Question

Why do so many firms apparently prefer FDI to either exporting (producing goods at home and then shipping them to the receiving country for sale) or licensing (granting a foreign entity the right to produce and sell the firm’s product in return for a royalty fee on every unit that the foreign entity sells)? Please support your answers with some examples from the real life ( if you can).

DQ 2

A) Why is the U.S. the largest recipient of FDI from companies in other countries?

B) What are companies from other countries looking for when they invest in the U.S.? What are the implications of COVID-19 on their decisions now?

C) Why is the U.S. often the largest source of FDI? Did you think it was China?

Answer 1

1) Before understanding why FDI is prefered , it is important to understand the difference between all of the them.

Firstly, FDI means Foreign Direct Investment which means that a company directly engages in setting up manufacturing or processing utilities in the foreign country and invests in the foreign country to capture the foreign market. Export, whereas means producing goods in the domestic country but selling it in the foreign country. And licensing means giving right or grant to a foreign company to establish its branches under its brand in the foreign company in return for some fee or royality.

• FDI is always prefered to exporting and licensing as the later two has some limitation which FDI covers up. Exporting has the limitation that due to changes in foreign country's law relating to trade may impose restriction in free flow of expoting of goods ( real life example- USA increasing taxes / quota for CHINESE companies exporting goods to USA). Also exporting leads to huge transportation cost which reduces the profitability.
• Licensing on the other hand gives the host country very less exposure in controlling its processing and production activities in the foreign country which may lead to not fulfilling quality standard as maintained by host company in its domestic market. Also, in case of licensing, host company needs to share its technical know how which may help the foreign company but affect the host company as their process and stratigies are now open to the foreign company.
• FDI is highly preferable as it has no transportation cost, also has no barrier effect like exporting. The company itself establishes its branch in the foreign market so it has its full control over the operation unlike licensing. Hence it is preferable to exporting or licensing.

2) a) USA is always on the top choice while a company thinks about FDI as USA is a stable economy and it always prefers to look at investor's demand. Being the developed economy, USA has a high skilled labour force which is a factor whike investing by investors through FDI as it will be operating there and need the workforce to run its operations. Moreover USA provides a fair and transparent environment , good infrastructure facility for all investors.

b) There are a number of factors which companies look before investing in USA. Along which are : productive/skilled labour force, innovative environment, fair and transparent environment, a stable economy so that it doesnt affect the company's objective and operations While choosing US, companies keep in mind the domestic and global access it would get by operating there.

Definately, COVID has brought a change in how investors think about investing as COVID has distrupted the economy badly and is affecting as everything went in lockdown thus economic activity didnt grow leading to high cost and low profit. But as economy is recovering, investors are feeling confident and will invest as and when they feel confident. And as always USA will be the choice while investing via FDI because of the above advantages that USA provides than that of other countries.

d) USA is also among the largest source of FDI as companies of USA are willing to go beyond the market of USA and invest in emerging and developing economies where labour is highly cheap and market is highly demanding like INDIA. USA remains at the too spot in FDI source in UK as well. Overall Chinese companies mainly move out of china than USA and invest in other nations to get benefited by cheap labour and unstable economic and geopolitical tension that impact their profitability by operating in China. Hence both are a good source of FDI in other countries.