Chapter 07 - Foreign Direct Investment

Chapter 07
Foreign Direct Investment
True / False Questions

1. (p. 242) A firm becomes a multinational enterprise when it undertakes foreign direct
investment.
TRUE

Difficulty: Easy

2. (p. 242) Licensing involves the establishment of a new operation in a foreign country.
FALSE

Difficulty: Easy

3. (p. 242) If a firm that makes bicycles in Germany acquires a French bicycle producer,
Greenfield investment has taken place.
FALSE

Difficulty: Medium

4. (p. 242) The amount of FDI undertaken over a given time period is known as the flow of FDI.
TRUE

Difficulty: Easy

5. (p. 242) The total accumulated value of foreign-owned assets at a given time is the inflow of
FDI.
FALSE

Difficulty: Easy

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6. (p. 242) FDI is seen by executives as a means of circumventing future trade barriers.
TRUE

Difficulty: Medium

7. (p. 244) Historically, most FDI has been directed at the developed nations of the world as
firms based in advanced countries invested in the others' markets.
TRUE

Difficulty: Medium

8. (p. 246) The total amount of capital invested in factories, stores, office buildings and the like
is referred to as the stock of FDI.
FALSE

Difficulty: Medium

9. (p. 246) The largest source country for FDI has been China.
FALSE

Difficulty: Medium

10. (p. 247) About 27 percent of the world's largest 100 nonfinancial multinationals in 2004 were
American companies.
TRUE

Difficulty: Medium

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11. (p. 247) In developing countries, about one third of FDI is in the form of mergers and
acquisitions.
TRUE

Difficulty: Hard

12. (p. 248) In 2004, about two thirds of FDI stock was in service industries.
TRUE

Difficulty: Hard

13. (p. 249) As compared to exporting and licensing, FDI is the more expensive and risky.
TRUE

Difficulty: Medium

14. (p. 250) Internalization theory is also known as the market imperfections approach.
TRUE

Difficulty: Medium

15. (p. 250) One of the problems of licensing is that it may result in a firm's giving away
valuable technological know-how to a potential foreign competitor.
TRUE

Difficulty: Medium

16. (p. 251) An oligopoly is an industry composed of a limited number of large firms.
TRUE

Difficulty: Easy

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17. (p. 252) When two or more enterprises encounter each other in different regional markets,
national markets or industries regional competition occurs.
FALSE

Difficulty: Medium

18. (p. 252) According to Vernon, location specific advantages can help explain the nature and
direction of FDI.
FALSE

Difficulty: Hard

19. (p. 253) Dunning, in the eclectic paradigm theory, suggests that a firm must establish
production facilities where foreign assets or resource endowments necessary to the production
of the product exist.
TRUE

Difficulty: Medium

20. (p. 254) Pragmatic nationalism traces its roots to Marxist political and economic theory.
FALSE

Difficulty: Medium

21. (p. 254) Classical economics and the international trade theories of Adam Smith and David
Ricardo form the basis for the free market view.
TRUE

Difficulty: Medium

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22. (p. 255) The free market view argues that FDI is a benefit to both the source country and to
the host country.
TRUE

Difficulty: Medium

23. (p. 255) Countries adopting a pragmatic stance pursue policies designed to maximize the
national benefits and minimize the national costs.
TRUE

Difficulty: Easy

24. (p. 256) An aspect of pragmatic nationalism is the tendency to aggressively court FDI
believed to be in the national interest by, for example, offering subsidies to foreign MNEs in
the form of tax breaks or grants.
TRUE

Difficulty: Medium

25. (p. 257) Foreign direct investment can make a positive contribution to a host economy by
supplying capital, technology and management resources that would otherwise not be
available and thus boost that country's economic growth rate.
TRUE

Difficulty: Medium

26. (p. 258) There is research supporting the view that multinational firms often transfer
significant technology when they invest in a foreign country.
TRUE

Difficulty: Medium

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27. (p. 258) Jobs created in local suppliers as a result of the MNE's investment and jobs created
because of increased local spending by employees of the MNE are examples of direct
employment effects of FDI.
FALSE

Difficulty: Medium

28. (p. 258) Host country citizens that are employed by an MNE following an FDI are an
example of an indirect effect of FDI.
FALSE

Difficulty: Medium

29. (p. 259) A country's balance of payments accounts keep track of both its payments to and its
receipts from other countries.
TRUE

Difficulty: Medium

30. (p. 259) A current account deficit exists when a country imports more than it exports.
TRUE

Difficulty: Easy

31. (p. 259) In recent years, the U.S. has run a persistent balance of payments surplus.
FALSE

Difficulty: Medium

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32. (p. 260) Host governments sometimes worry that the subsidiaries of foreign MNEs may have
greater economic power than indigenous competitors.
TRUE

Difficulty: Easy

33. (p. 261) FDI does not benefit the host country's balance of payments if the foreign subsidiary
creates demand for home-country exports of capital equipment, intermediate goods or
complementary products.
FALSE

Difficulty: Medium

34. (p. 262) The term offshore production refers to FDI undertaken to serve the home market.
TRUE

Difficulty: Easy

35. (p. 263) Countries cannot prohibit national firms from investing in certain countries for
political reasons.
FALSE

Difficulty: Medium

36. (p. 264) The two most common methods of restricting inward FDI are ownership restraints
and performance requirements.
TRUE

Difficulty: Medium

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37. (p. 265) The WTO has been very successful in efforts to initiate talks aimed at establishing a
universal set of rules designed to promote the liberalization of FDI.
FALSE

Difficulty: Medium

38. (p. 266) Licensing is a good option for firms in high-tech industries where protecting firmspecific expertise is of paramount importance.
FALSE

Difficulty: Medium

39. (p. 266-267) Typically licensing will be a common strategy in oligopolies where competitive
interdependence requires that multinational firms maintain tight control over foreign
operations so that they have the ability to launch coordinated attacks against their global
competitors.
FALSE

Difficulty: Medium

40. (p. 267) Licensing is more common in fragmented, low-tech industries in which globally
dispersed manufacturing is not an option.
TRUE

Difficulty: Medium

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Multiple Choice Questions

41. (p. 242) FDI occurs when a

A. Domestic firm imports products and services from another country
B. Firm ships its product from one country to another
C. Firm invests in the stock of another company
D. Firm invests directly in facilities to produce and/or market a product in a foreign country

Difficulty: Easy

42. (p. 242) A Greenfield investment

A. Is a form of FDI that involves the establishment of a new operation in a foreign country
B. Involves a 7 percent stock in an acquired foreign business entity
C. Involves a merger with a foreign business
D. Occurs when a firm acquires another company in a foreign country

Difficulty: Easy

43. (p. 242) If General Electric, a U.S. based corporation, purchased a 50% interest in a company
in Italy, that purchase would be an example of a(n)
A. Minority acquisition
B. Outright stake
C. Majority acquisition
D. Greenfield investment

Difficulty: Medium

44. (p. 242) The amount of FDI undertaken over a given time period is
A. The flow of FDI
B. The stock of FDI
C. The FDI outflow
D. The FDI inflow

Difficulty: Easy

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45. (p. 242) The stock of FDI is

A. The amount of FDI undertaken over a given period of time
B. The total accumulated value of foreign owned assets at a given time
C. The flow of FDI out of a country
D. The flow of FDI into a country

Difficulty: Easy

46. (p. 242) FDI has been rising for all of the following reasons, except
A. The globalization of the world economy
B. The general increase in trade barriers over the past 30 years
C. Firms are trying to circumvent trade barriers
D. There is a shift toward democratic political institutions and free market economies

Difficulty: Hard

47. (p. 244) Historically, most FDI has been directed at the _____ nations of the world as firms
based in advanced countries invested in
A. Underdeveloped, underdeveloped countries
B. Developed, underdeveloped countries
C. Developed, each other's markets
D. Underdeveloped, each other's markets

Difficulty: Easy

48. (p. 244) The U.S. has been an attractive target for FDI because of all of the following
reasons, except
A. Its small and wealthy domestic markets
B. Its dynamic and stable economy
C. Its favorable political environment
D. Its openness to FDI

Difficulty: Medium

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49. (p. 244) Identify the incorrect statement regarding the direction of FDI.
A. Historically, most FDI has been directed at the developing nations of the world
B. During the 1980s and 1990s, the United States was often the favorite target for FDI inflows
C. The developed nations of the EU have received significant FDI inflows
D. Recent inflows into developing nations have been targeted at the emerging economies of
South, East and Southeast Asia

Difficulty: Hard

50. (p. 246) Africa is not a popular destination for FDI because of all of the following reasons,
except
A. Political unrest in the region
B. Armed conflict in the region
C. Liberalization of FDI regulations
D. Frequent policy changes in the region

Difficulty: Easy

51. (p. 246) The total amount of capital invested in factories, stores, office buildings and the like
is summarized by
A. Gross fixed capital formation
B. Total investment capital
C. Total tangible investment
D. Gross depreciable investments

Difficulty: Easy

52. (p. 246) The largest source country for FDI since World War II has been
A. Japan
B. China
C. The United States
D. The United Kingdom

Difficulty: Medium

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53. (p. 247) Most cross-border investment is

A. In the form of Greenfield investments
B. Made via mergers and acquisitions
C. Between American and Japanese companies
D. Involved in building new facilities

Difficulty: Medium

54. (p. 247) Which of the following is not a reason why firms prefer to acquire existing assets
rather than undertake green-field investments?
A. Foreign firms are acquired because those firms have valuable strategic assets
B. Firms make acquisitions because they believe they can increase the efficiency of the
acquired unit by transferring capital, technology or management skills
C. Even though Greenfield investments are comparatively less risky for a firm acquisitions
always yield higher profits
D. Mergers and acquisitions are quicker to execute than green-field investments

Difficulty: Medium

55. (p. 247) In developing nations most FDI inflows are in the form of
A. Mergers
B. Greenfield investments
C. Acquisitions
D. Non-profit organizations

Difficulty: Medium

56. (p. 248) The sector composition of FDI shows that by 2004 approximately _____ of FDI
stock was in service industries.
A. One fourth
B. One third
C. Two third
D. Half

Difficulty: Hard

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57. (p. 248) The rise in FDI in the services sector is a result of all of the following, except
A. The general move in many developed countries away from manufacturing and toward
services
B. Accelerating regulations of services
C. Many services cannot be traded internationally
D. Many countries have liberalized their regimes governing FDI in services

Difficulty: Medium

58. (p. 248) When strategic assets such as brand loyalty, customer relationships or distribution
systems are important, _____ investments are more appropriate.
A. Merger and acquisition
B. Greenfield
C. Portfolio
D. New construction

Difficulty: Medium

59. (p. 249) _____ involves granting a foreign entity the right to produce and sell the firm's
product in return for a royalty fee on every unit sold.
A. Horizontal FDI
B. Licensing
C. Vertical FDI
D. Greenfield investment

Difficulty: Easy

60. (p. 249) In a licensing arrangement, the _____ bears the risk and cost of opening a foreign
market.
A. Licensee
B. Licensor
C. Acquiring firm
D. Greenfield investor

Difficulty: Medium

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61. (p. 250) Identify the theory that seeks to explain why firms often prefer foreign direct
investment over licensing as a strategy for entering foreign markets.
A. Internalization theory
B. Internationalization theory
C. Perfect markets theory
D. Small markets theory

Difficulty: Medium

62. (p. 250) According to the internalization theory, all of the following are drawbacks of
licensing as a strategy for exploiting foreign market opportunities, except
A. Licensing does not grant control over manufacturing, marketing and to a licensee in return
for a royalty fee
B. Licensing may result in a firm's giving away its know-how to a potential foreign
competitor
C. Licensing does not give the firm the tight control over manufacturing, marketing and
strategy that may be required to profitably exploit its advantage
D. A firms capabilities such as the management, marketing and manufacturing are often not
amenable to licensing

Difficulty: Medium

63. (p. 250) ______ is also known as market imperfections theory.

A. Internationalization theory
B. Internalization theory
C. Perfect markets theory
D. Small markets theory

Difficulty: Medium

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64. (p. 251) If four firms control 80 percent of a domestic market, then ______ exists.
A. An oligopoly
B. A monopoly
C. An oligarchy
D. Vertical integration

Difficulty: Medium

65. (p. 251) According to Knickerbocker

A. The firms that pioneer a product in their home markets undertake FDI to produce a product
for consumption in a foreign market
B. When a firm that is part of an oligopolistic industry expands into a foreign market, other
firms in the industry will be compelled to make similar investments
C. Combining location-specific assets or resource endowments and the firm's own unique
assets often requires FDI
D. Impediments to the sale of know-how increase the profitability of FDI relative to licensing

Difficulty: Hard

66. (p. 252) The eclectic paradigm was developed by

A. F. T. Knickerbocker
B. Adam Smith
C. Raymond Vernon
D. John Dunning

Difficulty: Easy

67. (p. 252) When two or more enterprises encounter each other in different regional markets,
national markets or industries, there is
A. Vertical integration
B. Horizontal integration
C. Multipoint competition
D. Monopolistic competition

Difficulty: Easy

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68. (p. 252) The product life cycle suggests that

A. Often the same firms that pioneer a product in their home markets undertake FDI to
produce a product for consumption in foreign markets
B. When a firm that is part of an oligopolistic industry expands into a foreign market, other
firms in the industry will be compelled to make similar investments
C. Combining location-specific assets or resource endowments and the firm's own unique
assets often requires FDI
D. Impediments to the sale of know-how increase the profitability of FDI relative to licensing

Difficulty: Medium

69. (p. 253) The _____ suggests that a firm will establish production facilities where foreign
assets or resource endowments that are important to the firm are located.
A. Product life cycle
B. Strategic behavior theory
C. Multipoint competition theory
D. Eclectic paradigm

Difficulty: Easy

70. (p. 253) Advantages that arise from using resource endowments or assets that are tied to a
particular location and that a firm finds valuable to combine with its own unique assets are
known as
A. Location specific advantages
B. Resource specific advantages
C. Competitive advantages
D. Directional advantages

Difficulty: Easy

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71. (p. 253) John Dunning, a champion of the eclectic paradigm, argues that
A. The firms that pioneer a product in their home markets undertake FDI to produce a product
for consumption in a foreign market
B. When a firm that is part of an oligopolistic industry expands into a foreign market, other
firms in the industry will be compelled to make similar investments
C. Combining location-specific assets or resource endowments and the firm's own unique
assets often requires FDI
D. Impediments to the sale of know-how increase the profitability of FDI relative to licensing

Difficulty: Hard

72. (p. 254) According to the _____ view of FDI, MNEs extract profits from the host country
and take them to their home country, giving nothing of value to the host country in exchange.
A. Imperialist
B. Conservative
C. Free market
D. Radical

Difficulty: Medium

73. (p. 254) Which of the following is not a reason that the radical position of MNEs was in
retreat by the end of the 1980s?
A. The strong economic performance of those developing countries that embraced capitalism
rather than radical ideology
B. The collapse of communism in Eastern Europe
C. The generally abysmal economic performance of those countries that embraced the radical
position
D. A growing belief in many capitalist countries that MNE's tightly controls key technology
and that important jobs in the MNEs' foreign subsidiaries go to home-country nationals

Difficulty: Medium

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74. (p. 255) According to _____ international production should be distributed among countries
according to the theory of comparative advantage.
A. The radical view
B. The eclectic view
C. Pragmatic nationalism
D. The free market view

Difficulty: Medium

75. (p. 256) A distinctive aspect of _____ is the tendency to aggressively court FDI believed to
be in the national interest by, for example, offering subsidies to foreign MNEs in the form of
tax breaks or grants.
A. The dogmatic view
B. Pragmatic nationalism
C. The radical view
D. The conservative view

Difficulty: Medium

76. (p. 257) When a company brings capital and/or technology to a host country, the host country
benefits from the
A. Competitive effect of FDI
B. The resource transfer effect of FDI
C. The balance of payments effect of FDI
D. The effect on competition and economic growth

Difficulty: Easy

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77. (p. 258) When jobs are created in local suppliers as a result of the FDI and when jobs are
created because of increased local spending by employees of the MNE, the MNE has a _____
effect on employment.
A. Direct
B. Indirect
C. Inward
D. Outward

Difficulty: Medium

78. (p. 259) A _____ keeps track of a country's payments to and its receipts from other
countries.
A. Federal payments ledger
B. Current accounting system
C. Checks and balances account
D. Balance of payments account

Difficulty: Easy

79. (p. 259) The _____ tracks the export and import of goods and services. A current account
deficit or trade deficit as it is often called, arises when a country is importing more goods and
services than it is exporting.
A. Current account
B. Debit account
C. Surplus account
D. Capital account

Difficulty: Medium

80. (p. 261) Three costs of FDI concerns of host countries arise from all of the following except
A. Adverse effects on competition within the host nation
B. Adverse effects on the balance of payments
C. The perceived loss of national sovereignty and autonomy
D. Debit on the current account of the home country's balance of payments

Difficulty: Hard

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81. (p. 262) FDI undertaken to serve the home market is known as
A. Greenfield investment
B. FDI substitution
C. Offshore production
D. Home market FDI

Difficulty: Medium

82. (p. 263) Double taxation is

A. Charging double taxes in the home country
B. Charging double taxes in the host country
C. Taxation of income in both home and host country
D. Paying income taxes at twice the normal rate

Difficulty: Easy

83. (p. 264) _____ are controls over the behavior of the MNE's local subsidiary.
A. Performance requirements
B. Ownership restraints
C. Double taxation laws
D. Greenfield restrictions

Difficulty: Easy

84. (p. 267) Licensing would be a good option for firms in which of the following industries?
A. High-technology industries in which protecting firm-specific expertise is of paramount
importance and licensing is hazardous
B. Global oligopolies, in which competitive interdependence requires that multinational firms
maintain tight control over foreign operations
C. Industries in which intense cost pressures require that multinational firms maintain tight
control over foreign operations
D. In fragmented, low technology industries in which globally dispersed manufacturing is not
an option

Difficulty: Hard

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85. (p. 267) _____ is essentially the service industry version of licensing, although it normally
involves much longer term commitments.
A. Franchising
B. Subsidizing
C. Greenfield investment
D. Patenting

Difficulty: Easy

Essay Questions

86. (p. 242) Discuss the connection between foreign direct investment and multinational
enterprises?
Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to
produce and/or market a product in a foreign country. The U.S. Department of Commerce
states that FDI occurs whenever a U.S. citizen, organization or affiliated group takes an
interest of 10 percent or more in a foreign business entity. Once affirm undertakes FDI, it
becomes a multinational enterprise.

Difficulty: Easy

87. (p. 242) What are the two forms of foreign direct investment?
The two forms of FDI are Greenfield investment or establishing a new operation in a foreign
country and mergers and acquisitions whereby a company expands internationally through an
existing firm. Acquisitions can be minority, majority or a 100% ownership position.

Difficulty: Medium

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88. (p. 242) Discuss the trends in FDI over the last 30 years. Be sure to differentiate between the
stock of FDI and the flow if FDI.
The flow of FDI refers to the amount of FDI undertaken over a given period, while the stock
of FDI refers to the total accumulated value of foreign-owned assets at a given time. Over the
last 30 years there has been a marked increase in both the flow and the stock of FDI in the
world economy. Over this period, the flow of FDI accelerated faster than the growth in world
trade and world output.

Difficulty: Hard

89. (p. 242) Discuss the reasons for the growth in FDI over the last 30 years.
FDI has grown more rapidly than world trade and world output for several reasons. First,
many companies see FDI as a means of circumventing potential trade barriers. Second,
political and economic changes in many of the world developing nations has been
encouraging FDI. Finally, the globalization of the world economy is having a positive impact
on the volume of FDI as firms now see the whole world as their market.

Difficulty: Medium

90. (p. 242-248) What is a Greenfield investment? How does it compare to an acquisition? Which
form of FDI is a firm more likely choose? Explain your answer.
FDI can take the form of a Greenfield investment in a new facility or an acquisition of or a
merger with an existing local firm. Research shows that most FDI takes the form of mergers
and acquisitions rather than Greenfield investment. Mergers and acquisitions are more
popular for three reasons. First, mergers and acquisitions are quicker to execute than
Greenfield investments. Second, foreign firms are acquired because those firms have valuable
strategic assets. Third, firms make acquisitions because they believe they can increase the
efficiency of the acquired firm by transferring capital, technology or management skills.

Difficulty: Hard

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91. (p. 248) Discuss the shift in FDI from manufacturing to services. What is driving the trend?
Over the last twenty years, the sector composition of FDI has shifted from extractive
industries and manufacturing toward services. By 2004, some 66 percent of the stock of FDI
was in services. Four factors are driving the shift to services. First, the shift reflects the
general move in many developed economies away from manufacturing and toward service
industries. Second, many services cannot be traded internationally and FDI is a principal was
to bring services to foreign markets. Third, many countries have liberalized their regimes
governing FDI in services making the option more attractive to firms. Finally, the rise of
Internet-based global telecommunications networks has allowed some service enterprises to
relocate some of their value creation activities to different nations to take advantage of
favorable factor costs.

Difficulty: Medium

92. (p. 249) Consider why firms selling products with low value-to-weight ratios choose FDI
over exporting.
Products with low value-to-weight ratios such as soft drinks or cement are frequently
produced in the market where they are consumed. When transportation costs are added to
production costs, it becomes unprofitable to shift such products over a long distance. For
firms that can produce low value-to-weight products at almost any location the attractiveness
of exporting decreases and FDI or licensing becomes more appealing.

Difficulty: Medium

93. (p. 250) Discuss the market imperfections explanation of FDI. What is its relationship with
internalization theory?
Market imperfections or factors that inhibit markets from working perfectly, provide a major
explanation of why firms prefer FDI to either exporting or licensing. In the international
business literature, the marketing imperfections approach is referred to as internalization
theory. According to the theory, FDI will be preferred when there are impediments that make
both exporting and the sale of know-how difficult and/or expensive.

Difficulty: Hard

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94. (p. 250) What is licensing? How does it work?

Licensing occurs when a domestic firm, the licensor, licenses to a foreign firm, the licensee,
the right to produce its product, to use its production processes or to use its brand name or
trademark. In return, the licensor collects royalty fees on every unit the licensee sells or on
total licensee revenues. The licensor also benefits from the arrangement in that the licensee
bears the cost and risk of expanding into a foreign market.

Difficulty: Medium

95. (p. 250) Compare and contrast the advantages of foreign direct investment over exporting
and licensing.
A firm will favor foreign direct investment over exporting as an entry strategy when
transportation costs or trade barriers make exporting unattractive. Furthermore, the firm will
favor foreign direct investment over licensing (or franchising) when it wishes to maintain
control over its technological know-how or over its operations and business strategy or when
the firm's capabilities are simply not amenable to licensing, as may often be the case.

Difficulty: Easy

96. (p. 251) Consider the notion that FDI flows are a reflection of strategic rivalry between firms
in the global marketplace. What is the main limitation of the theory?
The strategic behavior approach to explain FDI was initially expounded by Knickerbockers
who argued that in an oliogopolistic industry, a "follow the leader" mentality will prompt
firms to pursue FDI when another firm in the industry has already done so. However, the
theory fails to explain why the first firm decided to undertake FDI, rather than export or
license.

Difficulty: Medium

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97. (p. 252) What is multipoint competition? How do firms respond to multipoint competition?
Multipoint competition arises when two or more enterprises encounter each other in different
regional markets, national markets or industries. Economic theory suggests that firms will try
to match each other's moves in different markets to try to hold each other in check. If a firm is
successful with this strategy, the firm will ensure that a rival does not take a commanding
position in one market and then use the profits generated in that market to underwrite
competitive attacks in other markets.

Difficulty: Easy

98. (p. 252) Explain the product life cycle theory and its connection with FDI.
The product life cycle theory, developed by Ray Vernon, suggests that the same firms that
pioneer a product in their home country will undertake FDI to produce a product for
consumption in foreign markets. According to the theory, firms will invest in industrialized
countries when demand in those countries is sufficient to support local production. They
subsequently shift production to developing countries when product standardization and
market saturation give rise to price competition and cost pressures. Investment in developing
countries, where labor costs are lower is seen as the best way to reduce costs.

Difficulty: Medium

99. (p. 252-253) What are location-specific advantages? How do they help explain FDI?
Location specific advantages are advantages that arise from using resource endowments or
assets that are tied to a particular foreign location and that a firm finds valuable to combine
with its own unique assets. Natural resources such as oil and minerals for example, are
specific to certain locations. Firms must undertake FDI to exploit such foreign resources.

Difficulty: Easy

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100. (p. 253) Explain John Dunning's position on FDI. What is the eclectic paradigm?
John Dunning has argued that to fully understand FDI it is important to consider the role of
location specific advantages. According to Dunning, a firm will be prompted to undertake FDI
in an effort to exploit assets that are specific to a particular location. Dunning's theory, the
eclectic paradigm, combines the arguments of internalization theory with the notion of
location-specific advantages to suggest that combining location-specific assets or resource
endowments and the firm's own unique capabilities often requires the firm to establish
production facilities where the foreign assets or resource endowments are located.

Difficulty: Hard

101. (p. 254-256) Discuss the various political ideologies and their impact on foreign direct
investment.
The radical view writers argue that the multinational enterprise (MNE) is an instrument of
imperialist domination. The free market view argues that international production should be
distributed among countries according to the theory of comparative advantage. The pragmatic
nationalist view is that FDI has both benefits and costs.
The radical view has a dogmatic radical stance that is hostile to all inward FDI
The free market view is at the other extreme and based on noninterventionist principle of free
market economics. Between these two extremes is an approach called pragmatic nationalism.

Difficulty: Hard

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102. (p. 257-262) Discuss the benefits and costs of FDI from the perspective of a host country and
from the perspective of the home country.
The main benefits of inward FDI for a host country arise from resource-transfer effects,
employment effects, balance-of-payments effects and effects on competition and economic
growth. Three costs of FDI concern host countries. They arise from possible adverse effects
on competition within the host nation, adverse effects on the balance of payments and the
perceived loss of national sovereignty and autonomy.
The benefits of FDI to the home (source) country arise from three sources. First, the home
country's balance of payments benefits from the inward flow of foreign earnings. Second,
benefits to the home country from outward FDI arise from employment effects. Third,
benefits arise when the home-country MNE learns valuable skills from its exposure to foreign
markets that can subsequently be transferred back to the home country. The most important
cost/concern of FDI for the home country centers on the balance-of-payments and
employment effects of outward FDI.

Difficulty: Hard

103. (p. 266-267) Describe the situations when licensing is not a good option for a firm.
Licensing is not a good option in three situations. First, licensing is hazardous in high-tech
industries where protecting firm-specific expertise is very important. Second, licensing is not
attractive in global oligopolies where tight control is necessary so that firms have the ability to
launch coordinated attacks against global competitors.
Finally, in industries where intense cost pressures require that MNEs maintain tight control
over foreign operations, licensing is not the best option.

Difficulty: Medium

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Chapter 07 - Foreign Direct Investment

104. (p. 267) What is franchising? What type of firm uses franchising as a means of expanding
into foreign markets?
Franchising is essentially the service-industry version of licensing. With franchising, the firm
licenses its brand name to a foreign firm in return for a percentage of the franchisee's profits.
The franchising contract specifies the conditions that the franchisee must fulfill if it is to use
the franchisor's brand name.
Franchise agreements usually have a longer time commitment than do licensing arrangements.
Franchising is common in the fast food industry because fast food cannot be exported,
because franchising minimizes the costs and risks associated with opening a foreign market,
because brand names are relatively easy to protect, because there is no compelling reason for
a firm to have tight control over franchisees and because fast food know-how is easily
transferred.

Difficulty: Medium

105. (p. 267) How useful are the product life cycle theory and Knickerbocker's theory of
horizontal FDI to business?
The product life cycle theory and Knickerbocker's theory of horizontal FDI to business are not
particularly useful from a business perspective because the theories are descriptive rather than
analytical. The theories are useful for explaining historical patterns of FDI, but they do a poor
job of identifying the factors that influence the relative probability of FDI, licensing and
exporting.

Difficulty: Medium

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