Hedging your bets

Dec 10, 2004

Kettering professor examines determinants associated with the enormous growth in recent years of foreign direct investments (FDI).

For some people, the investment game is a terribly convoluted activity. Unless you follow the markets closely, the phrases Dow Jones and NASDAQ Composite may seem as unfamiliar to you as the Greek word for money (drachma).

A basic fundamental about investing is that it is risky. Financial analysts can't guarantee which fund will provide good returns. About the only firm assessment an analyst can make to a potential investor is that a fund has yielded increased returns over a period of time, but that's no guarantee the fund will continue providing such dividends. This, combined with the recent corporate embezzlement scandals of such companies as Enron and Tyco, cause a great deal of confusion and worry among investors.

One potentially interesting and perhaps opportunistic funding strategy may exist with direct foreign investment (FDI). However, most people are unfamiliar with this strategy. FDI, according to the 2002 United Nations Conference on Trade and Development (UNCTAD), refers to investments made to acquire lasting interest in companies and organizations that operate outside the economy of the investor. The investor's purpose is to gain an effective voice in the management of the enterprise. This does not suggest, however, that the investor has absolute control or seeks that control. According to Dr. Petros Ioannatos, an associate professor of Economics in Kettering University's Liberal Studies Dept. who studies FDI, the high growth of foreign direct investment has created three main currents of thought to explain this phenomenon and help investors determine whether or not FDI is a strategy they might wish to employ when considering their portfolio.

"The first thought, referred to as the market imperfections hypotheses, suggests that FDI is a direct result of an imperfect global market environment," Ioannatos said. "According to the second thought, called the internalization theory, FDI takes place as multinationals replace external markets with more efficient internal markets. The third, called the eclectic approach to international production, postulates that FDI emerges because of ownership, internalization and location advantages," he added.

But what does this mean to the general public?

"Foreign Direct Investment is a vehicle for U. S. owned business firms to acquire an interest in a business firm located outside the United States," Ioannatos said. "FDI is especially profitable in situations where the business environment in a foreign country is less competitive in the markets for products and resources in comparison with the respective domestic business situation. In this case, U. S. business firms can benefit from establishing a physical presence, in terms of FDI, in a given foreign market. In many cases, the enormous size of the foreign market, for example China, makes physical presence absolutely mandatory."

Perhaps one way to understand this idea is to take a broad view. A nation like the U.S., for example, may wish to invest in opportunities available in another country. But before the U.S. invests, analysts may wish to closely examine the social, political and economic climates of that country to determine whether or not foreign direct investment is worth the risk.

FDI serves as one focus of Ioannatos' research efforts over the past several years. Earlier in 2004, he presented a paper titled "The Demand Determinants of Foreign Direct Investment: Evidence From Non-nested Hypotheses" at the 2004 Midwest Economics Association Conference in Chicago. His work in this area is perhaps of significant importance to his teaching at Kettering based on the number of graduates who go into leadership position at companies throughout the world. Many of these grads are currently CEOs, presidents and vice presidents at their respective organizations. Thus, some of these individuals may have some input into foreign direct investment opportunities for their organizations, a situation that connects directly to Ioannatos' research.

"I enjoy sharing my research ideas as well as my research findings with students in my classes," he explained. "This helps students to better understand how Economics can help to answer the complex challenges of the ever changing business climate. In particular, the understanding of the causes and determinants of foreign direct investment helps students to comprehend the behavior of the contemporary business firm in the global international environment and, therefore, prepares them to become effective leaders at their respective organizations."

Currently, he teaches Econ 201: Economics Principles; Econ 342: Intermediate Microeconomics (Managerial Economics); Econ 344: Intermediate Macroeconomics (Economic Growth and Fluctuation); Econ 350: Comparative Economic Systems; and a graduate class titled Econ 513: Micro and Macroeconomics.

Written by Gary J. Erwin
(810) 762-9538
gerwin@kettering.edu