Models of Foreign Direct Investments

There are five major types of Foreign Direct Investments viz. Access to Intangible assets, Access to cheaper factors of production, Mutual Investment Model, Host Country Market Model and Regional Integration. These have been discussed below:

Access to Intangible Assets

The first type of FDI is taken to gain access to intangible assets, e.g. resources, technical knowledge, material know-how, patent or brand names, owned by a company in the host country.

Access to Cheaper Factors of Production

According to this model the company shall invest in order to gain access to cheaper factors of production, e.g. low-cost labour. The government of the host country may encourage this type of FDI if it is pursuing an export-oriented development strategy. Since it may provide some form of investment incentive to the foreign company, in form of subsidies, grants and tax concessions.

If the government is using an import-substitution policy instead, foreign companies may only be allowed to participate in the host economy if they possess technical or managerial know-how that is not available to domestic industry. Such know-how may be transferred through licensing. It can also result in a joint venture with a local partner.

Mutual Investment Model

This model involves international competitors undertaking mutual investment in one another, e.g. through cross-shareholdings or through establishment of joint venture, in order to gain access to each other’s product ranges. As a result of increased competition among similar products and R&D-induced specialisation this type of FDI emerged.

Both companies often find it difficult to compete in each other’s home market or in third-country markets for each other’s products. If none of the products gain the dominant advantage, the two companies can invest in each other’s area of knowledge and promote sub-product specialisation in production.

Host country market Model

This concerns the access to customers in the host country market. In this type of FDI there are not observed any underlying shift in comparative advantage either to or from the host country.

Export from the companies’ home base may be impossible, e.g. certain services, or the capability to request immediate design modifications. The limited tradability of many services has been an important factor explaining the growth of FDI in these sectors.

Regional Integration

This related to trade diversionary aspect of regional integration. This type occurs when there are location advantages for foreign companies in their home country but the existence of tariffs or other barriers of trade prevent the companies from exporting to the host country.

The foreign companies therefore jump the barriers by establishing a local presence within the host economy in order to gain access to the local market. The local manufacturing presence need only be sufficient to circumvent the trade barriers, since the foreign company wants to maintain as much of the value-added in its home economy.