2.2.1 - Multinationals and foreign direct investment

MNCs and direct investment

A multinational corporation (MNC) is a business that owns or controls operations, such as production facilities, in more than one country. Merely selling exports abroad does not by itself make a business an MNC.

Foreign direct investment (FDI) is investment by a business or investor from one country in productive assets or business operations in another, establishing a lasting interest and significant influence over the operation. Ownership or control of an overseas factory is a clear example; direct investment can also involve lasting influence without full control. Buying a small holding of foreign shares purely for a financial return, without significant management influence, is different from direct investment.

The MNC is the organisation; FDI is the investment activity. A domestic shoe manufacturer that sells shoes to foreign shops is an exporter. If it establishes and controls a factory abroad, that factory investment is FDI and its operations now extend across countries. The host country receives the investment; the home country is where the investing business originates.

Why firms invest abroad

Firms invest overseas when expected gains from international operations outweigh the costs and risks of establishing them.

Larger international sales can support economies of scale. A firm may spread research or equipment costs over greater output, or obtain discounts on large input orders. This can reduce average cost and improve competitiveness. Expansion creates this opportunity; poor coordination can still prevent the saving.

Locating near natural resources or cheap materials can reduce input and delivery costs and secure supplies. A food processor may build a plant close to crops instead of transporting bulky unprocessed produce. Access to raw materials is a reason for locating production abroad, not proof that every low-cost location is suitable.

Lower transport and communication costs make overseas expansion easier. Managers can coordinate distant sites quickly, and components can move between them at lower cost. These changes reduce the disadvantages of geographical distance. Producing near buyers can additionally reduce the transport cost of the finished product.

An overseas operation gives access to customers in different regions. Local knowledge can help a firm adapt its products, delivery and service to a new market. A nearby factory may serve customers faster and overcome some obstacles to exporting. A firm will still consider demand, infrastructure, political stability and the cost of complying with local rules.