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UBC Theses and Dissertations

Direct private foreign investment : a survey and reconsideration of traditional theory Chua, Joon Eng 1971

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DIRECT PRIVATE FOREIGN INVESTMENT: A SURVEY AND RECONSIDERATION OP TRADITIONAL THEORY • by CHUA JOON ENG B.A. Hons., University of Singapore, 1968 A THESIS SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF BUSINESS ADMINISTRATION IN THE FACULTY - OF ' COMMERCE AND BUSINESS ADMINISTRATION We accept t h i s t h e s i s as conforming to the required standard. THE UNIVERSITY OF BRITISH COLUMBIA August, 1971 In p r e s e n t i n g t h i s t h e s i s i n p a r t i a l f u l f i l m e n t o f the r e q u i r e m e n t s f o r an advanced degree at the U n i v e r s i t y o f B r i t i s h C o l u m b i a , I ag r e e t h a t the L i b r a r y s h a l l make i t f r e e l y a v a i l a b l e f o r r e f e r e n c e and s t u d y . I f u r t h e r agree t h a t p e r m i s s i o n f o r e x t e n s i v e c o p y i n g o f t h i s t h e s i s f o r s c h o l a r l y p u r p o s e s may be g r a n t e d by the Head o f my Department o r by h i s r e p r e s e n t a t i v e s . I t i s u n d e r s t o o d t h a t c o p y i n g o r p u b l i c a t i o n o f t h i s t h e s i s f o r f i n a n c i a l g a i n s h a l l not be a l l o w e d w i t h o u t my w r i t t e n p e r m i s s i o n . Department o f Commerce & Business Administrat ion The U n i v e r s i t y o f B r i t i s h C olumbia V a n c o u v e r 8, Canada Date &*f-~* / 9 7 / -The p u r p o s e o f t h i s s t u d y i s , f i r s t , t o o u t l i n e t h e n e o - c l a s s i c a l i n v e s t m e n t t h e o r y and t h e main competing hypo-t h e s e s which seem t o form t h e b a s e s o f t h e p o l i c y measures adopte d by governments o f c a p i t a l - i m p o r t i n g and c a p i t a l -e x p o r t i n g c o u n t r i e s t o s t i m u l a t e t h e f l o w o f d i r e c t p r i v a t e f o r e i g n i n v e s t m e n t s ( D P P I s ) , and, second, t o r e - examine and r e c o n s i d e r a few o f t h e a s s u m p t i o n s and i m p l i c a t i o n s o f t h e t h e o r y and t h e h y p o t h e s e s i n t h e l i g h t o f c e r t a i n r e p o r t e d i n v e s t i g a t i o n s o f d i r e c t f o r e i g n i n v e s t m e n t d e c i s i o n s o f f i r m s . A r e v i e w o f t h e n e o - c l a s s i c a l i n v e s t m e n t t h e o r y shows t h a t t h e t h e o r y assumes t h a t f i r m s aim a t p r o f i t m a x i m i z a t i o n , t h a t f i r m s s y s t e m a t i c a l l y scan d o m e s t i c and f o r e i g n e n v i r o n -ments f o r i n v e s t m e n t o p p o r t u n i t i e s and t h a t f i r m s u n d e r t a k e d i r e c t i n v e s t m e n t s , whether d o m e s t i c o r f o r e i g n , t o maximize t h e i r p r o f i t s . A c c o r d i n g t o t h i s t h e o r y , when f i r m s make i n v e s t m e n t d e c i s i o n s , t h e y have b e f o r e them a number o f i n v e s t m e n t p r o p o s i t i o n s , b o t h d o m e s t i c and f o r e i g n . They t h e n c a r e f u l l y a p p r a i s e t h e s e p r o p o s i t i o n s i n t erms o f c o s t s , b e n e f i t s and r i s k s and d e c i d e i n f a v o u r o f t h o s e p r o p o s i t i o n s which p r o m i s e them h i g h r e t u r n s and l o w r i s k s . T h i s t h e o r y t h e r e f o r e i m p l i c i t l y s u g g e s t s t h a t i t i s p o s s i b l e t o p r o v i d e c o n s i d e r a b l e s t i m u l a t i o n t o t h e f l o w o f DPFIs by m e r e l y a f f e c t i n g f i r m s ' e x p e c t a t i o n s o f r e t u r n s and r i s k s o f such i n v e s t m e n t s . • D i s a g r e e m e n t s o v e r t h e v a l i d i t y and u s e f u l n e s s o f t h e n e o - c l a s s i c a l i n v e s t m e n t t h e o r y a s an e x p l a n a t i o n o f t h e f l o w o f DPPIs l e a d t o a f o r m i d a b l e number o f a l t e r n a t i v e e x p l a n a t i o n s o r h y p o t h e s e s . Some o f t hese a r e : (1) t h e h i g h e r p r o f i t r a t e a b r o a d h y p o t h e s i s , (2) t h e l o w e r c o s t s a b r o a d hypothesi's, (3) t h e m o n o p o l i s t i c c o m p e t i t i o n h y p o t h e s i s , (4) t h e growt h o f t h e f i r m h y p o t h e s i s , (5) t h e m a r k e t i n g c o n s i d e r a t i o n s h y p o t h e s i s , (6) t h e market s i z e h y p o t h e s i s , (7) t h e maintenance o f market h y p o t h e s i s , and (8) t h e p r o -duct c y c l e h y p o t h e s i s . Each o f t h e s e h y p o t h e s e s i s ba s e d on a number o f a s s u m p t i o n s , most o f whi c h seem s i m i l a r t o t h o s e made by t h e n e o - c l a s s i c a l i n v e s t m e n t t h e o r y f o r most o f them i m p l i c i t l y assume t h a t : (1) f i r m s n o r m a l l y l o o k a c r o s s t h e i r n a t i o n a l b o u n d a r i e s f o r i n v e s t m e n t o p p o r t u n i t i e s , (2) f i r m s p o s s e s s f i n a n c i a l and s u i t a b l e m a n a g e r i a l r e s o u r c e s t o u n d e r t a k e d i r e c t i n v e s t m e n t s a b r o a d , (3) f i r m s a r e g e n e r a l l y p r e p a r e d t o u se t h e i r r e s o u r c e s t o i n v e s t i g a t e d i r e c t f o r e i g n i n v e s t -ment p r o j e c t s , and t h a t (4) f i r m s make c r o s s c o u n t r y com-p a r i s o n s o f p r o j e c t s t o d e t e r m i n e w h i c h p r o j e c t o r p r o j e c t s t h e y s h o u l d u n d e r t a k e . Some r e p o r t e d i n v e s t i g a t i o n s o f t h e f o r e i g n i n v e s t -ment d e c i s i o n s o f f i r m s , however, suggest t h a t f i r m s do n o t , i n f a c t , s y s t e m a t i c a l l y scan t h e g l o b e f o r a r e a s t o make an . i n v e s t m e n t and t h a t most f i r m s do not n o r m a l l y c o n s i d e r t h e p o s s i b i l i t i e s o f i n v e s t i n g a broad. The r e a s o n s why f i r m s do ' not n o r m a l l y l o o k a b r o a d f o r i n v e s t m e n t o p p o r t u n i t i e s can p r o b a b l y be f o u n d i n ; (1) o r g a n i z a t i o n t r a d i t i o n s and a t t i t u d e s , (2) g e n e r a l l y h e l d b e l i e f s o f f i r m s , (3) l i m i t -a t i o n of•company r e s o u r c e s , (4) d e p a r t m e n t a l s t r u c t u r e s , (5) c o m p l e x i t i e s o f i n v e s t i n g a b r o a d , and (6) i n f o r m a t i o n and i n v e s t i g a t i o n c o s t s . These i n v e s t i g a t i o n s a l s o suggest t h a t : (1) g e n e r a l l y f i r m s c o n s i d e r d i r e c t i n v e s t m e n t s a b r o a d o n l y when they a r e • " p r e s s u r e d " ( o r " t h r e a t e n e d " ) o r "persuaded" ( o r " i n s t i g a t e d " ) t o do so, (2) when f i r m s c o n s i d e r d i r e c t f o r e i g n i n v e s t m e n t p r o j e c t s , t h e y a g r e e i n p r i n c i p l e r i g h t from t h e b e g i n n i n g t o a c c e p t them, (3) f i r m s e v a l u a t e d i r e c t f o r e i g n i n v e s t m e n t p r o j e c t s s e q u e n t i a l l y and do not weigh them a l o n g s i d e each o t h e r , (4) d i f f e r e n t f i r m s u s e d i f f e r e n t • c r i t e r i a t o d e t e r -mine t h e a c c e p t a b i l i t y o f f o r e i g n i n v e s t m e n t p r o j e c t s . T h i s study a c c e p t s t h e c o n c l u s i o n s o f t h e s e i n v e s t -i g a t i o n s and s u g g e s t s t h a t any t h e o r y o f DPPIs has t o r e c o g n i z e t h a t d i r e c t f o r e i g n i n v e s t m e n t a l t e r n a t i v e s a r e not g i v e n t o f i r m s and t h a t t h e r e i s a need t o i n c o r p o r a t e t h e " i n i t i a t i n g f o r c e s " i n t o t h e t h e o r y . I t a l s o s u g g e s t s t h a t i t i s p r o b a b l y n ot p o s s i b l e f o r c o u n t r i e s t o p r o v i d e c o n s i d e r a b l e s t i m u l a t i o n t o t h e f l o w o f DPPIs w i t h o u t f i r s t d e v i s i n g some p o l i c y measures t o i n i t i a t e f i r m s t o c o n s i d e r i n v e s t m e n t o p p o r t u n i t i e s a c r o s s t h e i r n a t i o n a l b o u n d a r i e s . ABSTRACT . . . . . . . . . . . i i i ACKNOWLEDGEMENT . . x i i CHAPTER " I INTRODUCTION 1 purpose o f t h e Study 1 O r g a n i z a t i o n o f t h e Study 2 L i m i t a t i o n s and Problems E n c o u n t e r e d . . . 4 I I NEO-CLASSICAL INVESTMENT THEORY AND DIRECT PRIVATE FOREIGN INVESTMENTS 7 I n t r o d u c t i o n 7 Pure N e o - c l a s s i c a l Investment Theory . . . 10 B a s i c Assumptions and B a s i c Investment D e c i s i o n R u l e . Measures o f A c c e p t a b i l i t y and Investment D e c i s i o n R u l e . G e n e r a l N e o - c l a s s i c a l Investment Theory . . 1 5 R e l a x a t i o n o f B a s i c Assumptions. R e c o g n i t i o n o f R i s k s and U n c e r t a i n t y . I n c o r p o r a t i n g R i s k s and U n c e r t a i n t y i n Investment A n a l y s i s . E v a l u a t i n g D i r e c t P r i v a t e F o r e i g n Investment p r o j e c t s . 2 5 A d d i t i o n a l problems, V a r i a b l e s and Assumptions. E s t i m a t i n g Cash F l o w s , R e t u r n s and R i s k s . R e a c h i n g a C o n c l u s i o n . Nee— c l a s s i c a l Investment Theory: A S r i e f Review . . 37 Implications of-Neo-classical Investment Theory for Direct Private Poreign Investment Incentive Programs 38 Summary 40 Neo-classical Investment Theory. Implications of Neo-classical Investment Theory. Neo-classical Investment Theory and . Evaluating Investment Projects. I l l ALTERNATIVE HYPOTHESES OP DIRECT PRIVATE FOREIGN INVESTMENTS . 46 Introduction . 46 Higher P r o f i t Rate Abroad .Hypothesis . . . 48 Lower Costs Abroad Hypothesis . . . . . . 50 Monopolistic Competition Hypothesis . . . 52 Growth-of the Firm Hypothesis 55 • Marketing Considerations Hypothesis . . . 58 Market Size Hypothesis 60 Maintenance of Market Hypothesis 62 Product Cycle Hypothesis 64 Other Hypotheses 68 Summary 70 The Alternative Hypotheses. Their Assumptions. Their Implications. IV RECOGNITION AND CONSIDERATION OP DIRECT PRIVATE FOREIGN INVESTMENT ALTERNATIVES: CONSTRAINTS, HIDDEN RESISTANCES AND INERTIAS 75 Introduction . 75 Recognition and Consideration of Direct Private Foreign Investment Alternatives. . 76 Aspects of the Investment Decision-Making Process. Direct private Foreign Investment Theories and the Recognition and Consideration of Investment Alternatives. Empirical Evidence. Constraints, Hidden Resistances and •Inertias '86 Organization Traditions and Attitudes. . Psychological Obstacles or Generally Held B e l i e f s . L i m i t a t i o n of Company Resources. Departmental Structures. M u l t i p l i c i t y of Environments and Complexities of Investing Abroad. Information and Investigation Costs. Summary ' 102 V INITIATING FORCES, AND THE ORIGINATION, CONSIDERATION AND EVALUATION OF DIRECT PRIVATE FOREIGN INVESTMENT PROJECTS. . . . 105 Introduction . . . . '. 105 Some Relevant Aspects of the Behavioural Theory of the Firm I n i t i a t i n g Eorces and the Origination of Direct Private Foreign Investment Projects 1 10 The Consideration, Investigation and Evaluation of Direct private Foreign Investment Projects 115 Consideration of Investment projects. Commitment and the Investigation of Investment proposals. Company Investment C r i t e r i a and.Final Decision. Summary 126 VI CONCLUSION 128 Recapitulation 128 pol i c y Implications 130 The Exception 132 The Way Ahead 133 BIBLIOGRAPHY 136 APPENDIX I 152 APPENDIX I I 155 LIST OP ILLUSTRATIONS FIGURE . PAGE I PROJECT SELECTION DECISION IN THEORY 36 I I ASPECTS OE AN INVESTMENT DECISION-MAKING PROCESS. 78 I I I COMPLEXITIES OE INVESTING ABROAD. 97 The w r i t e r i s deeply i n d e b t e d to p r o f e s s o r Whatarangi W i n i a t a f o r h i s i n v a l u a b l e s u g g e s t i o n s and f o r h i s p a i n s -t a k i n g s u p e r v i s i o n o f t h i s study. He a l s o wishes to express h i s g r a t i t u d e to h i s two o t h e r s u p e r v i s o r s P r o f e s s o r B r i a n E. Burke and P r o f e s s o r J . D. 'Forbes f o r t h e i r u s e f u l comments and to t h e Canadian I n t e r n a t i o n a l Development Agency f o r making h i s s t u d i e s i n Canada p o s s i b l e . He acknowledges complete r e s p o n s i b i l i t y f o r t h i s study, i t s c o n c l u s i o n s and the weakness t h a t may remain i n t h e argument. \ \ CHAPTER ONE I N T R O D U C T I O N . purpose of the Study. Policy measures adopted by governments of c a p i t a l -importing and capital-exporting countries^ to encourage, stimulate and direct the flow of direct private foreign 2 investments (DPEIs) are based on certain theories and hypotheses regarding the underlying determinants of such investments. They are also based on certain assumptions regarding the behavior and motivations of private investors .and the manner by which they a r r i v e at a decision to under-take such investments. Countries which t r y to a t t r a c t direct private foreign investments may be called "capital-importing countries" or "host countries" whereas countries which t r y to encourage t h e i r c i t i z e n s to undertake direct investments abroad may be called "capital-exporting countries" or "source-countries". 2 The U. S. Department of Commerce regards direct private foreign investments as " a l l those foreign business enterprises i n which a_U. S. person, organization or a f f i l i a t e d group owned a 25 per cent, interest, either i n the voting stock of a foreign corporation, or an equivalent ownership i n a non-incorporated foreign enterprise." (U. S. Department of Commerce, U. S. Business Investments i n Foreign Countries, A Supplement to the Survey of Current Business. Washington, I960, For the purpose of t h i s study, however, we need not worry about the kind of precise d e f i n i t i o n necessary for s t a t i s t i c a l analysis. The term may, therefore, be simply taken to include a l l i n d u s t r i a l and commercial operations located within a country which are owned, either wholly or p a r t i a l l y , and controlled, either i m p l i c i t l y or e x p l i c i t l y , by private i n d i v i d u a l s , business firms or a f f i l i a t e d groups from another country. It i s the purpose of this study, f i r s t , to outline these theories and hypotheses together with their main assumptions and implications with regard to the manner in which private investors, particularly firms or companies', analyse direct foreign investment projects and the methods by which DPFIs can be stimulated, and, second, to re-examine and reconsider a few of these assumptions and implications in the light of the behavioural theory of the firm and certain reported investigations of direct foreign investment decisions of some companies. Organization of the Study Chapter Two.' of this study presents the main elements of the neo-classical investment theory. (The main elements of the classical investment theory are presented in Appendix I . ) 1 It outlines the early and modified assumptions of this theory and discusses the methods of evaluating investments as suggested by i t . The chapter also reviews some of the problems \ Like the classical investment theory, the neo-classical investment theory i s , simply stated, a set of abstract deductions on investment and investment behaviour of investors based on the assumptions that human action i s rational and that a l l rational action i s self-seeking in i t s nature. .But unlike the classical investment theory, the neo-classical investment theory i s more rigorous and makes " u t i l i t y " and "marginalism" as integral parts of i t s analytical apparatus. See Edmund Whittaker,' Schools and  Streams of Economic Thought, (Chicago: Rand McNally & Company, I960), pp. 18Y-190 and pp. 311-312 for a summary of these two schools of economic thought. associated-with evaluating direct private foreign investment projects and some of the implications neo-classical investment theory has for direct private foreign investment incentive programs. Chapter Three contains a . b r i e f survey of alt e r n a t i v e hypotheses — a l t e r n a t i v e to the c l a s s i c a l and neo-classical investment t h e o r i e s — which purport to pin-point the immediate or proximate cause for firms and investors to undertake direct investments abroad. I t contains not only a review of these alternative hypotheses but also a discussion of t h e i r main assumptions and implications. Chapter Tour attempts t'o re-examine and reconsider, i n the l i g h t of some reported investigations of direct foreign investment decisions of some companies, one of the main assumptions of the neo-classical investment theory and most alternative hypotheses of DPFIs — that direct foreign invest-ment alternatives are given to firms or that firms systematically scan the globe for areas to make an investment. I t also attempts to provide some explanations to the phenomena ac t u a l l y observed by various scholars. In Chapter Five, the res u l t s of past studies are pooled together to provide further insights into the foreign investment decision process of firms or companies, This chapter discusses the. i n i t i a t i n g forces i n DPFIs and the manner i n which most firms or companies probably consider, investigate and evaluate direct foreign investment projects. I t also contains some aspects of the behavioural theory of the firm relevant to the above issues. F i n a l l y , i n Chapter Six, the amin assumptions and implications both of the theoret i c a l materials and of the re-ported investigations are b r i e f l y r eiterated and summarized. The chapter also notes an exception to the observations made. I t concludes with some observations on changes that may be taking place with respect to the consideration of direct foreign investment projects. Limitations and'Problems Encountered. One major problem faced by the writer i n t h i s study arises from the paucity of the o r e t i c a l material on DPEIs, i n pa r t i c u l a r on the decision-making process involved.''" There i s a paucity of theoret i c a l material on DPFIs because, u n t i l recently, economists have neglected the study of such invest-ments. In international economics, scholars have concentrated on trade theory; the movement of goods has been seen as a powerful engine of economic growth and adequate for the "'"The l i t t l e t h eoretical material on DPFIs i s concentrated larg e l y on the study of Iong term ca p i t a l flows i n r e l a t i o n to the mechanism of adjustment i n the Balance df Payments together with the effects of such flows on the suinmarized statement of a country's economic transactions with the rest of the world. The second major problem faced by the writer pertains to the problem of sieving, selecting and sampling from the wide array of hypotheses, the main hypotheses and of dis -t i l l i n g from them the main ideas. The writer has solved t h i s problem by giving emphasis to those hypotheses and ideas which seem to him especially s i g n i f i c a n t and with which he i s closely f a m i l i a r . In the reconsideration of the th e o r e t i c a l material on DPFIs, the writer i s mainly concerned with pointing out that foreign investment alternatives are not given to firms, that most .firms probably do not normally look across t h e i r national boundaries for investment opportunities, that most firms probably only investigate direct foreign investment opportunities when they are pressured (or threatened) or persuaded (or instigated) to, that when firms evaluate direct foreign investment projects they probably have, before the investigation, i n p r i n c i p l e agreed to accept the project, and, that they probably do not carry out cross country comparisons of p r o f i t a b i l i t y . No attempt i s made i n t h i s study to prove or disprove the v a l i d i t y of any or a l l of the hypotheses nor i s there an effort made to develop a comprehensive and See David F e l i x , "International "factor Migration and World Economic Welfare," i n Bert p. Hoselitz (ed.), Economics and the Idea of Mankind, (Columbia University Press, New York, 1965), ppT 103 and 112 for similar views. c o n c l u s i v e t h e o r y o f d i r e c t p r i v a t e f o r e i g n i n v e s t m e n t d e c i s i o n . T h i s study i s an attempt t o p o i n t out what appear t o be i m p o r t a n t m i s s i n g l i n k s i n t h e t h e o r e t i c a l b a s e s o f government, p o l i c i e s t o s t i m u l a t e DPFTs. NEO-CLASSICAL INVESTMENT THEORY AND DIRECT PRIVATE FOREIGN INVESTMENTS. Introduction. The c l a s s i c a l economists such as David Ricardo, J. S. M i l l s , Adam Smith, Nassau William Senior and Karl Marx and the neo-classical economists such as Auguste Walras, A l f r e d Marshall, Karl Menger, P h i l i p Wickstead and Knut Wick s e l l , do not have a theory of direct private foreign investments separate from a theory, of direct private domestic investments or a theory of foreign investments separate from a theory of domestic investments. To them, ... the basic p r i n c i p l e s of foreign investments are e s s e n t i a l l y the same as those of home investments. The chief motive power that drives the machinery of both i s f i n a n c i a l p r o f i t . The p r i n c i p a l c r i t e r i a by which the goodness of a foreign investment i s judged are the same as those by which a domestic investment i s judged, and having separate theories for domestic and foreign invest-ments i s superfluous. They assume that the investment decision process i s a simple process i n which investors —sometimes conceived as made up of single entrepreneurs and sometimes conceived Edwin Walter. Kemmerer, "The Theory of Foreign Investments," in Annals of the American Academy of P o l i t i c a l and Social Science, Vol. LXVIII (November 1916y, p . l a s made up of firms acting as omniscient economic men— evaluate given alternative investment projects i n terms of costs and benefits and select and undertake those projects which w i l l help them (the investors) to achieve t h e i r goal of p r o f i t maximization. T h e y maintain that under conditions of certainty, investors have perfect knowledge of a l l invest-ment projects and o f " a l l the consequences attached to each and t h e y w i l l undertake any investment project that y i e l d s benefits i n excess of the resources used. Under conditions of uncertainty, however, t h e y maintain that investors w i l l s t i l l be attempting to select and undertake investment projects which w i l l help them to maximize t h e i r p r o f i t s but because of the lack of perfect knowledge, investors w i l l be making t h e i r . .investment decisions on the basis of'.expected returns., exp.ected costs and expected r i s k i n e s s of investment projects and on the basis of t h e i r own r i s k preferences and t h e i r investment budgets. Although the c l a s s i c a l and neo-classical investment theories are both b u i l t on the same basic assumption, that the primary goal of the i n d u s t r i a l concern i s the maximization of p r o f i t s i n the long run, there seems to be one important distinguishing feature between them.. While the c l a s s i c a l investment theory seems to be largely macro-oriented and attempts to explain the flow of investment i n the aggregate, the neo-classical investment theory seems to be lar g e l y micro-oriented and attempts to explain the investment decision-making process at the l e v e l of the firm or company. When viewed i n terms of a theory of DPFIs, the former, therefore, seems to attempt to provide an explanation as to why DPFIs flow from one country to another while.the l a t t e r attempts to explain why a firm or company chooses a foreign invest-ment project and undertakes direct investments abroad. The c l a s s i c a l and neo-classical investment theories have been severely c r i t i c i z e d . They have been l a b e l l e d as s t a t i c , normative and vague theories."'" But despite these c r i t i c i s m s , they are s t i l l held as the most convincing 2 " explanations for the flow of DPFIs. And, these theories seem to provide the basic assumptions on which the foreign investment incentives of many countries are devised. This chapter i s devoted to a discussion of the neo-•5 c l a s s i c a l investment theory, the methods of evaluating " See y a i r Aharoni, The Foreign Investment Decision Process (Boston: Harvard University, Graduate School of Business Administration, Division of Research, 1966), pp. 245-303 for a summary of the c r i t i c i s m s l e v e l l e d at the c l a s s i c a l and the neo-classical investment theories. o "The fact that many people s t i l l believe that "foreign investment i s primarily prompted by p r o f i t rates being d i f -f e r e n t i a l l y higher than those of alt e r n a t i v e domestic invest-ment opportunities or higher than export p r o f i t rates" and that "investment flows to the area of highest return" suggests that the c l a s s i c a l and neo-classical investment theories have wide general acceptance as explanations for the flow of DPFIs. See Judd Polk, Irene W. Meister and Lawrence A. Viet, U. S. Pro- duction Abroad-and the Balance of payments; A Survey of Corporate Investment Experience -(Few" York; National I n d u s t r i a l Conference Board, Inc. , 1S6'6), pp. 64-65 for s i m i l a r views. A summary of the c l a s s i c a l investment theory as i t applies to foreign investments i s presented i n Appendix I. investment projects — b o t h domestic and foreign p r o j e c t s — as suggested b y . i t and some implications of t h i s theory for direct private foreign investment incentive programs. Pure Neo-calssical Investment Theory. Basic Assumptions and Basic Investment Decision Rule. Neo-classical investment theory i n i t s pure form . accepts as i t s st a r t i n g point the following assumptions:"1' 1. There i s -perfect competition i n the market place, meaning that the. market i s made up of a large number of buyers and s e l l e r s of factor inputs,and factor outputs and that no single buj^er or s e l l e r i s able to influ/ence price. 2. A l l firms In the same industry produce homogeneous products so that the product of one firm i s a perfect substitute of another i n the same industry. 3. The primary goal of the firm, a buyer of factor inputs and a s e l l e r of factor outputs, i s the maximization of p r o f i t s . 4. The "state of the a r t " remains constant i . e . there are no technological changes. 5. Firms have perfect and costless knowledge of a l l present and future investment opportunities or alternatives, of a l l present and future factor prices, product prices, demand and supply con-dit i o n s , and cash flows associated with each investment al t e r n a t i v e , and of the courses of These assumptions are seldom a l l e x p l i c i t l y spelt out in an elucidation of the neo-classical investment -theory but the analyses outlined by i t implicit!;/ take these for granted. Some of these assumptions, however, are e x p l i c i t l y stated i n some expositions. For a summary of some of these assumptions see Yair Aharoni, op. c i t . , pp. 7 and 246 6. Investment a l t e r n a t i v e s or projects available to a firm are "independent" of one another, meaning that the p r o f i t a b i l i t y of any project i s not s i g n i f i c a n t l y affected by the acceptance or re-jec t i o n of any other project i n the set. 7. Firms can f r e e l y lend or borrow at the going mar-ket rate of interest i . e . there i s no l i m i t a t i o n on the amount of funds a firm can raise at the p r e v a i l i n g r i s k - f r e e interest rate. 8. Firms do not face any organizational complications or constraints. This flows from the assumptions that; ( i ) firms have ho l i m i t a t i o n on- the amount of funds they can raise, ( i i ) decisions are made by organizations rather than people, and ( i i i ) when people j o i n organizations, they agree to conform to, i n return for the "inducement" off ered, the goals set by the.organizations. Given that firms have available to them a set of investment projects — b o t h domestic and foreign investment p r o j e c t s — and that t h e i r goal i s to maximize t h e i r p r o f i t s , pure neo-classical investment theory postulates that the investment decision.process i s a simple process i n which firms investigate and evaluate a l l given investment projects with a view toward selecting and undertaking those projects which w i l l help them to maximize t h e i r p r o f i t s . Clearly, a business firm v a i l increase i t s p r o f i t s by selecting and undertaking any investment project that y i e l d s revenues i n excess of the cost of the resources needed for that project. I t follows, therefore, that according to t h i s theory, a firm w i l l undertake investment projects —whether they be domestic or foreign investment projects™ so long as the benefi resources used. And ... the cut-off point w i l l be where the revenues are equal to the costs of the resources used. F a i l u r e to extend investment to the point where revenues equal costs w i l l result i n the f u l l p r o f i t potential going unexploited; investment beyond that point -wi l l only . result i n certain projects making losses. ' But since the benefits and the costs associated with a project have a time dimension i n that some of the benefits are to be derived and some of the costs are.to be incurred i n the future, the theory i m p l i c i t l y assumes that i n evaluating investment projects firms take account of the time value of money. Measures of Acceptability and Investment Decision Rules. • Two measures of ac c e p t a b i l i t y that reasonably ensure that the time value of benefits and costs associated with projects are taken into account are: 1. The Internal Rate of Return. By d e f i n i t i o n , the in t e r n a l rate of return i s simply the rate of discount that w i l l equate the present value of the benefits with the present value of the costs associated with the project. I t Peter J. Dickerson, "Capital Budgeting i n Theory and Practice," i n Cal i f o rn i a ]•" an ag em en t R e v i e w. Vol. 6, No. 1, ( F a l l 1963), p.53 Z B t (1 + r) t = t c t (1 + r)' t=o t=o where B^ ... benefits derived from the project at the end of period t . C. ... costs associated with the project at the end of period t . n ... l a s t period i n which benefits or costs occur. r ... the rate of return. The Net present Value. The net present value of a project i s simply the difference between the present value of benefits and the present value of costs associated with the project or N.P.V. = Z B t ( l + k ) " t - it C t ( l + k ) - t t=o t=o where N.P.V... net present value. B^ ... benefits derived from the project at the end of period t . C^. ... costs associated with the project at the end of period t . n ... l a s t period i n which benefits or cost occur. k .. .' cost of c a p i t a l , which under pure neo c l a s s i c a l investment theory i s the market rate of interest. In the above formulation, the cost of cap i t a l i s assumed to remain constant over time. I f t h i s rate changes over time, the net present value of a project can be computed by N . P . V . = 2L B T ( i + i ^ ) - ^ - 53 c t ( l + i ^ r * t=o t=o where k^ i s the cost of c a p i t a l or the market rate of interest i n period i and the other symbols have the same meanings as before. As long as the in t e r n a l rate of return of a project exceeds the supply price of funds, which under pure neo-c l a s s i c a l investment theory i s the market rate of in t e r e s t , that project increases the p r o f i t s of the enterprise and should therefore be undertaken. Therefore, according to pure neo-classical investment theory, a firm undertakes a direct foreign investment project because the foreign investment project's i n t e r n a l rate of return i s greater than (or equal to) the market rate of in t e r e s t . Under the net present value c r i t e r i o n , a project w i l l increase the p r o f i t s of the firm i f i t has a po s i t i v e net present value. Therefore, under pure neo-classical invest-ment theory, a firm that uses the net present value measure to evaluate investment projects undertakes a direct foreign investment because the project has a posi t i v e net present valu e. General Neo-classical Investment Theory. Relaxation of Basic Assumptions. pure neo-classical investment theory has been attacked and c r i t i c i s e d by a number of economists.^ These attacks or c r i t i c i s m s f a l l into one of two l i n e s : 1. The theory i s u n r e a l i s t i c because i t does not have enough variables i n i t or because the variables of the theory do not i n fact correspond to the si g n i f i c a n t variables of the firm.2 2. The theory i s u n r e a l i s t i c because p r o f i t maxi-mization simply does not correspond to the actual p r i n c i p l e s which motivate and direct the behaviour of firms, or even i f firms want to maximize p r o f i t s there i s no way of doing i t . ^ Attempts to take into account some of the c r i t i c i s m s of the neo-classical investment theory i n i t s pure form and to extend the theory to include additional variables and to modify some of the c r u c i a l assumptions include the recognition See for example, E. H- Chamberlain, The Theory of Mono-p o l i s t i c Competition, (Cambridge: Harvard University press, 6th ed., 1950); Joel Dean, Managerial Economics, (Englewood C l i f f s , New. Jersey: P r e n t i c e - K a l i Inc., 19t>lTT~R. A. Lester, "Short-comings of the Marginal Analysis for Wage Employment problems," i n American Economic Review. Vol. XXXVI, No. 1, (March 1946), pp. 65-82; and Stephen Enke, "On Maximizing P r o f i t s , " i n American Economic Review, Vol. XLI, No. 4, (September 1951), ppT 566-578. Kenneth E. Boulding, "Implications for General Econ-omics of More R e a l i s t i c Theories of The Firm," i n American  Economic Review. Vol. 42, No. 2, (May 1952), p. 35 Ib i d . , p. 36 1. In the real business world, firms are not of atomistic size. Rather they are of different sizes. 2. In some industries, the number of firms i s small and a c t i v i t i e s of different firms are interdependent. 3. Products of firms i n the same industry are not necessarily perfect substitutes for each other. 4. Capital markets are far from perfect and firms do not face a perfectly e l a s t i c supply' curve of c a p i t a l . 5. Firms cannot lend or borrow freely at a given rate of interest so that investment budgets of firms are at any p a r t i c u l a r point in-time l i m i t e d i n amount. 6. The supply price of funds to a firm i . e . i t s cost of c a p i t a l , d i f f e r s not only from the market rate of interest but i t also d i f f e r s between firms. 7. The "state of the a r t " or technology does not remain unchanged. 8. Firms do not have f u l l and exact knowledge of a l l present and future factor prices, product prices, demand and supply conditions and cash flows associated with each project and they do not know exactly which of the courses of action w i l l help them to maximize t h e i r p r o f i t s . W i t h r e s p e c t t o t h e i n v e s t m e n t d e c i s i o n s o f f i r m s and t h e e v a l u a t i o n o f i n v e s t m e n t p r o j e c t s , t h e most i m p o r t a n t a s s u m p t i o n s r e l a x e d a r e t h e a s s u m p t i o n s t h a t i n v e s t m e n t d e c i s i o n s a r e made under c o n d i t i o n s o f p e r f e c t c e r t a i n t y ( p e r f e c t knowledge) and t h a t f i r m s f a c e a n o n - c a p i t a l r a t i o n i n g s i t u a t i o n (no l i m i t a t i o n on t h e amount o f f u n d s a t t h e For a f u l l e r discussion on extensions of pure neo-c l a s s i c a l investment theory, see Y a i r Aharoni, Op. c i t . , pp. 248-249. p r e v a i l i n g market r a t e o f i n t e r e s t ) . I t s h o u l d , however, he n o t e d t h a t n e o - c l a s s i c a l i n v e s t m e n t t h e o r y i n i t s m o d i f i e d o r g e n e r a l form s t i l l t a k e s f o r g r a n t e d t h a t : 1. t h e p r i m a r y g o a l o f t h e f i r m i s t h e m a x i m i z a t i o n o f p r o f i t s , . 2. i n v e s t m e n t a l t e r n a t i v e s a r e g i v e n t o t h e f i r m , ( T h i s f o l l o w s from t h e p r e s u m p t i o n t h a t because o f t h e p r e s s u r e o f c o m p e t i t i o n , t h e d e s i r e t o s u r v i v e as v i a b l e e n t i t i e s i n a c o m p e t i t i v e . environment and t h e g o a l t o maximize p r o f i t s , f i r m s c o n t i n u o u s l y scan d o m e s t i c and f o r e i g n environments f o r in v e s t m e n t o p p o r t u n i t i e s . ) 3. f i r m s do not f a c e any o r g a n i z a t i o n a l c o n s t r a i n t s o t h e r than f i n a n c i a l c o n s t r a i n t s , 4. f i r m s c o n s i d e r , i n v e s t i g a t e and e v a l u a t e a l l known i n v e s t m e n t a l t e r n a t i v e s b e f o r e t h e y make a d e c i s i o n t o a c c e p t o r r e j e c t a p a r t i c u l a r i n v e s t m e n t a l t e r n a t i v e , ( T h i s i m p l i e s t h a t b e f o r e and i n t h e p r o c e s s o f i n v e s t i g a t i o n o f in v e s t m e n t a l t e r n a t i v e s , f i r m s do not f e e l a commitment t o a c c e p t anjr o f t h e a l t e r n a t i v e s . ) and t h a t 5. due t o c a p i t a l r a t i o n i n g , f i r m s make comparisons o f t h e d e s i r a b i l i t y o f in v e s t m e n t a l t e r n a t i v e s o r p r o j e c t s and s e l e c t t h o s e a l t e r n a t i v e s o r p r o j e c t s w i t h h i g h e r n e t expected p r e s e n t v a l u e s o r ex p e c t e d i n t e r n a l r a t e s o f r e t u r n b e f o r e s e l e c t i n g t h o s e w i t h l o w e r ones. S i n c e t h e s e a s s u m p t i o n s form t h e g i s t o f the n e o - c l a s s i c a l i n v e s t m e n t t h e o r y and s i n c e t h e y seem to form t h e b a s e s o f t h e f o r e i g n i n v e s t m e n t i n c e n t i v e programs o f many countries, t h e i r v a l i d i t y w i l l be examined l a t e r i n t h i s study. N e o - c l a s s i c a l i n v e s t m e n t t h e o r y i n i t s g e n e r a l form r e c o g n i z e s t h a t f i r m s o p e r a t e i n a w o r l d o f u n c e r t a i n t y , t h a t i n making i n v e s t m e n t d e c i s i o n s f i r m s do not have p e r f e c t knowledge o f a l l t h e consequences a t t a c h e d t o each i n v e s t m e n t a l t e r n a t i v e and t h a t when f i r m s u n d e r t a k e i n v e s t m e n t p r o j e c t s t h ey f a c e a l l k i n d s o f r i s k s and u n c e r t a i n t i e s . " ' " The r i s k s and u n c e r t a i n t i e s r e c o g n i z e d i n neo-c l a s s i c a l i n v e s t m e n t t h e o r y , however, a r e o n l y t h o s e p e r t a i n i n 2 t o t h e outcomes o f i n v e s t m e n t a l t e r n a t i v e s . These i n c l u d e : c a l ami t y r i sk s - t h e r i s k s t h a t a f i r m ' s f u t u r e net o p e r a t i n g r e c e i . p t s f o r a l l t i m e may be wiped out because o f c a t a s t r o p h e s such as wars and r e v o l u t i o n s , f i r e s and f l o o d s , embargoes and c o n f i s c a t i o n s , t e c h n i c a l r i s k s - t h e r i s k s r e s u l t i n g , from an i n c r e a s e i n i n p u t i n r e l a t i o n t o o u t p u t , p r i c e r i s k s - t h e r i s k s t h a t p r i c e s o f p r o d u c t i v e s e r v i c e s may be i n c r e a s e d o r t h e p r i c e s o f goods s o l d may be d e c r e a s e d , •payment r i s k s - t h e r i s k s t h a t customers may d e f a u l t o r d e l a y t h e i r payments, t a x r i s k s - t h e r i s k s t h a t t h e t a x r a t e may be increased" o r t h e t a x a l l o w a n c e s decreased. A l t h o u g h prank E. K n i g h t i n R i s k , U n c e r t a i n t y , and  P r o f i t ( B o s t o n : Houghton M i f f l i n Company, 1 9 2 1 } , has drawn a d i s t i n ' c t i o n between r i s k and u n c e r t a i n t y — t h e former b e i n g a s i t u a t i o n where t h e p r o b a b i l i t i e s o f a l t e r n a t i v e outcomes a r e known w h i l e t h e l a t t e r a r e ; n o t — n e o - c l a s s i c a l i n v e s t m e n t theo g e n e r a l l y s t i l l t r e a t s u n c e r t a i n t y as synonymous w i t h r i s k . 9 T a i r A h a r o n i , op._ c i t . , p. 2 5 5 1. 2. ' 3 . . 4 . and 5 « Since neo-classical investment theory recognizes only r i s k s an'd uncertainties pertaining to the outcomes of investment alternatives, i t f a i l s , i n the context of the investment decision process, to recognize that there- i s uncertainty about investment opportunities and about the responses of people within and without the firm to investment proposals. In other words, i t f a i l s to recognize that certain investment opportunities or certain types of investment opportunities may never become known to certain investors and that although certain investors are f u l l y aware of certain investment opportunities or certain tjrpes of investment opportunities, they may not consider these opportunities simply because they regard these "outside t h e i r l i n e of business". Incorporating Risks and Uncertainty i n Investment Analysis. Neo-classical investment theory maintains that under conditions of uncertainty the investment decision process i s s t i l l simply one i n which firms and investors evaluate given investment projects with a view toward selecting and under-taking those projects which w i l l help them to maximize t h e i r p r o f i t s . What firms and investors attempt to maximize, however, i s not actual p r o f i t s — for t h i s cannot be known ex-ante— but rather expected return (or u t i l i t y ) . The. theory takes 'risks and. uncertainty into account are able to form some expectations of the pattern of future cash flows and.of r i s k s associated with each investment project"1' and by assuming that uncertainty can be compensated 2 for by higher returns. Since the r i s k s and uncertainty recognized i n neo-c l a s s i c a l investment theory only relate to the outcomes of investment alternatives, attempts to formally incorporate considerations of r i s k s and uncertainty i n investment analysis merely take the form of suggestions of better methods to evaluate investment projects or to obtain the expected net •present values or the expected in t e r n a l rates of return of projects. The methods suggested include: 1. The Method of Certainty Equivalents. When t h i s method i s used and the net present value of a project i s calculated, the r i s k elements i n the income stream are taken into account by multiplying the expected cash flows for each period of the project's l i f e by certainty equivalent c o - e f f i c i e n t s associated with them to obtain the certainty equivalent cash flows for each period In neo-classical investment theory expectations are treated as an exogenous variable. How expectations are formulat and how the expected values of the cash flows are known are not discussed. See Aharoni's comment i n Yair Aharoni, op. c i t . , p. 251 See for example, Joel Dean, o_n._ci_t. , p.568 of.the project's l i f e . These certainty equi-valent cash flows are then discounted by a r i s k free discount rate to obtain the net present value of the project."'" 2 . The Method of Risk Adjustment. Under t h i s method, the r i s k elements.in the income stream are taken into account by drawing up a subjective p r o b a b i l i t y d i s t r i b u t i o n for the net cash flows for each period of the . project's l i f e , c a lculating the expected value p of the net cash flow for each period and then discounting these by the firm's cost of capi t a l "to obtain the net present value of the project. 3. The Use of Simulation (Hertz's technique). According to David B. Hertz r i s k elements can be better taken into account by f i r s t deriving a p r o b a b i l i t y d i s t r i b u t i o n of possible rates of return on the investment and then computing the For a f u l l e r discussion of t h i s approach for adjusting r i s k s , .see James C. Van Home, Financial Management and Pol i c y (Englewood C l i f f s , New Jersey: pTentTce-Hall Inc., 1 9 5 8 7 " ^ pp. 66-67. 2 In calculating the expected values of the net cash flows for the various periods, account i s to be taken of the quality of the income streams. -'Using a firm's cost of ca p i t a l to discount the net cash flows of a project i s only appropriate i f the firm's cost of ca p i t a l i s higher than i t s opportunity cost a t t r i b u t a b l e to the resources used in the project. steps. I n Hertz's words they are: i . Estimate the range of values for each of the factors (e.g. range of s e l l i n g p r ice, sales growth rate, and so on) and within that range the l i k e l i h o o d of occurence of each value. . i i . Select at random from the d i s t r i b u t i o n of values for each factor one p a r t i c u l a r value. Then combine the values for a l l the factors and compute the rate of return (or present value) from that combination .... . i i i . Do t h i s over and over again to define and evaluate the odds of the occurence of each possible rate of return ... The result w i l l be a l i s t i n g of the rates of return we might achieve, ranging from a loss ( i f the fa.ctors go .against us) to whatever maximum gain i s possible with the estimates that have been made. Eor each of these rates the chances that i t may occur are determined ... The average expectation i s the average of the values of a l l outcomes weighted by the chances of each occuring."'-4. Adjustment of the Discount Rate. When t h i s method i s used and the i n t e r n a l rate of return of a project i s calculated, the r i s k elements associated with a project are taken into account by r a i s i n g the discount rate higher than the firm's cost of c a p i t a l — t h e higher the degree of r i s k s associated with the project, the higher i s the discount rate raised. Since the degree and the nature of r i s k s associated with, a project vary from country to country, from project to project and over the l i f e - t i m e of any p a r t i c u l a r project, firms using t h i s method of evaluating investment proposals may use different discount rates for projects located i n different countries (to r e f l e c t differences i n patterns of r i s k s as between countries), different discount rates for different projects (to r e f l e c t the fact that David B. Hertz, "Risk Analysis i n Capital Investment," i n Harvard Business Review, Vol. 42, Ho. 1, (January-February 1964), pn. 99-100 evironmental factors have diffe r e n t influences on different projects) and different discount rates for each year of the project's l i f e (to r e f l e c t the time pattern of uncertainty)." 1" In the above discussion on. the methods of i n -corporating r i s k s i n investment analysis, no reference was made to the measurement of r i s k s associated with the v a r i a b i l i t y of expected net cash flows although i n evaluating r i s k y investment projects a measure of t h i s v a r i a b i l i t y i s important. I t i s important because the best investment projects for a firm or an investor are not necessarily those with the highest net expected values or the highest expected • - i n t e r n a l rat.es of .r-eturn because a n .inv.estm.ent .pr.o.j.ect for which the expected net present value or the expected i n t e r n a l rate of return i s higher than that of another may be dangerous to the firm or investor i f during a p a r t i c u l a r time period the net receipts decline so much that the firm or investor 2 cannot f u l f i l l i t s obligations to i t s financiers. Therefore, i n evaluating r i s k y investment projects neo-classical invest-ment theory also suggests that the v a r i a b i l i t y of outcome values be determined. Widely used measures of t h i s v a r i a b i l i t y For a further discussion of t h i s method, see Robert B. Stobaugh, J r . , "How to analyse foreign investment climates," i n Harvard Business Review, Vol. 47, No. 5, (September-October 1963), pp. 101-103. 2 Sun e Carlson, Int ernati onal P i nan c i a l Deci sions (Amsterdam; North-Holland publishing Co., 1969) , ">P-24 of outcome values are the standard deviation (or the variance) and the semi-deviation (or the semi-variance).^ Thus, neo-classical investment theory suggests that two measures are essential i n the evaluation of given r i s k y investment proposals: (1) a measure of the expected return for each proposal, and ( 2 ) a measure of the r i s k s ( v a r i a b i l i t y of outcome values) associated with each proposal. Once these measures have been made for the various investment proposals before the firm, which of these proposals i t w i l l undertake depends on the expected rates of return of these proposals, the standard deviations or the semi-variances of t h e i r cash flows, the amount of r i s k s each proposal adds to the ove r a l l r i s k i n e s s of the firm, the r i s k preferences of the firm as 2 well as the ca p i t a l budget of the firm. Evaluating pirect Private Foreign Investment Projects. Additional problems. Variables and Assumptions. • Neo-classical investment theory assumes that i n making investment decisions, firms make estimates of costs For a detailed discussion on these raeasu.res, see Harry M. Markowitz, P o r t f o l i o Selection, (Mew York; John Wiley and Sons, Inc.., -1958'T, "Chapters 4 and 9". "How these measures are employed i s discussed below. and returns from a l l investment projects before them, weigh the potential investment projects i n one.foreign country alongside the projects located at home and i n other foreign countries and then make a firm decision and commitment to undertake any p a r t i c u l a r project or set of projects. In t h i s process of evaluation firms face more problems with regard to the evaluation of foreign projects than with regard to the evaluation of domestic projects becaiise i n evaluating foreign projects, firms have to deal with d i s s i m i l a r i t i e s i n f i n a n c i a l attitudes, i n s t i t u t i o n s , l e g a l system, governmental p o l i c i e s and other environmental variables. More s p e c i f i c a l l y , they w i l l have to consider such new variables as exchange rate r i s k s , d i f f e r e n t i a l i n f l a t i o n rates, taxes across national boundaries, different sources and costs of funds, e f f e c t i v e versus nominal rates of i n t e r e s t , fringe b e n e f i t s , ' j o i n t ventures, special induce-ments and developing l o c a l c a p i t a l markets."1" Neo-classical investment theory i m p l i c i t l y assumes, that when firms evaluate foreign investment projects, they are aware of these additional problems and variables and that, because of the i m p o s s i b i l i t y of obtaining perfect information on- these variables, firms w i l l make assumptions Stefan Robock discusses these problems at great length i n "Overseas Financing for IT. S. International Business," i n Journal of Finance, Vol. XXI, No, 2, (May 1966), pp. 300-302. about them. I f t h i s i s n o t done, i t i s n o t p o s s i b l e f o r them t o p r o c e e d t o c a l c u l a t e e x p e c t e d n e t p r e s e n t v a l u e s o r expected i n t e r n a l r a t e s o f r e t u r n . Some o f t h e major a d d i t i o n a l problems and major a d d i t i o n a l v a r i a b l e s f o r which a s s u m p t i o n s have t o be made i n c l u d e : . 1. F u t u r e exchange r a t e s and c o n v e r s i o n r i s k s . I n e v a l u a t i n g d i r e c t domestic i n v e s t m e n t p r o j e c t s , f i r m s a r e m a i n l y concerned w i t h s o l v e n c y r i s k s — r i s k s r e l a t i n g t o t h e s a f e t y and p r o f i t a b i l i o f t h e i n v e s t m e n t v e n t u r e p e r s e — but i n e v a l u a t i n g d i r e c t f o r e i g n i n v e s t m e n t p r o j e c t s , f i r m s a r e concerned not o n l y w i t h s o l v e n c y . r i s k s .but a l s o c o n v e r s i o n r i s k s — r i s k s r e l a t i n g t o c u r r e n c y d e v a l u a t i o n and c u r r e n c y d e p r e c i a t i o n — ^ f o r "not o n l y may t h e f u t u r e f o r e i g n exchange r a t e be d i f f e r e n t from t h a t a n t i c i p a t e d but v a r i o u s t y p e s ' o f r e s t r i c t i o n s may be i n t r o d u c e d a s r e g a r d s t h e t r a n s f e r a b i l i t y o f funds from one c o u n t r y t o 2 a n o t h e r . " F i r m s e v a l u a t i n g d i r e c t f o r e i g n i n v e s t m e n t p r o j e c t s , t h e r e f o r e , need t o develop s c h e d u l e s o f P e t e r p. G a b r i e l , "The Investment i n t h e LDC: A s s e t w i t h a F i x e d M a t u r i t y , " i n • C o l u m b i a J o u r n a l o f World B u s i n e s s , V o l . 1, No. 3, (Summer 1966Yr~p"! ITS" Sune C a r l s o n , op. c i t . , p.108 relevant anticipated exchange rates"1" i n order to convert incremental cash flows associated with a foreign investment project into domestic currency equivalents. Since i n most countries, different exchange rates are applied for different types of transactions and for different types of payments, "schedules of relevant anticipated exchange rates" means "series of foreign exchange rate projections over time for raw material imports, export sales, 2 dividend remittances and equipment importation." 2. Reinvestment Rate. To reduce pressure on t h e i r balance of payments and s t a b i l i s e t h e i r foreign exchange rates, countries may place r e s t r i c t i o n s on the remittance of cash flows of foreign subsidiaries located within t h e i r borders. This means that of necessity a parent company may have to reinvest some of the cash flows from i t s foreign subsidiaries i n the countries i n which such cash flows occur. See David B. Zenoff and Jack Zwick, International  Financial Management, (Englewood C l i f f s , New Jersey: Prentice-H a l l , Inc., 1SE9) Ch. 3 for an approach to appraising future exchange rates. 2 I b i d . , p. 146 3 See National I n d u s t r i a l Conference Board, Obstacles  and Incentives to private Foreign Investment, 1967-^8, Volume I; Obstacles,' (New York; National Industi-ia'l Conference Board, Inc. , 1969) 5 pp. 5, 6 and 16. Consequently, i n analyzing a foreign investment project, a firm may need to look beyond i t s f i r s t proposed commitment and include a l l subsequent reinvestments provoked by the i n i t i a l investment^ i . e . i t may need to look at foreign investment projects as commitments plus required reinvestments rather than merely i n i t i a l invest-ment choices. ^  ( A l t e r n a t i v e l y , i t may need to make some assumptions regarding the p o s s i b i l i t y of s e l l i n g the project at the end of a certain time period or the p o s s i b i l i t y of s e l l i n g stocks on the basis of the value of the foreign project and move to higher rate of return areas). I t may need to make some assumptions regarding the extent of reinvestments required, the return from such reinvestments together with the effects of such reinvestments on i t s future f i n a n c i a l f l e x i b i l i t y . 3. Income Tax issues. The amount of taxes a firm has to pay on the earnings of one of i t s foreign subsidiaries depends not only on the size of the earnings 3 received out also on the geographical location David B. Zenoff and Jack Zwiek, op. c i t . , p. 148 2 I b i d . , p. 149 3 ^This i n turn depends on the concept of income used and the methods of a l l o c a t i n g expenditures as between parent and subsidiarj'" allowed. o f the income source, the o f f i c i a l headquarters of the firm, the residence and n a t i o n a l i t y of i t s shareholders, i t s type of l e g a l orga,nization and so on. The amount of taxes i t has to pay to the country i n which i t s subsidiary i s located depends not only on the size of the earnings and the size of the c a p i t a l invested but also on whether earnings are repatriated or not and i f they are' repatriated on whether they are sent home i n the form of dividends, amortizations on loans.or of management and licence fees. The amount of taxes i t has to pay to its.own government, however, depends not only on the size and o r i g i n of repatriated and non-repatriated earnings but also on the amount of taxes paid abroad and on whether the earnings are re-patriated through a t h i r d country — a so c a l l e d "tax haven".*1" Since taxes affect the returns from a project, a firm i n evaluating a direct foreign investment project has, p r i o r to making the com-ment, to make some assumptions regarding i t s intention — t a k i n g p o s s i b i l i t i e s into consideration—-For a more general and detailed discussion of the tax problems i n connection 'with foreign investments, see Ban Throop Smith, "Financial Variables i n in t e r n a t i o n a l Business," i n Harvard Business Review, Vol. 44, Mo. 1, (January-February 1966), pp. 93-104; and Peggy Brewer Richman, Taxation of Foreign Invest- ment Income, (Baltimore; •Johns Hopkins -press, 1963)» to repatriate — e i t h e r wholly or p a r t i a l l y — • cash flows from the project, the timing and the methods of repat r i a t i o n as well as tax rates — b o t h at home and abroad— on different types of incomes over the l i f e span of the project. . Financing Alternatives. i n the case of domestic investments, different plans for financing a p a r t i c u l a r invest-ment alternative affect the return from the investment al t e r n a t i v e only through the cost of c a p i t a l . But i n the case of foreign investments, different f i n a n c i a l plans for financing a p a r t i c u l a r alternative a f f ects not only the cost of c a p i t a l but may also affect three other elements; i . the cost of the asset required to implement the al t e r n a t i v e , i i . the operating costs i n the foreign country under the al t e r n a t i v e , i i i . the magnitude of the dividend remittance p r i v i l e g e . This i s so because i n some foreign countries duties on imported raw materials vary with the method of financing the imports, the rate of the excess p r o f i t tax varies with the size of the l o c a l equity base and the remittance p r i v i l e g e varies with the size David B. Zenoff and Jack Zwiek, op. c i t . , p. 154 Consequently, i n analyzing a direct foreign investment a l t e r n a t i v e , a firm needs to i d e n t i f y or assume possible financing a l t e r n a t i v e s , regard a project as an investment al t e r n a t i v e financed i n a p a r t i c u l a r way and develop separate receipt and. disbursement projections for each project.^ Estimating Cash plows, Returns and Risks. Neo-classical investment theory assumes that once a firm has i d e n t i f i e d the problems and variables involved i n evaluating i t s set of investment projects and has made some assumptions regarding them, i t begins to make an estimation of the cash and cash value of non-cash outflows and inflows associated with each project. In the case of direct foreign investment projects, the theory seems to suggest that the cash flows considered are onljr the cash flows to the parent company for unless t h i s i s the case, i t i s not possible for the firm to compare the accep t a b i l i t y of both domestic and foreign projects alongside each other. With a foreign investment project, the cash and cash value of non-cash inflows and outflows to the parent company"*" may comprise: 1. the i n i t i a l cash investment together with the cash value of an old piece of machinery that i s to be shipped to the proposed foreign subsidiary. 2. the imputed cost of transf e r r i n g the know-how. (A cost may be imputed on the transfer of the know-how because by transferring know-how to other environments, the firm exposes i t s e l f to the p o s s i b i l i t y of competition i n the foreign market as well as i n other countries.2) 3 . income earned from increased exports either of parts or of finished products l e s s income l o s t through reduced exports. 4. dividends that the parent expects to receive from the proposed venture. Here allowance needs to be made for domestic and foreign tax l i a b i l i t i e s and credits, and for foreign exchange conversion costs. 5. management contracts, license fees, r o y a l t i e s , disclosure fees and contribution to overhead a f t e r allowance has been made for taxes, foreign exchange conversion costs, and for additional costs to provide the services covered by such payra ent s. 6. loan p r i n c i p a l repayment and interest (less domestic tax payments) . 7. income through transfer p r i c i n g . ( I f the proposed foreign subsidiary has a purchase or sales re-lat i o n s h i p with the parent or with other sub-s i d i a r i e s , i t may be possible to s h i f t income from the subsidiary to the parent or other subsidiaries through an a r b i t r a r y use of transfer prices (and vice versa). • 8. other incremental revenues l e s s costs a r i s i n g from economies and diseconomies of scale, including Some of these cash flows are discussed by Arthur Stonehill and Leonard Nathanson i n "Capital Budgeting and the Multinational Corporation," i n C a l i f o r n i a Management Review, Vol. X , No. 4 , (Summer 1968), pp. - 3 9 - 5 3 . o "•David B. Zenoff and Jack Zwiek, op. c i t . , pp. 157-158. and 9. terminal value of the assets, including any retained p r o f i t s . The theory assumes that once a firm has estimated a l l the incremental cash flows associated with.a foreign invest-ment project and has converted these into domestic currency equivalents using the estimated exchange rates at the time the flows are expected to occur, the firm then goes through a process of determining the net present value of the project by discounting the incremental cash flows ( i n domestic currency)' by the predetermined cost of ca p i t a l and of measuring i t s ris k i n e s s by determining the dispersion of possible net expected values. .This i s done for a l l the projects before i t . Reaching a Conclusion. According to neo-classical investment theory, once a firm has calculated the expected returns (measured by the net present value or the in t e r n a l rate of return) and the r i s k i n e s s (measured hy the standard deviation or the semi-deviation of the expected net cash flows) of the projects before i t , i t w i l l rank these projects based on the r e l a t i v e importance i t attaches to maximizing p r o f i t a b i l i t y versus minimizing r i s k s . And once the projects have been ranked, the firm-goes through a process of selecting and undertaking projects —beginning with the highest r a n k i n g — u n t i l i t s investment budget i s exhausted. 1 This process can be better explained with the help i of Figure 1. In the figure, the curves I to IV represent the firm's u t i l i t y functions — i n d i f f e r e n c e curves r e f l e c t i n g the firm's p attitude toward r i s k and p r o f i t s — and the dots represent investment alternatives plotted according to net expected values ( a l l p o s i t i v e , for projects with negative net expected values are rejected outright) and the associated standard deviations. Ceteris paribus, a firm w i l l rank a project with a .higher expected _r-et.urn .above .one with .a lower .expe.ct.ed return and one with lower r i s k s above one with higher r i s k s . Thus, i f the projects before a firm and the firm's u t i l i t y functions are as plotted i n Figure 1, the firm w i l l rank project 6 above project 2 and project 7 above project 3-But which project w i l l be ranked higher — project 6 or project 7? In t h i s i l l u s t r a t i o n , the u t i l i t y indifference curves of the firm indicate that the firm w i l l rank project 6 Projects selected, must, however, have pos i t i v e net present values or in t e r n a l rates of return greater than the cost of c a p i t a l . 2 For a discussion of u t i l i t y theory and .choice under uncertainty, see James c. T- Mao, Quantitative Analysis of Financial Decisions, (Toronto, On t a TTo] Th e Ma cm i 1 Ian~~C o • 7 Collier-Maemillan Canada Ltd. , 1969)', pp. 52-59. Return (Net expected value of available cash flows.') FIGURE 1 . PROJECT SELECTION DECISION IN THEORY. VJ4 above project 7 for project 6 i s on a higher u t i l i t y function of the firm than project 7. The firm w i l l only be " i n d i f f e r e n t " or be just as v a i l i n g to accept either project when both are on the same u t i l i t y function of the firm. Thus, i n the i l l u s t r a t i o n , the firm w i l l be just as w i l l i n g to accept project 1 as project 5 and just as w i l l i n g to accept project 2 as project 3. In other words, project 1 and project 5 v a i l have the same ranking and projects 2 and 3 v a i l also have the same ranking. But suppose indifference curve I I i s the firm's least acceptable return for r i s k trade-offs, then i n t h i s case, the firm w i l l reject both projects 1 and 5 for although both have po s i t i v e net present values, the returns associated with them are considered by the firm i n s u f f i c i e n t to compensate for the r i s k s expected. Weo-classical Investment Theory :A B r i e f Review. Neo-classical investment theory assumes that, because of the pressure of competition, the desire to survive as viable e n t i t i e s in a competitive environment and the goal to maximize p r o f i t s , firms continuously scan domestic and foreign environments for investment opportunities. Prom t h i s , i t concludes that when firms make investment decisions they ( 1 ) have a number of possible investment propositions, both foreign and domestic, before them, (2) c a r e f u l l y appraise these investment al t e r n a t i v e s i n terms of costs, revenues, p r o f i t s ' and r i s k s , (3) compare the r e l a t i v e returns and r i s k s from these alternatives, and, (4) decide i n favour of the investment alternatives that look most promising. Implications of Neo-classical Investment  Theory for Direct Private Foreign Investment Incentive Programs. Since neo-classical Investment theory postulates that firms scan the globe for investment opportunities, that they consider, investigate and evaluate these opportunities, and, that they select and undertake those opportunities which appear most promising i n terms of returns and r i s k s , the theory i m p l i c i t l y suggests that i t i s possible to provide considerable stimulation to the flow of DPFIs by merely a f f e c t i n g favour-ably firm's expectations of returns and r i s k s of such invest-ments. This i s because i f the returns expected from certain investment projects are raised and t h e i r expected r i s k s are lowered, these investment projects w i l l appear more promising and firms, both foreign and domestic, w i l l undertake them. In short, neo-classical, investment theory i m p l i c i t l y suggests that i f a country desires to stimulate DPFIs, i t has to devise incentive programs whereby returns from such investments w i l l be increased and t h e i r r i s k s reduced. This implies that i f a country wants to a t t r a c t DPFIs, i t v a i l be able to achieve i t s objective by 1. reducing or eliminating the tax load of foreign firms and investors either by granting them "tax holidays" or by granting them provisions for accelerated depreciation for plant and equipment and accelerated amortization for expenditures connected with.research and development, export promotion, etc., 2. offering foreign firms and investors t a r i f f exemptions or reductions on imports of raw materials and on plant and machinery, 3. o f f e r i n g them loans at low interest rates, 4. offering them grants and subsidies to meet the cost of machinery and equipment and other f i x e d assets including that of plant building and that of s i t e development. 5. offering them protection against competition through the erection of t a r i f f walls, introduction of import quotas and r e s t r i c t i o n s on the number of firms allowed to be set up i n the industry to which foreign firms are to be attracted, and 6. o f f e r i n g them protection against nationalism and p o l i t i c a l r i s k s through undonditional guarantees that t h e i r assets v a i l not be nationalized or i n the event of n a t i o n a l i z a t i o n , they v a i l be f u l l y and f a i r l y compensated,! because by o f f e r i n g foreign firms and investors these incentives In fact, these are the sort of incentives offered by most capital-importing countries. For a summary of the incentives they off e r , see National I n d u s t r i a l Conference Board, Obstacles and Incentives to private Foreign i n vest m ent 1967-1968,""Volume . 2: Incentives, Assurances and Guarantees, 7 New York: National In-d u s t r i a l Conference Board,"inc., 1969); and Reinhard Kovary, Investment policy and Investment L e g i s i a t i o n i n Under-developed Countries, (Rangoon: Rangoon University Press, 19"o0). a country a f f e c t s favourably t h e i r expectations of returns and r i s k s of investments located within i t s borders. For a country desiring to encourage i t s c i t i z e n s to undertake DPFIs, on the other hand, the theory i m p l i c i t l y suggests that i t w i l l be able to achieve i t s objective by off e r i n g i t s own c i t i z e n s and firms tax reductions or ex-emptions on t h e i r foreign earned incomes, loans with low or no interest rates and other incentives which w i l l increase the returns from foreign projects, and, by offe r i n g them protection against r i s k s of foreign operations including the r i s k s of expropriation, n a t i o n a l i z a t i o n , war and insurrection and non-convertibility of investment earnings. Summary. Neo-classical Investment Theory. Neo-classical investment theory assumes that the basic p r i n c i p l e s which govern foreign investments are ess e n t i a l l y the same as those governing domestic investments because, firms undertake investments, whether foreign or domestic, to maximize t h e i r p r o f i t s . I t , therefore, regards having separate theories for domestic and foreign investments as unnecessary. In i t s pure form, t h i s theory assumes that investment decisions of firms are made under conditions of perfect competition, perfect certainty, constant technology, and no organizational constraints or l i m i t a t i o n of f i n a n c i a l and other resources and that the investment decision process i s a simple process where firms evaluate given investment projects, "both foreign and domestic, with the object of selecting and undertaking those projects which w i l l ' help them to maximize t h e i r profits.' Since any project that y i e l d s revenues i n excess of the cost of the resources employed w i l l increase the p r o f i t s of the firm, the theory i n i t s pure form i m p l i c i t l y suggest that firms w i l l undertake any investment pxo.jject, whether foreign or domestic, so long as the benefits associated with the project exceed the resources used. This theory i n i t s pure form has been severely c r i t i c i s e d and some of i t s basic assumptions have been•labelled as u n r e a l i s t i c . But despite these c r i t i c i s m s , i t s t i l l maintains that i t is- v a l i d as an explanation of the investment decision process of firms — that i n making investment decisions, firms evaluate given investment alternatives i n terms of costs and benefits, weigh these alternatives alongside each other and select those alternatives which w i l l help them to maximize t h e i r p r o f i t s . The only differences admitted are that firms calculate the expected rather than the actual returns and costs (for actual returns and costs cannot be known ex-ante) associated with the investment alternatives and that they make t h e i r decisions on the basis of these expected returns, the r i s k i n e s s of these alternatives, t h e i r r i s k preferences and t h e i r invest-ment budgets. Implications of Neo-classical Investment Theory. Since neo-classical investment theory assumes that when firms make investment decisions, they (1) have before them a number of investment propositions, both foreign and domestic, (2) evaluate and compare the r e l a t i v e returns and r i s k s of these propositions, and (3) undertake those pro-positions which promise high returns and low r i s k s , i t i m p l i c i t l y suggests that i t i s possible to accelerate the. flow of DPFIs by merely a f f e c t i n g firms' expectations of returns and r i s k s of such investments and that "the growth of international direct c a p i t a l flows w i l l necessarily continue so long as opportunities for p r o f i t a b l e foreign investment abound.""'" What countries have to do to encourage DPFIs, therefore, i s to offer firms incentives such as "tax holidays", accelerated depreciation allowances and loans with low or no interest rates, and protection against competition, Peter P. Gabriel, "From Capital Mobiiiser to Management S e l l e r , " i n Columbia Journal of World Business, Vol. 2, No. 2, (March-April, l96777~P~7 nat i onali zat i on, r i sks. Neo-classical Investment Theory and Evaluating Investment Projects. I f firms have f u l l knowledge of a l l investment projects and of a l l the consequences attached to each project — a s i s assumed hy the neo-classical investment theory i n i t s pure form— the a c c e p t a b i l i t y of an investment project can be measured by determining either the actual net present value (NPV) or the actual i n t e r n a l rate of return (IRR) of the project. Where the NPV of the project i s p o s i t i v e or i t s IRR i s greater than the cost of c a p i t a l , the project adds to the p r o f i t s of the firm, and, according to neo-classical investment theory w i l l be undertaken. I f firms do not have f u l l knowledge of a l l the con-sequences attached to each investment project, NPVs or IRRs of the projects cannot be exactly determined. However, assuming that firms are able to form some expectations of the pattern of the future cash flows and of the r i s k s associated with each project — a s i s done i n neo-classical investment theory i n i t s general form— these NPVs or IRRs of investment projects can be estimated. Methods which can help firms to estimate the NPV or the IRR of a project or a set of projects more accurately include (1) the method of certainty equivalents, (2) the method of r i s k adjustment, (3) the use of simulation, and (4) the adjustment of the discount rate. But NPVs or IRRs i n themselves do not indicate the risk i n e s s of investment projects for they do not give any indi c a t i o n of the v a r i a b i l i t y of the' expected net cash flows of any of the project; the riskiness of any project can only he determined by calculating either the standard deviation or the semi-deviation of the expected net cash flows. Neo-classical investment theory assumes that i n evaluating a set of r i s k y investment projects, firms calculate the expected returns (measured by the ]NrpV or the IRR) and the r i s k i n e s s (measured by the standard deviation or the semi-deviation) of the projects before them. And once they have done t h i s , they rank the projects on the basis of the r e l a t i v e importance they attach to maximizing p r o f i t s versus minimizing r i s k s . And once they have ranked the projects, they select and undertake those projects —beginning with the highest r a n k i n g — u n t i l t h e i r investment budgets are exhausted. Neo-classical investment theory admits that i n t h i s process of evaluation, the foreign projects present special problems and require firms to make certain assumptions re-garding some of the major variables, por example, i t admits that i n evaluating DP PI projects, firms need to make some assumptions regarding (1) future exchange rates and conversion r i s k s , (2) the reinvestment rate, (3) income tax issues, and (4) financing alternatives, and to "re-interpret" the meaning of the term "project" for unless these additional assumptions are made, firms cannot calculate "accurately" the NPVs or the IRRs and the standard deviations or semi-deviations of the pro j ects. ALTERNATIVE HYPOTHESES OP DIRECT PRIVATE FOREIGN INVESTMENTS. Introduction. Neo-classical investment theory assumes that firms aim at p r o f i t maximization and i t asserts that they undertake direct investments abroad because these investments help them to-maximize t h e i r p r o f i t s . To some economists, t h i s explanation seems unconvincing because i t i s based on the assumption that when firms make investment decisions they evaluate a number of investment alternatives simultaneously "and make comparisons of them. To others, the theory i s unconvincing simply because they believe that p r o f i t maximization i s not the primary goal of firms. And to a t o t a l l y different group the theory i s unsatisfactory because i t does not pin-point the s i g n i f i c a n t variables considered by firms i n direct foreign investment deci sions. This disagreement among economists on the v a l i d i t y and usefulness of the neo-classical investment theory as an explanation of the flow of DPFIs has l e d to a number of a l t e r -native explanations or hypotheses, each of which purports to pin-point the immediate or proximate cause for firms to under-take such investments. Research e f f o r t s to v e r i f y the v a l i d i t y or non-v a l i d i t y of these hypotheses have r e l i e d i n the main on interviews, q u a l i t a t i v e evidence and check l i s t questionaires"'-and on an analysis of some published data as are available on direct investments by one country either i n various 2 countries abroad or i n p a r t i c u l a r industries. But a l l these e f f o r t s have not produced conclusions of any pragmatic value.5 Inspite of t h i s , these hypotheses are s t i l l regarded by many as plausible explanations for the flow of DPFIs or why firms undertake direct investments abroad. In t h i s chapter, these hypotheses and some of t h e i r main assumptions and Implications are outlined. Research e f f o r t s of t h i s nature include those of Basi, Robinson and of Behrman. See R. S. Basi, Determinants of United  States Direct Investment i n Foreign Countries, Kent s^ate University, Bureau of Economic and Business Research, Series No. 3, (Ohio: Kent State University, Bureau of Economic and Business Research, 1963); Harry J. Robinson, The Motivation and Plow of Private Foreign Investment, Stanford Research I n s t i t u t e , InTTernational Development Centre, Investment Series No. 4,(Menlo Park, C a l i f o r n i a ; Stanford Research I n s t i t u t e , International Development Centre, 1961); J. N. Behrman, "Foreign Associates and t h e i r Financing," i n Raymond F. Mikesell (ed.), op. c i t . , pp. 88-91. ~" 2 These include the e f f o r t s of Bendera and White, Scaperlanda and Mauer and of Stevens. See v. N. Bandera, and J. T. White, "U. S. Direct Investment and Domestic Markets i n Europe,." i n Economia Internationale, Vol. XXI, (February 1968), pp. 117-133; Anthony E. Scaperlanda and. Lawrence J. Mauer, "The Determinants of U. S. Direct Investment i n the E.E.C.," i n American Economic Review, Vol. LIX (September 1969), pp. 558-568 Guy V. G. Stevens, "Fixed Investment Expenditures of Foreign Manufacturing A f f i l i a t e s of U. S. Firms: Theoretical Models and Empirical Evidence," i n Yale Economic Papers, Vol, 9, No. 1, (Spring 1969), pp. 136-19B. ' " . 3 ^Dunning holds similar views, See John H. Dunning, gtndi i n International Investment. (London: George Allen & Unwin j/Fd. , 1970), pp. 7-8 The higher p r o f i t rate abroad hypothesis, b r i e f l y stated, says that firms undertake direct investments i n countries other than t h e i r own primarily because "they calculate that i n doing so they w i l l increase the return on t h e i r c a p i t a l . " 1 This hypothesis reasons that firms are in business to make a p r o f i t — n o t necessarily to maximize p r o f i t s — and i f a higher p r o f i t - r a t e can be earned abroad that i s where the firms' interest w i l l turn. This hypothesis, therefore, maintains that firms set up marketing f a c i l i t i e s abroad 'because they expect to earn a higher rate of return by employing t h e i r resources i n t h i s manner than by employing them i n other ways and rel y i n g on exports, that they invest i n manufacturing f a c t o r i e s abroad because the returns expected from these investments are higher than those expected from u t i l i z i n g the resources i n expanding home production or in. entering a new l i n e of domestic business and that they invest i n foreign lands i n the extraction of petroleum, t i n , gold and bauxite and i n the production of rubber, cocoa, coffee and r i c e because they are motivated by the prospect of earning rates of return above what they w i l l be able to obtain by employing t h e i r ¥. A. P. Manser, "professor Reddaway's Last Word?" i n National and Westminster Bank Quarterly Review-, "February 1969, p. 40. resources i n domestic investments. Like the neo-classical investment theory, t h i s hypothesis assumes that: • 1. firms are keen to invest i n foreign lands, 2. there are no governmental prohibitions or r e s t r i c t i o n s , placed either by the firms' own governments or by foreign governments, to firms undertaking direct investments abroad, 3. firms are continuously on the lookout for p r o f i t a b l e direct investments abroad, 4. firms possess f i n a n c i a l and. suitable managerial and technical resources to undertake direct investments overseas, 5- firms are generally prepared to invest f i n a n c i a l and managerial resources i n the investigation of investment projects located i n other countries, and that 6. when firms investigate foreign investment projects t h e i r objective i s to f i n d out whether such projects are more p r o f i t a b l e than domestic project and not merely to f i n d p r o f i t a b l e projects, and i t seems to suggest that i t i s possible to influence s i g n i f i c a n t l y "the s i z e and direction of the flow of DPFIs by merely r a i s i n g firms' expectations of p r o f i t rates from such investments. The only major difference between t h i s hypothesis and the neo-classical investment theory i s that t h i s hypothesis i m p l i c i t l y assumes that when firms make investment decisions, they compare one direct investment project abroad with one direct investment project at home while the neo-classical investment theory assumes that firms compare more than two investment projects at a time. Lower Costs Abroad Hypothesis. This hypothesis says that firms undertake direct investments i n certain foreign countries because they c a l -culate that i n doing so they w i l l reduce t h e i r costs of .supplying t h e i r products either.to the foreign l o c a l market or the home market or other foreign markets. I t probably has i t s o r i g i n i n Weber's theory of loc a t i o n , which when reduced to i t s lowest terms, states that "the entrepreneur selects the plant size which minimizes the sum of a l l expenditures. 1 , 1 Stated d i f f e r e n t l y , t h i s hypothesis claims that firms undertake direct investments abroad either because production 2 .costs are JLo.wer ao.ro.ad than .at .home JOT .because af ..on.e or more of the following reasons: 1. Reduced transport costs. 2. Reduced d i s t r i b u t i o n , inventory and servicing costs. 3. Reduced t a r i f f duties and taxes. 4. The cheapness of u n s k i l l e d labour. 5. Abundance of certain natural resources. Melvin L. Greenhut, "Games, Capitalism and General Location Theory," i n The Manchester School of Economics and Social Studies, Vol. XXV, No. 1,""(January 1957), p.o4. ~ 2 For an int e r e s t i n g discussion on some of the factors that affect costs of .production see Robert. Theobald, p r o f i t Potential i n the Developing; Countries. (New York; American Management Association, T962)", pp~ &Q-69, ^Por an in t e r e s t i n g discussion on low foreign labour cost as a factor i n a t t r a c t i n g foreign investment, see Irvin g B. Eravis, "The Cheap Labour Myth," i n Challenge, Vol. 7, No. 10, (July 1959), pp. 46-50. Like the higher p r o f i t rate abroad hypothesis, t h i s hypothesis too seems to accept most of the assumptions of the neo-classical investment theory for the assumptions that t h i s hypothesis makes probably include the following: 1. Firms are keen and anxious to invest i n foreign lands. 2. There are no governmental prohibitions or r e s t r i c t i o n s , placed either by the firms' own governments or by foreign governments, to firms undertaking direct investments abroad, 3. In the course of t h e i r operations and competition with- r i v a l s , firms are continuously on the lookout for cost reduction investment opportunities across t h e i r national boundaries. 4. Firms possess f i n a n c i a l and suitable managerial and technical resources to undertake direct investments overseas. 5. Firms are generally prepared to invest f i n a n c i a l .and managerial resources. i n the investigation of. investment projects located i n other countries. 6. ' When firms investigate and evaluate foreign invest-ment projects, they are mainly interested to seek projects which v a i l help them to reduce t h e i r cost of servicing t h e i r present markets or markets whose demand schedules of the products they intend to produce are well known to them. This implies that i t assumes that firms have f u l l knowledge of the revenue side of t h e i r operations. 7. A firm's a b i l i t y to compete depends primarily on i t s a b i l i t y to cut down costs. I f , as suggested by t h i s hypothesis, cost items are the most s i g n i f i c a n t variables considered by firms i n evaluating foreign investment projects, then i t i s possible, ceteris paribus, for capital-importing countries to a t t r a c t foreign firms to establish manufacturing fa c t o r i e s i n them by merely granting them t a r i f f exemptions, 'grants and subsidies of various forms and by helping them to keep wages and other manufacturing costs low. Monopolistic Competition Hypothesis. The monopolistic competition hypothesis a t t r i b u t e s the flow of DPFIs largely to the advantages foreign firms enjoy over domestic firms. According to t h i s hypothesis, a firm that undertakes direct investments overseas does so not only because i t expects to earn a higher rate of return by investing abroad than at home but also because i t has some advantages over existing or pot e n t i a l l y competitive firms i n the same l i n e of production i n the foreign country and i s able to earn more than lo'cal 'firms can. I t maintains that t h i s must be the explanation for ... the firm's operation must have higher returns abroad than at home to compensate for r i s k s , higher i n foreign operations than i n domestic. But i t must also have a higher return than l o c a l firms i n the foreign country to cover the extra costs of operating at a distance from i t s headquarters, otherwi se, ... those firms, operating more cheaply i n other respects because they are nearer the locus of decision-making and without the f i l t e r of long l i n e s to d i s t o r t communication would put the intruder out of business. "Charles P. Kindleberger, "public Policy and the International Corporation," (mimeograph) A Statement submitted to Hearings on "Foreign Trade and the Anti-Trust Laws," of the Subcommittee on Anti-t r u s t and Monopoly of the Committee on the Judiary, United States Senate, p. 2. 2 Charles P. Kindleberger, American Business Abroad, (New Haven and London: Yale University Press, 19697", p. 12 This hypothesis surmises that the advantages foreign firms which undertake DPFIs have over firms i n the host countries a r i s e from one or more of the following sources: 1. Monopolies of knowledge and technology. 2. Superiority of managerial and entrepreneurial talent. 3 . Internal economies of scale which the large foreign firms can take advantage of by horizontal integration and possibly charging monopoly prices. 4. External economies of scale which the'foreign firms with t h e i r worldwide credit standing can take advantage of by v e r t i c a l integration. 5. Imperfectly competitive markets for goods, owing to product d i f f e r e n t i a t i o n , special marketing s k i l l s , r e t a i l price maintenance and administered prices. 6. Imperfectly competitive markets for factors, including i n addition to technology and entre-neurship, access to a larger volume of credit and at lower rates of interest.. 7. -Government interference i n goods and factor markets for national, economic, p o l i t i c a l or r a c i a l purposes. And i f the industry i s new to the country, the foreign' firms which are already i n the industry may have an advantage over l o c a l entrepreneurs who are just attempting to enter into i t simply because the marginal cost of extending operations i s substantially lower than what an entrepreneur has to incur i n terms of research expenditures, costly experimentation and These advantages of foreign firms and t h e i r implications for a thoery of DPFIs are more elaborately discussed by Kindleberger i n American Business Abroad, pp. 12-27. advertising when he f i r s t ventures into a new. industry and sets up a new. plant. *"-But what induces firms enjoying certain "monopolistic .advantages" to investigate the p o s s i b i l i t y of undertaking di r e c t investment projects i n certain countries abroad? Do these firms systematically scan the globe for investment opportunities which they can exploit? The hypothesis i s s i l e n t on these points, i t seems to take for granted that foreign investment a l t e r n a t i v e s or projects are given to • these firms or to assume that i f firms have some hunches that they enjoy some "monopolistic advantages" over l o c a l firms i n certain countries and that they may be able to earn ' higher returns there than at home and higher returns than l o c a l firms can, these firms w i l l immediately undertake in v e s t i g a t i o n s of investment projects located there. This-suggests that the hypothesis i m p l i c i t l y assumes that: 1. firms are keen to undertake d i r e c t investments abroad, 2. firms scan foreign and domestic environments for • investment opportunities^, 3. firms are generally prepared to invest f i n a n c i a l and managerial resources i n the in v e s t i g a t i o n of dir e c t foreign investment projects, 4. firms with "monopolistic advantages" over l o c a l firms do not face organizational or other constraint i n undertaking d i r e c t investments abroad, and that 5 . only "rates of return" are v i t a l i n investment analyses and decisions. I f t h i s hypothesis f u l l y explains the cause of the flow of DPFIs and i f firms with "monopolistic advantages" continuously (1) scan foreign and domestic environments for investment opportunities, (2) weigh potential projects located i n foreign countries against s i m i l a r potential projects located at home, (3) make calculations of costs and revenues to see whether p r o f i t rates are higher for foreign projects than for domestic ones, and (4) calculate to see whether l o c a l investors w i l l be able to earn more than them i f they too decide to undertake si m i l a r projects, then the most eff e c t i v e way for a country to att r a c t foreign investments i s by increasing or protecting the "monopolistic advantages" enjoyed by foreign firms and investors and the most effective way for a country to encourage i t s c i t i z e n s and firms to undertake direct invest-ments abroad i s by creating "monopolistic advantages" for them and allowing- them to exploit these advantages abroad.-Growth of the Firm Hypothesis. According to the growth of the firm hypothesis, a successful firm grows (and expands) and as i t does, " i t s expansion i t s e l f tends to create opportunities for further expansion — o p p o r t u n i t i e s that did not- exist before the i expansion was undertaken,""'"— for with the completition of Edith Penrose, "Limits to the Growth and Size of Firms," i n American Economic Re •'lew, Vol. XLV, No. 2, (May 1955), p. 532 i t s expansion plan, unused services l a r g e l y i n the form of managerial services become available for further production at no extra cost to the f i r m . 1 This drives i t to further growth and expansion. In growing, the firm may well go abroad. 2 A s l i g h t v a r i a t i o n of t h i s hypothesis connects the drive to further growth and expansion of a successful firm not with the release of unused managerial and other services 3 but with the "apparently ceaseless flow o i surplus income" and i t s ever-increasing pool of retained earnings; the pool of retained earnings grows because when a firm makes ex-ceptional p r o f i t s i t does not d i s t r i b u t e them a l l out as dividends.^" Because of t h i s growth of surplus cash flows, the firm desires to f i n d rewarding o u t l e t s 5 and to grow and expand. I b i d . , p. 536 2 Kindleberger, American Business Abroad, p. 536 3 See Stanley Hyman, Management and World Development (London: S i r Isaac pitman and Sons LTOT. VWTJT P- 53" ^Firms normally do not d i s t r i b u t e a l l p r o f i t s as dividends because they fear that extra dividends may lead stockholders to expect more and because ploughed-back earnings can help stockholders to escape the personal income tax and can be cashed i n , i f need be, a t the lower rate on capi t a l gains. See Kindleberger, American Business Abroad, p. 10 ' " ~ ' ' r— ''Christopher Lay ton i n Trans-Atlanti c Investments, (•Boulogne-Sur-Seine, prance; The Atlan^ic~instI.fute, 24 Quai du-4 Septembre), p.24, at t r i b u t e s United states direct inves ments i n Europe i n the l a t e f i f t i e s l a r g e l y to "the desire simply to f i n d a rewarding outlet for the large cash flow companies have enjoyed during the long American boom." What makes a firm grow and expand abroad rather than at home, however, i s not made. e x p l i c i t i n t h i s hypo-thesis —although Penrose seems to suggest that d i f f e r e n t i a l s i n expected p r o f i t rates are the b a s i s 1 — • for what the advocates of t h i s hypothesis i s p a r t i c u l a r l y concerned i s to explain that a pre-disposition to grow — e i t h e r at home or abroad— i s inherent i n the very nature of firms. Since t h i s hypothesis does not make e x p l i c i t what makes, growing firms consider foreign-investment projects, i t can only be inferred that t h i s hypothesis too takes for granted that foreign investment al t e r n a t i v e s are given to firms or that i t i s i n the nature of firms to look for investment opportunities i n foreign lands. This suggests that i t also accepts many of the assumptions made by the neo-classical investment theory. For example, i t seems to accept the neo-classical assumptions that firms (at least growing firms) are keen to invest i n foreign lands, that they are normally prepared to invest time and money i n the investigation of foreign investment projects, and that they are free to undertake direct investments abroad i f they so decide. The only neo-classical assumption that t h i s hypothesis seems to reject i s the assumption that firms possess f i n a n c i a l and managerial resources to undertake direct investments See Edith Penrose, "Foreign Investment and-the Growth of the Firm," i n Econorn i c Journal, Vol. LXVI, No. 262, (June 1956), p. 224 overseas. I t points out that only growing firms possess these resources. I f , as suggested by t h i s hypothesis, only growing firms consider, investigate, evaluate and undertake direct investment abroad, then countries w i l l only be able to stimulate growing firms to -undertake such investments. This implies that they should direct t h e i r incentive programs mainly to such firms. Marketing Considerations Hypothesis. The marketing considerations hypothesis maintains that the main reason subsidiary plants have been set up i n foreign countries i n great numbers arises from the need to sustain marketing e f f o r t s to obtain increased business. 1 I t maintains that foreign subsidiaries are established either to help market the companies' products more e f f e c t i v e l y or to help gear t h e i r products to the needs and requirements 2 of the foreign l o c a l market. Howe Martyn, Multinational Business Management, (Lexington, Massachusetts: D. C. Heath and Co". , 1970) , p. 13 p Sanford Rose i n "The Rewarding Strategies of M u l t i -nationalism, " ( i n Fortune, September 15, 1968, p. '104), note that "there i s some evidence that companies are excessively concerned with adapting products to s p e c i f i c markets." According to t h i s hypothesis, companies usually begin business operations abroad by exporting d i r e c t l y to l o c a l v,Tholesalers or agents; companies adopt this,as a f i r s t step toward foreign investments because they r e a l i z e that foreign operations are i n t r i c a t e and r i s k y . But a f t e r a time, these companies may f i n d that t h e i r penetration of the foreign market has gone far enough to require expenditure on l o c a l stockholding and sales and promotional a c t i v i t i e s and that they have understood some of the complexities of foreign operations. At t h i s stage, the companies set up : s e l l i n g subsidiaries abroad so as to ensure that "the volume of sales i s maximized, that standards of the companies are maintained and that adequate aft e r sales service and main-tenance i s a v a i l a b l e . " 1 And as they become established, they may r e a l i z e that the foreign country has certain p e c u l a r i t i e s i n consumer preferences, i n engineering standards, l e g a l codes and other technical requirements and that they w i l l be able to increase t h e i r volume of sales i f they undertake l o c a l production and redesign t h e i r products to suit l o c a l requirements. At t h i s stage, they set up foreign subsidiaries so as to achieve a more f l e x i b l e response to the changing demands of the foreign l o c a l market. This hypothesis assumes that firms undertake direct foreign investments only to serve t h e i r markets which they ^Robert Theobald, op. c i t . , p. 26 have established through exports and that firms without large foreign markets 'do not consider such investments. I t also seems to assume that firms with large export markets are constantly analyzing t h e i r markets for advantages of under-taking marketing, assembly or manufacturing operations there. I f firms normally begin foreign operations with direct exports and undertake direct investments abroad only i n stages, then the most effective way for countries to get foreign firms to set up manufacturing f a c t o r i e s within t h e i r borders i s to encourage them f i r s t to become exporters, and, once they have b u i l t up t h e i r export markets, to encourage the l o c a l c i t i z e n r y to demand certain changes i n the desrgn or technical c h a r a c t e r i s t i c s of ihe exporters' products. Market Size Hypothesis. Economists who look at the geographical d i s t r i b u t i o n of DPFIs seem to think that such investments are undertaken larg e l y because of the size of the market. According to t h i s hypothesis, firms undertake direct investments overseas primarily because the overall size of the foreign country's market 1 — b o t h current and p o t e n t i a l — i s large. The "great """The ove r a l l t o t a l size of a country's market i s generally thought to be some function of the population size of the country, i t s Gross National product and i t s rate of growth of Income. See Robert Theobald, op, c i t . , pp. 53-60 for a f u l l e r discussion on the size of a. country's market. international expansion of industry since World War Two has been i n pursuit of markets .—populations with purchasing power,""'" they claim. The l o g i c of t h i s hypothesis runs as follows. A large market enables firms to i n s t a l l special purpose equipment, take advantage of bulk purchases, spread over-head and other fixe d costs over a larger number of units of output, and to economize on the use of transport'. I t enables firms to introduce technology meant for mass production, to enjoy economies of scale and to reduce t h e i r unit manu-facturing costs. Therefore, as soon as the size of a country's market i s large enough or appears to be growing to a size large enough to permit the capturing of economies of scale, firms w i l l rush into the country to establish manufacturing plants. ^  This hypothesis assumes that: (1) firms are keen and anxious to undertake direct foreign investments and are constantly on the look-out for foreign investment opportunities, (2) firms are prepared to invest time and money i n the inves-t i g a t i o n of foreign investment opportunities, (3) firms have some way to discover that a country's market has grown i n Howe Martyn, Intemational Business; P r i n c i p l e s and Problems, (Hew York: The Free Press, 1964)". p. 17 Anthony E. Scaperlanda and Lawrence J. Mauer, size, (4) firms are more concerned with the size of the foreign country's market as a whole rather than t h e i r own market size as participants i n the market, (5) firms under-take direct investments i n certain foreign countries to produce goods la r g e l y for these countries, 1 and, (6) firms do not face organizational or other obstacles to under-taking direct investments abroad. Maintenance "of Market Hypothesis. The maintenance of market hypothesis asserts that companies undertake assembly or manufacturing operations i n a foreign country primarily because they want to hold on to or maintain a market within that country that they had.already p established through exports from the home base. Like the marketing considerations hypothesis, t h i s hypothesis assumes that companies f i r s t enter foreign countries with t h e i r products through exports, But unlike the marketing considerations hypothesis, t h i s hypothesis does not assume that companies which have entered foreign markets through exports are anxious to substitute foreign subsidiaries for The whole set of countries which make up a common market may be thought of as one country. 2 E. R. Barlow and I r a T. Wender, Foreign Investment and Taxation, (Englewood C l i f f s , New Jersey: pFentice-Hal], Inc. , 1955) , p. 146 exports. In fact, t h i s hypothesis takes the l i n e that so long as the companies f i n d that they can continue to serve t h e i r foreign markets through exports, they w i l l continue to serve these markets that way and not launch direct invest-ment operations there; i t i s only when these companies are threatened with the l o s s o f . t h e i r export markets either "because of t a r i f f duties, quotas or exchange controls imposed by the governments of the host countries or because of strong-competition from l o c a l manufacturers or because of some inadequacies of t h e i r foreign d i s t r i b u t o r s that they begin to investigate the p o s s i b i l i t i e s of undertaking direct invest-ments there. This hypothesis seems to assume that generally firms are unwilling to undertake direct investments overseas, that only firms which have developed export markets undertake direct investments abroad, that when firms undertake direct investments abroad, they produce goods only for the l o c a l foreign markets, and that when firms f i n d that t h e i r export markets are being threatened, they w i l l probably undertake direct investments i n these markets. I t seems to suggest that the most effective way for countries to attract foreign firms to establish .subsidiaries and branches within t h e i r borders i s f i r s t to attract them as exporters and once these exporters have got themselves established, to threaten them with the loss of t h e i r export markets. The product cycle hypothesis puts emphasis on the technical c h a r a c t e r i s t i c s of products as a determinant of the flow of DPEIs and l i n k s the flow of such investments to the product cycle thesis. This hypothesis t r i e s to explain not only why firms undertake direct foreign investments but also why a substantial part of direct foreign investments since World War TWO has been undertaken by IJ. S. firms. In b r i e f t h i s hypothesis states that new products, p a r t i c u l a r l y those associated with high income and labour saving, are l i k e l y to be f i r s t introduced i n the United States. These products when they are f i r s t introduced are not "matured" and the technical c h a r a c t e r i s t i c s of the pro-ducts make them unsuitable for production overseas. They are, therefore, produced domestically and sold i n the home market as well as abroad. But as the export markets for these pro-ducts expand and as the products and t h e i r production processes become "standardized" certain forces set i n to push the producers to locate t h e i r production plants abroad. Raymond- Vernon 1 explains why United States producers rather than producers i n other countries are l i k e l y to be the See Raymond Yemon, "International Investment and International Trade i n the product Cycle," in Quarterly Journal of Economics, Vol. LXXX, (May 1966) ,. pp. 190-207'." f i r s t to introduce new products associated with high income or labour saving i n the following way. F i r s t , "the United States market consists of consumers with an average income which i s higher ... than i n any other national market." 1 Second, the market i s "characterised by high unit labour costs and r e l a t i v e l y unrationed ca p i t a l compared with 2 p r a c t i c a l l y a l l other markets." These two ch a r a c t e r i s t i c s of the United States market make i t a place where new products associated, with high income and: labour saving are l i k e l y to be f i r s t introduced. The united States producers rather than producers i n other countries are l i k e l y to- be the f i r s t to spy and a v a i l themselves of the opportunity of introducing such new products because an "entrepreneur's consciousness of and responsiveness to opportunity are a function of communication ... and ... that ease of communi-cation i s a function of geographical proximity." This hypothesis asserts that the f i r s t producing f a c i l i t i e s for new products w i l l be located i n the United States because i n the early stages of a product's l i f e : 1. the design of the product i s often i n a constant state of f l u x and there i s a real advantage for manufacturers to be close to the market for t h e i r product; they can rapidly translate demands for 2 I b i d . , p. 192 •Void. , p. 192 design changes into more suitable products. 1 2. the production processes are unstable. This demands the manufacturers to keep t h e i r invest-ments on fixed assets and fixed overheads down as far as possible by making use of outside services of sub-contractors, specialized suppliers, engineers and s c i e n t i s t s . These services are more readily available i n the United States than elsewhere. 3. cost differences are unimportant. Cost differences are unimportant because the price e l a s t i c i t y of demand for the output of ind i v i d u a l firms i s comparatively low3 and because entry into the market i s l i m i t e d by know-how. *+ Hence, t h i s hypothesis argues that such new products w i l l f i r s t be produced i n the United States and be exported. But i n time a- number of changes occurs that pushes the manufacturers to- undertake production of the product abroad. F i r s t , "the product becomes s u f f i c i e n t l y standardized for price competition, hence cost considerations, to begin to play a s i g n i f i c a n t role i n l o c a t i o n a l decisions. -Second, "the demand i n some non-United States markets grows s u f f i c i e n t l y large to support a l o c a l production f a c i l i t y that can exploit "'"Louis T. Wells, J r . , "A Product L i f e Cycle for Inter-national Trade?" i n Journal of Marketing, Vol. o2, (July 1968), p. 2 2 Seev Hirsch, l o c a t i o n of Industry and International Comp e t i t i v en e s s, (Oxford: C l a r en do n "p ress, 196*71, pp. 19-20 ^Raymond Vernon, op. c i t . , p. 195 4 See- Hirsch, op. c i t . , p. 19 Raymond Vernon, ravager__in the international economy, (Englewood C l i f f ; Few JerseKTrenTic"e^Ta!LT inc., 1968)", p.81 the existing scale economies.""1" Third, the United States manufacturers face a stagnant demand and . f a l l i n g prices i n the home market pa r t l y because of the entry of new competitors — patents on t h e i r products may have e x p i r e d — and p a r t l y because the demand for t h e i r products has reached a "peaked-plateau". Fourth, potential foreign producers now have a market close fit hand and t h e i r costs may be lower than those 2 ' of the United States manufacturers. A l l these forces may make the United States manufacturers r e a l i z e that i f they do not start producing overseas some others w i l l . Those who r e a l i z e t h i s undertake direct investments abroad. Thus, l i k e the market considerations and the maintenance of market hypotheses, t h i s hypothesis assumes that firms undertake direct operations abroad i n stages —beginning with direct exports and f i n a l l y ending up with establishing sub-s i d i a r i e s and branches i n the export markets, and, l i k e them, i t seems to assume that only firms with developed export mar-kets undertake direct investments abroad-and that when firms undertake direct investments abroad, they produce goods only for their export markets. This hypothesis therefore suggests that countries which desire to encourage foreign firms to establish subsidiaries or branches within t h e i r borders should f i r s t a t t r a c t them as exporters and help them to b u i l d up t h e i r export markets. I t also suggests that countries v a i l only be able to a t t r a c t firms producing "standardized" products to undertake direct investments abroad. Other Hypotheses.' There i s a formidable number of hypotheses on why firms undertake direct investment projects located i n countries other than t h e i r own and i t i s not possible to -discuss a l l of them i n t h i s study. The following are some of the hypotheses l e f t undiscussed; 1. Firms undertake direct investments abroad because direct investments abroad make i t possible for them to exercise influence over the price develop-ments of raw materials with a view to s t a b i l i z a t i o n of p r i c e s . 1 2. Firms undertake direct investments abroad becau.se they want to ensure a continuous supply of raw materials which are not produced at home or occur 2 only 'in i n s u f f i c i e n t quantities. W i l f r i e d G-uth, Capital Exports to j.ess Developed Countries,"(Dordrecht-Holland; D. R e i d e i l publishing Company, 1963), p. 30. Ibid. , p. 30 3. Firms undertake direct investments abroad because of v e r t i c a l integration. The;/ desire to undertake the whole range of operations from the production of the raw materials they use to the f i n a l sale of t h e i r manufactured goods. 1 4. Firms undertake direct investments abroad because ' o f t h e i r desire to d i v e r s i f y geographically. Geographical d i v e r s i f i c a t i o n ensures that p o l i t i c a l upheavals i n any one country and f a i l u r e of any one p a r t i c u l a r . enterprise do not affect firms c r i t i c a l l y . 5. Investors undertake direct investments i n certain countries because they have a kindred ancestry, s i m i l a r language and mutual t r a d i t i o n s with the people there. 2 I m p l i c i t i n a l l these hypotheses i s the assumption that there are opportunities for p r o f i t s i n direct foreign investments for i t i s i l l o g i c a l to i n f e r that the hypotheses w i l l assume that firms undertake direct investments, whether foreign or domestic, to incur losses. I m p l i c i t i n most of these hypotheses i s also the assumption that firms make cross comparisons of projects located i n different countries to determine which project or set of projects they should under-1 Charles P. Kindleberger, I nt e rn at i o rial E conom i c s, (Homewood, I l l i n o i s : Richard D. Irwin Inc., Revised Ed. 1958), p.39!: 2 Gerald Krefeta and Ruth Marcssi, Investing Abroad, (New York: Harper & Row, Publishers, 1965), p. 2. But what prompt firms to consider direct investment projects abroad? What prompt them to" consider potential investment projects located i n certain countries but not i n others? And what prompt them to make cross country comparisons, of'projects? Most of the hypotheses are s i l e n t on these points. This i s probably because most of them accept the neo-classical assumption that firms are keen to invest abroad and are systematically scanning the world for areas to make an invest-ment. Summary. The Alternative Hypotheses. Disagreements over the v a l i d i t y and usefulness of the neo-classical - investment theory as an explanation of why firms undertake direct investments abroad and of how firms make direct foreign investment decisions have led to a for-midable number of alternative explanations or hypotheses, each of which purports to pin-point the immediate or proximate reason for firms to undertake direct investments overseas. Some of the main hypotheses generally offered to explain why firms undertake direct' investments in foreign lands are.: 1. The Higher P r o f i t Rate Abroad 'Hypothesis. This states that firms utillertake d irect investments abroad because they are able to earn a higher rate of p r o f i t abroad than at home. 2. The Lower Costs Abroad Hypothesis. This states tTiat firms undertake direct investments abroad because such investments enable them to reduce t h e i r costs of supplying goods to t h e i r present markets or some markets known to them. 3• The Monopolistic Competition Hypothesis. This states that firms undertake direcLT"investments abroad because .they enjoy some "monopolistic advantages^over foreign firms and want to e a p i t a l i z e A t h e i r advantages. 4* The Growth of the "Firm Hypothesis. This states that firms grow (ana" expand")- and. as they do so, they release unused managerial and f i n a n c i a l resources. These lead to further growth and expansion — b o t h , at home and abroad. 5. The Marketing Considerations Hypothesis. This states that firms undertake direct, foreign investments because they desire to market t h e i r products more e f f i c i e n t l y and to serve the special needs of the l o c a l foreign markets. 6. The Market Size Hypothesis. This states that i t i s the size of the' foreign country's market that a t t r a c t s foreign firms to undertake direct operations there, 7' The Maintenance of Market Hypothesis. This states that firms undertake direct inve-st'ments abroad because of their- desire to hold onto foreign markets which they have b u i l t up through exports. 8. The product Cycle Hypothesi_s. This states that each manufactured product has a l i f e cycle of i t s own. i n the early stages of a manufactured product's l i f e cycle, the product.and i t s pro-> duction processes are not "standardized" and some factors m i l i t a t e against producing the pro-duct abroad but as the product, and I t s production processes become »standardized" a number of forces push the producers to undertake production of the product abroad. 9. The Raw Material Supplies Hypothesis. This states that firms undertake direct" investments abroad because o f t h e i r d e s i r e t o ensure a c o n t i n u o u s s u p p l y o f t h e i r raw m a t e r i a l r e q u i r e m e n t s . and 10. The D i v e r s i f i c a t i o n o f R i s k s H y p o t h e s i s . T h i s s t a t e s t h a t f i r m s u n d e r t a k e d i r e c t i n v e s t m e n t s ..- ab r o a d because t h e y want t o d i v e r s i f y t h e i r i n v e s t m e n t s g e o g r a p h i c a l l y . G e o g r a p h i c a l d i -v e r s i f i c a t i o n r e d u c e s r i s k s . T h e i r Assumptions. Each h y p o t h e s i s o f DPEIs i m p l i c i t l y o r e x p l i c i t l y makes a number o f as s u m p t i o n s , most o f which seems t o be s i m i l a r t o t h o s e made by t h e n e o - c l a s s i c a l i n v e s t m e n t t h e o r y . I t i s , however, d i f f i c u l t — p r o b a b l y I m p o s s i b l e — t o s p e l l out a l l t h e assu m p t i o n s o f each o f t h e s e hypotheses because some o f t h e s e hypotheses have a number o f v a r i a t i o n s and, ther e f o r e . , a number o f d i f f e r e n t s e t s o f ass u m p t i o n s . . There i s , however, one assumption t h a t i s made by a l l t h e hypotheses and a l l o f t h e i r v a r i a t i o n s . T h i s i s t h e assumption t h a t f o r f i r m s t o u n d e r t a k e d i r e c t i n v e s t m e n t s a b r o a d t h e r e must be an o p p o r t u n i t y f o r t h e f i r m s u n d e r t a k i n g such i n v e s t m e n t s e i t h e r t o make p r o f i t s o r to p r e v e n t t h e l o s o f p o t e n t i a l p r o f i t s . But what d i r e c t s t h e a t t e n t i o n o f f i r m s t o t h e oppor-t u n i t y abroad to make p r o f i t s o r t o p r e v e n t t h e l o s s o f p o t e n t i a l p r o f i t s i s not made c l e a r i n most o f t h e s e hypothes T h i s i s p r o b a b l y because most o f them assume t h a t f i r m s a r e keen to invest i n foreign lands and are continuously on the look-out for investment opportunities abroad. Most of them also seem to assume that: 1. there are no governmental prohibitions or r e s t r i c t i o n s to firms undertaking direct investments abroad, 2. firms possess f i n a n c i a l and suitable managerial and technical resources to undertake direct investments abroad, 3- firms are generally prepared to invest f i n a n c i a l and managerial resources i n the investigation of direct foreign investment projects and that 4. firms make cross comparisons of projects located i n different countries to determine which of the pro-jects or sets of projects they should undertake. I t should, however, be noted that each hypothesis has one or two assumptions c h a r a c t e r i s t i c only to i t s e l f . For example, with the lower cost hypothesis, the special assumption made i s that a firm's a b i l i t y to compete i n t e r n a t i o n a l l y depends primarily on i t s a b i l i t y to cut down costs while with the maintenance of market hypothesis, the special assumption made i s that firms are not w i l l i n g to invest i n t h e i r export markets unless they are threatened with the lo s s of these markets. Their Implications. Each hypothesis of LTFls has certain implications for direct foreign investment incentive programs. For example, with the lower cost abroad hypothesis, the main implication i s t h a t c o s t i t e r a s a r e t h e most i m p o r t a n t v a r i a b l e s c o n s i d e r e d by f i r m s i n d i r e c t f o r e i g n i n v e s t m e n t d e c i s i o n s and c o u n t r i e s d e s i r i n g t o a t t r a c t f o r e i g n f i r m s s h o u l d h e l p them t o keep wages and o t h e r m a n u f a c t u r i n g c o s t s l o w , w h i l e w i t h t h e p r o -duct c y c l e I r y p o t h e s i s t h e main i m p l i c a t i o n i s t h a t c o u n t r i e s s h o u l d d i r e c t t h e i r i n c e n t i v e programs t o f i r m s p r o d u c i n g " s t a n d a r d i z e d " p r o d u c t s . However, p a r t l y because a l l t h e hypotheses i m p l i c i t l y assumes t h a t f o r f i r m s t o u n d e r t a k e d i r e c t i n v e s t m e n t s abroad t h e r e must be some o p p o r t u n i t i e s f o r p r o f i t s and p a r t l y because most o f them do not make e x p l i c i t what prompts f i r m s t o c o n s i d e r d i r e c t i n v e s t m e n t s abroad, t h e g e n e r a l i m p r e s s i o n t h e s e hypotheses c o l l e c t i v e l y seem t o c r e a t e - i s t h a t i t i s p o s s i b l e t o encourage t h e f l o w o f DPFIs by i n c r e a s i n g t h e r e t u r n s from such i n v e s t m e n t s . RECOGNITION AND CONSIDERATION OE DIRECT PRIVATE FOREIGN INVESTMENT ALTERNATIVES : CONSTRAINTS, HIDDEN RESISTANCES AND INERTIAS. Introduction. Neo-classical investment theory and most hypotheses of.DPFIs assume that when companies make investment decisions they have a large number of possible investment propositions, both domestic and foreign, before them. The companies then carefu l l y appraise each of these p o s s i b i l i t i e s i n terms of some c r i t e r i a and decide i n favour of the investment that looks most promising. This implies that the theory and most of the hypotheses also i m p l i c i t l y assumes that companies are anxious to invest: abroad, that they are continuously scanning domestic and foreign environments for investment opportunities, and-that they are prepared to invest time and money i n the investigation of foreign investment projects. In t h i s chapter, the assumption that companies normally scan the globe for investment alternatives i s re-examined i n the l i g h t of some reported investigations of the direct foreign investment decisions of some companies. This chapter begins by o i i t l i n i n g four aspects of the investment decision process from the i n i t i a l recognition to the acceptance of an investment project or projects. I t then goes to point out that neo-classical investment theory and most hypotheses of DPFIs seem to take for granted the f i r s t aspect of the decision process — t h e recognition or generation of potential investment p r o j e c t s — because they assume that firms normally search for investment opportunitie across t h e i r borders. Once t h i s i s done, i t brings together the r e s u l t s of some studies made by other scholars and argues that companies probably do not normally scan the globe for investment opportunities and that investment alternatives cannot be taken as given. The chapter concludes with some explanations as to why companies probably do not normally consider, investigate and evaluate foreign investment project Recognition and Consideration of Direct  Private Foreign Investment Alternatives. Aspects of the Investment Decision Making Process. A descriptive model of an investment decision from the i n i t i a l recognition to the acceptance of an investment project or projects should show that there are at least four aspects to the process: 1. Recognition or generation of a potential invest-ment project or projects. . 2. Collection of information on and preliminary-investigation of the project or projects. 3. Comprehensive evaluation of the "p o t e n t i a l l y acceptable" project or projects.1 4. Pin a l decision on whether to accept or reject . , the "pot e n t i a l l y acceptable" project or projects. "These four aspects are similar to those recognized by Williams and Scott, and also Quirin and to those suggested by Aharoni's 2 discussion of the foreign investment decision process. Although these four aspects suggest a s e r i a l process — a n d to some degree they a r e — they cannot be said to be successive and ordered steps for "investigation and evaluation ""3 are often not preliminary to the decision but fused with i t . " ^ Figure 2 attempts to depict these four aspects. The f i r s t aspect (and also the f i r s t step i n an investment decision process), recognition or generation of a potential investment project or a set of projects, has to do with how and when ideas for investment are germinated or generated. I t has to do with a c t i v i t i e s and conditions, which cause firms to search for or to recognize an investment A project i s defined as "p o t e n t i a l l y acceptable" to a firm i f a f t e r the preliminary investigation, the firm i s prepared to evaluate i t i n d e t a i l , 2 See Bruce R. Williams & W. F. Scott, Investment Pro-posals and Decisions, (London: G-eorge Allen & IJnwin Ltd., 1965), p. 18; Q. David Quirin, T he Capita 1_ Expend i ture De c i s i on, •(Homewood, I l l i n o i s : Richard D. Irwin, ~lnc7, 1967) , pp. 15-24; and Yair Aharoni, op. c i t . , Chapters 3 to 6. ^Bruce R. Williams & W. P. Scott,- op. c i t . , p. 18 The dashed l i n e s and arrows indicate the p o s s i b i l i t i e s of '"recycling" from a " l a t e r " stage to the r e p e t i t i o n of an e a r l i e r one, caused by the lack of information at the e a r l i e r stage or changed circumstances at the l a t e r stage. Recognition or generation of a potential investment project or projects. f I I I i I I I I I I Collection of information on and preliminary investigation of a potential investment project or projects. t I Comprehensive evaluation of a " p o t e n t i a l l y acceptable" investment • project or projects. P i n a l decision and choice of investment . projects. FIGURE I I . ASPECTS OF AN INVESTMENT DECISION MAKING PROCESS. Source: based-on Figure 3 i n Albert H. Rub en stein and Chadwick J. Haberstroh, Some Theories of Organi sat 1.on , (Hornewood, I l l i n o i s : Richard p. Irwin, and Dorsey Press,Revised Ed i t i o n , 1966), p. 589, project or a set of projects which they are prepared to investigate and evaluate and to which they.are prepared to. commit t h e i r managerial and f i n a n c i a l resources. 1 With respect to DPFIs, t h i s aspect of the investment decision process has to do with a c t i v i t i e s and conditions which lead firms to search or to. recognise investment projects located outside t h e i r boundaries. The second aspect, c o l l e c t i o n of information and preliminary investigation, has to do with the c o l l e c t i o n of as much "free" or "low cost" pertinent information as possible and the preparation of rough estimates of outlays, revenues and operating costs of the project or projects. The object of t h i s preliminary investigation i s to derive a preliminary estimation of the interna l rate of rates of return or some other measures of d e s i r a b i l i t y and to determine whether more detailed and comprehensive analysis and evaluation of the project or projects are warranted. Generally, i f a preliminary investigation shows that a project or a set of projects appears promising i n terms of the firm's goals and i n the l i g h t of the various constraints faced by the firm, a comprehensive evaluation of the project For a discussion on project recognition and generation see G. David Quirin, op^ c i t . , pp. 16-19• 2 These constraints include among others, f i n a n c i a l and managerial resources. • . or projects i s made. This aspect of the investment decision-making process involves making detailed investigation of revenue, c a p i t a l costs, operating costs, sources of funds and so on and these estimates of the projects' benefits and costs are converted into measures of d e s i r a b i l i t y . 1 The fourth aspect, f i n a l decision, i s a simple process of either accepting or rej e c t i n g a p a r t i c u l a r project or of selecting, i n terms of the firm's goals and i n the l i g h t of i t s constraints, the most desirable investment projects from a set of projects. Under the neo-classical investment theory, t h i s means selecting the most p r o f i t a b l e investment projects. As the f i r s t step i n an investment decision-making process i s the recognition or generation of investment a l t e r -natives, the f i r s t step i n a DPFI decision-making process must be the recognition or generation of DPFI projects or alternatives. And the f i r s t prerequisite to a DPFI must, therefore, be general willingness on the part of firms to 2 consider direct foreign investment alternatives. For a f u l l e r discussion on project evaluation, see G. David Quirin, op. c i t . , pp. 1 9 - 2 1 ; and Douglas Arthur From son, "Management' of large Capital Projects," (unpublished M. B. A. thesis, University of B r i t i s h Columbia, 1 9 6 9 ) , pp. 2 7 -35. 2 Peter P. Gabriel, The international Transfer of Cor-porate S k i l l s : Management ContractsT n _Less Developed"Countries, (Boston: Harvard University, G-raoTuafe 'School oT~Business,"" ~ Division of Research, 1 9 6 Y ) , p. 7 9 -Direct Private Foreign Investment Theories and the Recognition and Consideration of Investment Alternatives. The pure neo-classical theory of investment assumes that investment decisions are made under conditions of perfect, certainty and that investors are f u l l y aware of a l l available investment alternatives — b o t h domestic and foreign. I t assumes that firms have accurate information on the costs to be incurred and the returns to be received from alternatives and that decisions are made on the basis of t h i s information. 1 When i t i s recognized that investment decisions are made under conditions of uncertainty, neo-classical investment theory only ..recognizes the uncertainty of income flows and continues to'take for granted that investment al t e r n a t i v e s , including direct foreign investment alternatives, are given to firms. The i m p l i c i t assumption i s that because firms aim at p r o f i t maximization, they w i l l "systematically search the p world for the most p r o f i t a b l e investment opportunities" and that they w i l l continuously adjust t h e i r p o r t f o l i o of invest-3 ments to changes i n the pattern of alternatives available. ' R. M. Cyert, W. R. D i l l and J. &. March, "The Role of Expectations i n Business Decision Making," i n Administrative  Science Quarterly, Vol. 3, No. 3, (December 19587, P- 309 2 Charles D. Hyson and Dale R. Weigel, "Investment i n the LDCs: The Unresolved Debate," i n Columbia Journal of _W_qrld Business, Vol. V, No. 1-, (January-pebruary 1970**7~p." 37 •7. R^. M. Cyert, et. a l . , on._cit., p. 309 Most a l t e r n a t i v e hypotheses of direct private foreign investments — a l t e r n a t i v e to the neo-classical investment t h e o r y — also either take for granted that investment a l t e r -natives are known to firms or i m p l i c i t l y assume that firms systematically search the globe for areas to make an invest-ment. The higher p r o f i t rate abroad, the lower costs abroad and the monopolistic competition hypotheses, for example, a l l i m p l i c i t l y assume that because the primary goal of firms i s • to make p r o f i t s , p r o f i t s are a powerful propelling force to drive firms to look across t h e i r national boundaries for invest-ment opportunities. Only a few of the al t e r n a t i v e hypotheses of DPFIs' recognizes that investment alternatives are not given to firms, that normally firms do not search and consider direct foreign investment projects and that only when certain stimulants or i n i t i a t i n g forces are brought to bear on firms, w i l l they consider the p o s s i b i l i t i e s of investing abroad. In the case of the maintenance of market hypothesis, for example, the i n i t i a t i n g forces recognized include a l l those forces which threaten to cut o f f or reduce substantially a firm's export sales whereas i n the case of the product cycle hypothesis, the i n i t i a t i n g forces recognised include stagnating demand and f a l l i n g prices i n the home market, the entry of new competitors and the threat of competition i n the foreign market. Investment alternatives can be taken as given or for granted i f investment decision makers have perfect knowledge of a l l investment alt e r n a t i v e s — b o t h domestic and f o r e i g n — and of a l l the consequences attached to each. But once imperfect knowledge about the future i s admitted and once perception and cognition intervene between the investment decision makers and t h e i r objective environments, investment alternatives cannot be taken as given. They must be sought and the.consequences which w i l l follow on each a l t e r n a t i v e w i l l have to be determined. 1 Empirical Evidence. p A number of economists who examine the investment decisions of companies f i n d that most compani-es do not normally look across t h e i r national boundaries for p r o f i t a b l e investment opportunities and that i n only a few cases are direct private investments overseas the result of aggressive economic motives and careful analysis of potential gains from alternative employment of c a p i t a l . B a r l o w and yjender, for example, i n t h e i r comprehensive survey of the foreign investment decisions of some TJ. S. Herbert A. Simon, "Theories of Decision Making i n Economics and Behavioural Science," i n American Economic Review V o l . XLIX, Ho. 3 , (June 1 9 5 9 ) , p. 2 7 2 p These include E. R. B a r l o w , I r a I. V/ender, y a i r Aharon Peter S. Gabriel', and Judd Polk. companies f i n d , t h a t : ... most companies v/ho a r e not f o r e i g n i n v e s t o r s have n e v e r g i v e n s e r i o u s thought t o i n v e s t i n g i n f o r e i g n c o u n t r i e s , ... a company t y p i c a l l y does n ot c o n s i d e r v a r i o u s a r e a s o f t h e w o r l d i n which i n v e s t m e n t may (might) t a k e p l a c e , f i n d an o p p o r t u n i t y f o r a p a r t i c u l a r p r o d u c t i n a c o u n t r y and make an i n v e s t m e n t , ^ ... i t i s a c o m p a r a t i v e l y r a r e s i t u a t i o n f o r a company t o i n v e s t i n a f o r e i g n c o u n t r y s o l e l y a s a r e s u l t o f an a p p r a i s a l i n d i c a t i n g t h a t e x c e l l e n t p r o f i t s can be o b t a i n e d , ^ and t h a t ... i n t h e m a j o r i t y o f cases ... t h e s h i f t from e x p o r t t o l o c a l m a r k e t i n g o r assembly o r manufacture i s not t h e r e s u l t o f smooth n a t u r a l t r a n s i t i o n . U s u a l l y something happens t h a t makes i t n e c e s s a r y f o r manage-ment t o d e c i d e whether i t i s w i l l i n g t o manufacture o r assembly l o c a l l y i n o r d e r t o h o l d onto a f o r e i g n market. ' Stobaugh J r . , i n h i s s t u d i e s a.lso comes to a s i m i l a r c o n c l u s i o n f o r he o b s e r v e s t h a t "most companies do not make use o f a l a r g e s c a l e r a t i o n a l s c r e e n i n g p r o c e s s t o i d e n t i f y f o r e i g n i n v e s t m e n t o p p o r t u n i t i e s . He e x p l a i n s t h e phenomena i n t h e f o l l o w i n g way: 2 I b i d . , p. 158 9 I b i d . , p. 158 4 I b i d . , p. 147 5 Robert B. Stobaugh J r . , "Where i n t h e world s h o u l d w nut t h a t p l a n t ? " i n H a r v a r d B u s i n e s s Review, V o l . 47, No. 1. ... most companies i n t e r e s t e d i n f o r e i g n e x p a n s i o n make'so many d i f f e r e n t p r o d u c t s , and t h e r e a r e so many c o u n t r i e s , t h a t s e a r c h i n g f o r a.good i n v e s t m e n t o p p o r t u n i t y r e p r e s e n t s a major e f f o r t . As a r e s u l t , d e c i s i o n s on i n v e s t m e n t s o f t e n a r e made i n r e a c t i o n t o c i r c u m s t a n c e s o f t h e moment r a t h e r t h a n as a r e s u l t o f a c a r e f u l s e a r c h f o r t h e ' b e s t o p p o r t u n i t y . ! And A h a r o n i who l o o k e d a t t h e d i r e c t f o r e i g n i n v e s t -ment d e c i s i o n s o f companies contemporaneously too o b s e r v e s that-most companies a r e o n l y concerned w i t h domestic i n v e s t -ments and t h a t they " s i m p l y do not i n p r a c t i c e c o n s i d e r 2 i n v e s t i n g a b r o a d . " A c c o r d i n g t o him, f o r most companies, "the p o s s i b i l i t y o f f o r e i g n i n v e s t m e n t i s not c o n s i d e r e d because i t i s never c o n c e i v e d o f a s ' a p o s s i b i l i t y worth any tim e and e f f o r t ,,3 The e v i d e n c e , t h e r e f o r e , seems t o be i n support o f t h e h y p o t h e s i s t h a t companies a r e g e n e r a l l y not a n x i o u s t o u n d e r t a k e d i r e c t i n v e s t m e n t s abroad, t h a t most companies do not n o r m a l l y c o n s i d e r and i n v e s t i g a t e d i r e c t i n v e s t m e n t p r o j e c t s o v e r s e a s t o t h e p o i n t o f l e a r n i n g t h e economics o f t h e s i t u a t i o n and whether o r not i t w i l l be p o s s i b l e t o make l a r g e p r o f i t s , t h a t ... most d e c i s i o n s t o i n v e s t a b r o a d a r e p r e c i p a t e d by f a c t o r s which a r e beyond company c o n t r o l but which make i t i m p r a c t i c a l f o r t h e company t o s e r v e f o r e i g n markets o n l y t h r o u g h e x p o r t s . 1 I b i d . , p. 1;>5 ^ Y a i r A h a r o n i , op. c i t . , p. 50 5 I b i d , , p. 53 ^Judd P o l k , e t , a l . . op. c i t . , p. 43 and that for most companies undertaking direct investments overseas, ... t h e i r investment decisions are made i n response to competitive necessities that affect the entire earning position of t h e i r operations abroad rather than as a result of the search for the best opportunity. Constraints. Hidden Resistances and I n e r t i a s . I t i s not d i f f i c u l t to f i n d some explanations as to why most firms are not interested i n foreign investments and why most of them do not normally consider direct foreign invest-ment projects to the point of evaluating them. The explanations can probably be found i n : 1. Organization t r a d i t i o n s and attitudes. 2. Psychological obstacles or generally held b e l i e f s . 3. l i m i t a t i o n of company resources. 4. Departmental structures. 5. M u l t i p l i c i t y of environments and complexities of investing abroad. 6. Information and investigation costs. Organi zation Traditions and Attitudes, "Each firm at any moment i n i t s history has a series of attitudes which may roughly be defined as policy or strategy. 1 These attitudes include views on the sort of business i n which the firm ought to p a r t i c i p a t e , the types of products i t w i l l produce, the market and market segments for which products are now or w i l l be designed, the extent to which i t w i l l d i v e r s i f y or concentrate on i t s a c t i v i t i e s , the rate i t should grow, the standard of performance i t should seek and so on. With age, each firm has i t s own accepted ways of doing things and handling problems and members of the firm accept these as a way of l i f e —perhaps the only way of l i f e . The "accepted ways of doing things and handling problems", and these attitudes and traditions-must have a strong and powerful influence over the character, the goals and the opportunities of the firm and over the recognition and consideration of investment alternatives. Firms which f i n d t h e i r present p o l i c i e s and practices suitable i n the sense that t h e i r goals are achieved by following these p o l i c i e s and adopting these practices must be very u n w i l l i n g to change these t r i e d and established ways of doing things for "there i s a certain safety i n doing the Richard D. Robinson ( i n International Management. (New York: Holt, Rinehart and WinsTJoh, " 1W/T7 p. T~f, defines a strategy as "a policy choice that, once being made tends to be i n s t i t u t i o n a l i z e d and thereby r e s i s t change i n the short run." job the established way."1 This view i s c l e a r l y brought out by Hoopes who maintains that: ... the mature organization has usually developed a strong momentum of i t s own i n certain directions, propelled by basic convictions and. p o l i c i e s that have become ingrained, p a r t i c u l a r l y where the organ-i z a t i o n has been successful. Such an organization i s l e s s able to look freshly at each day's experience, . for i t has become habituated to approaching i t s problems through an elaborate body of precedents and rules that are heresy to challenge. This suggests that firms whose past exposure to direct foreign investment experience i s l i m i t e d — a n d most firms f a l l into t h i s category— and who do not face any serious problems i n exporting t h e i r products are not l i k e l y to follow a policy of considering foreign investment opportunities side by side with domestic projects. In fac t , as some econ-omists have found, they may even refuse to make a preliminary analysis or investigation of foreign investment projects when such project proposals are brought to them i n general terms simply because direct foreign investments are "outside t h e i r l i n e of business" or because these projects w i l l "disturb the "'"Herbert S. Kleiman, "A Case Study of Innovation," i n Business Horizons, Vol 9, No. 4, (Winter 1966), p. 69 2 Townshend Hoopes, "C r e a t i v i t y : Key to Organizational Renewal," in- Business Horizons, Vol. 6, No. 4, (Winter 1963), p. 38 ^Peter S. Gabriel believes that a company's willingness to consider a foreign investment project tends to be a function, of i t s previous exposure to foreign experience. See Gabriel, International Transfer of Corporate S k i l l s , p. 79 balance of the firm.""'" Hence, most firms do not normally consider direct foreign investment projects partly because t h e i r t r a d i t i o n s and attitudes m i l i t a t e against such invest-ments. Psychological Obstacles or Generally Held B e l i e f s . A second explanation as to why companies do not normally consider investing abroad can perhaps be found i n the b e l i e f s generally held by companies and t h e i r executives for i f they believe that direct foreign investments are not i n t h e i r interest they are not l i k e l y to consider such invest-ments whereas i f they believe that foreign investments are in t h e i r i n t e r e s t s the;/ w i l l consider such investments. According to Robert Theobald, "few companies have adopted the b e l i e f that investment abroad i s necessary for 2 continued p r o f i t i n the company." This therefore p a r t l y explains why companies do not normally look across t h e i r national boundaries for investment opportunities. 'Barlow and Mender j and Robinson i n t h e i r studies came across numerous companies who turned down foreign investment projects without investigation simply as a matter of policy. See S. R. Barlow and I r a T. -vender, OJ3._ c i t . , pp. 195-200; and Richard D. Robinson, International Business Pol i c y , (New York: Holt, Rinehart and Winston, 19o"4), p. 189 for examples. Robert Theobald, op. c i t . , p. 19 A more satisfactory explanation, however, must be sought i n the i n t e r e s t s , b e l i e f s and attitudes of company executives. According to Barlow and Wender, executives i n companies unfavourably i n c l i n e d toward direct foreign invest-ments —and most companies by t h e i r reluctance to consider direct investments abroad i m p l i c i t l y show that they belong to t h i s category of companies— are not interested i n foreign opportunities or operations and they have not gathered s p e c i f i c information about foreign markets. As a result of t h e i r lack of interest i n and knowledge of foreign markets and operations, these executives have a tendency to exaggerate the r i s k s and problems of foreign operations''" and they are l i k e l y to have some deep seated i n h i b i t i o n s as regards invest-ments i n unfamiliar areas. 2 They ... are pessismistic about the future opportunities i n foreign countries ... have the general a t t i t u d e that a l l foreign investment i s inadvisable because of the i n s t a b i l i t y of foreign countries, the prospect of another war, or the general attitude of foreign governments ... feel-that there, i s no opportunity to get p r o f i t s out of foreign countries because of exchange r e s t r i c t i o n s . ^ Their attitude toward and t h e i r b e l i e f s as regards foreign investments l e a d the executives to see a l l kinds of S. R. Barlow and I r a T. Wender, op. c i t . , p. 194 p Bryson thinks that t h i s i s the most serious obstacle to direct foreign investments. See George D. Bryson, P r o f i t s  from Abroad, (New York: Mcc-raw-Hill Book Co., 1964), p. 5 "5 E. R. Barlow and I r a T. Wender, op. c i t . , p. 195 obstacles i n investing abroad. These psychological obstacles — o b s t a c l e s which exist i n the minds of company executives and which operate independently of the merits of s p e c i f i c foreign investment proposals— affect direct foreign invest-ments t y p i c a l l y by preventing firms from making intensive investigation of foreign p r o j e c t s . 1 jjimi tat ion of Company Resources. A company planning to invest abroad w i l l have to have a stock of resources, not simply f i n a n c i a l c a p i t a l but also resources of managerial and technical s k i l l s for unless a company possesses these, i t w i l l not be able to invest at home, l e t alone abroad. Foreign operations, however, c a l l for more resources than domestic operations because "a longer time dimension i s required for success i n international business than i n purely domestic because of the growth factor and associated 2 r e s t r i c t i o n s on monetary movement." They also c a l l for different kinds of resources partly because "determining the feasibility/" of a foreign venture requires i n d i v i d u a l s with I b i d . , p. 200- See also Gabriel, International Transfer of Corporate S k i l l s . , pp. 15-20 o '"Robinson, International Management, p. 7 an i n t e r n a t i o n a l mentality,"""' and p a r t l y because "management o f o v e r s e a s o p e r a t i o n s r e q u i r e s i n d i v i d u a l s who a r e t e c h n i -c a l l y competent, f a m i l i a r w i t h a company's methods and a b l e " 2 t o command t h e t r u s t o f s e n i o r e x e c u t i v e s , " and have a 3 t r a i n i n g i n . f o r e i g n l a n g u a g e s and i n m a r k e t i n g . . W h i l e f i n a n c i a l r e s o u r c e s may not be a s e r i o u s p r o -blem w i t h many companies, f i n d i n g p e o p l e i n t h e company who have th e n e c e s s a r y q u a l i f i c a t i o n s , e x p e r i e n c e and s k i l l s t o e v a l u a t e and manage, a d i r e c t f o r e i g n i n v e s t m e n t o p e r a t i o n can be a r e a l and g r a v e problem f o r most companies. T h i s i s A c c o r d i n g t o F. T. Haner ("Determining t h e " F e a s i b i l i t y o f F o r e i g n V e n t u r e , " i n B u s i n e s s Horizons,. V o l 9 , Ho. 3 , ( P a l l 1 ' 9 6 6 ) , p. 3 9 ) , t h e i n d i v i d u a l 'witn an i n t e r n a t i o n a l m e n t a l i t y has t h e f o l l o w i n g t y p i c a l c h a r a c t e r i s t i c s . "He a d a p t s t o new s u r r o u n d i n g s and r e t a i n s s e l f - c o n t r o l . D e t e r m i n a t i o n and r e s o u r c e f u l n e s s seem n a t u r a l . Somehow, he s t a y s h e a l t h y and spends much l e s s t i m e on h i s back i n a h o t e l room. He a d a p t s t o u n c o m f o r t a b l e s i t u a t i o n s and i m m e d i a t e l y b e g i n s t o l o o k f o r s o l u t i o n s t o problems a s t h e y a r i s e . He does not a l w a y s e n j o y l o c a l f o o d but does not o f f e n d by making a major i s s u e o f h i s e a t i n g h a b i t s . The u g l i n e s s o f p o v e r t y i s a s d i s a g r e e a b l e t o him as t o o t h e r s but does not a f f e c t h i s e v a l u a t i o n o f t h e . p o t e n t i a l o f the p r o j e c t o r t h e s t a t u r e o f l o c a l p e o p l e . " p John Payweather, I n t e r n a t i o n a l B u s i n e s s Management; A Conceptual Framework, (New York; M c G r a w - H i l l Book Co., 1969), p. 2 9 3 -A c c o r d i n g t o p e t e r P. Vogel ("Round 2 i n I n t e r n a t i o n a l B u s i n e s s , " i n B u s i n e s s H o r i z o n s , V o l . X I , No. 4, (August 1968), pp. 57-62), d u r i n g t h e i n i t i a l p e r i o d o f t h e e n t r y o f t h e U n i t e d S t a t e s i n t o t h e w o r l d market, many c o r p o r a t i o n s gave maximum importance t o knowledge o f l a n g u a g e s and men were sent abroad because o f t h e i r knowledge o f l a n g u a g e s . A f t e r I 9 6 0 , however, t h e emphasis was on men w i t h g r e a t e x p e r i e n c e i n m a r k e t i n g . He found t h a t b o t h c a t e g o r i e s o f men were i n a d e q u a t e l y p r e p a r e d . He suggested t h a t t h e y s h o u l d be g i v e n t r a i n i n g b o t h i n language and i n m a r k e t i n g . because most companies have not undertaken direct foreign investments and are, therefore, not l i k e l y to possess per-sonnel who are conversant with direct foreign investment project evaluation and management. Most companies are, therefore, l i k e l y to be prone against considering foreign investment opportunities — s i m p l y because they do not possess the resources to undertake such operations. Departmental Structures. Another reason why most companies normally consider and evaluate only domestic rather than foreign projects can probably be found i n the way most companies are departmentally structured. Generally, the structure of companies —except that of the few i n t e r n a t i o n a l l y oriented companies— i s designed with the needs of the domestic environment i n mind. 1 This means that most companies do not have an international business department which handles both exports and foreign investments. Rather, t h e i r exports are l i k e l y to be handled by t h e i r sales departments .and t h e i r foreign investments, i f any, by t h e i r investment departments. Such a structure i s l i k e l y to act as a check to the consideration of direct foreign investment projects because ... the manner in.which a company i s structured r e l a t i v e to exports, foreign operations and research hears very heavily on the way i n which management reacts to foreign projects,^ and because ... there i s no group i n the company s p e c i f i c a l l y assigned to the task of developing foreign projects.2 A companjT- structure which i s designed with the needs of the domestic environment i n mind may also act as a check to the consideration of DPFIs through discouraging company personnel to propose such investments. Company personnel are discouraged from proposing such investment projects because such proposals usually generate c o n f l i c t s — a n d most company personnel -are not l i k e l y to l i k e open confrontations with t h e i r c olleagues— between the proposers and the sales per-sonnel. C o n f l i c t s usually a r i s e because proposals for manu-facturing or l i c e n s i n g enterprises abroad may mean that the sales people may have t h e i r export sales, which they have b u i l t up, ''destroyed" by foreign manufacture.^ Hence, most companies do not normally look abroad for investment opportunities partly because of the way they are departmentally structured. Robinson, International Business pol i c y , p. 198 2 I b i d . , pp. 204-205' •5 For a further discussion on t h i s , see Robinson, International Business pol i c y , pp. 198-207. M u l t i p l i c i t y of Environments and Complexities of Investing Abroad. I'f a company has a l l i t s investments within the l i m i t s of i t s own national borders, i t w i l l most probably be operating under one p o l i t i c a l , l e g a l , economic and so c i a l system and i t s executives may have to deal with people who speak a common language, believe i n the same r e l i g i o n and have a kindred ancestry, mutual t r a d i t i o n s , a si m i l a r frame of mind and value system. I t s executives can operate with ease and confidence for the domestic d i s t r i b u t i o n patterns, trade terms, and nuances of consumer tastes and preferences, competitors' strength and weaknesses are a l l second nature to them.1 By comparison, i f a company has i t s investments with-i n a number of national boundaries, i t s executives w i l l have to cope with not only a more elaborate set of organisational variables but also a far more complex and sensitive array of factors for direct investment abroad involves operating e f f e c t i v e l y : 1. within different national sovereignties; . 2. under widely disparate economic conditions; 3. with peoples l i v i n g within different value systems and i n s t i t u t i o n s ; John G. McDonald, "Minimizing the Risks of Moving Abroad," i n Business Horizons, Vol. 4, No. 1, (Spring 1961), p. 0 0 4. as-part of an i n d u s t r i a l revolution set i n the complex world; ' 5. often over greater geographical distances; 6". i n national markets varj^ing greatly i n population and area.l Figure 3 presents some of the complexities involved i n foreign operations. I t tracks some of the more important implications for the firm's executives generated by these six variables and t h e i r interplay. To take an example, according to. Robinson, ... different national sovereignties generate different l e g a l , monetary, and p o l i t i c a l systems. Each l e g a l system implies a unique set of relevant r i g h t s and obligations i n r e l a t i o n to property, taxation, control of monopoly, business organisation, contract. These i n turn require the firm to consider new organizational relationships, acquire new s k i l l s , adopt new accounting and control procedures, that i s , new i n the sense of being different from that required i n a purely domestic setting. More s p e c i f i c a l l y , the executives w i l l have to deal with new variables such as foreign exchange, d i f f e r e n t i a l i n f l a t i o n rates, tax and interest rate d i f f e r e n t i a l s — b o t h effective and nominal— across national boundaries, special inducements of and possible c o n f l i c t s with host countries beside differences i n production and marketing costs i n the countries i n which the company has i t s investments. Further-more, they w i l l have to deal with differences i n human re-lationships —which i n some respects are r e f l e c t e d i n costs but which at the same time add to the challenges, s a t i s f a c t i o n s Robinson, International Management, p. 3 Ibid. , p. 3 Important V a r i a b l e s in the I n t e r n o t i o n o l S y s t e m Which G e n e r a t e : Int'l P o l i t i c o l System Different Legal Systems Di f ferent Monetary Sys tems Di f ferent Po l i t i ca l Sys tems D i f f e r e n t Economic S y s t e m s Agrar ian - B a s e d Soc ie ty Not ional Poverty - R e l a t i v e E l ite - M a s s D i f f e r e n t i a t i o n Drive For Catch -up Economic Development Author i tar ian ism Foreign Refe rence Models D i f ferent Communications S y s t e m s Time D i f fe rence D i f fe rent Market Size -13 -14 FIGURE III. COMPLEXITIES 0 Source; Richard D. Robinson: International Management,, (New York: Holt, Rinehart & Winston, l?6It),.pp. ' Leod ing to D i f fe rences in : / P e r c e i v e d National Power (Pressures Against Al iens {Property Rights Taxation Ant i t rust Low Corporote Law Contract Low {Currency Exchonge. Control ^ Finoncial Policy I Monetary Policy ( Financial Institution ) 4 ^Contro ls over Business y> {Import And Export Controls ^ Property Rights I E f f e c t i v e n e s s of Market Econ. f Elasticities of Supply & DemondJ ' vo lue of Time Degree of T rad i t iona l i sm 6^  Foctor Mix Regional ism (^Education and S k i l l Levels {Institutional Paternal ism Incentives Urbonizot ion 'Growth Rates Pressure for High Rate of 8/ Investment I Role of Government (i.e. In Planning, Control ) ^ / P r e s s u r e for Immediate \ Consumption 1 Q ^Borrowing o f . P o l i t i c o l And \ Sociol Concepts II ^Bor rowing of Technology f l o n g u a g e ^Communicat ions Medio I, /'inventory Levels or Means of \_ Transport Which Require The Firm To — . - B u i l d Ne* Def ' N ^ - A s s e s s Politicol ef enses Vulnerability ^•Consider New Organizational Relat ionships 14 { Contro l of Monopoly and Competi t ion Acquire New Ski l ls Consider New Accounting Procedures Consider Mew. Credit Instruments Assess The Politicol Vulner-ability of Its Enterprise Use Mew Methods of Market Analys is Consider Production Market ing, and Trcining P r o b l e m s - N e w Mixes Reconsider Substcnce of Sales -Consider Organizational and Personnel Policies in ? New Light ' A s s e s s Inf lat ion Vulnerabil ity - A s s e s s Vulnerabil i ty to State Contro l and/or Compe tition -Deol with Morket Controls -New Patterns of L c b c r -Management Relations -Consider New Processes end ' Processes Mixes (-i.e.Plants} Acquire New Ski l ls Incur Added Cost Face New Problems cf Control Incur Higher C-OSlS 'Consider New Operating Po l ic ies Note: Many Important Re lat ionsh ips Are Not Charted Here This Scheme Is Presented Only as an I l lustrat ion INVESTING ABROAD. and f r u s t r a t i o n s of managements In ways that cannot he reduced to pecuniary terms." . I f a company wishes to consider investing abroad, i t s executives w i l l , therefore, need to have a comprehensive knowledge of the m u l t i p l i c i t y of variables imbedded i n the foreign.environments — n o t only i n general terms of an investment climate but also i n more s p e c i f i c terms for a p a r t i c u l a r investment. They w i l l also be required to acquire new tools, concepts, a n a l y t i c a l methods and types of i n -formation for they w i l l now be faced with a wider range of p operational problems. This ca,n affect the willingness of companies to search and consider DPFI alternatives i n more than one way. • F i r s t , i t can affect the search for and the con-sideration of DPFIs by discouraging executives to propose such investments or to make a preliminary investigation and analysis of them when these are brought to them i n general terms. The executives are discouraged from proposing and from making a preliminary investigation and analysis of direct foreign investment projects either because the: mere mechanics of international transactions and of foreign operations are ""Dan Throop Smith, op. c i t . , p. 93 2 Stefan H. Bobock and Kenneth Simmonds, "What's New. in International Business?" i n Business_Horisons, Vol. 9, No, 4, (Winter 1966) , p. 45 " ." insurmountable to them1 or because they fear that i f they propose such investments they may have to take charge of these, operations — a task for which they, are ill-equipped. Second, the complexities of investing abroad can check the consideration of DPFIs because of the investments required i n t r a i n i n g executives. Most, companies are u n l i k e l y to be prepared to incur f i n a n c i a l costs or to take management personnel away from tasks closer at hand so as to provide them with t r a i n i n g i n the mechanics of foreign operations, especially when they are operating successfully at home and have "unlimited" p r o f i t a b l e domestic projects; however, they are probably prepared to undertake the investment i n t r a i n i n g t h e i r executives i n foreign operations when they are faced • with some serious problems for which an investment abroad appears to be an easy solution. Information and Investigation Costs. Before a company invests i n „a new venture i t w i l l attempt to weigh i t s p r o f i t prospects against the r i s k of incurring losses. To do t h i s , requires information i n many ' Kolde believes that even the mere mechanics involved i n exporting and importing i s often insurmountable to the ty p i c a l corporate executive. See En del J-. Kolde, International Business Snternrise, MSS, Chapter 8, p. 16 s p e c i f i c ' d i r e c t i o n s . F o r example, t h e company needs t o have g e n e r a l i n f o r m a t i o n p e r t a i n i n g t o t h e b a s i c s t r e n g t h s and weaknesses o f t h e economy o f t h e c o u n t r y i n which t h e v e n t u r e i s t o be u n d e r t a k e n , t h e a d m i n i s t r a t i v e and p o l i t i c a l s t r u c t u r e o f t h e c o u n t r y , and i t s c u r r e n t l e g i s l a t i o n c o v e r i n g such t h i n g s as t a x e s , i n c e n t i v e s f o r f o r e i g n i n v e s t m e n t s , l o c a l ownership r e q u i r e m e n t s and m o n o p o l i s t i c p r a c t i c e s . 1 I t a l s o r e q u i r e s s p e c i f i c i n f o r m a t i o n such as t h e s i z e o f the market f o r i t s p r o d u c t , t h e share o f t h e market i t can conquer, i t s s e l l i n g p r i c e , i t s c o s t o f p r o d u c t i o n i n c l u d i n g t h e c o s t o f - c a p i t a l , s e l l i n g expenses and o t h e r overhead e x p e n d i t u r e s , 2 and not o v e r l o o k i n g e s t i m a t e d l o s s e s . Such i n f o r m a t i o n i s g e n e r a l l y more e a s i l y o b t a i n e d f o r t h e d o m e s t i c t h a n f o r a f o r e i g n market. I n f a c t , v e r y o f t e n d e t a i l e d s t a t i s t i c s f o r t h e f o r e i g n market a r e l a c k i n g so t h a t a p p r a i s i n g i n v e s t m e n t p r o j e c t s l o c a t e d i n i t i s not o n l y - d i f f i c u l t but p r a c t i c a l l y i m p o s s i b l e . D F u r t h e r m o r e , where t h e r e i s ample q u a n t i t y o f i n f o r m a t i o n , t h e r e may be q u e s t i o n s o f r e l i a b i l i t y and r e l e v a n c e , p a r t i c u l a r l y where t h e r e i s c o n f l i c t i n g o p i n i o n and e v i d e n c e . I n v i e w o f t h e ^ F o r a f u l l e r d i s c u s s i o n on t h e n a t u r e o f g e n e r a l i n f o r m a t i o n i n v e s t o r s r e q u i r e , see Appendix I I . 2 Henry G. Aubrey, " I n d u s t r i a l . Investment D e c i s i o n s : A Comparative . A n a l y s i s , " i n The J o u r n a l _ o f Economic H i s t o r y , V o l . XV, (December 195:3), p\- yJ3 ^ T h i s i s p a r t i c u l a r l y t r u e o f t h e LDCs f o r i n some t h e r e a r e no t r a d e l i t e r a t u r e , market s u r v e y s , t r a d e a s s o c i a t i o n s o r market r e s e a r c h companies t o r e l y on. g r e a t e r d i f f i c u l t y o f o b t a i n i n g i n f o r m a t i o n f o r a f o r e i g n market, companies can be ex p e c t e d t o have a r e l u c t a n c e t o c o n s i d e r d i r e c t i n v e s t m e n t a b r o a d i f domesti c d i r e c t i n v e s t -ment o p p o r t u n i t i e s a r e s t i l l a t t r a c t i v e . I n f o r m a t i o n a l s o a f f e c t s companies' w i l l i n g n e s s t o c o n s i d e r d i r e c t f o r e i g n i n v e s t m e n t p r o j e c t s t h r o u g h c o s t o f c o l l e c t i o n . F o r a s c e r t a i n i n f o r m a t i o n i s r e q u i r e d b e f o r e companies can weigh t h e p r o s p e c t s o f an i n v e s t m e n t p r o j e c t and a s the c o l l e c t i o n o f i n f o r m a t i o n , e s p e c i a l l y o f t h e r i g h t i n f o r m a t i o n , i n v o l v e s a h i g h c o s t , b o t h i n terms o f .fi n a n c e and -in terms o f t h e d i v e r s i o n o f management a t t e n t i o n from o t h e r t a s k s c l o s e r a t hand, companies w i l l have t o d e c i d e whether t h e y want t o i n v e s t i n t h e c o l l e c t i o n o f t h e r e q u i r e d i n f o r m a t i o n b e f o r e t h e y can c o n s i d e r , a n a l y z e and e v a l u a t e t h e proposed i n v e s t m e n t p r o j e c t . Where t h e c o s t o f o b t a i n i n g t h e r e q u i r e d i n f o r m a t i o n i s e x h o r b i t a n t — a n d t h i s i s more l i k e l y t o be t h e case f o r i n f o r m a t i o n p e r t a i n i n g t o a f o r e i g n t h a n a domestic p r o j e c t — companies may d e c i d e n o t t o i n v e s t i n t h e i n f o r m a t i o n . 1 Even i f companies a r e p r e p a r e d t o i n v e s t i n t h e c o l l e c t i o n o f g e n e r a l i n f o r m a t i o n p e r t a i n i n g t o f o r e i g n T r a d i t i o n a l economic t h e o r y t e l l s u s t h a t ' a n i n v e s t o r w i l l i n v e s t i n i n f o r m a t i o n o n l y so l o n g a s the m a r g i n a l e x p e c t e d r e t u r n from the i n f o r m a t i o n g a i n e d exceeds t h e e x p e c t e d oppor-t u n i t y c o s t . But t h i s i s not o f much h e l p becau.se i t i s d i f f i c u l t to. c a l c u l a t e t h e c o s t as w e l l a s t h e r e t u r n s . markets, they.are not l i k e l y to be prepared to carry out on--the- spot-investigations of foreign investment proposals, 1 involving lengthy negotiations i n foreign countries over matters such as.tax incentives, foreign exchange rates and a v a i l a b i l i t y , assurance of continued t a r i f f and other forms of p r o t e c t i o n , 2 because such on-the-spot-investigations are expensive and time consuming —and the investment project or projects investigated and evaluated may a f t e r a l l be rejected. I t i s perhaps mainly for t h i s reason that companies do not 3 normally consider direct foreign investment projects. Summary. An investment decision from the i n i t i a l recognition to the acceptance of a project or projects involves: 1. Recognition or generation of a potential invest-ment project or a set of projects. I t should be noted that even with respect to exports Vernon finds that "entrepreneurs are not readily disposed to pay the price of investigating overseas markets of unknown dimension and unknown promise." See Vernon, "international Investment ... i n the Product Cycle," p. 2o2 2 For a discussion on the problems and troubles involve i n determining the f e a s i b i l i t y of a foreign investment venture and i n carrying out negotiations i n foreign countries, see Eaner, "Determining F e a s i b i l i t y of Foreign Ventures,"; Haner, "'Investment Negotiations i n Developing Countries,"; and Williams, "Negotiating Investment i n Emerging Countries." -^This i s also the conclusion of Aharoni's study. See Yair Aharoni, on. c i t . , Chanter 4. 2. Collection of information and preliminary invest-igation of the project or projects. 3. Comprehensive evaluation o f t h e " p o t e n t i a l l y acceptable" project or projects, 4 . p i n a l decision on whether to accept or reject the " p o t e n t i a l l y acceptable" project or projects. Neo-classical investment theory and most hypotheses on direct private foreign investments ignore the recognition or generation of potential investment projects and take for granted that investment al t e r n a t i v e s , both domestic and foreign, are given to firms. The assumption they i m p l i c i t l y make here i s that the firms' search for higher p r o f i t s lead them to scan the home and foreign environments for investment projects. Empirical studies of the investment decisions of some firms reveal that at least with respect to foreign investments such i s not the usual case. I t seems that firms do not, i n fact, systematically scan the globe for areas i n which to make an investment and that most firms do not normally con-sider the p o s s i b i l i t i e s of investing abroad. Several explanations can be given as to why firms do not normally consider the p o s s i b i l i t i e s 'of undertaking-direct investments abroad. F i r s t , they may not consider such p o s s i b i l i t i e s because t h e i r t r a d i t i o n s , attitudes, departmental structures and resources m i l i t a t e against, undertaking direct foreign investments, second, they may not consider such invest-ments because of t h e i r misconceptions about the climate of investment in.other countries and because of t h e i r b e l i e f that a l l foreign investments are. bad. Third, they may not consider foreign investments because of t h e i r unwillingness to invest t h e i r . f i n a n c i a l resources i n the t r a i n i n g of t h e i r managerial personnel i n the mechanics of foreign .' -investment operations,.an area of business operations i n which they are not favourably i n c l i n e d , f i n a l l y , they may not consider such investments because of t h e i r unwillingness to invest t h e i r f i n a n c i a l and managerial resources i n the c o l l e c t i o n of scanty and probably unreliable information . and i n the investigation and evaluation of projects which af t e r a l l they may not undertake. INITIATING FORCES, AND THE ORIGINATION, CONSIDERATION, INVESTIGATION AND EVALUATION OF DIRECT PRIVATE FOREIGN INVESTMENT PROJECTS. Introduction Surveys into the direct foreign investment behaviour of-companies reveal that most companies do not normally con-sider making direct investments abroad, that "most companies do not have a "master plan" for international investment . arrived at through careful evaluation of the various pos-s i b i l i t i e s •of employing c a p i t a l so as to maximize the return on i t , " 1 and that most company decisions to undertake direct 2 investments are not the result of continued planning. I f most companies do not normally make use of a large scale screening process to i d e n t i f y direct foreign investment opportunities, how do direct foreign investment projects usually originate within them? And when they become aware of or are alerted to such projects, how do they consider, investigate and evaluate them? Are direct foreign investment Judd Polk, et. al... op. c i t . , p. 73 See Chapter Four of t h i s study. decisions- the result of evaluations of alternatives or are they made for each proposal on i t s own merits alone,, independent of other proposals? Do companies rel y s o l e l y on the discounted cash flow method to evaluate investment projects? I f not, what are other c r i t e r i a companies use to determine the acce p t a b i l i t y of direct foreign investment projects? Before we draw iipon the res u l t s of past research into the foreign.investment decision behaviour of companies to answer these questions, i t i s not inappropriate to review some aspects of the behavioural theory of the firm, especially those r e l a t i n g to search and search behaviour, because the manner i n which direct. foreign investment pro'jects originate within companies and the manner i n which these projects are considered and evaluated are suggested by t h i s theory. Some Relevant Aspects of the Behavioural Theory of the "Firm. One concept which may have some relevance to the behavioural theory o f the firm i s the concept of homeostasis — t h a t i s of a mechanism for s t a b i l i z i n g a variable or a group of variables within a certain l i m i t of t o l e r a t i o n . When applied to organizations, t h i s concept suggests that: ... every ... organization i s characterized by a group of ... variables and the organization consists mainly i n more or l e s s elaborate - apparatus to maintain these variables between an upper and a lower l i m i t . Should any of the essential variables r i s e above the upper l i m i t , machinery must•be brought into play to reduce i t ; should i t f a l l below the lower l i m i t , machinery must be brought into play to raise i t . x • Another concept which may have some relevance to the behavioural theory of the firm i s the notion of s a t i a t i o n , a notion which'enters rather prominently into the treatment of motivation i n psychology. This notion, b r i e f l y stated, maintains that "the motive to act stems from drives and action 2 terminates when the drive i s s a t i s f i e d . " This notion, there-fore has some p a r a l l e l s to the concept of homeostasis for both these notions suggest d i s s a t i s f a c t i o n as a stimulant to search and search behaviour being induced only when performance f a l l s short of the l e v e l of aspiration. I f business behaviour can be explained i n terms of these notions, then i t can be expected that: 1. company goals are stated not i n maximizing terms but rather i n s a t i s f L c i n g terms. 2. companies do not attempt to maximize p r o f i t s but rather to a t t a i n a certain .level or a certain rate of p r o f i t , or to hold a certain share of the market or a certain l e v e l of sales. xZenneth E. Boulding, op. c i t . , p. 36 2 ' Simon, "Theories of Decision Making i n Economics and Behavioural Science," pp. 262-263. 3. -within companies variables or a group of variables are allowed to fluctuate within certain ranges without arousing much concern among the participants. 4. search — i n c l u d i n g the search for investment p r o j e c t s — and search behaviour within companies w i l l be induced only when performance f a l l s short of the l e v e l of aspiration or when the companies are faced with certain problems for which no satisfactory solution readily presents i t s e l f . • There i s some evidence that business goals are, i n fact, stated i n s a t i s f i c i n g terms. F i r s t , there i s the series of studies stem ing from the pioneering work of Hall and Hitch"*" that indicates that businessmen often set prices by applying a standard mark-up to costs. Second, there i s the series of studies, which indicates that the investment behaviour of companies i s strongly influenced by the amount of accumulated ' 3 funds. Third, there i s the work of Cyert and Marchr which indicates that companies consider resources as fi x e d and impose f e a s i b i l i t y rather than optimal i t tests on proposed expenditures or projects. 1. R. 1. Hall and C. J. Hitch, "Price Theory and Business Behaviour," i n Oxford Economic Papers, i\To. 2. (May 1939), PP. 12-49. ^See for example, Robert Eisner, Determinants of Capital Expenditure; An Interview Stud;,', S-tudies i n Business Expectations and pTaiming~No7 2~, (Urbana, I l l i n o i s ; univer-s i t y of I l l i n o i s , 1956); P. W. S. Andrews, "A Further Inquiry into the Effects of Rates ©f Interest," i n Oxford Economic  Papers, Ho. 3, (February 1940) , pp. 32-73; and j . J. Polak and J. Tinbergen, The Dynamics of Business Cycles. A Study i n  Economic Fluctuations, ( c h i cago: University of CnTcago Press, 1950)7 3 See Richard M. Cyert and James &., March, A Behavioural Theory of the Firm, (Englewood C l i f f s , Hew Jersey: Prentice-Hall ~ Inc., 19o5l7 Chapter 4. Researches into the search and investment decision behaviour of companies1 also confirm that the notion of homeostasis and of s a t i a t i o n have some relevance to the behavioural theory of the firm. They also provide some other in t e r e s t i n g insights into the behaviour of companies. They indicate that: 1. search i s usually a response to some s p e c i f i c event rather than as a form of continued planning. I t i s generally motivated by a problem. 2. once a problem or problem area i s recognised, there i s l o c a l rather than general scanning of alternatives to solve the problem. 3. during the early scanning process, only rough expectation data are used to scan out obviously inappropriate actions or alternatives. 4. once a few alternatives are considered as satisfactory, these are sequentially considered i n d e t a i l . < 5. the non-comparability of expected costs and returns leads to estimates that are vague and easily-changed, and makes the decisions • exceptionally susceptible to factors of attention focus and of available organisation slack. 6. a firm commitment to an action i s taken before the search for information proceeds very far. 7. the search becomes more and more intensive as the decision approaches implementation. 8. the company considers resources as fixe d and imposes f e a s i b i l i t y tests rather than optimality t e s t s on the proposed expenditure or project. Q the f i r s t s a t isfactory solution to be discovered i s accented. See Bruce R. W i l l i a m s & W. p. Scott, op. c i t . ; R. M. Cyert, et. a l . , op^ c i t , , ; and p a r t i c u l a r l y Herbert A. Simon, "New Developments i n the Tneory of .the Eirrn," in American Economic Review, Vol. 52, No, 2, (May- 1962) , pp. 1-15" These r e s e a r c h e s a l s o suggest t h a t not o n l y a r e o r g a n i z a t i o n s l o o k i n g f o r a l t e r n a t i v e s but a l t e r n a t i v e s a r e a l s o l o o k i n g f o r o r g a n i z a t i o n s . 1 i n i t i a t i n g F o r c e s and t h e O r i g i n a t i o n o f D i r e c t p r i v a t e F o r e i g n Investment P r o j e c t s . S e v e r a l s t u d i e s o f t h e f o r e i g n o p e r a t i o n s o f companies r e v e a l t h a t t y p i c a l l y ' ' a company's i n v o l v e m e n t w i t h a f o r e i g n c o u n t r y b e g i n s w i t h a r e l a t i v e l y s m a l l e x p o r t o r s e r v i c e h a n d l e d by company p e r s o n n e l abroad and t h a t g e n e r a l l y a company o n l y c o n s i d e r s - d i r e c t i n v e s t m e n t s o v e r s e a s when i t i s f a c e d w i t h a problem o r c e r t a i n problems which t h r e a t e n t h e achievement o f one or more o f i t s b r o a d g o a l s and when t h e n a t u r e o f t h e t h r e a t t o i t s g o a l s i s such t h a t f o r e i g n i n v e s t m e n t i s t h e e a s i e s t and most l o g i c a l r e s p o n s e ; ^ q u i t e f r e q u e n t l y t h e problem f a c e d by t h e company i s s i m p l y a c h a l l e n g e o r a t h r e a t t o an e x i s t i n g p r o f i t a b l e s i t u a t i o n . R. M. C y e r t , e t . a l . , op. c i t . , p. 338 2 See f o r example t h e work o f E. .R. B a r l o w and I r a T. Wender, op. c i t . ; Yair A h a r o n i , op. c i t . ; Judd P o l k , e t . a l . , op. c i t . , and Vernon, " I n t e r n a t i o n a l Investment . „. i n the p r o d u c t C y c l e . " 3 ' D i r e c t i n v e s t m e n t s i n raw m a t e r i a l p r o d u c t i o n a r e t h e e x c e p t i o n s . ^ C h a r l e s D. Hyson and Dale R. Veigel, op. c i t . , p. 38 These s t u d i e s a l s o r e v e a l t h a t t h e main f o r c e s o r p r e s s u r e s t h a t u s u a l l y u p s e t t h e normal c h a i n o f ev e n t s i n . accompany and l e a d some i n d i v i d u a l s i n i t t o f o c u s a t t e n t i o n on t h e p o s s i b i l i t i e s o f i n v e s t i n g a b r o a d and t o devote t i m e and o t h e r r e s o u r c e s t o t h e i n v e s t i g a t i o n o f t h i s p o s s i b i l i t y " 1 " a r e : 1. force's o r p r e s s u r e s which t h r e a t e n t h e company w i t h t h e l o s s o f i t s e x p o r t s a l e s and i t s f o r e i g n market. These i n c l u d e : i . government a c t i v i t i e s which t a k e t h e foi7n o f : a. t h e i n t r o d u c t i o n o f i m p o r t quotas and h i g h t a r i f f d u t i e s on t h e company's p r o d u c t s . b. t h e i n t r o d u c t i o n o f f o r e i g n exchange c o n t r o l w i t h r e s p e c t t o t h e compare's p r o d u c t s o r w i t h r e s p e c t t o goods i m p o r t e d from t h e company's c o u n t r y . c. an agreement by t h e government o f t h e c o u n t r y t o which t h e company i s e x p o r t i n g i t s p r o d u c t s w i t h o t h e r governments t o form a common market and l i b e r a l i s e t r a d e w i t h i n t h e common market a r e a . d. t h e i n t r o d u c t i o n o f l e g i s l a t i o n t o impose i m p o r t r e s t r i c t i o n s and l i m i t a t i o n on t h e number o f companies a l l o w e d t o produce t h e company's p r o d u c t s . i i . s t r o n g c o m p e t i t i o n i n t h e f o r e i g n market posed by l o c a l m a n u f a c t u r e r s o r o t h e r f o r e i g n e x p o r t e r s . l a i r A h a r o n i c a l l s t h e s e -forces " i n i t i a t i n g f o r c e s . " i i i . inadequacies of the l o c a l d i s t r i b u t o r s , who may be doing a poor job of marketing the company's products or who may not have funds for expansion to serve the - market adequately." i v . l o c a l d i s t r i b u t o r s deciding to drop the company's l i n e in favour of that of another company. 2. forces or pressures which threaten the. company with the loss of i t s home market. These include among others: i . strong competition from abroad. i i . strong competition i n the domestic market from other l o c a l manufacturers leading to a sharp decline i n the company's sales. i i i . a cut-off or a threat of a cut-off of the company's raw materials which can only be obtained from abroad. 3 = forces or pressures which threaten to reduce the company's r e l a t i v e standing i n the home market and which threaten to pre-empt i t from investing i n foreign markets. These usually a r i s e when other-domestic companies, p a r t i c u l a r l y r i v a l companies, undertake investments abroad. Forces or pressures which threaten the loss of a company's export market bring the p o s s i b i l i t i e s of foreign investment to the attention of the decision makers within the company and immediately p r e c i p i t a t e a decision on t h e i r part as to whether they are w i l l i n g to set up an assembly plant or convert t h e i r assembly operations into manufacturing operations because i f they do not make the decision immediately the company may face exclusion from the market i n which i t has been operating p r o f i t a b l y . Forces which threaten the lo s s of a company's home market, p a r t i c u l a r l y where the threat originates from abroad, p r e c i p i t a t e a decision on the part of management as to whether i t i s w i l l i n g to undertake foreign investments because the company's very survival i s being threatened. And forces which threaten to pre-empt a company from a foreign market or markets pr e c i p i t a t e a decision because i f i t . does not make a decision i t may f i n d that i t s future growth and expansion may be r e s t r i c t e d and that i t may not be able to maintain, b u i l d and f o r t i f y i t s position i n the foreign and.domestic markets. Although i n most cases companies consider investing abroad only when they are pressured or faced with some threat to one or more of t h e i r broad goals — a n d t h i s i s usually the case with companies having a large export base rather than with those without much contact with a foreign market 1 — t h e r e are occasions when a company may be persuaded to consider investing i n a foreign market by some "individuals so close to the firm —and. so important to i t — that management feels compelled to manifest some po s i t i v e response to proposals 2 suggested by them." Some of the in d i v i d u a l s from whom proposals may originate include the company's regular d i s t r i b u t o r s or customers within the foreign country —who may request that they be given permission to establish l o c a l manufacture or 1E. R. Barlow and I r a T . V/ender ( i n op. c i t . , pp. 198-200) show that industries with the smallest percentage of export to t o t a l production are those with the smallest r e l a t i v e number of companies as foreign investors. Hence the above implication. 2 Robinson, International Business Po l i c y , p. 208 assembly operations on a l i c e n s i n g basis — a n d other companies which have been the company's main'buyers and which have just started foreign operations. -Sometimes the stimulus for getting a company to consider and appraise an investment opportunity abroad comes from some high ranking executives within the organization who may have had the project l y i n g at the back of t h e i r mind for quite some time. 1 In these cases, for the company to be persuaded to consider such proposals, the executives presenting the proposals must be very important i n the company, i n f l u e n t i a l and capable enough to convince skeptical executives that such proposals are meritorious and that i t i s worthwhile to go abroad to judge whether conditions are a t t r a c t i v e for invest-, 2 menxs. There are also occasions when a company Is instigated to consider direct investments abroad by some ind i v i d u a l s and i n s t i t u t i o n s who have no connection with i t . For example, some foreign i n d u s t r i a l i s t s may, because of rapid technological change or of having si m i l a r i n t e r e s t s and philosophy, put a proposal to the company for a l i c e n s i n g management, a j o i n t venture or a merger, or some foreign government agencies or 'See Yair Aharoni, op. c i t . , pp. 58-61 p Zwiek finds that "certain i n d i v i d u a l s by vir t u e of longevity of successful, company service and company status are the best project supporters." See Jack Zwiek, "Is Top Management Really on Top?" i n Columbia Journal of World Business, Vol. 1, No. 1, (Winter 1966J, p. 90 some development banks may, because of t h e i r desire to promote economic growth within t h e i r country, put before the company a tentative investment project. Besides, the company's home government may request that the company consider certain overseas projects. In a l l these instances, the company i s l i k e l y to investigate the proposal seriously i f the tentative proposal i s accompanied by a preliminary report suggesting that such an arrangement may prove to be very a t t r a c t i v e to the company i n terms of p r o f i t s , that there are opportunities of growing i n the protected overseas market and that a rej e c t i o n of the proposal may injure the company's foreign or domestic operations. The Consideration, Investigation and Evaluation of Direct private Foreign Investment Projects. Consideration of Investment Proposals. Once a company i s alerted to a direct foreign investment project as a consequence of pressure or persuasion, the pro-ject i s either rejected outright or considered depending on the nature of the i n i t i a t i n g force, the gravity of threat to the company's goals the proposed project posed, the nature of support the project enjoyed from key people i n management,'1" the " The personal interest and support of key people i n the company i s l i k e l y to play a larger role i n the foreign than i n the domestic case precisely because of the greater number of imponderables. p o l i t i c a l orientation and p o l i t i c a l s t a b i l i t y of the country of suggested investment"'" and a host of other factors. . I f the product c h a r a c t e r i s t i c s of the company are 2 suitable for foreign investment and the proposed project poses a serious threat to the achievement of one or more of the company's goals or i f i t enjoys the support of key people i n management, the project i s l i k e l y to be considered. I t i s also l i k e l y to be considered i f the potential investment the company has been alerted to promises i t a market for components and other products or u t i l i z a t i o n of an old piece of machinery which i t possesses or c a p i t a l i z a t i o n of i t s know-how and spreading of i t s f i x e d costs^ or i f I t has surplus funds for which i t has not been able to f i n d some suitable domestic investments or i f the i n i t i a l outlay for the proposed invest-ment i s s m a l l 4 and the investment incentives offered by the The National I n d u s t r i a l Conference Board Survey of Obstacles and Incentives to private Foreign Investment, 1967-68 indicates that there might be outright rejection of investment proposals coming from countries with a s o c i a l i s t or communist p o l i t i c a l orientation or with the threat of p o l i t i c a l i n s t a b i l i t y and nationalism. See Conference Board, Private Foreign Investment: Obstacles, pp. 3-4 2 Vernon i n "International Investment i n the Product Cycle," shows that only companies whose products have "matured" and are "standardized" w i l l be l i k e l y to undertake DPFIs. Aharoni c a l l s a l l tnese inducements " a u x i l i a r y forces". See Yair Aharoni, cro. c i t . , pp. 70-74-4Most v/riters, including Barlow and Wender, and Vernon conclude that except for investments -in raw material production, companies are generally unprepared to invest i n a foreign project i f the size of the i n i t i a l investment i s large. foreign government appear a t t r a c t i v e . I f only one investment project i s presented before management and t h i s i s a project i t i-s prepared to consider, t h i s project i s generally considered on I t s own merits; management does not normally look for other projects and compare t h i s project with other potential projects i n the domestic market or i n some other countries. This i s partly because of the enormous cost, both i n terms of finance and i n terms of the diversion of management attention from tasks closer at hand, involved i n c o l l e c t i n g information and i n making on-the-spot-investigations of projects. This assertion finds support not only from Barlow and V/ender's survey but also from a number of other studies. For example, Barlow and Wender found that a large United States manufacturing company alerted to an investment opportunity abroad, ... did not compare t h i s investment proposal with the p o s s i b i l i t y of investment i n any other country. I t looked at t h i s investment proposal alone. The only consideration was whether i t seemed sound. I t was not a question of whether t h i s investment would be more pr o f i t a b l e than other possible investments abroad or i n the United States, 1 and with another company they found that when the foreign government imposed import r e s t r i c t i o n s and the company's di s t r i b u t o r did not have cap i t a l required for l o c a l manufacture the company, E. R. Barlow and I r a T. Vender, on. c i t . , p. 173 ... on a p u r e l y / I n d i v i d u a l b a s i s ... d e c i d e d t o go ahead w i t h t h i s i n v e s t m e n t ... t h i s i n v e s t m e n t p r o -p o s i t i o n was not compared w i t h o t h e r p o s s i b i l i t i e s a broad o r a t home. The s i t u a t i o n was a p p r a i s e d ; i t was d e c i d e d t h a t t h e e x p e n d i t u r e was n e c e s s a r y and t h a t a p r o f i t would be made; then t h e d e c i s i o n t o go ahead.was reached,1 S i m i l a r c o n c l u s i o n s were r e a c h e d by P o l k e t . a l . , i n t h e i r s u r v ey. They c l a i m t h a t : ... companies i n d i c a t e d t h a t v e r y few d e c i s i o n s a r e reached by comparing d i f f e r e n t i n v e s t m e n t o p p o r t u n i t i e s , i n c l u d i n g o p p o r t u n i t i e s i n t h e U n i t e d S t a t e s . Most companies do not have a "master p l a n " f o r i n t e r n a t i o n a l i n v e s t m e n t a r r i v e d a t t h r o u g h c a r e f u l e v a l u a t i o n o f t h e v a r i o u s p o s s i b i l i t i e s o f e m p l o y i n g c a p i t a l so as t o maximize t h e r e t u r n on i t . On t h e c o n t r a r y , each p r o p o s a l i s c o n s i d e r e d on i t s own m e r i t s . 2 I f , on- t h e o t h e r hand, management i s a l e r t e d t o a number o f f o r e i g n i n v e s t m e n t p r o j e c t s s i m u l t a n e o u s l y and t h e y a l l pose some t h r e a t to t h e company's g o a l s , commonsense suggest t h a t t h e company i s l i k e l y t o c o n s i d e r and e v a l u a t e t h e a l t e r n a t i v e which poses the g r e a t e s t amount o f t h r e a t b e f o r e c o n s i d e r i n g t h e o t h e r a l t e r n a t i v e s . T h i s i s borne out by e m p i r i c a l s t u d i e s f o r B a r l o w and Vender found t h a t : ... i n g e n e r a l , t h e company t a k e s a c t i o n i n t h o s e c o u n t r i e s where a c t i o n i s most r e q u i r e d . I t does not .. n e c e s s a r i l y / expand i t s p l a n t i n t h e c o u n t r y t h a t w i l l p r o v i d e t h e g r e a t e s t p r o f i t ; r a t h e r i t expands i n t h e c o u n t r y whgre t h e p r e s s u r e i s g r e a t e s t f o r such e x p a n s i o n . ~J Thus i t can be c o n c l u d e d t h a t i n g e n e r a l companies c o n s i d e r 1 I b i d . , p. 174 p Judd P o l k , e t . a l . , op. c i t . , p. 73 E. R. B a r l o w and .Ira T, Vender,, op. c i t . , p. 175 direct foreign investment alternatives sequentially and i f the alternative examined s a t i s f i e s the constraints set, the alternative i s accepted. . •-• Commitment and the Investigation of Investment proposals. According to Aharoni, investigating and evaluating a direct private foreign investment project i s a very c o s t l y 1 2 and time consuming a f f a i r . P a r t l y because of t h i s , a company i f i t decides to investigate a proposed project, must have right from the beginning accepted i n p r i n c i p l e to carry out the investment. 3 This acceptance of the project i n p r i n c i p l e even before investigating i t i s also p a r t l y the result of the company's p r i o r commitments —commitments such as to hold the market or to have a certain share of the market— and of the power structure i n .the company.^ Yair Aharoni ( i n op_. c i t . , p. 109) notes.that the on-the-spot-investigation alone may cost up to $ 1 0 0 , 0 0 0 i n out-of-pocket expenses. 2 "According to P. T. Haner, with a team of investigators, a company needs about two weeks of preparation i n the United States and about a month of f i e l d work i n the foreign country to have a reasonably r e l i a b l e estimate of the potential of a project, See Haner, "Determining F e a s i b i l i t y of Foreign Ventures," p. 37 3 Williams i n his investigation on ca p i t a l expenditure decisions of companies found t h i s to be true of domestic invest-ments with costly investigations. See Bruce R. . Williams,. "Capital Expenditure Decisions," i n The Journal of Management Studies, . Vol. 1 , (September 1 9 6 4 ) , p. 125* T a i r Aharoni, op. c i t . , p. 125 ' The decision to proceed with the investigation of a project i s usually based on some hunches, confidence that i t w i l l succeed, some crude estimates of the effect on sales and p r o f i t s and a judgement about the "climate- of opinion" i n the company. I f the impact of the i n i t i a t i n g force i s strong and the company's hunch i s that the project has a "good chance of success", i t w i l l investigate the project. In the f i r s t phase of the investigation, several generally available crude indicators are consulted to form some opinion of the f e a s i b i l i t y of the opportunity considered. The s p e c i f i c crude indicators used depends on the nature of the project. In general, what i s attempted at t h i s stage of the investigation process i s to make some crude examination of the r i s k s and uncertainties involved, of the market size expected and of possible c o n f l i c t s of the suggested project p with e x i s t i n g company p o l i c i e s and resources. I f at the' end of t h i s preliminary investigation, the company s t i l l decides to continue with the investigation, i t w i l l carry out on-the-spot-investigation. This involves company executives going abroad to determine the attitude of the foreign government, to compare government and company plans so as to obtain clues to both potential problems and unusual benefits, and, i f i t i s to be a jo i n t venture, to Ibid . , p. 91 I b i d . , p. 91 evaluate l o c a l partners. I t also involves company executives going abroad to carry out negotiations with foreign suppliers, manufacturers and representatives of the government of the host country. Company executives whilst abroad w i l l also have to make a detailed analysis of the demand and supply of the product the company i s going to produce, the market i t intends to serve, the competition i t w i l l face, the types of incentives, both i n the form of tax reductions and exemptions and i n the form of subsidies and grants offered by the foreign government, and a host of other factors so as to obtain a detailed forecast of revenue and operating costs and make estimates of ca p i t a l costs of the project."*" In t h i s process of investigation, the company's commitment to accept the project increases. The act of investigation creates new additional commitments because; 1. once the company has spent time and money on investigating the project, the executives f i n d i t hard to look at t h i s investment•of scarce resources as a sunk cost.2 2. the fact that a group of people — i n s i d e or outside the investigating o r g a n i z a t i o n — knows that an investigation i s being carried on may cause a f e e l i n g of commitment. This r e s u l t s because once an investigation has begun, a decision to reject the investment proposal may create some psychologically or s o c i a l l y un-desirable effect. The investigator may fee l ~?or a searching analysis on various aspects of on-the-spot-investigation, see Haner, ."Determining F e a s i b i l i t y of Foreign Ventures,"; Haner, "Investment Negotiations i n Developing Countries,"; and Williams, "negotiating Investment i n Emerging Countri es." p Yair Aharoni, op. c i t . , p. 132 t h i s w i l l be interpreted as a f a i l u r e ; he may think t h i s w i l l hamper his re l a t i o n s with these people or his s o c i a l standing among them, or w i l l destroy further deals.^ 3. of negotiations with prospective partners and f i n a n c i a l i n s t i t u t i o n s . Negotiations with them create new additional, commitments because a decision to retreat may be perceived as harmful to .future r e l a t i o n s with a l l these groups. ^  This suggests that once an investigation on a project i s under way, for a decision not to proceed with the project, the facts as they emerge from the investigation and evaluation have to be very much against the project or the conditions inside the company and i n i t s environment have to change very unfavourably towards i t . Company Investment C r i t e r i a and F i n a l Decision. Once a company has completed the on-the-spot-investigation i t has to make a decision as to whether i t i s going to accept or reject the project investigated. In considering whether or not to proceed with a p a r t i c u l a r investment project, companies usually make use of a number of c r i t e r i a as a basis for evaluation, prom Polk et. a l . ' s survey, some of the commonly used c r i t e r i a , which a ceo r ding-to the companies indicate the "return on investment", include: I b i d . , pp. 132-133 I b i d . , p. 1^ 5 1. r a t i o of earnings to sales, 2. r a t i o of earnings to t o t a l c a p i t a l employed, 3. r a t i o of earnings to a subsidiary net worth, 4. r a t i o of earnings to a parent's " t o t a l investment", 5. r a t i o of repatriated funds to a parent's " t o t a l investment", 6. r a t i o of increment i n cash flow to increment i n investment, 7. r a t i o of net cash flow to average funds employed, and many other refinements of these basic r a t i o s . 1 Their survey also reveals that companies whose s t a b i l i z e d annual sales, volume tends to exceed the value of t o t a l assets employed i n the enterprise and who produce and merchandise nondurable consumer goods l i k e food, drugs, photographic and recording supplies, writing instruments and the l i k e , tend to emphasize earnings to sales r a t i o s as c r i t e r i a for determining the a c c e p t a b i l i t y of investment projects; few of these companies use the discounted cash flow method as a measure of "return on investment", These companies also consider other f i n a n c i a l measurements". For example, they consider the length of the payout period and whether the volume of sales i s supported by an adequate investment structure but in general these other f i n a n c i a l measures are not used as the main yardstick i n t h e i r judd Polk, et. a l . , op. c i t . , p. 65 'Ibid. , p. • 67 ; ' 124 e v a l u a t i o n .of d i r e c t f o r e i g n i n v e s t m e n t p r o j e c t s . Companies b e l o n g i n g t o c a p i t a l i n t e n s i v e i n d u s t r i e s and u s i n g m a n u f a c t u r i n g p r o c e s s e s r e q u i r i n g complex p l a n t equipment, on t h e o t h e r hand, use as t h e i r main f i n a n c i a l y a r d s t i c k s p r o j e c t e d r e t u r n s on company i n v e s t m e n t , which i n c l u d e p r o j e c t e d r e t u r n on t o t a l c a p i t a l employed and p r o j e c t e d r e t u r n on t o t a l p a r e n t company i n v e s t m e n t and many o f t h e i r r e f i n e m e n t s . I t i s t h i s group o f companies which commonly employ t h e d i s c o u n t e d cash f l o w method and which r e g a r d t h e l e n g t h o f the payout p e r i o d as a "major" c o n s i d e r a t i o n 1 — t h o u g h t h e r e i s no g e n e r a l agreement as t o what i s r e g a r d e d as an a c c e p t a b l e " r a t e o f r e t u r n " o r what i s r e g a r d e d as a d e s i r a b l e o r • a c c e p t a b l e payout p e r i o d . I n a d d i t i o n t o t h e s e b a s i c c r i t e r i a , t h e companies a l s o r e v i e w t o see whether c e r t a i n a d d i t i o n a l inducements a r e p r e s e n t . These may i n c l u d e t h e o p p o r t u n i t y f o r t h e company t o s e l l raw or s e m i - f a b r i c a t e d m a t e r i a l s t o t h e new s u b s i d i a r y and t h e o p p o r t u n i t y t o n e g o t i a t e s i g n i f i c a n t r o y a l t i e s o r t e c h n i c a l f e e s , and, i f i t i s t o be a j o i n t v e n t u r e , t h e l o c a l p a r t n e r ' s f i n a n c i a l s t a n d i n g , m a r k e t i n g e x p e r i e n c e , e a r n i n g s r e c o r d and so on may a l s o be e x p l o r e d . The company may a l s o e x p l o r e t h e p o s s i b i l i t y o f o b t a i n i n g funds l o c a l l y t o f i n a n c e t h e p r o j e c t . Generally, once the negotiations have been concluded, the project evaluated and found feasible'and informal approval have been secured from s t r a t e g i c a l l y placed personnel i n the finance department and at operating l e v e l s , the project i s i presented to top management for f i n a l approval."" Sometimes, i n the report presented to either the Board of Directors or the top management of the company or 2 the top management of the international d i v i s i o n more than one investment alternative i s included i n the write-ups and the decision makers are expected to select the "best" a l t e r -native out of the alternatives presented. According to Zwick, the evidence he gathers suggests that these other alternatives are not seriously contemplated and they are included merely to serve as f o i l s to highlight the proposed scheme's desirable c h a r a c t e r i s t i c s ^ — i m p l y i n g that i n essence only one invest-ment alternative i s considered and evaluated at a time, that companies do not make cross country comparisons of investment projects, and, that when they consider, investigate and evaluate direct foreign investment projects, they have i n p r i n c i p l e agreed right from the beginning to undertake the projects. "*"Jack Zwick, op. ci_t. , p. 9 2 p These are the groups which make the f i n a l decision. See Robinson, Internatiqnal Business P o l i c y , p. 2 1 6 5Jack Zwick, op. c i t . , p. 9 2 Neo-classical investment theory and most hypotheses of. DPFIs i m p l i c i t l y assume that companies- are continuously •scanning foreign environments for investment opportunities. They/ also i m p l i c i t l y assume that when companies make invest-ment decisions they appraise potential investment projects located i n one foreign country alongside other foreign and domestic projects and decide in favour of the one that looks most promising. Empirical studies made by some scholars reveal that companies i n fact do not normally look beyond t h e i r national boundaries f o r Investment opportunities. 1 This leads one to wonder as to how foreign investment projects usually originate within companies and as to how these projects are generally considered and analyzed. Since the behavioural theory of the firm may provide some- insights into the process, some aspects of i t are reviewe In b r i e f , the behavioural theory of the firm postulate that company goals are stated i n s a t i s l i c i n g terms, that search behaviour within companies i s generally induced only when performance f a l l s short of the l e v e l of aspiration or See Chapter Four of t h i s study. when the companies face some serious problems for which no satisfactory solution readily presents i t s e l f , and that when companies' examine al t e r n a t i v e solutions to solve t h e i r pro-blems, they examine these alternatives sequentially and accept the f i r s t s a t isfactory solution. Empirical studies confirm that at least with respect to direct foreign investment decisions, companies behave lar g e l y i n the manner indicated by the behavioural theory for these studies reveal that: 1. companies generally only consider undertaking-direct investments abroad when they are threatened with the l o s s either of their home or foreign market or with a reduction i n t h e i r r e l a t i v e standing i n t h e i r home market, or when they are persuaded by some high ranking o f f i c i a l or di s t r i b u t o r or i n d u s t r i a l i s t s or government agencies to do so. 2. companies consider foreign investment alternatives or propositions one at a time and do not weigh one proposition against another. (This suggests that ' the companies adopt f e a s i b i l i t y rather than op-t i m a l i t y t e s t s for investment projects.) 3. when companies consider direct foreign investment projects they agree i n p r i n c i p l e , even before the investigation, to accept the projects investigated 4. a company's commitment to accept a project increas with the mere act of investigation. 5. different companies use different c r i t e r i a for measuring the acc e p t a b i l i t y of investment projects 6. a company uses a number of c r i t e r i a to determine the acceptability of a project. C O N C L U S I O N Re cap i t u l a t i on Neo-classical investment theory and most al t e r n a t i v e hypotheses of DPEIs either i m p l i c i t l y assume that investment alternatives are given to firms or that firms systematically scan the globe for p r o f i t a b l e investment projects. They also assume that: ( l ) there are no governmental r e s t r i c t i o n s to firms undertaking direct investments abroad, (2) firms possess f i n a n c i a l and suitable managerial and technical resources to .undertake direct foreign .investments, (3) .firms are generally prepared to invest t h e i r time, money and other resources i n the investigation of foreign investment projects, (4) firms carefully appraise foreign investment projects i n terms of costs, benefits, r i s k s or some other c r i t e r i a , and that ' (6) firms undertake those projects which appear most promising to them i n terms of these c r i t e r i a . The theory and the hypotheses seem to suggest that i t i s possible to provide considerable stimulation to the flow of DPFIs by merely a f f e c t i n g firms' expectations of returns and r i s k s of such investments. They suggest that what countries have to do to encourage the flow of DPFIs i s to offe r firms incentives such as "tax holidays", accelerated depreciation allowances, loans with low or no interest rates and protection against competition, n a t i o n a l i z a t i o n , war and insurrection and other p o l i t i c a l r i s k s . Some empirical studies of the investment decisions of firms suggest that: (1) some "hidden resistances" and " b u i l t - i n - i n e r t i a s " including the cost of information and investigation m i l i t a t e against firms normally looking abroad for investment opportunities, (2) firms generally consider investment opportunities abroad only when they are "pressured" (or "threatened") or when they are "persuaded" (or "instigated") to do so, (3) when firms consider direct foreign investment projects, they agree i n p r i n c i p l e even before the investigation to accept the projects, (4) when firms consider investment alternatives abroad, they consider these alternatives one at a time and do not weigh one against another, and that (5) firms apply f e a s i b i l i t y rather than optimality tests to foreign investment projects. These observations suggest that any theory of DPFIs has to recognize that direct foreign Investment alternatives are not given to firms and that there i s a need to incorporate the " i n i t i a t i n g forces" into the theory;. They also suggest that i t i s probably not possible for countries to accelerate the flow of DPFIs s i g n i f i c a n t l y without f i r s t devising some policy measures which w i l l get firms to consider investment opportunities abroad for unless firms are f i r s t i n i t i a t e d to consider.investment projects across t h e i r national boundaries they are not l i k e l y to investigate, evaluate and undertake such projects. P o l i c y Implications. Since firms do not normally look abroad for invest-ment opportunities because of some "hidden resistances" and " b u i l t - i n - i n e r t i a s " and since firms only consider direct foreign investment projects when they are "threatened" or "persuaded" to do so, any DPFTs incentive program to be effective needs to incorporate policy measures which w i l l .help remove some of the -crippling "hidden resistances" and " b u i l t - i n - i n e r t i a s " of firms and which w i l l "pressure" or "ins t i g a t e " them to look abroad for investment opportunities. There are many measures which capital-exporting countries can adopt to achieve these objectives. Some of these measures are: 1. granting t a r i f f preferences (or opening t h e i r markets) to cap i t a l importing countries. 2. organizing educational programs on various aspects of foreign operations to help remove some of the deep seated i n h i b i t i o n s of firms, including some of the "generally held b e l i e f s * and some of t h e i r hobbling attitudes towards direct investments abroad. providing information on the general economic social and p o l i t i c a l c h a r a c t e r i s t i c s of foreign economies and on s p e c i f i c industries. 4. presenting firms with s p e c i f i c direct foreign investment proposals. 5. subsidising firms with the cost of investigation , • of direct foreign investment projects. • There are also many measures which capital-importing countries can take to increase foreign firms' willingness to consider or to i n i t i a t e them to consider projects located within t h e i r (the capital-importing countries') borders. These measures include: 1. pressurising foreign firms to consider them by creating a customs union.1 2. attempting to create a good image of themselves i n the eyes of prospective investors by setting-up investment centres charged with the respon-s i b i l i t y of advertising t h e i r basic a t t r i b u t e s . 3. i d e n t i f y i n g , analysing and suggesting viable projects to foreign investors or t h e i r governments. 4. agreeing to share the cost of investigation of projects located within t h e i r boundaries and as s i s t i n g foreign firms with the actual invest-igation of these projects. 5. introducing prospective foreign investors who are keen on jo i n t ventures to l o c a l i n d u s t r i a l i s t s who have similar i n t e r e s t s . 6. a s s i s t i n g l o c a l i n d u s t r i a l i s t s to seek out prospective foreign partners to form j o i n t ventures. This assumes that before the formation of the union, trade between the member countries and countries outside the union was s i g n i f i c a n t and that the countries forming the union can come to some kind of an agreement as to what industries-are to be located i n .each of the countries. This study asserts that generally firms do not consider investments abroad side by side with domestic investments or investments i n some other foreign countries and that they do not normally consider such investments unless "pressured" or "persuaded" to do so. While these assertions are probably true of firms with no or few direct investments overseas, they may not be true of firms which are. i n t e r n a t i o n a l l y oriented. For such firms, i t may be a deliberate policy to embark on foreign operations or to allocate firm resources into high return pr.o.ject.s. without geographical limitation.. The i n t e r n a t i o n a l l y minded or oriented firms may even have a separate c a p i t a l budget for foreign projects and a research and development department charged with the re s p o n s i b i l i t y of continuously scanning the international environment, analyzing investment opportunities i n foreign countries and presenting them to the top management for •consideration. For these firms, there may be a steady flow of direct foreign investment proposals from the firms' research and development departments and the firms' overseas investments may even exceed t h e i r domestic. For such firms, incentives such as reduction or exemption of corporate taxes i n one form or another may be effective as inducements for them to consider and undertake direct investments abroad. The Way Ahead. This study, having surveyed the results of past investigations, into the foreign investment decisions of firms, asserts that at the present state of international business most firms probably do not normally scan the international environment for investment opportunities; DPFIs are often the result of investment opportunities "forced upon" or '"presented" "to the investors. However, i t admits that probably changes are taking place i n the attitudes of executives and top management and i n the p o l i c i e s of firms. And a l l seem to point to greater awareness and b e l i e f that p r o f i t a b l e investment opportunities abound abroad, a willingness to search for these opportunities and a desire to undertake such investments. Many firms are probably slowly changing to make international operations an integral part of th e i r business instead of a haphazard appendage of the domestic operation. There are many forces that seem to be bringing t h i s about. F i r s t , swifter communication and more rapid trans-portation are making i t easier for firms to manage and control t h e i r foreign subsidiaries and branches. This i n -creases t h e i r willingness to undertake overseas operations and encourages them to search for investment opportunities abroad. • Second, as firms become more sophisticated and adopt modern accounting and budgeting practices and managerial p r i n c i p l e s which recognize no national boundaries i n the search for investment opportunities"*" firms are l i k e l y to be-pushed i r r e s t i b i l y i n the direction of l o c a t i n g t h e i r investments i n areas which promise them lower r i s k s and higher rate of return. Another group of factors which seem to contribute toward the i n t e r n a t i o n a l i z a t i o n of firms run from the greater a v a i l a b i l i t y of information, the encouragement and persuasion of governments and the ease with which complex budgetary calculations can be made with the help of the computer. F i n a l l y , the fact that the managers of banks, mutual Earley 1 s ^ t u d i e s of accounting and budgeting practices show increasing adoption of managerial techniques u t i l i z i n g managerial p r i n c i p l e s . See James S. Earley, "Business Budgeting and the Theory of the Firm," i n Journal, of I n d u s t r i a l Economics, November i 9 6 0 , pp. 23-4 2 ; and James "S. E&riey, "Marginal P o l i c i e s of Excellently Managed Companies," i n American Economic Review, Vol. 30,VI, 1 9 5 6 , pp. 44-70. funds, insurance companies and other f i n a n c i a l i n s t i t u t i o n s , rather than those managing the actual corporate property, may prove, to be the group which predominate i n shaping the objectives of giant corporations 1 may mean that giant firms w i l l become more p r o f i t conscious and search for investment opportunities across t h e i r national boundaries. When firms become interna t i o n a l i z e d , capable of spreading risks.and of maneuvering themselves among the s h i f t i n g patterns of t a r i f f s , taxes and exchange controls, they w i l l be continuously scanning the international environ-ment for investment opportunities. At such a time foreign investment incentive programs based solely on- p r o f i t i n -centives w i l l be effective to induce firms to undertake direct foreign investments. The question i s "When?" 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"International Investment and International Trade i n the Product Cycle," Quarterly Journal of Economics, Vol. LXXX, May 1966, pp. 190-207. Vogel, Peter P., "Round 2 i n International Business," Business .Hori zons, Vol. XI, No. 4, August 1968, pp. 57-62. Walter, James E., The Investment process. Boston: Harvard University, Graduate School of Business Administration, Division of Research, 1962. Weber, C. Edwards, and Gerald Peters (ed.), Management Action; Models of A dm i n i s t r a t i v e Deci s i o n s. ScranTon, Pennsylvania; Internatlonal Texfbook" Co, , 19~69. Wells, Jr.,. Louis T. , "A Product L i f e Cycle for International Trade?" Journal of Marketing, Vol. 32, July 1968, pp. 1-6. Whitman, Marina von Neumann, The United States Investment-Guaranty Program. Princeton; Princeton University press, 1959. Williams, B. R., "Information and C r i t e r i a i n Capital Expenditure Decisions," The Journal of Management Studies, Vol. 1, September 1964, pp."TT6-1277 Williams, Bruce R. , and V/. P. Scott, Investment proposals and Decisions. London: G-eorge Al l e n and Unwin Ltd. , 1965. Williams, Simon, "Negotiating Investment i n Emerging-Count r i e s , " Harvard Business Review, Vol. 43, No. 1, January-Eebruary 1965,' 'pp. 89-99-Wolfe J r . , Charles, and Sidney C. .Sufrin, Capital Formation and Eoreign Investment i n ITnderdevelop ed Areas. Sj r a cu s e, New York: Syracuse University press, 195*8. Zenoff, David B., and Jack Zwick, International Financial  Management. Englewood C l i f f s , New Jersey: prentice-Hall Inc. , 19o9. .Zwick, Jack, "Is Top Management Really on Top?" Columbia  Journal of World_Business, Vol. 1, No. 1, Winter 19D6, pp. 87-9"67 "~ APPENDIX THE CLASSICAL THEORY OE FOREIGN - INVESTMENTS. In theorizing on the causes of the flow of private foreign investments, the c l a s s i c a l economists did not make any d i s t i n c t i o n between direct and p o r t f o l i o investments or between direct investments and other forms of international c a p i t a l flows. Rather, they considered direct private foreign investments e s s e n t i a l l y as a form of ca p i t a l move-ment along with the issuance of bonds, purchases and sales of outstanding s e c u r i t i e s and trade i n short term credit i n s t r u m e n t a n d looked upon the explanation for the flow, of such investments as es s e n t i a l l y the same as for the tran national movement or export of c a p i t a l . According to them, cap i t a l moves across national boundaries (or DPFIs flow from one country to another) because of international p r o f i t rate d i f f e r e n t i a l s . They maintained that owners of c a p i t a l t r y to obtain the largest possible material advantage for themselves, t h e i r family and, i n a l e s s degree t h e i r friends and acquaintances from Charles p. Kindleberger, American Business Abroad, (New Haven and London: Yale University Press, 196~97, pp. 1-the employment of t h e i r c a p i t a l 1 and they (the owners of capital) w i l l export t h e i r capital abroad only i f the rate of return on t h e i r c a p i t a l i s higher 'abroad than at home. According to the c l a s s i c a l economists, therefore, c a p i t a l exports (including DPFIs) are undertaken because the rate 2 of p r o f i t i s higher abroad than at home. Many of the c l a s s i c a l economists who believed i n the above explanation for c a p i t a l exports (and for DPFIs) also thought that the rate of return on capi t a l i s a function of the ca p i t a l stock of the country and that as cap i t a l accumulates within a country there i s a tendency 3 for the p r o f i t rate to f a l l so that according to them, there i s an automatic mechanism dire c t i n g the flow of ca p i t a l (and of DPFIs) from countries where ca p i t a l i s abundant to countries where i t i s scarce. Some of them, notably B e r t i i o h l i n , saw interest rate as the rate of return on investment or the p r o f i t rate C. K. Hob son, The Export of Capital, (New York; Macmillan Co., 1914), p.. 24 2 The rate of p r o f i t referred to here i s the "general l e v e l of p r o f i t . " 3 However, they were not i n agreement as to how the accumulation of capi t a l lowers the rate of p r o f i t . Adam Smith, for example, put i t down to the excessive competition of capit a l within the country; I. P. Maithus to the p r i n c i p l e of diminishing returns from investments i n lands or industry; Sismondi to overproduction by c a p i t a l i s t s and to the reduced capacity of workers to buy i n d u s t r i a l products as mechani zat ion proceeds; and Karl Marx to the declining proportion of "variable and attributed c a p i t a l exports and direct investments over-seas primarily to international interest rate d i f f e r e n t i a l s . They claimed that "the immediate cause which c a l l s f o r t h an international c a p i t a l movement i s usually a difference between the interest rates of two countries, which i s large enough to outweigh the costs of transfer occasioned by the obstacles to such c a p i t a l flows.""1' But because they l i n k e d interest rate to the country's supply of cap i t a l r e l a t i v e to other factors of production (though with some qu a l i f i c a t i o n s ) they too seem to suggest that there i s an automatic flow of capi t a l (and of DPFIs) from economies which are well supplied with to those short of c a p i t a l . c a p i t a l " (the fund set aside by the c a p i t a l i s t s to pay wages) to "constant c a p i t a l " (the fund invested by the c a p i t a l i s t s i n machines and raw materials). Carl Iversen, A sp_ects of the Theory of Intemational Capital Movements, (New York: Augustus M.~Kellev, Publisliers, 19577T P. 94 COMPILATION AND DISSEMINATION OP GENERAL INFORMATION REQUIRED BY INVESTORS.1 To execute a f e a s i b i l i t y study of an investment opportunity, a potential investor needs two types of i n f o r -mation; 1. general information of the economy, including general economic data revealing the basic strengths and weaknesses of the economy, current regulations and incentives, and 2. s p e c i f i c economic and technical data r e l a t i n g to the investment proposal. The f i r s t type of Information i s best compiled and disseminated by government agencies of investing countries (or j o i n t l y by government agencies of host and investing countries) while the second by those of host countries when they write up project proposals for submission to potential investors. This i s because the f i r s t type of information i s subject to a great deal of interpre t a t i v e analysis, and, i f provided by government agencies of host countries, may be considered by potential investors as suspect and unreliable. The kind of general information which government This discussion i s based largely/ on John J. Beauvois a r t i c l e , "International Intelligence for the International Enternrise," published i n C a l i f o r n i a Management Review, Vol. No. Ai (Winter 1961), pp. 39-46 agencies of investing countries may u s e f u l l y provide to potential investors so as to give them some idea of the "basic strengths and weaknesses of a foreign country ' s economy include among others: 1. the size, structure and growth rate of the population-, 2. the size and d i s t r i b u t i o n of the gross national product, 3. the s e n s i t i v i t y of the economy to depressions and i n f l a t i o n s , 4. a projection of growth and a description of factors that may accelerate or dampen the country's economic progress, 5. the economic and s o c i a l dynamism of the people, and 6. the size of the country'.s national debt, i t s trade balance and s t a b i l i t y of i t s currency. Beside the general information pertaining to the general strengths and weaknesses of the country's economy, the government agencies may f i n d i t p r o f i t a b l e to provide investors with an i n t e r p r e t a t i v e analysis of the l o c a l foreign bu sin ess fram ewo rk, i n eluding: 1. the degree of state ownership of, or p a r t i c i p a t i o n i n the economy, 2. the nature of i n d u s t r i a l concentration and climate of competition, 3. banking f a c i l i t i e s available and nature of credit offered, 4. water, power and transport and u t i l i t y f a c i l i t i e s available and standards of service, 5. a v a i l a b i l i t y and cost of personnel and labour, both s k i l l e d and u n s k i l l e d , and 6. price l e v e l and price f i x i n g mechanisms. In addition, the general information disseminated should include an analysis of the investment climate, together with an interpretation of the current l e g i s l a t i o n , covering such things as: 1. incentives to attract foreign investors, 2. t a r i f f s , import or export quotas, 5. l o c a l ownership requirements, 4. patents, copyright, and trademark, 5. l o c a l content of manufacture, and 6. exchange control and t r a n s f e r a b i l i t y of p r o f i t s , r o y a l t i e s an d di v i den ds. As p o l i t i c a l and s o c i a l factors are as equally :" important as economic variables i n investment decisions, the information disseminated should also include an i n t e r p r e t i v e analysis of t he country's: 1. present p o l i t i c a l system, 2. p o l i t i c a l parties, t h e i r r e l a t i v e strength i n terms of votes and representation both at the national and the l o c a l l e v e l s , and t h e i r attitudes toward foreign investors, 5. l o c a l unions, t h e i r strength and influence i n the l i f e of the country, and 4. social customs. In addition, the general information disseminated should also outline the present government's general p o l i c i e s and t h e i r significance for business, natters dealt with under 1. the l o c a l government's s t a b i l i t y , past record and outlook for the future, 2. attitude toward free trade, 3. trade agreements with other countries, and 4. p o l i t i c a l and economic a f f i l i a t e s . F i n a l l y , the general information should also include an analysis of the administrative structure of the country dealing s p e c i f i c a l l y with such things as: 1. agencies that a s s i s t investors to analyze invest-ment proposals, purchase land, arrange j o i n t ventures and so on, and 2. l o c a l standards of administration, for instance, the spread of corruption and the speed .with which decisions on investment and l i c e n s i n g are made. 

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