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Theories of FDI - Essay Example

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Foreign Direct Investment, in general understanding, is the investment made by a foreigner individual or company in a home country in a productive capacity (Halifax Initiative, n.d). This may include the purchase of land, equipment, buildings or the construction of new equipment or buildings in the local country…
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Theories of FDI
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Theories of FDI

Download file to see previous pages... According to US, FDI is the "ownership or control of 10 percent or more of an enterprise's voting securities, or the equivalent interest in an unincorporated business" (Pustay & Griffin, 2006) Foreign Direct Investment can either be inwards or outwards. In the inwards flow, is where the foreigners take control of the host country's assets (Razin & Sadka, 2001). Governments of third world countries usually encourage such investment since it is beneficial for the country as higher currencies come in the host country. They usually give tax holidays, subsidies, low interest loans, grants, lifting of certain restrictions etc. to foreign investors to encourage them further. In the outwards flows, the residents of the host country take control of the foreign assets. This can happen through either purchasing available resources in the foreign country or by making investments in new buildings, lands and equipment in a foreign country or by leading a joint venture with a local partner in a foreign country (Razin, 2002).3. Why to opt for going abroad - An investment abroad can be to gain profits found due to lower costs, capitalize on the market opportunity or get the knowledge of host countries operations to reduce costs and increase efficiency.John Dunning, professor at the University of Reading (UK) and Rutgers University (US) provided the Eclectic theory of FDI which is also known as OLI paradigm. This paradigm is a combination of three concepts which helps to answer some of the questions asked in the preceding section.
1. Ownership Advantages
The ownership advantage addresses the "WHY" question of reason for going abroad. A firm trying to go abroad either sees a market opportunity where it can gain profits or it sees a chance for it establish itself and survive in the long run. It gives firm specific advantages in either a costs cuts or higher revenues. China has emerged as a very lucrative place for investment due to lower manufacturing costs. Many of the industry giants including Sony, Honda, Apple etc. have started to manufacture their products in China after staring in Japan.
Although the foreign firm (or individual) would be outsider with limited knowledge about the internal systems of the host country, the benefits resulting from the FDI will be far greater than the costs incurred to gain local market knowledge and to communicate and operate at a long distance. (Enderwick, 2005) (Dunning, 1993) (Dunning, Kogut & Blomstrom, 1990 ...Download file to see next pagesRead More
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