Question

For each of the following, specify whether the foreign direct investment is horizontal or vertical; in addition, describe whether that investment represents an FDI inflow or outflow from the countries that are mentioned. a. Vodafone (a U.K.-based company) plans to improwe its network and services in Romania after the results in this market lagged behind other countries b. General Electric (an American company) buys Alstom (another American company) energy assets. c. Exxon (an American company) plans the construction of new delayed coker unit in Belgium. d. PetroChina (a Chinese company) plans to invest in global oil and natural gas assets in a venture in Western Australia.

Short answer

a. Horizontal FDI, inflow for Romania. b. Not applicable, no cross-border investment. c. Horizontal FDI, inflow for Belgium. d. Horizontal FDI, inflow for Australia.

Step-by-step solution

- Vodafone's Investment Type

To determine whether the investment is horizontal or vertical, we need to identify if Vodafone is investing in the same business activity abroad. Since Vodafone is a telecommunication company improving its network services, the activity remains the same, indicating that the investment is horizontal. As Vodafone is a U.K.-based company investing in Romania, this represents an FDI inflow for Romania.

- General Electric's Investment Type

General Electric and Alstom are both in the energy sector. Since General Electric is acquiring energy assets from another American company, this transaction does not cross international borders. As such, there is neither FDI inflow nor outflow; it is a domestic transaction, not relevant for FDI categorization.

- Exxon's Investment Type

Exxon, an oil company, is investing in the construction of a new delayed coker unit, which is a process unit in a refinery. Since this is the same industry, the investment is horizontal. As the construction is in Belgium, it's an FDI inflow for Belgium.

- PetroChina's Investment Type

PetroChina is investing in assets that are in the same industry as its main business (oil and natural gas). Therefore, it is a horizontal investment. Since this investment is in Western Australia, it represents an FDI inflow to Australia.

Key concepts

Horizontal FDI

Horizontal Foreign Direct Investment (FDI) occurs when a business invests in the same industry abroad as it operates in at home. Essentially, a company is duplicating its home country business activities in another country. For example, if a smartphone manufacturer based in country A opens a production plant in country B, this is considered horizontal FDI.

The primary motivation for horizontal FDI is often to bypass trade barriers, access new markets, or reduce transportation costs. In the case of Vodafone from the exercise, improving its network and services in Romania after underperforming in that market is a clear example of horizontal FDI. Vodafone is essentially expanding its telecommunications services, which is its core business, into a new geographic location.

Why Choose Horizontal FDI?

• Market Access: Companies like Vodafone seek to establish a direct presence in new markets to capitalize on local demand.
• Competitive Advantage: Operating in the same line of business in a foreign country helps maintain brand consistency and corporate culture.
• Efficiency: It may lead to cost savings through economies of scale.

Horizontal FDI can provide companies with new avenues for growth outside their saturated home markets.

Vertical FDI

Contrastingly, Vertical Foreign Direct Investment (vertical FDI) is when a company invests in a foreign operation, but not necessarily in the same business activity. It involves different but related activities⁠—for example, a manufacturer investing in a foreign company that supplies raw materials needed for its products. Vertical FDI is split into two further categories:

Upstream vertical FDI

When the investment moves toward the source of production, like a car manufacturer investing in a tire factory.

Downstream vertical FDI

When the investment moves closer to the end consumer, such as a clothing retailer acquiring a foreign clothing factory.

Unfortunately, in the provided exercise examples, we do not have a vertical FDI scenario, but understanding this concept is essential. Companies engage in vertical FDI for various reasons, such as securing supply chains or optimizing their production processes to be closer to primary resources or target markets.

Key Motivations for Vertical FDI

• Control: Gaining better control over supply sources or distribution networks.
• Cost Reduction: Reducing costs by integrating the supply chain.
• Access to Resources: Securing vital natural resources or technology.

Vertical FDI allows firms to enhance resource allocations across borders, ultimately impacting global trade dynamics.

FDI Inflow

FDI inflow refers to the investment made by a foreign entity into the domestic structures, equipment, and organizations of a host country. It is an indicative measure of foreign ownership and economic influence within a country's borders. For instance, as detailed in the exercise, the investments made by Vodafone in Romania and by Exxon in Belgium are examples of FDI inflow into those respective countries.

The impact of FDI inflow can be significant for the host country; it can bring technological advancement, expertise, and capital⁠—all of which can be catalysts for economic growth. The host country also benefits from job creation and potential tax revenue.

Advantages of FDI Inflow:

• Economic Growth: Infusion of capital and technology can drive growth.
• Employment: New ventures create jobs.
• Trade Balance: Can improve the host country's trade balance through exports.

While FDI inflow is beneficial, it is also crucial for the host country to manage these investments to ensure they don't lead to excessive foreign control or negative impacts on local businesses.

FDI Outflow

On the flip side, FDI outflow represents investments made by a domestic country into foreign enterprises. This indicates the extend to which a country's businesses expand their economic activities to international markets. For example, when PetroChina, a Chinese company, invests in oil and natural gas assets in Western Australia, as presented in the exercise, it accounts as an FDI outflow from China.

FDI outflow showcases a country’s entrepreneurial strengths and its firms’ capabilities to manage cross-border operations. While it reflects positively on the investing country by indicating robustness and expansion, there are also critiques that it may signify exporting jobs or neglecting domestic investment opportunities.

Purposes of FDI Outflow:

• Global Influence: Elevates the home country’s position in international business.
• Resource Access: Secures resources or strategic assets abroad.
• Diversification: Diversifies risk and operations across various markets.

FDI outflow underlines the global nature of modern businesses and their search for strategic international opportunities.