Foreign Direct Investment (FDI) in Australia

Foreign Direct Investment (FDI) in Australia

At present, Australia is one of the world’s largest recipients of foreign direct investments (FDI), and the country benefits greatly from the expansion of multinational giants into its economy. “Australia has long been seen as a young country with vast natural resources which have been developed with the aid of foreign capital… more quickly than would otherwise have been the case.” (Groenewold 2000: 45). According to Zelade (1996), Sydney is ranked 7th among top cities for US multinationals. In 2002, “global foreign direct investment inflows to Australia more than tripled” (Australia: The Right Mix for Investors? 2003: 16).

Why is Australia currently considered a very attractive country for foreign investors? As Groenewold (2000) marks, very little research has been conducted regarding the determinants of FDI into Australia, despite its importance. The most important FDI theories which can be applied in such a case include FDI internalization theory, Knickerbocker’s oligopolistic reaction theory, Dunning’s eclectic paradigm, and Vernon’s theory of international product life-cycle.

According to FDI internalization theory, which is an extension of transaction costs theory, MNCs expand their operations in foreign countries through subsidiaries because this form is the most efficient for them. The central idea of the theory is that MNCs which possess some unique characteristics (such as know-how) can benefit in foreign markets from their competitive advantages. The companies are able to increase their profitability by operating overseas due to the imperfection of the markets. The internalization theory also focuses attention on the determination of the form of the subsidiary which would be the most appropriate for MNCs- full ownership of the subsidiary or participation in the joint-venture.

Internalization theory approach is not applicable in Australia for the most part due to a relatively small number of competitive and cost advantages which the country offers to MNCs. Yip (2000) states that FDI drivers into Australia include market globalization drivers, cost globalization drivers, government globalization drivers, and competitive drivers. Among those drivers, competitive ones are the most insignificant in this country. “Australia’s competitive globalization drivers are probably the weakest of the four. The country is strategic in very few industries, and most of these being agricultural or extractive rather than manufacturing or services.” (Yip 2000: 306). At the same time, it is necessary to mention that Australia does have a few industries which offer certain competitive advantages to MNC’s, such as oil exploration. Shell Australia, Esso Australia Resources (U.S.), Mobil Oil, British Petroleum (U.K.) are among 20 top foreign investors into Australia. “The largest foreign-funded companies operate primarily in extraction, including oil resources and mining” (Yip 2000: 299).

Cost advantages in Australia are relatively weak, and thus cannot be considered important determinants of MNCs’ investments into Australia. “Australia’s biggest cost disadvantage lies in its relatively high labor costs $13,54 hourly labor costs in manufacturing in 1998, compared with $2.59 in Malaysia, and $0.09 in Indonesia.” (Yip 2000: 301). Another cost disadvantage Australia has is the unfavorable location of its major business cities. “Australia is primarily an unfavorable location at the southern end of the Asia-Pacific region, and its major cities, other than Darwin (with a very minor population and business significance), are not on the northern coastline, but the eastern and southern tips of the coast.” (Yip 2000: 302).

Besides internalization theory, FDI’s determinants have been explained by Knickerbocker in his oligopolistic reaction theory has pointed at the fact that MNCs often seek expansion in order to fight oligopolistic competition which exists in their domestic markets. According to the specialist’s view, this practice is mostly used by companies which are pioneers in the industry and produce revolutionary products because they are able to acquire a large part of the market in foreign countries very soon after entering it. Knickerbocker also states that by expanding overseas, MNCs seek to win a share of the market from their present competitors. The author argues that “the risk-avoiding members of an oligopolistically structured industry will follow one another into any substantial foreign market in which one of them has set up production.” (Barclay 2000: 23).

Knickerbocker’s oligopolistic reaction theory can be widely applied to determine FDI inflow in Australia. Australia is a very attractive country for MNCs seeking to win a share from their oligopolistic competitors for many reasons. First, its consumer market is very large and has a large purchasing power due to the high living standards in the country. Second, Australia has consumers with Western mentality but it is located in Asia. Therefore, it can serve as a very favorable market to enter for MNCs seeking to expand to Asia. The largest investors into Australia currently include United States, UK, and Japan. Most of the FDIs are received by largest cities in Australia, such as Sydney and Melbourne. By locating their subsidiaries in these locations, foreign companies seek to target large numbers of consumers with a high level of income. For example, Sydney-based Motorola Australia is a very profitable subsidiary due to an extensive market of consumers using cell phones. However, the company has built a software center in Adelaide.

There are many other MNC’s which became more competitive in the global market by launching subsidiaries in Australia. Multinational car manufacturers are one of the largest investors and include Mitsubishi, Toyota, and Ford. For instance, Japanese Toyota which was ranked 9th among largest foreign investors into Australia in 1995 and is based in Melbourne, plans to increase its investments into this country in future. Toyota’s management has mentioned that Australia is a very attractive market for it because global strategies applied by the company usually work in Australia and do not need to be altered like in some countries with a more complex market. Therefore, Australia offers great opportunities for oligopolistic competition.

Opposite to Knickerbocker’s theory, Dunning (2003) considers ownership-specific advantages crucial in MNC’s expansion decisions. Those companies which have an efficient ownership structure in comparison with their competitors will seek to internalize their activities but never externalize. According to Dunning’s eclectic paradigm, “internalization advantages include the desire to avoid search and negotiation costs, to protect the reputation of the firm and to engage in practices such as transfer pricing and cross-subsidization” (Barclay 2000: 26). An important issue marked in the eclectic paradigm is that MNC’s gain “transaction cost advantages” by operating overseas (Dunning 2003). The choice of favorable location for subsidiaries is very crucial for MNCs in this regard and those companies which make correct choices usually obtain important advantages.

Dunning’s theory of FDI’s is applicable in Australia because it represents a very favorable location for MNCs seeking to protect the image of their firms and increase the quality of their resources. “Australia can play a significant technological role for MNCs because of its high educational levels and the presence of many domestic companies that have developed strong technological capabilities, particularly in sectors related to Australia’s natural resources-agriculture, mining, and minerals.” (Yip 2000: 294).

Vernon’s theory of international product life-cycle is a combination of macroeconomic concept of product cycle and trade theory. The author argues that when the company first starts producing the product, it is highly differentiated and the demand for it is very high in the domestic market. On other stages of the life of the product, as the demand increases, the company starts opening subsidiaries in at first highly-developed countries. When the demand for the product is for the most part satisfied and the product enters the stage of decline, the company starts offering it in low-developed countries in order to keep the sales at the same high level. At this stage, subsidiaries in low-developed countries “replace exports from the home country or even export back to it” (Barklay 2000: 29). Vernon also agrees with Knickerbocker’s theory of MNCs expansion guided by actions of rivals. Despite positive features of this theory, as Dunning (2003: 110) states, Vernon’s theory has many limitations. Vernon “was concerned with the changing location of value-adding activity of a firm as its products moved through the various phases of their life cycles”, but he completely neglected the issues of coordination between the MNC’s headquarters and subsidiaries launched in other countries. Besides, at present differences between higher and lower developed countries become not as distinct, and MNCs cannot always benefit from shifting their production to lower developed countries as they did in the past.

Vernon’s theory can applicable for Australia in certain ways. As Australia belongs to highly-developed countries, it is being used by multinationals as a new market for their products on the second stage of their products’ life-cycle. For example, such companies as Toyota, Ford and others are looking for new customers for their production because the demand in their home countries is not able to satisfy the supply which they can offer. They are looking for expansion worldwide to those countries which have consumers with a high purchasing power and demand for luxury products, such as cars. Australia is a perfect market for those companies which cannot realize their potential to the fullest in the domestic market.

Bibliography.

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