Foreign Direct Investment, Trade Theories, Barriers

Three Types of Foreign Direct Investment (FDI)

Foreign Direct Investment can be categorized into three main types:

• Market Seeking: FDI is driven by the desire to be closer to customers. Proximity reduces transportation costs and potentially tariffs. Firms weigh the benefits of FDI against exporting, where production is concentrated in one location.
• Efficiency Seeking: Upstream and downstream products are manufactured in different locations, leveraging factor intensity and factor prices. This strategy aims to optimize production costs.
• Resource Seeking: FDI provides access to scarce resources. Output from resource-seeking FDI is seldom sold in the host country market.

Consequences of FDI for Host Countries

FDI can have several effects on host countries, both positive and negative:

• Capital Market Effects:
  • Foreign-exchange earnings
  • Risk sharing
  • Increased competition for local scarce capital
• Technology and Production Effects:
  • Access to new technologies
  • Export diversification
  • Plants are often for assembly only and can be dismantled
• Employment Effects:
  • Direct creation of new jobs

New Trade Theory

Assumption: Firms have increasing returns to scale and offer differentiated goods.

Type of trade: Intra-industry.

Effects of trade:

• Increasing competition between firms across the globe leads to lower prices.
• Firms need to emphasize their differentiation.
• Imports of new varieties lead to more consumer choice.

New New Trade Theory

Assumption: Firms are heterogeneous, offer differentiated products, profit from economies of scale, and have to take fixed and variable costs of exporting into account.

Type: Intra-industry.

Effect:

• Only the most productive firms can bear the cost of exporting.
• Less productive domestic firms are crowded out as only highly productive firms export.
• Trade increases productivity in a country because only the most productive firms trade.

Trade Barrier Theory

Direct investments arise because firms are prevented from other forms of foreign trade activities due to trade barriers. Direct investment is sometimes the only alternative to enter a specific foreign market.

Trade Barriers:

• Duties
• Non-tariff barriers:
  • License quotas
  • Import quotas
  • Embargos
  • Buy national policies