Unit -2 lecture-6 (international investment theory)

1. Branch - MBA
International Business Management
DR. APJ ABDUL KALAM TECHNICAL UNIVERSITY
By
Dr. B. B.Tiwari
Professor
Department of Management
Shri Ramswaroop Memorial Group of Professional Colleges, Lucknow
Unit-2: Lecture – 6
International Trade Theories:
International Investment Theories

2. Origin of the theory: Introduction
 International investment theory explains the flow of investment capital into and
out of a country by investors who want to maximize the return on their
investments.
 One of the major factors that influence international investment is the potential
return on alternative investments in the home country or other foreign markets.
 Theories of international investment can essentially be divided into two
categories: Micro (industrial organization) theories and Macro (cost of
capital) theories

3. Cont…..
• Broadly there are two types of foreign investment, namely, foreign direct investment
(FDI) and foreign portfolio investment (FPI).
• foreign direct investment : FDI refers to investment in a foreign country where the investor
retains control over the investment. It typically takes the form of starting a subsidiary, acquiring
a stake in an existing firm or starting a joint venture in the foreign country. Direct investment
and management of the firms concerned normally go together.
• Portfolio investment : If the investor has only a sort of property interest in investing the
capital in buying equities, bonds, or other securities abroad, it is referred to as portfolio
investment.
• That is, in the case of portfolio investments, the investor uses capital in order to get a return on
it, but has not much control over the use of the capital.

4. International Investment Theories:
 Theory of Capital Movements.
 Market Imperfections theory
 Internationalization Theory
 Location Specific Advantage Theory
 Eclectic Theory Free Trade

5. Theory of Capital Movements
• Capital is one of the factors of production (land, labor and
entrepreneur etc.)
• International capital movement is any transfer of capital between
countries (with goal of obtaining extra profit)
• It can be in the form of physical capital and financial capital
• The profit can be interest rate, dividend, share, on profit of corporation
abroad or rent.

6. Cont……
• The term international capital movement refers to borrowing and lending
between countries. These capital movements are recorded in the capital account
of the balance of payment.
• One of the most important developments in the world economy in the 1990s has
been the spectacular surge in international capital flows. These flows have
emanated from a greater financial liberalisation, improvement in information
technology, emergence and proliferation of institutional

7. Classification of International Capital Movements:
• Home and Foreign Capital
• Government and Private Capital
• Short-Term and Long-Term Capital
• Direct and Portfolio Capital

8. Factors Influencing International Capital Movements:
• Rate of Interest
• Marginal Efficiency of Investment
• Bank Rate
• Speculation
• Foreign Capital Policy
• Economic and Political Conditions
• Exchange Control Policy
• Tax Policy

9. Market Imperfections theory
 An imperfect market refers to any economic market that does not meet the rigorous
standards of the hypothetical perfectly—or purely—competitive market.
 Pure or perfect competition is an abstract, theoretical market structure in which a series
of criteria are met.
 Imperfect markets are characterized by having competition for market share, high
barriers to entry and exit, different products and services, and a small number of buyers
and sellers.
 Market structures that are categorized as imperfect include monopolies, oligopolies,
monopolistic competition, monopsonies, and oligopsonies.

10. Cont…
• Market imperfections theory is a trade theory that arises from international
markets where perfect competition doesn't exist. In other words, at least one of
the assumptions for perfect competition is violated and out of this is comes what
we call an imperfect market. We know that a perfect market isn't really
attainable. Even in the United States, we have imperfect markets. Remember, the
assumptions for a perfect market are:
• Buyers and sellers are both price takers
• Companies sell virtually identical products
• Buyers and sellers have perfect information
• Multiple companies owns a small market share
• There is no barrier of entry or exit

11. Internationalization Theory
 Explains the process by which firms acquire and retain one or more value-chain
activities inside the firm – retaining control over foreign operations and avoiding the
disadvantages of dealing with external partners
 The concept of internalization theory is to transfer the superior knowledge to foreign
subsidiary and obtain higher return or fee on its investment. It comes into contract and
provide authority to use its competitive advantages in the form of license, franchise or
other form.
 Explains why a firm would choose to enter a foreign market via FDI rather than
exploit its ownership advantages.
 Transaction costs- costs of entering into transaction(negotiating, monitoring and
enforcing a contract) Eg: Honda

12. Difference between Internationalization and Globalization
• Globalization refers to the processes by which a company brings its business to the
rest of the world. Internationalization is the practice of designing products, services
and internal operations to facilitate expansion into international markets
• Example: A company that manufacture hair dryers must ensure that their products
are compatible with different watts used in different countries.

13. • Even with strong protections firms protect their knowledge through secrecy. Instead of
licensing their knowledge to independent local producers, firms exploit it themselves in
their own production facilities.
• Most applications of the theory focus on knowledge flow. Proprietary knowledge is easier
to appropriate when intellectual property rights such as patents and trademarks are
weak.
• Internalization occurs only when firms perceive the benefits to exceed the costs. When
internalization leads to foreign investment the firm may incur political and commercial
risks due to unfamiliarity with the foreign environment. These are known as ‘costs of
doing business abroad’, arising from the ‘liability of foreignness’. When such costs are high
a firm may license or outsource production to an independent firm; or it may produce at
home and export to the country instead.
Cont…

14. Location Specific Advantage Theory
• Location advantages are the ones that a particular country provide that might create incentives
for a firm to move into that country. So, the difference with the ownership advantages that we
covered before, is that ownership advantages are the ones created within the firm.
• For example: a lumber company in Oregon has a location-specific advantage to a lumber
company in Arizona because there are simply more trees in Oregon.
• A company's business strategy as well as external developments such as e.g. geopolitical
trends lead to locational challenges in terms of creating or reducing new operations or facilities.
• Location plays a huge role in attracting and retaining the best employees, many of whom keep
a close eye on where they're based in order to optimize work-life balance. Good location decisions
can significantly boost a company's long-term performance.

15. factors that one should consider when choosing the best business location:
• Style of Operation. Is your business going to be formal or elegant?
• Demographics
• Foot Traffic
• Parking and Accessibility
• Competition
• Site's Image and History
Cont…

16. • Published by John H. Dunning in 1979and refined by him several times since then (1988, 1993), is a
key contribution to the separation of international business studies
• The eclectic paradigm is a business approach that analyses whether a company should make
a foreign direct investment.
• The eclectic paradigm is a theory that provides a three-tiered framework for companies to follow.
They follow the frameworks when deciding whether they should invest abroad.
• The eclectic paradigm theory posits three kinds of advantages for a multinational company:
1. Ownership.
2. Location.
3. Internalization.
Eclectic Theory: Dunning (OLI model )

17. Eclectic Theory: Dunning (OLI model )
FDI will occur when 3 conditions are satisfied:
Ownership Advantage:
• A firm must own some unique competitive advantage that overcomes competitions. firm’s specific competencies such as
knowledge, skills, capabilities, relationships, or physical assets.
• Eg: Brand name
Location Specific Advantage:
• Business should be done in a more profitable foreign location than a domestic one. specific advantages that exist in the host
market, such as natural resources, low-cost labor, or skilled labor.
• Eg: Labour, raw materials
Internalization Advantage:
• The firm must benefit more from controlling foreign business activity rather than hiring other local companies to provide
service. the degree of control over foreign operations, such as foreign-based manufacturing, distribution, or other value
chain activities.
• Eg: Hiring locals

18. Example: Sony in China
• Ownership-specific advantages: Sony possesses a huge stock of
knowledge and patents in the consumer electronics industry, as
represented by products like the Play station.
• Location-specific advantages: Sony desires to manufacture in
China, to take advantage of China’s lowcost, highly knowledgeable
labor.
• Internalization advantages: Sony wants to maintain control over its
knowledge, patents, manufacturing processes, and quality of its
products. Thus, Sony entered China via FDI.

19. THANK YOU