Foreign Direct Investment in Emerging Markets - Vietnam and Korea

Table of Contents

I. List of Tables and Figures

1. Introduction

2. General overview of Foreign Direct Investment
2.1 Definition FDI
2.2 FDI versus alternatives
2.3 Business-oriented motivations
2.4 Before decision: Economic analysis

3. Country Introduction - Vietnam

4. Country Introduction - Korea

5. FDI in Vietnam and Korea
5.1 Classification of FDI in Vietnam and Korea according to world FDI 2007
5.2 Recent Development
5.3 FDI in Vietnam - according to sectors and countries
5.4 FDI in Korea - according to sectors and countries

6. Risks
6.1 General risks
6.2 Risks and weaknesses in Vietnam
6.3 Risks and weaknesses in Korea

7. Conclusions

8. Sources

I. List of Tables and Figures

Figure 1: Most preferred investment regions (WIR 2008)

Figure 2: GDP Development by Sectors (UNCTAD)

Figure 3: Annual GDP growth of selected economies (2002-09)

Figure 4: Volume of FDI flows in Vietnam and Korea (2004-07)

Figure 5: Value of cross-border M&As in Vietnam and Korea (20004-07)

Figure 6: No. of Greenfield FDI projects in Vietnam and Korea (2002-07)

Figure 7: Vietnam: Inward investment stock regarding to sectors

Figure 8: Korea: Inward investment stock regarding to sectors

Figure 9: Korea: Outward investment flow Sources:

Figure 1 World Investment Report 2008 (UNCTAD 2008a)

Figure 2 World Investment Report 2008 (UNCTAD 2008a)

Figure 3 World Bank, General Statistics Office of Vietnam, WKO

Figure 4 World Investment Report 2008 (UNCTAD 2008a)

Figure 5 World Investment Report 2008 (UNCTAD 2008a)

Figure 6 World Investment Report 2008 (UNCTAD 2008a)

Figure 7 Investment map (UNCTAD / ITC 2006)

Figure 8 Investment map (UNCTAD / ITC 2006)

Figure 9 Investment map (UNCTAD / ITC 2006)

1. Introduction

Foreign direct investment (FDI) is found almost everywhere in the world today and closely connected to worldwide globalization. Why do enterprises which are successfully operating in their home market decide on making investments in unknown and more insecure markets? Why do investment destinations have an interest in admitting foreign investors into the economy? Considering that FDI has grown in importance in the global economy in the last decades, obviously there has to be significant advantages for both sides. The World Investment Report (WIR) of UNCTAD reports in their recent publication (2008) high records in FDI flows in the world (UNCTAD 2008a). While developed countries still attract the largest volume of FDI inflows, developing countries possess the highest growth rate in drawing a significant volume of investment into their economy. Transforming and emerging markets in South, East and Southeast Asia particularly showed rapid development of generated inflows and their economies are prospering. China is a famous example. In our paper, we would like to introduce a not so well-known little tiger – Vietnam – and South Korea, which is after impressive growth in the last decades due to FDI now on its way to becoming an industrialized country.

First we will give a short theoretical overview of FDI. We will not analyze all global flows and development of FDI. Our focus lies in the development and framework of FDI in both above-mentioned countries and answering the question which impact did FDI have on their economic development. Therefore follows an especially economical introduction of both countries and then a deeper look into sectors of FDI. We will give a short classification of development in Vietnam and in South Korea in comparison to global trends. In the final part of our paper, we will go into risks and weaknesses of both countries. At the end, we will give our conclusion concerning the impact of FDI on the two reviewed countries.

2. General overview of Foreign Direct Investment

Before we analyze the development and impact of FDI in both countries, we would like to give a short general introduction on FDI, including motivations of enterprises and relevant approaches for decision making in a wider economic context.

2.1 Definition FDI

The following definition provides a good, short characteristic in order to identify foreign direct investment. “Foreign direct investment reflects the objective of obtaining a lasting interest by a resident entity in one economy (direct investor) in an entity resident in an economy other than that of the investor (direct investment enterprise). The lasting interest implies the existence of a long-term relationship between the direct investor and the enterprise and a significant degree of influence on the management of the enterprise.” (OECD 1996: 7).

Four main dimensions are important (Eng 1998: 403):

1. Transfer of capital from a source country to a host country
2. Element of control over management policy and decisions

This feature distinguishes FDI from other forms of international investment. Lower limit to assume a relevant degree of influence is a minimum of 10 percent shareholding (less than 10 percent it is referred to as portfolio investment). An investment between 10 percent and 50 percent ownership is called cooperative arrangement (no single party holds a majority). An investor has a majority control beginning with 50 percent shareholding.

3. Parent Company as a source of funds for foreign operations

4. Balance of payment or capital flows (equity plus intercompany loans plus reinvestment of profits (earned by foreign affiliates)).

2.2 FDI versus alternatives

Economy is in general a hard and expensive business. Enterprises have to take care of their resources. Hence they can not invest wherever and how often they want. Enterprises have to monitor potential aims or areas in which to invest. A well and successfully operating enterprise should pre-test how the products of their company will be accepted in a foreign economy before making extensive investment decisions.

To explore foreign markets for their products, companies normally follow a sequence of steps: In the beginning merchandise is exported which is produced in the home country. If the volume of sales meets the expectations of the exporter and the customers are satisfied, companies give licenses to partners or clients; this can be seen as a successful step. In this step the company allows the buyer of a license to produce the companies’ products – e.g. chips or software - for a certain time. It is a very individual contract and companies can design this contract as it seems best for them. If companies sell licenses, export and production costs can be reduced.

If the market is performing well and the company can reach an acceptable profit, they can go on to the next step. They can start the foreign distribution of products through affiliate entities, the famous “foot in the door”. Good examples of this are car dealerships. Therefore, car manufacturers offer their cars in a lot of different regional markets. The main production at this time is still in the source country.

If it is not profitable enough just to export the companies’ products or the host country attracts investment due to good investment conditions companies can go abroad and start foreign production. In this step, investors can choose different ways to place their investment in the host country. One well-known FDI type is franchise. Here, enterprises sell the right to operate under their brand name. Franchisees are independent companies, but they fit the label, the branding and whatever the franchisor has arranged in the franchise contract.

Another way is to become partner of a joint venture. A joint venture is a collaboration of companies. Partners launch a new, legally independent business unit in which the founding companies (two or more) are involved with their capital. Besides the capital, the founding companies usually share basic resources like technology, intellectual property rights, technical or marketing know-how and facilities. Mostly one of the partners has the capital, the technology and the know-how and the second partner knows the local conditions, has cheap labour or is just a local partner because it is required by the law of this country. The contract is very often time limited, so investors have to leave the joint venture and the foreign partners gain the skills to launch their own businesses. A strategic alliance is more or less equal to a joint venture. The difference is that the partners only share resources or risks and do not start a new company.

If the stock market is opened and the law ensures equal treatment and legal security, the investors could also merge or acquire foreign companies as an entry into new markets. They can also get an access to new technologies or just to the know-how of the merged firm. Mergers and acquisitions (M&A) can be very expensive and very often the partners fail when they try to unify two different corporate cultures. A good example for an unsuccessful M&A from the recent past is the merger of Daimler Benz AG with Chrysler LLC. (Jansen 2007: 21 f.)

In all these investing enterprises there are foreign partners who can help with employees, special market skills and factories. However sometimes it is almost impossible to find potential partners in the host country and the investor has to find another way. If there is no business partner to be found, firms can choose to do a Brownfield or Greenfield investment. In the case of a Brownfield investment, enterprises invest in old or idle industries (Chowdhry 2007: 2). Greenfield means that firms launch a new company in an industry sector which did not exist before in this area. If an enterprise does make such an investment, it can easily teach and spread its corporate culture since almost everyone will accept it; this is due to the fact that they have no other or “old” corporate culture. Another benefit is that investors can organize the management and contracts of employees as they want. Maybe one of the most important reasons to do a Brownfield or a Greenfield investment is better protection against plagiarism and simultaneous production by their foreign partners.

Risk increases from step to step. The foreign distribution and foreign production steps constitute direct investment; export and licensing are alternatives. If companies choose export or selling licenses as alternatives and if they do not invest abroad, investors can easily and quickly leave markets and look for the next opportunity. If an enterprise has invested in a foreign destination, they have the risk that they can loose the whole investment or get no reward from their partner for the provided skills and technologies (Eng 1998: 408).

2.3 Business-oriented motivations

If companies have invested somewhere they bear a risk. Usually companies want to be secure, but sometimes they have motivations to make business decisions which are not safe at all. But such decisions are necessary to maintain or increase a company’s market positions. To be successful in business, companies are not able to afford standstill.

There are several reasons for firms to decide on making foreign direct investment. The top five firm specific motivations are the need

1. for markets
2. for production efficiency
3. for raw materials
4. for information and technology
5. to minimize or diversify risks.

The need for markets means that, if the enterprises want to grow, they need more customers. However, if they are, for example, the market leader or a monopolist, it is quite hard to find more clients in this market, because they already have won most of the clients over. Due to this, enterprises have to find a new market where they can sell their products or services. The firms can also change their strategy to create new markets. For example, Company A is a car producer and seller and they want to give the opportunity to their clients to finance their cars in their new founded “car seller bank”. In this bank, Company A can also offer accounts or other saving products, so the company has entered the finance market as new pillar. A good example of this is the Mercedes Benz Bank (Mercedes Benz Bank) or the BMW Bank (BMW Bank). However, it is also possible to sell the cars to new customers in a foreign market.

The need for production efficiency means that enterprises want to produce faster or cheaper. If enterprises want to produce faster or on a higher quality level, they normally have to invest in well-developed countries with a good infrastructure and a good-skilled and highly motivated labour force, like in Germany. If the company wants to produce cheaper, it has to invest in a low-wage country. The employees are also very often highly motivated; however they work for lower wages, because it is their chance to start a better life or just the option to survive.

The need for raw materials is a need to keep the production alive. Companies always need raw materials and if there is an easier or cheaper way to get it, companies might make this investment. For example, if the enterprise produces or sells jewels, they could merge gold or diamond mines to get better conditions. If the enterprise is a car manufacturer, they could do a joint venture with a steel corporation to launch a component supplier.

The need for information and technology is also a need to maintain or increase market positions. If the company has better information, it can make better decisions or develop innovative strategies. If they can buy technologies, it could be much cheaper than developing them. If it is a company which is producing medicine, it can spend a lot of money in research like Bayer AG or it can just buy the license to produce it, like Ratiopharm AG. The second way might be cheaper, because companies never know the result of their researches when they start it.

The need to minimize or diversify risks is a motivation to reduce particularly risk-costs. Risks can be reduced by hedging or diversifying the investment. To diversify means the enterprise has to distribute investments among different markets or products in order to limit losses in the event of a fall in a particular market or industry. To hedge means that an enterprise takes a second deal or position that is the opposite of the first one. One of the deals will be successful and one not. In the case that the first deal fails, the company is secure because it receives the money it lost in this deal by the gain of the (second) hedge deal (Eng 1998: 409).

2.4 Before decision: Economic analysis

While business-oriented motivations show firm-specific factors that may lead to foreign direct investment, a broader view and an economic analysis are also necessary before making a decision (Eng 1998: 412). Below we would like to introduce some approaches to understanding firms are encouraged to invest in foreign markets.

Competitive Advantage

The strategic decision for foreign direct investment should start with self-evaluation to identify if the firm has sustainable competitive advantages (Moffett et al. 2009: 478 f.). The competitive advantage should be firm-specific, transferable and also strong enough to compensate potential disadvantages of operating abroad (see 6. “Risks”).

Competitive advantages could be

- Economies of scale and scope (advantage of being large),
- Managerial and marketing expertise,
- Advanced technology (scientific and engineering skills),
- Financial strength (e.g. availability of capital),
- Differentiated products.

Differentiated products are an advantage created by firms. They originate research-based innovations or considerable marketing expenses to gain brand identification. It is very expensive and not so easy for competitors to copy such products (ibid: 480).

When an enterprise knows their specific advantages it should search worldwide for a country where it is possible to exploit market imperfections (Eng 1998: 413). The Coca Cola Company is a good example of an enterprise which utilizes such advantages.

Role of Government

The policy of governments can play an important role in the decision-making process for FDI. Governments can offer economic incentives and create market imperfections, for example by providing subsidies to foreign investors. Other aspects could be tax incentives or the existence of tariffs and non-tariff barriers on imports (ibid: 414).

Portfolio Theory

Another interesting approach to understanding decision-making in enterprises for direct investment is portfolio theory. Portfolio theory explains that a diversified portfolio may realize better overall outcomes than one that is not well-diversified. Following this theory enterprises diversify their activities internationally to enhance probability of a better risk-return outcome than operating only in one market (ibid: 416 f.). During the last several years, Vietnam became a new target destination for foreign investors who earlier mainly invested in Chinas textile and clothing industry which follows also the portfolio theory.

Behavioural Approach

Behavioural factors also have an impact on the decision-making process. If an enterprise has no experience in operating abroad it may choose the foreign destination in a more careful way than if it already had many experiences from former investments. The reason is the difficulty to gather and process all the information that would be needed to make a perfectly rational decision based on all existing facts. Swedish economists for example observed that inexperienced Swedish firms tended to invest first in countries that are similar in cultural, legal and institutional terms such as Norway, Denmark or Germany. After their initial investments and first experiences they felt up to take greater risks in later investments with regard to cultural distance and also the size of investment (Moffett et al. 2009: 483 f.). Those same Swedish economists also identified a connection between the size of an enterprise and their involvement in an international network: the bigger an enterprise is, the more foreign subsidiaries it has.

3. Country Introduction - Vietnam

The Vietnam War (1964 – 1975) left Vietnam in a desolate situation. What started to happen to the country only a few years later was almost a wonder. The Socialist Republic of Vietnam was founded in 1975 and is a developing country with a population of approximately 85 million inhabitants (Germany 82 million inhabitants). The capital of Vietnam is Hanoi (2.6 million inhabitants) while Ho-Chi Minh-City is the biggest (5.2 million inhabitants) and economically most important city of the country. Vietnam has a one-party system with the Communist Party of Vietnam holding exclusive power.

Vietnam covers an area of 330,000 km² (in comparison: Germany: 357,000 km²) (GTAI). Most people have no religion (81 percent), 9 percent are Buddhists, 8 percent are Catholics and 2 percent belong to other religions (i.e. Cao Dai). Vietnam has a young population – the median age is 26 years (in comparison Germany: 43 years) (Lexas Information Network).

Economy

Vietnam has emerged in recent years as one of the world’s most attractive new investment destinations. According to the latest World Investment Report 2008, Vietnam remains in sixth place among the most preferred investment regions. This is due to Vietnam being the second fastest growing economy in the world and because of the availability of skilled and cheap labour (UNCTAD 2008a: 33).

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