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Chapter 08 Foreign Direct Investment Answer Key

True / False Questions 1.

A Japanese car manufacturer acquires an Italian producer of car tires. This is an example of a greenfield investment. FALSE This is an example of an acquisition. A greenfield investment involves the establishment of a new operation in a foreign country.

2.

The amount of FDI undertaken over a given time period is known as the flow of FDI. TRUE The flow of FDI refers to the amount of FDI undertaken over a given time period (normally a year).

3.

FDI has been declining in the last few decades because protectionist pressures have become less intense. FALSE Despite the general decline in trade barriers over the past 30 years, firms still fear protectionist pressures. Executives see FDI as a way of circumventing future trade barriers.

4.

Developing nations currently account for the largest share of FDI inflows. FALSE Even though developed nations still account for the largest share of FDI inflows, FDI into developing nations has increased.

5.

Other things being equal, the greater the capital investment in an economy, the more favorable its future growth prospects are likely to be. TRUE FDI can be seen as an important source of capital investment and a determinant of the future growth rate of an economy.

6.

The largest source country for FDI has been China. FALSE Since World War II, the United States has been the largest source country for FDI, a position it retained during the late 1990s and early 2000s. Other important source countries include the United Kingdom, France, Germany, the Netherlands, and Japan.

7.

The majority of cross-border investment in the developed world is in the form of greenfield investments rather than mergers and acquisitions. FALSE The majority of cross-border investment is in the form of mergers and acquisitions rather than greenfield investments.

8.

Mergers and acquisitions are quicker to execute than greenfield investments. TRUE Mergers and acquisitions are quicker to execute than greenfield investments. This is an important consideration in the modern business world where markets evolve very rapidly.

9.

Licensing involves the establishment of a new operation in a foreign country. FALSE Licensing involves granting a foreign entity (the licensee) the right to produce and sell the firm's product in return for a royalty fee on every unit sold.

10.

When transportation costs are added to production costs, it becomes unprofitable to ship some products over a large distance. This is particularly true of products that have a high value-to-weight ratio. FALSE When transportation costs are added to production costs, it becomes unprofitable to ship some products over a large distance. This is particularly true of products that have a low value-to-weight ratio and that can be produced in almost any location.

11.

By placing tariffs on imported goods, governments can increase the cost of exporting relative to foreign direct investment and licensing. TRUE By placing tariffs on imported goods, governments can increase the cost of exporting relative to foreign direct investment and licensing.

12.

Internalization theory seeks to explain why firms often prefer foreign direct investment over licensing as a strategy for entering foreign markets. TRUE Internalization theory seeks to explain why firms often prefer foreign direct investment over licensing as a strategy for entering foreign markets.

13.

Licensing gives a firm tight control over manufacturing, marketing, and strategy in a foreign country that may be required to maximize its profitability. FALSE Licensing does not give a firm the tight control over manufacturing, marketing, and strategy in a foreign country that may be required to maximize its profitability.

14.

An oligopoly is an industry composed of a limited number of large firms. TRUE An oligopoly is an industry composed of a limited number of large firms (e.g., an industry in which four firms control 80 percent of a domestic market would be defined as an oligopoly).

15.

Rivals rarely imitate what a firm does in an oligopoly. FALSE Rivals often quickly imitate what a firm does in an oligopoly.

16.

Knickerbocker's theory explains why the first firm in an oligopoly decides to undertake FDI rather than to export or license. FALSE Knickerbocker's theory and its extensions can help to explain imitative FDI behavior by firms in oligopolistic industries, it does not explain why the first firm in an oligopoly decides to undertake FDI rather than to export or license.

17.

John Dunning pioneered the eclectic paradigm. TRUE The eclectic paradigm has been championed by the British economist John Dunning.

18.

According to the pragmatic nationalistic view, the MNE is a tool for exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries. FALSE According to the radical view, the MNE is a tool for exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries.

19.

The radical view traces its roots to Marxist political and economic theory. TRUE The radical view traces its roots to Marxist political and economic theory.

20.

The free market view argues that FDI is a benefit to both the source country and to the host country. TRUE The free market view argues that international production should be distributed among countries according to the theory of comparative advantage.

21.

In practice only a few countries country have adopted the free market view in its pure form. FALSE In practice no country has adopted the free market view in its pure form.

22.

The pragmatic nationalist view highlights only the benefits of FDI. FALSE The pragmatic nationalist view is that FDI has both benefits and costs.

23.

Countries adopting a pragmatic stance pursue policies designed to maximize the national benefits and minimize the national costs. TRUE Countries adopting a pragmatic stance pursue policies designed to maximize the national benefits and minimize the national costs. According to this view, FDI should be allowed so long as the benefits outweigh the costs.

24.

An aspect of pragmatic nationalism is the tendency to aggressively court FDI believed to be in the national interest by, for example, offering subsidies to foreign MNEs in the form of tax breaks or grants. TRUE An aspect of pragmatic nationalism is the tendency to aggressively court FDI believed to be in the national interest by, for example, offering subsidies to foreign MNEs in the form of tax breaks or grants.

25.

Recent years have seen a marked increase in the number of countries that adhere to a radical ideology regarding FDI. FALSE Recent years have seen a marked decline in the number of countries that adhere to a radical ideology regarding FDI.

26.

Research supports the view that multinational firms often transfer significant technology when they invest in a foreign country. TRUE Research supports the view that multinational firms often transfer significant technology when they invest in a foreign country.

27.

Direct effects of FDI arise when jobs are created in local suppliers as a result of the FDI and when jobs are created because of increased local spending by employees of the MNE. FALSE Indirect effects arise when jobs are created in local suppliers as a result of the investment and when jobs are created because of increased local spending by employees of the MNE.

28.

Host country citizens that are employed by an MNE following an FDI are an example of an indirect effect of FDI. FALSE Direct effects of FDI arise when a foreign MNE employs a number of host-country citizens.

29.

A country's balance of payments accounts keep track of both its payments to and its receipts from other countries. TRUE A country's balance-of-payments accounts track both its payments to and its receipts from other countries.

30.

Governments normally are concerned when their country is running a surplus on the current account of their balance of payments. FALSE Governments normally are concerned when their country is running a deficit on the current account of their balance of payments.

31.

If the FDI is a substitute for imports of goods or services, the effect can be to improve the current account of the host country's balance of payments. TRUE If the FDI is a substitute for imports of goods or services, the effect can be to improve the current account of the host country's balance of payments.

32.

In general, FDI in the form of greenfield investments should increase competition. TRUE In general, while FDI in the form of greenfield investments should increase competition, it is less clear that this is the case when the FDI takes the form of acquisition of an established enterprise in the host nation

33.

FDI does not benefit the host country's balance of payments if the foreign subsidiary creates demand for home-country exports of capital equipment, intermediate goods, or complementary products. FALSE FDI can benefit the home country's balance of payments if the foreign subsidiary creates demands for home-country exports of capital equipment, intermediate goods, complementary products, and the like.

34.

For the home-country, the current account of the balance of payments improves if the purpose of the foreign investment is to serve the home market from a low-cost production location. FALSE The current account of the balance of payments suffers if the purpose of the foreign investment is to serve the home market from a low-cost production location.

35.

Offshore production refers to FDI undertaken to serve the host market. FALSE The term offshore production refers to FDI undertaken to serve the home market.

36.

The two most common methods of restricting inward FDI are ownership restraints and performance requirements. TRUE Host governments use a wide range of controls to restrict FDI in one way or another. The two most common are ownership restraints and performance requirements.

37.

The WTO supports the promotion of international trade in services. TRUE The WTO embraces the promotion of international trade in services.

38.

As transportation costs or trade barriers increase, exporting becomes unprofitable, compared to FDI and licensing. FALSE As transportation costs or trade barriers increase, exporting becomes unprofitable, and the choice is between FDI and licensing.

39.

Licensing is usually a good option for firms in high-tech industries where protecting firm-specific expertise is of paramount importance. FALSE Licensing is usually not a good option for firms in high-tech industries where protecting firm-specific expertise is of paramount importance.

40.

The product life-cycle theory and Knickerbocker's theory of horizontal FDI tend to be very useful from a business perspective because the theories are more descriptive than analytical. FALSE The product life-cycle theory and Knickerbocker's theory of FDI tend to be less useful from a business perspective.

Multiple Choice Questions 41.

FDI occurs when a firm: A. ships its products from one country to another. B. invests directly in facilities to produce a product in a foreign country. C. invests in the shares of another company operating in the same country. D. grants permission to another company in a different country to use its brand name. Foreign direct investment (FDI) occurs when a firm invests directly in facilities to produce or market a product in a foreign country.

42.

Which of the following is an example of a greenfield investment? A. A Chinese sugar maker setting up a sugar crushing facility in Cuba. B. A Serbian automobile company purchasing a Croatian component manufacturer. C. A Finnish mobile phone manufacturer expanding its production facility in Finland. D. An Indian oil exploration company acquiring an oil refining company. A greenfield investment involves the establishment of a new operation in a foreign country.

43.

The stock of FDI is: A. the amount of FDI undertaken over a given period of time. B. the total accumulated value of foreign-owned assets at a given time. C. the flow of FDI out of a country. D. the amount of foreign direct investment made by domestic companies over a given period of time. The stock of FDI refers to the total accumulated value of foreign-owned assets at a given time.

44.

The _____ of FDI refers to the amount of FDI undertaken over a year.

A. stoc k B. net value C. accumulated value D. flo w The flow of FDI refers to the amount of FDI undertaken over a given time period (normally a year). 45.

Which of the following is the prime reason why Africa has attracted FDI in recent years? A. Growth of the services sector B. Complete deregulation of markets C. Wave of privatization D. Raw material availability In recent years, Chinese enterprises have emerged as major investors in Africa, particularly in extraction industries where they seem to be trying to assure future supplies of valuable raw materials.

46.

Which of the following summarizes the total amount of resources invested in factories, stores, office buildings, and the like? A. Gross capital index B. Gross fixed capital formation C. Gross domestic product D. Gross national product Gross fixed capital formation summarizes the total amount of capital invested in factories, stores, office buildings, and the like.

47.

Which of the following primarily explains why developing nations are characterized by lower percentage of cross-border mergers and acquisitions compared to developed nations?

A. Fewer target firms to acquire in developing nations B. Fierce opposition to mergers and acquisitions in developed nations C. Unwillingness of foreign companies to invest in developing nations D. Presence of import quotas in developing nations In the case of developing nations, only about one-third of FDI is in the form of crossborder mergers and acquisitions. The lower percentage of mergers and acquisitions may simply reflect the fact that there are fewer target firms to acquire in developing nations. 48.

When contemplating FDI, why do firms apparently prefer to acquire existing assets rather than undertake greenfield investments? A. Greenfield investments are characterized by reduced management control B. Mergers and acquisitions are preferred because most greenfield investments fail. C. It is easier and less risky for a firm to build strategic assets than acquire similar assets. D. Mergers and acquisitions are quicker to execute than greenfield investments. Mergers and acquisitions are quicker to execute than greenfield investments. This is an important consideration in the modern business world where markets evolve very rapidly.

49.

A French wind power company gives an Indonesian company the right to produce and sell wind turbines in return for a royalty fee on every unit sold. Which business practice is this an example of? A. Acquisiti on B. Licensin g C. Exportin g D. Greenfield investment Licensing involves granting a foreign entity (the licensee) the right to produce and sell the firm's product in return for a royalty fee on every unit sold.

50.

Which of the following specifically reduces the viability of an exporting strategy specifically for products with low value-to-weight ratios?

A. Foreign exchange controls B. Trade barriers C. Transportation costs D. Output quality When transportation costs are added to production costs, it becomes unprofitable to ship some products over a large distance. This is particularly true of products that have a low value-to-weight ratio and that can be produced in almost any location. 51.

Which of the following is a way in which governments increase the attractiveness of FDI and licensing relative to exporting? A. By implementing import quotas B. By imposing FDI limits in industries C. By increasing tax rates D. By limiting free flow of capital By limiting imports through quotas, governments increase the attractiveness of FDI and licensing.

52.

Identify the theory that seeks to explain why firms often prefer foreign direct investment over licensing as a strategy for entering foreign markets. A. Internalization theory B. Product life-cycle theory C. Perfect markets theory D. Random walk theory A branch of economic theory known as internalization theory seeks to explain why firms often prefer foreign direct investment over licensing as a strategy for entering foreign markets (this approach is also known as the market imperfections approach).

53.

In which of the following situations does the internalization theory recommend FDI as opposed to licensing?

A. When the firm has know-how that can be adequately protected by a licensing contract B. When the firm produces products that have a low value-toweight ratio C. When a firm's skills and know-how are amenable to licensing D. When the firm needs tight control over a foreign entity Licensing does not give a firm the tight control over manufacturing, marketing, and strategy in a foreign country that may be required to maximize its profitability. When tight control over a foreign entity is desirable, foreign direct investment is preferable to licensing. 54.

Which of the following best describes an industry composed of a limited number of large firms? A. An oligopoly B. A monopoly C. An oligarchy D. A perfectly competitive market An oligopoly is an industry composed of a limited number of large firms (e.g., an industry in which four firms control 80 percent of a domestic market would be defined as an oligopoly).

55.

Which of the following is a direct consequence of the interdependence between firms in an oligopoly? A. Increased regulation B. Increased consumer welfare C. Imitative behavior D. Longer product lifecycles The interdependence between firms in an oligopoly leads to imitative behavior; rivals often quickly imitate what a firm does in an oligopoly.

56.

Which of the following observations concerning Knickerbocker's theory is true?

A. It does not explain imitative FDI behavior by firms in oligopolistic industries. B. Economists favor this theory as an explanation for FDI compared to the internalization theory. C. It addresses the issue of whether FDI is more efficient than exporting or licensing for expanding abroad. D. It does not explain why the first firm in an oligopoly decides to undertake FDI rather than to export or license. Although Knickerbocker's theory and its extensions can help to explain imitative FDI behavior by firms in oligopolistic industries, it does not explain why the first firm in an oligopoly decides to undertake FDI rather than to export or license. 57.

_____ arises when two or more enterprises encounter each other in different regional markets, national markets, or industries. A. Horizontal integration B. Multipoint competition C. An oligopoly D. Vertical integration Multipoint competition arises when two or more enterprises encounter each other in different regional markets, national markets, or industries.

58.

According to Knickerbocker's theory: A. when a firm has valuable know...