Multinationals and Foreign Direct Investment

Multinationals are active in different countries. This note explores why this is the case and how multinationals can be competitive in these foreign environments. At the same time, the note discusses recent trends in foreign direct investment (FDI). Excerpt UVA-G-0613 Rev. July 27, 2009 Multinationals and Foreign Direct Investment Globalization has increased the interconnectedness of countries: International trade flows and international capital flows between countries have grown dramatically in the last few decades, and there have also been significant international migration flows. This interconnectedness is changing the way we look at companies. It no longer makes sense to focus merely on the activities of a company in one region when studying its business strategy. Companies not only look beyond the domestic market and export or import, they also routinely extend their operations to neighboring or far-off countries and set up affiliates there. Production and sales decisions therefore have to be embedded in a global strategy. Multinationals, which are defined as companies that have a significant equity share in another company in a different country (an affiliate or subsidiary), are responsible for one out of every five dollars in sales of manufacturing goods in the United States and one out of every four euros in Europe. Also, the United Nations Conference on Trade and Development (UNCTAD) estimates that one-third of worldwide goods and service trade is intrafirm trade—that is to say, trade between subsidiaries of the IBMs, Samsungs, or British Petroleums of this world that are active in different countries, or trade between their subsidiaries and headquarters. This note focuses on the operations of multinationals and the particular challenges they face. A good starting point for thinking about multinationals is to realize that they operate in a foreign environment in which, on the surface, they should have a competitive disadvantage compared with domestic firms. Multinationals are not as familiar as local firms are with local customs, traditions, or languages, and they may not have the same insight into the quality of local suppliers that domestic firms may have. Hence, the preeminent question: What is it that multinationals bring to the table that makes them able to compete successfully despite their disadvantages? Why do multinationals extend their reach beyond their countries of origin? Before turning to those questions, we should focus first on foreign direct investment (FDI) with which multinationals are often associated in statistics and which gets absorbed in the aggregate macro category of Investment (I). FDI Flows . . .