Outward FDI Trends: Comparing the United States, Europe, China and Japan

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CHAPTER 1 
OUTWARD FDI GLOBAL TRENDS 
 
 
1 FDI: definition and purpose 
 
“Foreign direct investment (FDI) is defined as an investment involving a long-term 
relationship and reflecting a lasting interest and control by a resident entity in one 
economy (foreign direct investor or parent enterprise) in an enterprise resident in an 
economy other than that of the foreign direct investor (FDI enterprise or affiliate 
enterprise or foreign affiliate). 
FDI implies that the investor exerts a significant degree of influence on the 
management of the enterprise resident in the other economy. Such investment involves 
both the initial transaction between the two entities and all subsequent transactions 
between them and among foreign affiliates, both incorporated and unincorporated” 
(UNCTAD, 2007, p. 245). The three components of FDI are: equity capital, reinvested 
earnings, and intra-company loans; at the international level the 10% of equity 
ownership and voting power is enough to qualify a foreign direct investment. 
The advantage linked to FDI comes from the possibility to locate and to co-ordinate 
the activity of the firm in the best way; in other words FDI allow the firm to pursue the 
global optimization of its business. The theory of localization mirrors the general 
theory of international trade: the localization of each activity is often determined by 
the endowments of resources, or rather by transportation costs or trade barriers. For 
example the mining of aluminium has to be located where you can find bauxite and the 
fusion where energy is available at low costs; the producers of semiconductors have 
localized high skilled project activities in Massachusetts and California, while low 
skilled activities such as assembling in Ireland or Singapore; otherwise American car 
producers have localized the production of car destined to the European market in 
Europe to avoid transportation costs (KRUGMAN-OBSTFELD, 2007). On the other 
hand, the advantage coming from the brilliant co-ordination of activities is well 
explained by the theory of internalization according to firms which decide to make 
transactions inside themselves rather than turning to the market: this recalls the well 
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known issue of vertical integration. For example technology transfer could not be 
possible when knowledge is not formalized but lies in a group of people within the 
firm: a way of avoiding this problem could be to directly obtain the rent coming from 
the possession of the technology by exploiting it abroad through the constitution of 
foreign affiliates (KRUGMAN-OBSTFELD, 2007). 
 
1.1 Main types of FDI: the way firms build their competitive advantage 
Economic theory has determined four main types of FDI linked to the ways through 
which firms build or reinforce their competitive advantage: 

 Market-seeking: its aim is to realize a direct presence in the foreign market to 
rapidly develop sales revenue and control the marketing mix policy; moreover it 
allows firms to pursue strategic goals such as threatening competitors by 
entering their home market, or rather to follow customers which have chosen to 
internationalize themselves (UNCTAD, 2006). The choice of entering a new 
market could also respond to the will of exploiting specific opportunities offered 
by the location of the foreign firm: the chance to trade within a free-trade area, 
the possibility to evade trade barriers, the advantage to be perceived as a local 
firm (VALDANI-BERTOLI, 2006);   

 Resource-seeking: together with the precedent point, this one represents the 
most important presupposition of FDI by far. It refers to investment aimed to get 
production factor supplies at low cost; the most important among these are: raw 
materials, labour, public incentives, and the chance to restrain logistic costs. 
Each of them is worth a short comment (MARIOTTI-MUTINELLI, 2003): 

 Raw materials: the availability of low cost inputs is among the key factors 
leading to the choice of undertaking FDI towards less developed countries. 
Thanks to the economic growth of the last decade, new countries have appeared 
on the international scenery: from Asian countries, China and India in particular, 
to those of the Mediterranean basin (including North Africa and the Middle 
East) and those of Eastern Europe and the ex USSR. The level of quality of 
these nations’ production is gradually converging towards Western standards, 
while European, American and Japanese firms are now facing the threat of new 
competitors together with the opportunity of exploiting their low cost input: 
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energy (electricity and oil), partly-finished goods, expertise. It is necessary to 
underline that these dynamics don’t regard only multinationals, but also SMEs 
in their search to maintain their position on the market in response to changes 
involving the global competitive framework; 

 Labour: although labour represents an input like energy or expertise, a separate 
treatment is important because of the mistakes committed in the past based on 
the choice of only delocalizing its costs. Firstly, the importance of labour cost 
on the whole level of costs depends on the characteristics of the production 
process, and represents a key factor in labour-intensive industries. Moreover, it 
is to be considered that labour is not a homogeneous factor in terms of skill and 
attitude towards quality: FDI regarding complex productions must consider not 
only labour costs, but mainly availability and the cost of  skilled labour;   

 Public incentives: they don’t strictly represent an input, but as an element which 
has an impact on costs and characterizes the economic framework of the firm, 
they represent a resource worth justifying an FDI. This sort of incentive is often 
referred to as “explicit” given the clear purpose of attracting FDI; they can take 
different forms: credit inducements, lower tax and customs rates, simplified 
models of company, slim bureaucracy, first-class infrastructures and well-
equipped industrial-logistic areas. Nevertheless there are also “implicit” 
incentives such as a simple rules and regulations context1;  

 Logistic costs: this sort of costs regards the international semi-finished and 
manufactured  products handling, i.e. goods flow from the producer to the 
market. It comes clear that in loco production shortens the distance between 
supplier and buyer lowering global logistic costs, mainly transportation and 
customs taxes. The connection of this sort of cost with FDI appears clear when 
we look at the relationship between exports and affiliate sales. For both U.S. and 
European firms, sales realized by foreign affiliates strongly outclass exports to 
foreign markets (HAMILTON-QUINLAN, 2006): for example the global sales 
                                                 
1
 It is the case of the U.S. with regards to the pharmaceutical sector: they have become a key pole of 
attraction of FDI thanks to abundant venture capital and researchers, slack obstacles to scientific 
research, united with a strong per capita consumption and freedom in fixing prices (VALDANI-
BERTOLI, 2006).  
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of U.S.-owned affiliates in 2004 totalled $ billions 3768.7 while total U.S. 
exports $ billions 1151.9;  

 Efficiency-seeking: let’s first clarify what we mean by efficiency, that is the 
synergies obtainable through the international integration of production and 
services looking for a global optimization rather than low cost inputs. This type 
of investment is considered of primary importance in countries belonging to 
South-East Asia, such as Hong-Kong, Malaysia, Korea, Taiwan and partly 
China and Singapore. Moreover they are often undertaken by firms operating in 
global markets, characterized by strong competition and labour intensive 
productions (MARIOTTI-MUTINELLI, 2003). The international localization of 
this kind of investment in particular depends strictly on the nature of the product 
and on the network in which it is located; we can then distinguish between 
(UNCTAD 2006, p. 160): 
o Buyer-driven network: big buyer control, the marketing strategy and the 
access to the market, and strive to organize, co-ordinate and control the 
value chain of industries such as food, clothes, footwear, furnishing and 
toys. Firms belonging to such nets tend to invest in low-cost countries 
with the result of being forced to move to other low-cost countries 
frequently as soon as labour cost tend to converge towards the levels of 
home economy; 
o Producer-driven network: the key characters of each market own 
strategic technologies and other firm-specific advantages, and take 
responsibility for the quality and productivity of other firms belonging 
to the net, mainly suppliers. Typical industries are automotive and 
electronics; 

 Created asset-seeking: investment led by the will to increase self-
competitiveness through the acquisition of strategic assets such as technologies 
not available in the home market, or rather links with global value-chains. This 
kind of investment typically regards firms located in emerging or developing 
countries (particularly China), and are often undertaken for various reasons: the 
necessity to lower costs of production or the will to expand on overseas markets. 
Moreover its destination is usually represented by developed countries, yet in 
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the forefront of technology and skills. One of the reasons why pure forms are 
not undertaken is because developing-country firms must first master the 
capability of managing created assets: for example Haier, Arcelik and Lenovo, 
have been motivated by the need to make a name for their brand on international 
markets before completing their manufacturing and engineering skills. In 
particular Lenovo has contemporarily tried to make a name for itself as a global 
brand and to acquire technological skills to complete its firm-specific 
advantages in China, by acquiring the computer division of IBM (UNCTAD 
2006, p. 163).    
 
 
2 Global trends: outward FDI dimensions and directions 
 
Global FDI flows (both inward and outward) exceeding in 2007 the previous peak of 
2000 thanks to six reasons (UNCTAD, 2008): 
• Relatively high economic growth; 
• Widespread strong corporate performance; 
• Sensible depreciation of the dollar against other major currencies; 
• Record values of cross-border M&As; 
• Overall policy of great openness; 
• The emergence of sovereign wealth funds as direct investors. 
However the satisfaction for these results pairs with concerns about the global 
financial crisis: the sentiment is that the slowing down of the United States and the 
world economy with a higher cost of credit may negatively affect FDI flows. For 
example global M&As activity has begun to decrease in the first half of 2008 (29% 
lower than in the second half of 2007), and corporate profits are sharply declining; 
nevertheless the depreciation of the dollar has increased flows to the U.S. especially 
for countries that suffer exchange rate changes. As a result estimated FDI flows for 
2008 are expected to account for about $1600 billion, 10% less than 2007.   
The scenery we are going to investigate is that of world single areas as the source of 
FDI; firstly we want to briefly outline the results achieved by these single areas, then 
to point our attention to four of them: the U.S., the EU, China and Japan. 
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2.1 FDI outflows in the last three years: ranking of world areas 
FDI outflows in 2007 reached record levels in all regions, and almost all sub-regions 
(UNCTAD, 2008): the share of developed countries increased; that of developing 
registered a decline; the one of transition economies maintained its upward trend. 
The aim of this chapter is to investigate the dimension of FDI outflows for the last 
three years, first on aggregate, then unbundling for World areas and (when possible) 
single countries.  
 
World (TAB. 2.1): 

 Developed countries: the biggest source of FDI with $1.692 billion in 2007 
(56% more than the 2006 level); with outflows exceeding inflows for $445 
billion they represent the largest net outward investors. The U.S., the U.K., 
France, Germany, Spain, Italy and Japan account for 74% of the total, that is 
$1.256 billion, thanks to strong reinvested earnings (31% more than in 2006) 
and large intra-company loans (almost nine times more than in 2006) 
(UNCTAD, 2008, p. 75);  

 Developing countries: they are growing in importance as a source of FDI thanks 
to outward expansion of Asian TNCs, reaching $253 billion; 

 South-East Europe and the CIS: with $51 billion, these states attain a new high, 
more than twice the 2006 level. The Russian Federation remains the main 
source accounting for $46 billion (90% of the total): its TNCs invested heavily 
in Africa to increase their access to raw materials and other strategic 
commodities to strengthen its position in the energy industry and to support its 
value-added activities in the metal industry. 
 
World areas 2005 2006 2007
Developed countries 749 (85.0%) 1087 (82.2%) 1692 (84.8%)
Developing countries 118 (13.4%) 212 (16.0%) 253 (12.7%)
South-East Europe 
and the CIS 14 (1.6%) 24 (1.8%) 51 (2.5%)
World total 881 (100%) 1323 (100%) 1996 (100%)
TABLE 2.1 Global FDI outflows for World Regions (2005-2007)                                                  
($/billions and % of world total)
Source: adapted from UNCTAD, 2008
 
 
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Developed countries (TAB. 2.2): 

 United States: they maintained their position as first source of FDI in the World 
with $314 billion (42% more than 2006), concentrated in the services sector 
(above all holding companies); the main part of U.S. TNCs investment ($175 
billion) went towards the EU, then to Asia and the Pacific, the Caribbean and 
Canada (UNCTAD, 2008, p. 76);  

 EU (-27) countries: FDI from this region nearly doubled in 2007, reaching 
$1.142 billion, thanks to the financial strength of European TNCs that allowed 
them to undertake large foreign acquisitions. Among the World’s ten major FDI 
source countries, six were European: the UK, France, Germany, Spain, Italy and 
Luxembourg. 
o FDI from the UK in 2007 were more than three times larger than in 
2006, to $266 billion, led by several large scale M&As (for example 
Barclays Bank continued to acquire banks in Africa); France was the 
third largest investor in the World with $225 billion; Germany reached 
its highest level with more than 80% of FDI directed to developed 
countries; FDI from the twelve new EU members registered a low 
performance, $14 billion, even if a few TNCs are gaining importance 
within the EU (UNCTAD, 2008, p. 76);    

 Japan: outward FDI from Japan reached their record level in 2007, $74 billion, 
thanks to strong net equity capital outflows and reinvested earnings (UNCTAD, 
2008, p. 76). 
 
Developed countries 2005 2006 2007
USA -13 (-1.47%) 217 (16.4%) 314 (15.73%)
EU-27 554.8 (62.97%) 572 (42.24%) 1142 (57.21%)
Japan 46 (5.22%) 50 (3.78%) 74 (3.71%)
Others 161.2 (18.28%) 248 (19.78%) 162 (8.15%)
Total from Developed 749 (85.0%) 1087 (82.2%) 1692 (84.8%)
TABLE 2.2 FDI outflows from Developed Countries (2005-2007)                                                  
($/billions and % of World total)
Source: adapted from UNCTAD, 2006, 2007, 2008