Chapter 18Foreign Direct Investment Theoryand Political RisknQuestions18-1.Evolving into Multinationalism. As a firm evolves from a purely domestic into a true multinational enterprise, it must consider (a) its competitive advantages, (b) its production location, (c) the type of control it wants to have over any foreign operations, and (d) how much monetary capital to invest abroad. Explain how each of these considerations is important to the success of foreign operations.If a firm lacks sufficient competitive advantage to compete effectively in its home market, it is unlikely to have sufficient advantages of any type to be successful in a foreign market. This is because the competitive advantages of the home market must be enduring, transferable, and sufficiently powerful to enable the firm to overcome the assorted difficulties of operating in a foreign environment. Foreign operations must be located where market imperfections are such that the firm can take advantage of its competitive advantages to the degree necessary to earn a risk-adjusted rate of return above the firms cost of capital.The firm must decide upon the degree of control it will need over the foreign operation, recognizing that greater control usually involves both greater risk and a greater investment. Viewing a spectrum of degrees of control, licensing and management contracts provide a low level of control (along with a low level of financial investment); joint ventures necessitate a somewhat higher level of control; and greenfield direct investments and/or acquisition of an existing foreign firm require the highest degree of control (along with a higher level of financial investment).The spectrum of investment approaches (licensing, management contracts, joint ventures, and direct investment) require in that order ever-increasing investment of more monetary capital. The firm must decide if the benefits of greater investment (presumably greater profits, plus possibly acquiring market share or forestalling competitors from gaining a greater market share) are worth the differing amounts of monetary capital needed.18-2.Theory of Comparative Advantage. What is the essence of the theory of comparative advantage?The essence of the theory of comparative advantage is that a country should specialize in producing those goods and services for which it has a relative cost advantage compared to other countries, export a portion of those goods and services, and use the proceeds from those exports to import goods and services for which it has a relative cost disadvantage. The theory focuses on the concept of “relative advantage” for each country. Relative advantage means a comparison of the ratio of costs between items within one country to the ratio of costs within another country. A country might have an absolute advantage in everything, but it will still gain by specializing where its relative advantage is greatest.18-3.Market Imperfections. MNEs strive to take advantage of market imperfections in national markets for products, factors of production, and financial assets. Large international firms are better able to exploit such imperfections. What are their main competitive advantages?MNEs strive to take advantage of imperfections in national markets for products, factors of production, and financial assets. Imperfections in the market for products translate into market opportunities for MNEs. Large international firms are better able to exploit such competitive factors as economies of scale, managerial and technological expertise, product differentiation, and financial strength than are their local competitors. In fact, MNEs thrive best in markets characterized by international oligopolistic competition, where these factors are particularly critical. In addition, once MNEs have established a physical presence abroad, they are in a better position than purely domestic firms to identify and implement market opportunities through their own internal information network.18-4.Strategic Motives for Foreign Direct Investment (FDI). a.Summarize the five main motives that drive the decision to initiate FDI. Strategic motives drive the decision to invest abroad and become a MNE. These motives can be summarized under the following five categories. i.Market seekers produce in foreign markets either to satisfy local demand or to export to markets other than their home market. U.S. automobile firms manufacturing in Europe for local consumption are an example of market-seeking motivation. ii.Raw material seekers extract raw materials wherever they can be found, either for export or for further processing and sale in the country in which they are foundthe host country. Firms in the oil, mining, plantation, and forest industries fall into this category.iii.Production efficiency seekers produce in countries where one or more of the factors of production are underpriced relative to their productivity. Labor-i