Hello again. In the last video, we concentrated on international trade; we looked at the nature of trade barriers; we examined the possible motives of trade growth. In this video, we're going to look at the trends of international foreign direct investment or FDI as it's called; we'll look at the problems of its measurement; we'll explore some of the reasons behind its growth. A foreign direct investment involves the purchase or expansion of a business in one country by business in a foreign country. It can take several forms: it can involve the purchase of shares, a merger, establishment of new business facilities, and finally, enlargement of existing foreign business. But note, it does not include the purchase of local or national government bonds. Now the data on FDI is usually solicited from individual companies, and this is where the problems start. Let's look at the United States, which is the largest owner of FDI stock in the world – it owns almost 22 % of the total world foreign direct investment. The authorities there collect annual data, and every five years they hold a benchmark survey. The annual surveys only target the larger firms – the argument, after all, that they account for most of the FDI. In the benchmark surveys, they take a wider range of firms, but they also then have three different forms, and the detailed information is only solicited from firms with a turnover of more than 150 million. Now this is a situation in the United States. Imagine what happens as we slide down the scale towards less-rich states and less efficient administrations. Immediately after the Second World War, there was really only one source of foreign capital and that was the United States. It was only when Europe had replenished its depleted reserves of foreign exchange at the end of the 1950s that it began to re-enter the FDI market. But after that, the volume of annual FDI has grown very, very rapidly, and today it stands at 1.3 trillion dollars. Initially, three quarters of this FDI went to other developed economies. As late as 1990, the share of FDI going to developing economies was less than 20 %, but since then it's grown extremely steadily. By today, it's well over 50 percent. So, what determines foreign direct investment? But before answering that question, it's useful to distinguish between three different forms. The first, takes the form of investment into broadly similar activities as those of the investing company. For example, a car company might invest in assembly and production facilities abroad. And we can call this horizontal investment. The second is towards investment activities higher or lower in the production chain. For example, an oil drilling firm might branch into shipping and refining and retail outlets. We can call this vertical investment. And finally, we have examples of firm that shift foreign direct investment and even their headquarters to profit from differences in regulatory regimes and tax levels. I suppose we can call this tactical investment. For example, the iconic Swedish furniture giant Ikea, almost 350 stores in 43 countries and earnings of 4 billion dollars, is not based in Sweden – it's based in the university town in Leiden in the Netherlands. Actually, it's about five-minute cycle ride from where I live. Now for each of these different forms, there are different determinants, but one factor uniting them all is a regulatory framework in the home country. Although the international financial system established after the war witnessed the freeing of commercial transactions, the freeing up of payments for trade and associated services, many countries maintained controls over capital flows until deep into the 1980s. One exception was the United States. United Kingdom was also an exception – it freed up its FDI but only to countries traded in sterling, which meant basically its colonies and some of the Commonwealth. Now let's move specifically a second factor determining FDI, especially horizontal FDI, is the desire to leapfrog international trade barriers and to get access to markets on the same basis as domestic producers. But as the impact of trade barriers diminishes, so then does the power of this explanation, and this brings us to a third factor. In situations where trade barriers don't play a major role, then they use the same kind of gravity models as used for international trade. Explanation's then based on the size of markets for the products concerned and the geographical and cultural difference. Add to this some economic specification for cost differentials and much of the horizontal FDI flows can be explained – this is the sort of North-North trading. If we look at horizontal FDI towards less-developed countries, then the balance of explanations needs to shift away from the accent on markets and towards an emphasis on the type of enterprise and the factory advantage. Is it labor intensive? Is there low labor costs? But here you need to ask the question, why the preference for ownership rather than outsourcing? Why own the firm rather than get somebody else to do it for you? And one important factor here is the knowledge intensity of the product. If you own the business, you can also control access to the technology and therefore preserve conditions of monopoly. But these factors aren't likely to operate in the same way for vertical integration, especially since it started shifting so markedly towards developing countries. In this case, the explanation would lie in gaining access to raw materials supplies and securing that access by investing lower down the supply chain. And then that final category of tactical investment. I like my Ikea example, but there's not much evidence that such considerations play an important role in overall patterns of FDI location. Ikea is an exception rather than the rule. It's a shame, really; it's a nice story. Okay, let's pull this all together now. In this video, we've looked at the rise of foreign direct investment. We've examined some of the factors that could explain its growth and distribution. In the next video, we're going to turn our attention to financial markets. Meanwhile, we prepared a visualization of the world map of FDI and we'd like you to look at it now.
