Foreign Direct Investment Free Essays

Foreign direct investment (FDI) is probably the single most important factor contributing to the globalization of the international economy. FDI are increasingly strong economic links between developing and industrialized countries, and also among developing countries. Foreign direct investment in developing countries (LDCs) have increased nearly four-fold in the 1990s and now account for almost 40 per cent, reaching some $120 billion in 1997. We will write a custom essay sample on Foreign Direct Investment or any similar topic only for you Order Now Foreign direct investment is now by far the largest source of all capital flows to the less developed world. The objective of the FDI is to encourage the flow of investments for productive purposes among member†s countries, and in particular to developing countries. To serve this objective, the WTO must provide some type of guarantees (or insurance) covering foreign direct investment for all parties† host countries, home countries and Multinational corporations† against all the obstacles like Different needs, political risks, abuse of labor, Transfer Restriction, Breach of Contract, corruption, and Tax breaks. WTO must carry out advisory and technical assistance for these parties so that their interests are protected, and must emphasis on multilateral investment agreement (MIA. ) No unilateral action or bilateral The host countries or the developing countries are interested in: (I) development of their services, communities and infrastructure that may help their industrialization and development, (III) production of exportable goods and (III) continuous technological development in their industrial production and services Once MNC has been attracted to a particular destination country, they expect a high level of facilitation services. Governments all too often give inadequate attention to servicing investors† needs, even though large sums of money may have been spent on promotion activities and success has been achieved against fierce international competition. In retune, Investors from industrialized countries want to come to developing countries for two main reasons. First, they apprehend that the return on capital in their home country is not adequate; second, they want to combine their capital with the cheap labor of the host country to reduce the cost of production. So the WTO should regulate the minimum wage for the worker in the host county. If the FDI is only for capturing the domestic market, it may still generate profit for the investor, but such profit may leave the country in foreign exchange. Where there are two serious implications. First, in profitable domestic consumption sectors, foreign investments may overwhelm domestic investors (which may generally not be as strong as the foreign counterparts) and in some cases may eliminate them. Second, some critical sectors, like land, minerals and forests, where countries often like to have effective control on ownership because of social, political and strategic reasons, may, in a big way, pass under the control of foreign nationals. Investors have freedom without any responsibility, except in respect of their own profits. The implementation of the obligations of home countries are ought to be ensured by locating the MIA in the WTO, so that for any perceived infringement, action can be taken against exports of the country. Tax breaks for multinational corporations Multinational corporations, whether American- or foreign-owned, are supposed to pay taxes on the profits they earn in their home country. For example, American companies and individuals aren’t supposed to gain tax advantages from moving their operations or investments to low-tax offshore â€Å"tax havens. † But the tax laws often fail miserably to achieve this goal. Moreover, IRS data show that foreign-owned corporations doing business in the United States typically pay far less in U. S. income taxes than do solely American firms with similar sales and assets. The same loopholes that foreign companies use are also utilized by U. S. -owned multinationals, and even provide motivation for American companies to move plants and jobs overseas. As a result, the WTO must fix these problems in the current system. The WTO must oblige all multinational corporations to provide income report in the overseas operation. Also, the Home County has the right to inspect every movement of goods and services between a multinational company’s domestic and foreign operations, and then attempt to assure that a fair, â€Å"transfer price† was assigned to each real or notional transaction. Host countries insist that foreign firms must meet high domestic-content requirements, take on local partners, or engage in technology-sharing agreements, by contrast, suffer lags in technology acquisition, absence of best management techniques, weak penetration of foreign markets, and flimsy development of a supplier base. Yet developing countries and economies in transition can†t find ways to protect and reward foreign investors who promise to meet domestic content, joint venture, or technology-sharing requirements. Political actions, changes in governments, events or instability may result in unfavorable changes in the value of a foreign security. A new treaty, the repeal or modification of an existing treaty or a change in formal diplomatic relations between the home and the host countries could affect the value or liquidity of investments in that country. Corruption in the developing countries The definition of corruption is misuse of power for private benefit or advantage. Corruption is to all appearances widespread in developing countries and has very serious repercussions on their peoples’ quality of life – above all that of the poor and disadvantaged. This power may, but need not, reside in the public domain. Besides money , the benefit can take the form of protection, special treatment, commendation, or promotion; generally speaking corruption encompasses four main distinguishing features: Undesirable effects on third parties (home county). Also the effects of corruption in developing countries ends up as obvious ignore of community interest. The WTO should monitor the MNC operations in the developing countries so that the real objective is achieved, and to protect the other parties. Breach of Contract † home, host countries and multinational corporations† Different needs of investors and host countries Investors from industrialized countries want to come to developing countries main reason profit. The host developing countries, on the other hand, are interested in development of their services and technological development in their industrial production and services. These two objectives are not incompatible. And the interest of foreign investors and host governments may be harmonized. But it is critical that any FDI agreement meet both objectives. This can be achieved if the investors decide on the capability of specific projects, and the host governments decide on the priority sectors and conditions of FDI, consistent with their economic and development objectives. Wherever the two agree, FDI will flow. But for FDI to have a beneficial effect, it is important to realize that the roles of both sides are significant. An MIA is really not necessary for this purpose. What is needed is that governments have clarity of objectives, and these are spelt out clearly. Sets of transparent and stable criteria adopted and announced by governments can help the foreign investors to assess the viability of investments under those conditions. Naturally, governments wishing to encourage foreign investments will lay down criteria, which will welcome the investors in priority sectors rather than scare them away. If there is sufficient scope for the convergence of the interests of investors and those of the host governments and if it can be brought about by the domestic policies and measures of host governments, why is it then that some industrialized countries are pressing for a multilateral discipline? The main reason is to eliminate or, at least, constrict the powers of host governments regarding the choice of the priority sectors for FDI and obligation of conditions on such investments, so that foreign investors are able to operate unencumbered by such constraints. The main objective of the investors naturally is to earn high profit in a short time and repatriate the profit. And the objective behind bringing the proposed discipline on investments into the folds of the WTO Agreement is to utilize its dispute settlement process to enforce the discipline. The WTO, through its provision of cross-sector retaliation, will enable them to take restrictive measures against the developing countries, which may be perceived as violating the discipline. Foreign investment is often welcome to countries, as it increase the country’s capital and investment stocks. But the main implication of FDI is that the returns on such investments – in the form of dividends and profits, as well as many fees including license fees, management expenses and so on – are sent out of the country in foreign exchange. Hence, if the investments do not help the country, either directly or indirectly, to earn foreign exchange, the negative effects of the outflow may be serious. A change in the exchange rate between the two countries currency may reduce the value of an investment in a security valued in the foreign currency, or based on that currency value. How to cite Foreign Direct Investment, Essay examples Foreign Direct Investment Free Essays Introduction Foreign direct investment (FDI) occurs when a foreign investor exerts direct control over domestic assets. It normally consists of an international capital flow from the home country to a host country for the purpose of acquiring partial or full ownership of tangible business activity. Technically, it is the book value of the equity held by the foreign investor that is attached to the asset. We will write a custom essay sample on Foreign Direct Investment or any similar topic only for you Order Now In most cases, the asset is a firm in a developed country, such as the United States, and the equity consists of two components: ordinary (common stock) and retained earnings. If both foreign and domestic investors own the common stock, then only a portion held by foreign investors is considered to be FDI, and if only a threshold percentage is attained, that is deemed to give the foreign investor control of the business. In the United States, this threshold is 10%, but some countries establish a higher minimum level of stock ownership, usually 25% (Aliber 2003, pp. 91). Foreign investment can take place in two ways: Foreign investors can establish new firms overseas, which they control, or foreign investors can acquire controlling interests in the previously established domestic firms, or spin-offs of such firms. FDI as a vehicle of transnationalization is a major contributor of economic development. Transnational corporations (TNCs) act as significant transmitters of economic, social, cultural, and political change into different countries, sectors, and motivations. TNCs take advantage of geographical differences in the distribution of factors of production (natural resources, capital, labor, etc.) and local policies (taxes, trade incentives, subsidies, etc.). Other than FDI, TNCs engage in various kinds of collaborative ventures by which they coordinate and control transactions within geographically dispersed production networks (Borensztein et al. 2008, pp. 115). Resulting from these ventures, the global economy is envisaged as linking together t wo sets of networks: (1) Organizational (in the form of production circuits and networks) and (2) Geographical (which include localized clusters of economic activity). Political Perspectives Since FDI requires the flow of capital across national borders, it has always been intertwined with politics. Viewed in this way, three different political perspectives to FDI can be identified: radical view, free market view, and pragmatic nationalism. The radical view, which can be traced back to Marxism, treats FDI as a vehicle for exploitation of domestic resources, industries and people. Those governments who hold a radical view are hostile to FDI and therefore are in favor of nationalizing foreign firm assets or putting into place mechanisms to discourage inbound foreign firms’ operations (Braconier et al. 2005, pp 313). The free market view, on the other hand, is more in favor of FDI and promotes its rationale not least because it enables countries to tap into their absolute or comparative advantages by specializing in the production of certain goods and services. According to the free market view, FDI can be regarded as a win-win situation for both home and host countr ies. While prior to and during the 1980s the radical-based view FDI was more common in Africa, Asia, Eastern Europe, and Latin America, the free market-based FDI is now more influential across the world and in particular in emerging economies such as Brazil, India, and China (Braunerhjelm 2005, pp. 119). Finally, the third view, which reflects the current dominant perspective toward FDI and is practiced by most countries around the world, is called pragmatic nationalism. Based on a pragmatic nationalism political view, FDI is only approved when its benefits outweigh its costs. For example, this view holds that FDI in the Chinese auto industry should only take the form of a joint venture (JV). By adopting such restrictive policies, the Chinese government helps the domestic auto industry learn from their foreign counterparts (Buckley and Hashai 2004, pp. 61). Theories of Foreign Direct Investment There are several theories that attempt to account for foreign aid. The prevailing ones include Dunning’s eclectic approach and the product cycle. John Dunning’s eclectic paradigm emphasizes the critical role of geographical location in understanding the complex nature of TNC behavior. The location aspect, as encapsulated in this theory, suggests three primary motivations: (1) foreign-market-seeking FDI, (2) Efficiency (cost reduction)-seeking FDI, and (3) resource-seeking or strategic-asset-seeking FDI. In general, a firm’s motivations to be transnational can be classified into two categories: (1) Market orientation, which pertains to marketing, sales, or production designed to serve a specific geographical market, and (2) Asset orientation, when most of the assets required by a firm to produce and sell specific goods and services have an uneven geographic distribution, especially in the natural resources industry. For a TNC to invest successfully abroad, it must possess advantages that no other firm has, the country it wishes to invest in should offer location advantages, and it must be capable of internalizing operations. Internalization tends to become synonymous with the ability of firms to exercise control over operations essential for the exploitation of ownership and location advantages (Yeung 2007, pp. 1). Raymond Vernon introduced the â€Å"locational† aspect to the product life cycle concept, which in the original form had no spatial connotation. First advanced in the mid 1960s, it emanated from the premise that the United States possessed comparative advantage in product innovation. To maximize production flexibility and minimize uncertainties in the early stages of a product’s life cycle, firms develop innovations for and introduce them to large high-income domestic markets but eventually set up foreign production facilities in other advanced economies to defend their monopolistic advantages resulting from an innovational lead. This also happens because, as products become more standardized, they get more price sensitive and firms turn to low-cost less developed countries (LDCs) to maximize profits. Vernon describes the phases as revolving around product development, product growth, product maturation, and product standardization. Impacts of FDI on Host Country Economies However, not all FDI is always in the best interest of the host country. Some nations have been increasingly viewing TNCs as a threat to economic autonomy. At times, they tend to be responsible for exerting negative influences on the host economy, for example, crowding out domestic firms and suppressing domestic enterprises. Profit maximization is inherently linked with maximization of efficiency and not necessarily with national, economic, and social goals. From the perspective of TNCs, various decisions have to be taken that can affect their effective working in the country—mainly since they operate in different economic, political, social, and cultural environments (Trevino and Upadhyaya 2003, pp. 45). A lot is said as to why firms choose to transnationalize rather than simply export their products. Two of the reasons commonly cited are that (1) Competition is extremely global and volatile and (2) It creates an environment wherein advantages are rapidly created and eroded. Firms increasingly compete not with rivals on a national level but across the globe. Higher sales and profits result from foreign subsidiaries because domestic markets, where the company started, tend to get saturated over time and it is fruitful to conquer foreign markets with more potential consumers than in the home country. The information technology revolution, which began in the United States in the 1980s, was an important source of structural change in the international economic and business environment affecting FDI. There was a sudden upsurge in asset-seeking direct investment in the United States. Foreign companies, chiefly European, were responsible for a gamut of mergers and acquisitions with U.S. companies—primarily with those possessing advanced technology or marketing prowess. The size and growth of the U.S. and Chinese markets have made these countries primary destinations for foreign companies using FDI as a stimulus for profits (Graham Marchick 2006, pp. 277 ). Importance of FDI FDI has been known to provide a longer-term contribution to GDP and income growth, as against bank loans and portfolio investments. The long-term perspective of FDI makes it relatively less volatile. FDI is considered to be an important carrier facilitating the spread of technology and is said to contribute to growth in a much wider way than domestic investment. The contribution of FDI is enhanced due to the interactions with human capital in the host country (Dunning Gugler 2008, pp. 113). Furthermore, FDI is said to expand the level of know-how in the host country through training and skill acquisition. Summarily, the four basic reasons why companies establish subsidiaries in foreign countries are (1) Gaining access to natural resources, (2) Protecting or expanding sales in lucrative markets, (3) Seeking low-cost production, and (4) Acquiring strategic assets. The United Nations, the European Union, and Japan have been the main sources and recipients of FDI for the past several decades. From 1998 to 2000, these three units together accounted for 75% of global FDI inflows. In totality, a country’s climate for FDI is built by factors such as relatively accommodative government policies—covering trade barriers and regulation of capital inflows; quality of governance; political stability; presence of laws and regulations; macroeconomic, fiscal, monetary, and industrial policies; and quality of infrastructure. Foreign Direct Investment in Emerging Economies The United States continues to be the largest FDI host country, with about US$2791.3 billion in 2007. The outward investment position increased to US$336.6 billion. Among the outward investments, about US$16.1 billion (3.1%) went to Ireland and US$4.2 billion (3%) to Singapore. Chart 1.1 China’s total foreign investments inflows According to U.S.-China Business Council, among emerging economies, China’s role as an investor country has been highlighted in the past few years. By 2004, China was the eighth most favored FDI source among developing countries. The liberalization of Chinese FDI policy in 1992 led to increased Chinese outward direct investment (ODI). The growth in Chinese ODI policy developments was driven by cautious internalization, government encouragement, expansion and regulation, implementation of a â€Å"go global† policy, and heightened domestic competitive pressures, which led to the opening up of protected industries and markets to foreign and domestic competitors (2008, pp. 81). A comparative advantage as a manufacturing hub and a firm-specific advantage such as state-ownership of a large part of an industry further stimulate this growth. Chinese ODI has been positively associated with Chinese exports to the host country (the former promoting the latter), a moderate demand of inflation, and rising levels of political risk in the host country. A distinctive feature that remains with China as against other emerging economies is that many of its multinational enterprises remain in state hands, although corporatized to focus on commercial objectives. Table 1.2 Top 10 FDI inflows. China’s overall FDI inflows stood at US$82.7 billion, an increase from US$69.47 billion. The top 10 FDI inflows were mainly from Hong Kong, the British islands, South Korea, Japan, Singapore, and the United States, amounting to about US$3 billion in 2006 and about US$2.62 billion in 2007. According to the Ministry of Commerce (MOFCOM) of the People’s Republic of China, the outbound nonfinancial FDI for the first half of 2007 reached US$7.8 billion, while for the full year in 2006; it was US$21.2 billion. Of this, 86% was provided by central government sources. Most of China’s ODI flowed to 172 destinations, which included Latin America and Asia. In India, the overall record of macroeconomic stability, a sizable domestic market, and a relatively high degree of political stability has attracted large volumes of FDI. The foreign investment in India during 2007–2008 was driven by FDI and portfolio investment inflows. FDI inflows in India increased from US$9.17 billion in 2005–2006 to US$22.95 billion in 2006–2007 and US$34.92 billion in 2007–2008. India emerged as the second most favored FDI destination after China in 2005 and 2006. During these years, investments through Mauritius remained the largest component, followed by Singapore, the United Kingdom, and the Netherlands. Inflows from the United States stood at the sixth position at US$3.46 billion in 2005–2006, US$7.06 billion in 2006–2007, and US$4.86 billion in 2007–2008. Sectorwise, these inflows were mainly directed to financial services, construction, and manufacturing. On the other hand, ODIs from India increased from US$13.5 billion during 2006–2007 to US$17.9 billion during 2007–2008 and flowed mainly into the manufacturing sector (Dicken 2007, pp. 191). Within the European Union, Ireland is fast emerging as the most FDI-intensive economy in Europe and a global competitor to RD investment. Since the 1990s, Ireland’s economic development policies, which have encouraged Greenfield investments by foreign companies in manufacturing and service sectors so as to produce output for export markets, and the establishment of upstream linkages between foreign and indigenous companies and the creation of industrial clusters with them have stimulated an export-led growth of the manufacturing sector. In Singapore, another emerging FDI destination, the total ODI was recorded at US$406.7 billion in 2005 and US$484.1 billion in 2006. Financial services and manufacturing have been major draws for Singapore companies venturing abroad. In 2005 and 2006, Singapore invested about US$9.8 billion and US$8.5 billion in the U.S. market. The FDI inflow in Singapore was at US$323.8 billion and US$363.9 billion, the FDI inflow from the United States alone constituting about 10% of this inflow. The current scale, proliferation, and importance of collaborative ventures between firms across boundaries have brought out the significance of transnational strategic alliances between firms (especially competing firms). Strategic alliances are formal agreements between firms to pursue specific strategic objectives in order to enable them to achieve specific goals. It involves sharing of risks and rewards. For RD ventures, for example, cooperation is limited to research into new products and technologies, while manufacturing and marketing remain the responsibility of individual firms (Cohen 2007, pp. 171). Globalization, technological advances, and the emergence of new players have propelled a change in FDI movement. Globalization, by removing most of the natural and artificial barriers to cross-border information flows and transactions, has widened locational choice options for firms. By lowering transport, communication, and distribution costs, technological advances have helped overcome many obstacles to overcome space. Examples of Foreign Direct Investment Venture capital, seed capital, and other types of direct investment play an important role in the development of nanotechnology by providing the funding for entrepreneurs to develop commercial products based on the nanotechnology, and establish themselves as for-profit businesses. As of June 2009 the Website www.nanotech-now.com listed over 100 funding sources for nanotechnology businesses. An example of a seed capital firm is MMEI (Molecular Manufacturing Enterprises Incorporated), a privately held corporation that provides funding at the early stages of product development in molecular nanotechnology: for example, in developing a laboratory-bench model into a working prototype that could be used to attract venture capital. A different type of service is provided by Silicon Valley Nano Ventures: they help make connections between investors and businesses and charge fees for successful transactions that may include a percentage of the transaction and/or stock or options in the compan y. Foreign direct investment (FDI) is increasingly important in the global economy, but the term denotes more than simply a direct investment made by a foreign investor. Specifically, FDI refers to a case of a company in one country establishing an enterprise in another country—such as Coca-Cola opening a plant in Mexico, Volkswagen opening a factory in Detroit, Intel opening a chip fabrication plant in Taiwan, and so on. Foreign direct investment is a vital part of the economic relationships between countries, and in particular can be a key to attract for developing or industrializing countries. Though the largest amounts of capital are involved in direct foreign investment among the industrialized countries (or â€Å"Global North†), direct foreign investment from industrialized countries to developing countries (or â€Å"Global South†) is a matter of constant discussion among international bodies like the World Trade Organization, and is seen as (at least potentia lly) a beneficial arrangement for both sides (Aliber 2003, pp. 94). Typically, the subsidiary established by a foreign direct investor is a factory or other manifestation of the foreign company’s global presence, but it can include real estate holdings (and often does, in the case of businesses in the hotel and hospitality industry) and businesses unrelated to the foreign company’s ordinary business. Foreign ownership may not always be apparent to the public. In the United States, the public is generally not aware that national supermarket chains and major breweries are owned by foreign-based multinational corporations. Because foreign direct investment involves money coming into a nation’s economy from outside, there are often incentives offered by the local government to encourage it, particularly when the FDI does not pose a competitive threat to domestic industry. There may be tax incentives, special regulatory exceptions, or subsidies provided for job training in order to create domestic jobs and disincentives the importation of foreign employees or infrastructure subsidies (Cohen 2007, pp. 176). Singapore provides a good example of a government successfully attracting FDI to develop commercial nanotechnology. Singapore is a small and densely populated Asian nation with a strong central government and a high standard of living, but has not historically been known as a center of scientific innovation. In order to overcome this handicap and create a biotechnology industry able to compete with the United States and Europe, the Singapore government has been involved in establishing biomedical science centers since the 1980s, including the Institute of Bioengineering and Nanotechnology, whose current research projects include developing nanocomposite materials for solar cell applications and nanofoams to be used in human bone replacement and repair. Singapore has been successful in attracting foreign investment in these centers, in part through the provision of financial incentives, a strong infrastructure, regulatory policies that favor business and the availability of a well-edu cated workforce. Among the companies who have invested in the biomedical industry in Singapore are GlaxoSmith-Kline, Schering-Plough, Merck, Genencor, AstraZeneca, and Bristol Myers Squibb. Conclusion Foreign direct investments is a long-term capital flow or investment in which a non-resident entity has significant management control of voting stock (10% or more) over an enterprise in a foreign or host country. Unlike short-term capital flows, foreign direct investment (FDI) is not immediately susceptible to reversibility. The bulk of FDI activities in developing countries are undertaken by multinational or transnational corporations. A transnational corporation is a firm that is head quartered in a home country but controls assets of enterprises that are central to its profitability in foreign or host countries. References Aliber, R. (2003), the multinational paradigm. Cambridge: MIT Press, pp. 91-98 Borensztein, E., De Gregorio, J. , and Lee, J.-W. (2008), How does foreign direct investment affect economic growthJournal of International Economics vol. 45 pp. 115–135 Braconier, H., Norback, P., and Urban D. (2005), â€Å"Multinational Enterprises and Wage Costs: Vertical FDI Revisited,† Journal of International Economics v.67/2 , pp 313 Braunerhjelm, P., Oxelheim L., and Thulin P., (2005), â€Å"The Relationship between Domestic and Outward Foreign Direct Investment,† International Business Review v.14, pp. 119-131 Cohen, S. (2007). Multinational corporations and foreign direct investment: Avoiding simplicity, embracing complexity. New York: Oxford University Press, pp. 171-77 Dicken, P. (2007). Global shift: Mapping the changing contours of the world economy. New York: Guilford Press, pp. 191-204 Dunning, J., Gugler, P. (2008), Foreign direct investment, location and competitiveness, Amsterdam: Elsevier, pp. 113-119 Graham, E. , Marchick, D. (2006). US national security and foreign direct investment, Washington, DC: Institute for International Economics, 277 P. Buckley and N. Hashai (2004), â€Å"A Global System View of Firm Boundaries,† Journal of International Business Studies v.35, pp. 61-69 Trevino, L. and Upadhyaya, K. (2003), Foreign aid, FDI and economic growth: Evidence from Asian countries. Transnational Corporations vol. 12 pp. 45–72 U.S.-China Business Council, (2008), foreign investment in China, Washington, DC: Author, pp. 81 Yeung, H. (2007), from followers to market leaders: Asian electronic firms in the global economy, Asia Pacific Viewpoint vol. 48 pp. 1–25. How to cite Foreign Direct Investment, Essay examples