Theories of International Investments

International investments mean investments beyond borders. International investments refer to investments by entities of a nation in nations other than their own. Foreign investments involve export of capital. The opportunity for International investments is directly emanating from economic reformist policies adopted by most of the countries of the world including centrally planned and command economies. Liberalization, Privatization and Globalization (LPG) are vigorously pursued by the countries giving an up-thrust on investment opportunities.

Broadly there are two types of foreign investment, namely, foreign direct investment (FDI) and foreign portfolio investment (FPI). FDI refers to investment in a foreign country where the investor retains control over the investment. It typically takes the form of starting a subsidiary, acquiring a stake in an existing firm or starting a joint venture in the foreign country. Direct investment and management of the firms concerned normally go together. If the investor has only a sort of property interest in investing the capital in buying equities, bonds, or other securities abroad, it is referred to as portfolio investment. That is, in the case of portfolio investments, the investor uses capital in order to get a return on it, but has not much control over the use of the capital.

FDIs are governed by long-term considerations because these investments cannot be easily liquidated. Hence, factors like long-term political stability, government policy, industrial and economic prospects, etc., influence the FDI decision. However, portfolio investments, which can be liquidated fairly easily, are influenced by short-term gains. Portfolio investments are generally much more sensitive than FDIs to short term uncertainties.

Foreign investment and foreign trade are related. 60-70% of world trade is directly or indirectly connected to FDI. 50% of world trade is either within the same organizational entity (intra-firm trade) or between parties which engage in co-operative relationship.

Types of International Investment Theories

The theories of international investments seek to explain the reasons for international investments. Theories of international investment can essentially be divided into two categories: Micro (industrial organization) theories and Macro (cost of capital) theories.

The micro economic orientations differed between the earlier and subsequent  literature’s. The early literature that explains international investment in micro economic terms focuses on market imperfections, and the desire of multinational enterprises to expand their monopolistic power. Subsequent literature centered more on firm-specific advantages owing to product superiority or cost advantages, stemming from economies of scale, multi-plants economies and advanced technology, or superior marketing and distribution. According to this view, multinationals find it cheaper to expand directly in a foreign country rather than through trade in cases where the advantages associated with cost or product are based on internal, indivisible assets based on knowledge and technology. Alternative explanations for international investment have focused on regulatory restrictions, including tariffs and quotas that either encourage or discourage cross-border acquisitions, depending on whether one considers horizontal or vertical  integration’s.

Studies examining the macro economic effects of exchange rate on international investment centered on the positive effects of an exchange rate depreciation of the host country on international investment in-flows, because it lowers the cost of production and investment in the host countries, raising the profitability of foreign direct investment. The wealth effect is another channel through which a depreciation of the real exchange rate could raise international investment. By raising the relative wealth of foreign firms, a depreciation of the real exchange rate could make it easier for those firms to use retained profits to finance investment abroad and to post a collateral in borrowing from domestic lenders in the host country.

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