For companies based in countries with unstable or unpredictable political regimes FDI may be a way of ensuring safety from interference in, or expropriation of, their business. Such fears led to FDI in Australia and North America by Hong Kong-based firms prior to its repatriation by the People’s Republic of China.

The criteria by which investment opportunities are selected will vary between companies. MNCs often prefer to invest in their own domestic market, and they will only go abroad if they can secure a higher rate on capital by doing so. Sometimes the MNC will undertake a foreign investment that is uneconomic, the main reasons for this being:

  • To ensure an outlet for some other aspect of its worldwide operations (e.g. an oil company may construct a refinery as an outlet for its own crude oil production).
  • To safeguard its existing interest (e.g. by producing a new but uneconomic car, in order to keep a brand name alive for the sake of a larger, successful model).

Studies indicate that many MNCs do not have a master plan for international investment but review each individual project on its merits. In many cases it is generally the viability of the project, rather than the finance available for investment, that is the key to the investment decision

International Finance CIFA Notes

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