2020

1. Why do firms prefer FDI over exporting and licensing?

The answer can be found by examining the limitations of exporting and licensing.

Exporting involves producing goods at home and then shipping them to the receiving country for sale.

Licensing involves granting a foreign entity (the licensee) the right to produce and sell the firm's product in return for a
royalty fee on every unit sold.

Limitations of Exporting

• When transportation costs are added to production costs, it becomes unprofitable to ship some products over a
large distance. This is particularly true of products that have a low value-to-weight ratio and that can be
produced in almost any location. For such products, the attractiveness of exporting decreases.

• Thus Cemex, the large Mexican cement maker, has expanded internationally by pursuing FDI, rather than
exporting.

• By placing tariffs on imported goods, governments can increase the cost of exporting.

• Similarly, by limiting imports through quotas, governments increase the attractiveness of FDI.

Limitations of Licensing

• According to internalization theory, licensing has three major drawbacks as a strategy for exploiting foreign
market opportunities.

• FDI is more profitable than licensing:

(1) when the firm has valuable know-how that cannot be adequately protected by a licensing contract;

(2) when the firm needs tight control over a foreign entity to maximize its market share and earnings in that
country; and

(3) when a firm's skills and know-how are not amenable to licensing.

2. Compare and contrast the following view of FDI?

The radical view

• They note that key technology is tightly controlled by the MNE, and that important jobs in the foreign
subsidiaries of MNEs go to home-country nationals rather than to citizens of the host country.

• FDI by the MNEs of advanced capitalist nations keeps the less developed countries of the world relatively
backward and dependent on advanced capitalist nations for investment, jobs, and technology.

FDI can never be instruments of economic development, only of economic domination.

• THE FREE MARKET VIEW

• The free market view argues that international production should be distributed among countries according to
the theory of comparative advantage.

• Countries should specialize in the production of those goods and services that they can produce most efficiently.

• Within this framework, the MNE is an instrument for dispersing the production of goods and services to the
most efficient locations around the globe.
 Dell decided to move assembly operations for many of its personal computers from the United States to Mexico
to take advantage of lower labor costs in Mexico.

• PRAGMATIC NATIONALISM

• The pragmatic nationalist view is that FDI has both benefits and costs. Many countries are also concerned that a
foreign owned manufacturing plant may import many components from its home country, which has negative
implications for the host country balance-of-payments position.

• Recognizing this, countries adopting a pragmatic stance pursue policies designed to maximize the national
benefits and minimize the national costs.

According to this view, FDI should be allowed so long as the benefits outweigh the costs.

3. Why the FDI inflow in Bangladesh is lowest in this region? What Bangladesh needs to do overcome this problem?

• In 2020, foreign investors invested around USD 17 billion in Vietnam, USD 64 billion in India, USD 18.58 billion in
Indonesia, whereas Bangladesh received USD 2.56 billion and of the amount USD 1.6 billion.

• A foreign investor generally evaluates a country based on its ease of doing business ranking and overall
economic climate. Although Bangladesh advanced eight notches in the World Bank's ease of doing business
2020 ranking to 168 out of 190 countries, there are still significant bottlenecks in doing business.

• For instance, transferring a property title in Bangladesh takes an average of 271 days, almost six times longer
than the global average of 47 days.

Resolving a commercial dispute through a local first-instance court takes an average of 1,442 days, almost three times
more than the 590 days' average among OECD high-income economies accounted for reinvested earnings by the already
existing foreign companies in the country

• According to the World Bank, to get electricity connection in Bangladesh, a new business needs 150.2 days,
whereas in Vietnam it takes 31 days, in Singapore 30 days, in Malaysia 24 days and in neighbor India 55 days.

Existing foreign investors often complain about bureaucratic tangles in Bangladesh that stand in the way of business
operations and obtaining various licenses. Then there are hidden costs in matters related to procedure, policy, law and
infrastructure that seriously weigh upon the cost of doing business.

• How to overcome

• When investors intend to come to a country, the level of convenience of doing business in the host country plays a
crucial role in making investment decisions. They assess the clarity in existing policies, reliability of government
officials and adherence to rules and regulations, look at the rate of return on their investment and whether they will
be able to repatriate their profit or funds, and most importantly, whether there is sufficient security for their
investments.

• Therefore, urgent policy focus is required to remove the deterrents discussed above that are responsible for the
high cost of investment.

If implemented successfully, the country will not only become a lucrative investment destination but it will also help to
raise our ease of doing business ranking, an important indicator for FDI decisions of foreign investors.

Beside poor infrastructure, lack of land, acute shortage of power and gas for new industries, finding the right people and
getting them to work productively are the biggest problems of Bangladesh today.

2021

1. How beneficial is FDI for developing country?

Capital Inflow: FDI involves investment in physical assets or the establishment of business operations in a foreign
country. This infusion of capital can help finance infrastructure development, industrial projects, and other
critical sectors, fostering economic growth.

Technology Transfer: Multinational corporations often bring advanced technology, managerial expertise, and
best practices to the countries where they invest. This transfer of knowledge can enhance the productivity and
competitiveness of local industries, spurring innovation and skill development.

Employment Opportunities: FDI projects typically create job opportunities for local populations, both directly
through employment within foreign-owned enterprises and indirectly through the growth of supporting
industries and supply chains.

Export Promotion: Foreign investors often leverage their global networks to facilitate exports from the host
country. This can expand market access for local producers, increase export revenues, and improve the balance
of trade.

Stimulating Economic Development: FDI can catalyze broader economic development by attracting
complementary investments, stimulating domestic entrepreneurship, and encouraging the development of a
skilled workforce and supportive institutions.

2. FDI is driven by four main factors, markets, natural resources, assets and efficiency seeking?

Foreign Direct Investment (FDI) is primarily driven by four main factors:

1. Market-seeking: Companies invest in foreign markets to gain access to larger consumer bases, expand their
market share, or tap into emerging markets with growing purchasing power.

2. Natural resources-seeking: FDI is attracted to countries abundant in natural resources, such as oil, minerals, or
agricultural products. Companies invest in these regions to secure access to vital resources for production or to
exploit their extraction and export potential.

3. Asset-seeking: Companies seek to acquire strategic assets abroad, including technology, brands, intellectual
property, or infrastructure. This enables them to enhance their competitiveness, innovate, and gain a foothold
in new markets.

4. Efficiency-seeking: FDI is often driven by the quest for cost efficiency. Companies may invest in countries with
lower labor costs, favorable regulatory environments, or tax incentives to optimize production processes, reduce
operational expenses, and maximize profitability.

2019

1. Describe the benefits and costs of FDI in home and host countries?

• HOST-COUNTRY BENEFITS

• The main benefits of inward FDI for a host country arise from resource-transfer effects, employment effects,
balance-of-payments effects, and effects on competition and economic growth.

• Resource-Transfer Effects

Foreign direct investment can make a positive contribution to a host economy by supplying capital, technology, and
management resources that would otherwise not be available and thus boost that country's economic growth rate.

Employment Effects
 • Direct effects arise when a foreign MNE employs a number of host-country citizens. Indirect effects arise when
jobs are created in local suppliers as a result of the investment and when jobs are created because of increased
local spending by employees of the MNE.

• An OECD study found that foreign firms created new jobs at a faster rate than their domestic counterparts

Balance-of-Payments Effects

• The persistent U.S. current account deficit has been financed by a steady sale of U.S. assets (stocks, bonds, real
estate, and whole corporations) to foreigners.

• First, if the FDI is a substitute for imports of goods or services, the effect can be to improve the current account
of the host country's balance of payments.

• A second potential benefit arises when the MNE uses a foreign subsidiary to export goods and services to other
countries. Much of the dramatic export growth was due to the presence of foreign multinationals that invested
heavily in China during the 1990s.

Effect on Competition and Economic Growth

• When FDI takes the form of a Greenfield investment, the result is to establish a new enterprise, increasing the
number of players in a market and thus consumer choice.

In turn, this can increase the level of competition in a national market, thereby driving down prices and increasing the
economic welfare of consumers.

Adverse Effects on Competition

• When a foreign investor acquires two or more firms in a host country, and subsequently merges them, the effect
may be to reduce the level of competition in that market, create monopoly power for the foreign firm, reduce
consumer choice, and raise prices.

• Adverse Effects on the Balance of Payments

• First, set against the initial capital inflow that comes with FDI must be the subsequent outflow of earnings from
the foreign subsidiary to its parent company.

• A second concern arises when a foreign subsidiary imports a substantial number of its inputs from abroad, which
results in a debit on the current account of the host country's balance of payments.

• National Sovereignty and Autonomy

• Some host governments worry that FDI is accompanied by some loss of economic independence.

• The concern is that key decisions that can affect the host country's economy will be made by a foreign parent
that has no real commitment to the host country, and over which the host country's government has no real
control.

Home country benefits

The benefits of FDI to the home (source) country arise from three sources. First, the home country's BOPs
benefits from the inward flow of foreign earnings.

• FDI can also benefit the home country's BOPs if the foreign subsidiary creates demands for home-country
exports of capital equipment, intermediate goods, complementary products, and the like.

• Second, benefits to the home country from outward FDI arise from employment effects. As with the BOPs,
positive employment effects arise when the foreign subsidiary creates demand for home-country exports.
 • Home country costs

• First, the BOPs suffers from the initial capital outflow required to finance the FDI. This effect, however, is
usually more than offset by the subsequent inflow of foreign earnings.

• Second, the current account of the BOPs suffers if the purpose of the foreign investment is to serve the home
market from a low-cost production location.

• Third, the current account of the balance of payments suffers if the FDI is a substitute for direct exports.

FDI is reduced home-country employment.

2. Compare and contrast these explanations of FDI: (i) Internalization theory; (ii) Vernon's product life-cycle theory
and (iii) Knickerbocker's theory of FDI.

Let's compare and contrast the explanations of Foreign Direct Investment (FDI) provided by Internalization theory,
Vernon's product life-cycle theory, and Knickerbocker's theory of FDI:

1. **Internalization Theory**:

- **Explanation**: Internalization theory suggests that firms engage in FDI to internalize transactions that would
otherwise occur in the market. Firms invest abroad to retain control over valuable assets, technology, or resources,
rather than relying on licensing or contractual arrangements with foreign firms.

- **Focus**: Internalization theory emphasizes the importance of firm-specific advantages, such as proprietary
technology, brand reputation, or managerial expertise, which drive firms to invest directly in foreign markets to protect
and exploit these advantages.

- **Contrast**: Unlike other theories, internalization theory does not focus explicitly on market imperfections or
differences in factor endowments between countries but instead emphasizes the strategic decisions of individual firms
to expand internationally.

2. **Vernon's Product Life-Cycle Theory**:

- **Explanation**: Vernon's theory suggests that FDI occurs as products mature through their life cycles. Initially, new
products are developed and produced in the home country (innovation stage). As demand grows, production may be
outsourced to other countries with lower production costs (growth stage). Eventually, production shifts to countries
with large consumer markets (maturity stage), and FDI may occur to access those markets or lower production costs.

- **Focus**: Vernon's theory focuses on changes in comparative advantage over the product life cycle, driven by
factors such as economies of scale, production costs, and consumer preferences.

- **Contrast**: Unlike internalization theory, Vernon's theory does not emphasize firm-specific advantages but rather
highlights the role of product characteristics and market dynamics in driving FDI decisions.

3. **Knickerbocker's Theory of FDI**:

- **Explanation**: Knickerbocker's theory suggests that FDI is driven by oligopolistic rivalry among firms in the same
industry. Firms invest abroad to preempt or retaliate against competitors' investments, leading to a pattern of "follow-
the-leader" behavior.

- **Focus**: Knickerbocker's theory focuses on the strategic interactions and competitive dynamics among firms
within the same industry, highlighting how FDI decisions are influenced by the actions of competitors.

- **Contrast**: Unlike internalization theory and Vernon's theory, Knickerbocker's theory does not explicitly consider
firm-specific advantages or changes in product life cycles but instead emphasizes the role of competitive behavior and
interdependence among firms in driving FDI.
In summary, while all three theories offer explanations for FDI, they differ in their focus and underlying assumptions.
Internalization theory emphasizes firm-specific advantages and transaction costs, Vernon's theory focuses on changes in
comparative advantage over the product life cycle, and Knickerbocker's theory highlights competitive dynamics and
oligopolistic rivalry among firms.

3. Which theory do you think offers the best explanation of the historical pattern of FDI? Why?

Among the theories discussed, Vernon's Product Life-Cycle Theory offers the best explanation of the historical pattern of
FDI. This theory suggests that FDI occurs as products mature through their life cycles, with production shifting from the
innovating country to other countries with lower production costs and eventually to countries with large consumer
markets.

Vernon's theory aligns well with historical trends in FDI, particularly the patterns observed during the post-war era of
globalization. During this period, many multinational corporations expanded their operations internationally, initially
seeking lower production costs in countries with abundant labor and resources. As products matured and global markets
grew, FDI shifted towards accessing large consumer markets in developed countries.

This theory also accounts for the role of changing comparative advantage over time, driven by factors such as economies
of scale, technological advancements, and shifts in consumer preferences. It provides a framework for understanding
how FDI patterns evolve in response to changes in global market dynamics and product life cycles.

Overall, Vernon's Product Life-Cycle Theory offers a comprehensive explanation of historical patterns of FDI by linking
changes in comparative advantage to the stages of product development and market expansion, making it a compelling
framework for understanding the dynamics of international investment.