The simplest way of earning a return on investment in a foreign country is to purchase financial assets such as stocks and bonds in a foreign company. The next simplest alternative is either to export to a foreign country or license a foreign company. These alternatives allow a company to avoid the risks and expenses associated with transferring personnel, dealing with foreign languages and cultures, obtaining supplies, developing markets, operating in foreign political environments, and a host of other problems.

Nevertheless, many of the world`s most successful companies find it in the interest of their investors to incur these risks and expenses by making direct foreign investments. In the following sections we explore the political, economic, and competitive motives behind direct foreign investment.

Political Motives

Some of the most obvious motives for direct foreign investment are political. Governments are frequently convinced that it is in their best interest to deny or restrict their citizens` access to goods and services from abroad. Despite the clear disadvantages of denying consumers foreign goods that are better made and/or less expensive, governments often act out of a desire to protect domestic jobs from perceived threats or out of nationalism and/or xenophobia.

Foreign businesses that are denied the right to export to a country often find that they can penetrate the market by agreeing to manufacture or at least assemble goods within the target country. Sometimes these same tactics are used to overcome restrictions on imports such as quotas, tariffs, and import duties. Local production mitigates concerns about job loss and nationalistic pride.

Political motives for direct foreign investment are not always related to overcoming restrictions on trade. Sometimes political factors are used by local authorities as inducements. Parent organizations that are located in countries where increased taxation, regulation, and/or other forms of interference are present or threatened can avoid these problems by transferring operations to countries that will treat them more favorably. A truly multinational business is usually less subject to unfavorable political action because local governments are constrained by the ability of the business to transfer operations elsewhere, costing the current host country jobs, revenues, and perhaps prestige.

Economic Motives

Economic factors can also motivate direct foreign investment. Some companies can obtain substantial economies of scale in areas such as research and development, marketing, distribution, financing, and production by operating at volumes that can be justified only by a worldwide market.

For example, the Swedish auto and aerospace markets are not large enough to spread the substantial investment required to develop advanced products. Swedish auto and aerospace companies are compelled to participate in multinational production and distribution. Companies in larger countries are able to spread these costs over a much larger sales volume.

In addition to economies of scale that are provided by multinational operations, companies can overcome shortages and imperfections in local markets for factors of production. Perhaps the local population cannot provide sufficient numbers of technicians and engineers, or particular raw materials may be unavailable or overpriced in local markets. Multinational production facilitates access to the factors of production at the lowest available cost.

As explained in Chapter 13, multinational corporations that produce and sell in many countries can exploit fluctuations in real exchange rates. When exchange rate changes raise inflation-adjusted prices in one country and lower them in another, the company can shift production to the low-cost country and sales to the high-price country.

Competitive Motives

Competitive motives for direct foreign investment are closely related to, and difficult to distinguish from, economic and political motives. A business may make direct foreign investments in cases where the immediate economic and/or political benefits are not clear. The motive is often related to securing the business against the threat of existing or potential competition.

For example, companies may seek to establish international market share or production even though the effort is apparently unprofitable, as in cases of dumping, or the export of products at prices that are below the cost of production. The purpose of such actions is often to undermine an existing or potential competitor. Once market share is established, production costs fall or prices are raised. In many cases, dumping constitutes an illegal activity punishable by fines and compensatory payments to companies that have been damaged.

In some cases, companies have lobbied for the establishment of protectionist barriers against foreign businesses in order to foster the development of a domestic industry that does not yet exist (known as "infant industry" policies).

Another example of competitively motivated direct foreign investment is a merger with or an acquisition of a foreign business for the purpose of gaining access to foreign technology. Sometimes investments are made in foreign companies in order to gain access to foreign marketing or production expertise. Many governments have established barriers to such acquisitions.

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