Foreign Direct Investment - Essay Example

Running Head: Foreign Direct Investment Foreign Direct Investment Name Course Lecturer Date It has been pretty obvious for the last decade that foreign direct investment (FDI) has evidently grown dramatically as a significant form of the international capital transfer. The world flow of foreign direct investment has actually tripled. FDI may be defined as the cross-border expenditure established to expand or acquire corporate control of those assets that are productive. According to Organization for Economic Co-operation and development (OECD), FDI may also be defined as a category of all investments that reflect the main objective of creating a lasting interest by an enterprise in a given economy, that is, direct investor, in an enterprise that is different from the direct from the direct investor. The drastic change in the political and economic environment has of course led to renewed interest in the reimbursement FDI may offer to the developing countries in maintaining and achieving the economic growth. This growing interest in FDI is as a result of the utilization of the foreign capital that is injected in the economy. Foreign direct investment is said to be easier and stable to services as compared to the bank credit (Claessens et.al, 2001). FDI is a long term economic activity where profits are meant to be earned. It is important to note that the foreign direct investment in the less developed is now being appreciated. However, the less developed countries seem to play a passive role in the volume and direction FDI. As described by the modern growth theory, economic growth is mainly as a result of accumulation of capital that leads ultimately to investment. It is therefore, evident that an enabling environment should thrive for excellent investment. As a result good conditions that facilitate foreign direct investment inflow should be examined. The factors are classified as social, political, legal and economic factors. Economic factors include; fiscal, trade, monetary, infrastructural facilities and exchange rate policies. Other factors include production cost, low labor, investment climate and political stability assist in attracting and retaining the FDI in the host country (Hsiao, 2001). FDI does increase capital, improve the labor factor and has the potential to increase the total productivity factor. In addition, FDI have additional indirect and permanent effects on the output growth rate. Though foreign direct investment can produce a great effect on the output growth, the effects seem to diminish due to the diminishing return principle (Aizenman, 2002). FDI has been perceived to impact economies in the world of business and the very nature of global economy. It has continued to affect the pattern of major business activity in the world. Of importance is the fact that it has continued to assists in shaping the economic development and growth globally. Of great concern is the shifting of these patterns leading to differences in dynamic. In the OECD countries, FDI is considered to be a vital driver of the economic growth. This is so as production that is internationalized helps to boost competitive pressure in different countries, further exploit the advantages of countries and enterprises and stimulate innovative activity and technology transfer (OECD, 2001a). Therefore, it is very important that the policy should be enhanced that eliminate or reduce hindrances to FDI. Foreign Direct Investment can generally be measured in two ways: financial investment stocks and flows and the activities of the foreign affiliates in a host country (OECD, 2002b). The effects of foreign direct investment can be categorized into two; direct and indirect. Direct effects are not dependent on the interaction among translational companies and the innovative system and absorptive capacity. The direct effects include increased supply, greater access to currencies that are on reserve, the formation of gross fixed capital, growth in exports and a rise in tax revenue. Therefore, it can be concluded that the direct effects of foreign direct investments are almost similar to the effects of national companies would have on economic growth. The indirect effects are mainly determined by innovative system and absorptive capacity. The reciprocal interaction observed between innovative system and transnational companies definitely leads to effects on the receiving economy in form of capacity building and high technology content in the so called productive sector. The effects include human capital development, spillovers in wages and productivity, capacity building and technology transfer and monetary externalities for promoting new path for learning and for all local business. Therefore, FDI through the above mechanism does contribute to the economic growth in a way that is different from national investment. This of course does demonstrate the gain obtained from foreign investment (Aizenman, 2002). Patterns of FDI Foreign Direct Investment flows was relatively stable in the 1990s; significantly picked up in end of the decade and in 2001 fell to levels two times at the beginning of the 1990s. In the 1990s, the internationalization of products, therefore, increased. The marked decline of flows at the start of the fresh decade reflected a rectification to sustainable levels rather than reversal of the trend and the real importance of cross-border possession of assets increases, therefore, mirroring the role of FDI in global economy. In 2000, the OECD countries did account for over 75% of global outward FDI. Most of the activity consisted of acquisitions and mergers of existing businesses as seen in the Greenfield investment (OECD, 2002c). In 1998, the EU countries and the United States held almost three-quarters of the total OECD outward and inward FDI positions. Germany, France and the United Kingdom were the largest receivers and suppliers of FDI in the European Union countries. Belgium, at the time was a major host to the foreign business while the Netherlands was a significant large investor (OECD, 2001b). In most countries, Gross Domestic Product (GDP) relative to foreign direct investment differs. FDI positions have significantly grown faster in most countries than GDP. FDI, in comparison to the size economy, is chiefly large in smaller countries, for example, the outward positions of Switzerland and the Netherlands and the inward position of Belgium, Ireland and New Zealand. It is important to note that in the OECD countries, inward FDI plays a major role in the economy. However, in Japan, the outward FDI is observed to be much higher as seen in the inward FDI. It has been seen that the patterns of the total FDI that has been hosted or invested by the most countries has shown a great difference in relation to bilateral patterns. This is seen in the OECD countries. According to data provided in 1998, the most recent year that the bilateral data was significantly compete, host partners diverse across the investing countries, the number was seen to be ranging from 10 for Turkey and Hungary to more than 20 for various countries in the EU, Canada and Unite d States. In addition, while some countries concentrated on evenly distributing their FDI among the partners, some of them only concentrated on a small number of host countries. In some countries for example, Mexico, Austria, United Kingdom and Canada, their FDI comes from few investor countries. Proximity and openness factors are the major explanations for the observed patterns. As seen in the OECD, a major share of foreign direct investment does take place among countries that are bound mainly by the region trade agreements and geographically closeness. Thus, for example in the European countries they tend to host more FDI from countries originating from the European Union than from other countries while in Mexico and Canada their FDI is seen to originate largely from the United States. Similarly, most countries locate located in the Pacific shore tend to be hosting more FDI from Japan or the United States as compared to other countries in the OECD. Foreign affiliates in the host countries accounted for share of the economic activity and thus, provided a better indication of the definite extent of internalization of production. It is suggested that the surge as observed in the FDI flows in the 1990s were mainly mirrored by an increase in the major activities of the foreign affiliates. Actually in most countries foreign affiliates accounted for the business employment in the OECD. However, in Belgium and Hungary they had greater shares of the foreign affiliates in services and manufacturing respectively while Japan in both sector was observed to be low in Japan. In fact, their industrial distribution of the foreign affiliates tends to be more concentrated in very few industries. In 2010 globally speaking, worldwide FDI rose slightly after falling in 2008 and 2009 as a result of financial crisis and international economic which mostly started in the develop countries. However, it was also observed in both the transition and developing countries. In 2010 however, recovery of investment varied from one region to another. E For the first time, developing and transition countries marked a pass of 50 per cent mark of the global flows. In addition, the FDI outwards flow from the transition and developing countries’ economies have also increased and reached a 22 per cent mark. For example, in Caribbean and Latin America, FDI rose by 40% while in Africa by 15%. In this context, Caribbean and Latin America took a greater role in the FDI flows. There was a decline in flows to the developed countries and an increase in the developing countries which resulted to the developed countries accounting for half of the total global FDI flows in the year 2010. The United States was main FDI recipients in 2010, among the developed countries and the reinvesting earning went up by 43%. Belgium, France and United Kingdom are among the other countries that have greatly benefited in the developed countries. In the developing countries, India, China, Russia Federation and Brazil were among the largest recipients (Lipsey, 2001). The ratio of FDI-to-GDP in the developing countries rose due to increase in the investment flows. However, in Africa this was not evidence in 2010. This may have resulted from lack of an environment that will constantly boost business activity in Africa. The most present global financial crisis has evidently showed that FDI is one of the most stable of the flow of capital received by transition and developing countries, even during the times of economical crisis. Not only does foreign direct investment contribute to the economy growth through technology transfer and capital formulation but also through the intensification of the knowledge through skill acquisition and labor training (Borga and Mataloni, 2001). Cross-border acquisitions and mergers have been a significant FDI mechanism in the past and recent years thus enabling most transnational companies to get into new markets and put into use the knowledge and capacity of the local firms. This resulted to increase of global operations by 38 per cent as seen in 2009. The rise showed a positive trend that would be strengthened in the coming years as much as the rise could not reverse the felt effects of 2008 and 2009. The steady growth in cross-borders acquisitions and mergers contrasts with the great trend observed in the Greenfield investments, that continued to decrease in value and both number in 2010 (OECD, 2002c). Despite the fact that Greenfield investments in transition and developing countries did increase, compensation of was not observed in the fall in projects among the developed countries. It is evident that developed countries are the main source of foreign direct investment. However, the share of transition and developing countries has recently shown a sharp increase which has been consistence with increase importance of economies as seen in the global economy. In addition, the source in the developing countries has doubled and has reached 23 per cent in 2010. The seen steady and gradual growth in the investment in the transition and developing countries is a major and significant characteristic of foreign direct investment flows in future years (Markusen, 2002). Contribution of currency flows to the reduction of domestic policy influence In the global policy environment, three significant changes have been observed: reduction of domestic policy influence, an increase in conflict between developing and industrialized nations and weakening of the international institutions which are tradition. Typically, these major changes have in turn have had effects on the policy responses in the investment field and international trade. The effects of rising global linkages on domestic economy have been noteworthy. Policymakers have noted that it is difficult to isolate international market event and domestic economy which may be as a result of currency flows (Markusen, 2002). Global market forces have continued to counteract the activities of domestic policy measure. Decisions that were made in the domestic purview have been revised as a result of the influence from abroad (Johnson & Langley, 2002). It is important to note that international factors have great influence on domestic economy policy. In addition, there is an escalation of clash between the non-territorial and fixed geography of different nation’s nature of the problems and solutions in today’s economy. The local governments are in a position of dealing with problems facing individual states or nations while global entities or transnational are needed to deal with greater issues for example environment, resources and economics (Nicoletti et al., 2003). Agricultural policies, for instance- a domestic issue, have already been thrust into the international business or realms. Any changes in the agricultural policies such as quantity restrictions, agricultural subsidies and quality regulations may be interrupted by the international trade partner, who may speak up in reaction to the global effects resulting from these changes (Goldstein & Barton, 2010). In this case the domestic policy is influenced by the exchange of export and imports, that is, currency flows. On the hand, if a country does contemplate on specific policies on industry such as industrial collaboration or innovation, may often call for opposition from the trading partners, who are certain that such policies may interfere with their own industries policies. The resulting constrains and reactions are results of the growing currency flows and interdependence among different nations and of most important closer linkages in industries (Hsiao, 2001). These examples highlight global benefits of trade in the world: the United States, in 2007 exports have grown twice compared to the imports, jobs supported by exported in the United State rose from 13% to 18% compared to other jobs, from data gathered, a company that does export is most likely to succeed if compared to competitors who do not (Claessens et.al, 2001). It is well put that the economic world has been increasingly been turned upside down. For instance, currency flows were determined by trade flows and consequently exchange rate. In recent past, it has been note that current flows have been increasing from a daily volume of approximately $17.5 billion in 1980s to about $1.5 trillion in the 1990s. However, in 2001 the trade volume ranged around $ 1.2 trillion. This resulted to the currency flow setting value of exchange rates that are independent of trade. Consequently, the exchange rates are determining the level of trade at the present. It has also been noted that currency flows outnumber the trade flows (Menon, 2006). The interactions between domestic and global financial flows have significantly limited the freedom of a government in control actions involving the domestic policies. For instance, if the Federal Reserve of the United State or the European Central Bank change the interest rate levels, it will be observed that that these changes will not only affect the domestic activities but will also lead to the trigger of international flow of capital which may enhance, reduce or most likely undo the domestic effects. This has resulted in the government remain powerless in implementation of efficient and effective policy as much as they know what is needed (Sally, 2000). It is evident that the governments have found out that domestic regulations have significant international repercussions. However, most legislatures in some countries do ignore these repercussions. This of course will lead to creation of threats and results to a company being placed at a competitive disadvantage in the marketplace internationally or else it will make it easier for a foreign company and penetrate and compete in domestic market (Nicoletti et al., 2003). As a result of currency flow, policymakers are increasingly finding themselves with greater responsibilities and at the same time with less and fewer tools to carry out. This has led to creation of more segments of domestic economy which are becoming more vulnerable to the international shift. In addition, they are to some extent less uncontrollable. However, to regain power to at least influence some policies, most governments have decided to restrict influence of trade in the world by charging tariffs, erecting barrier and implementing regulations on imports (Barton, 2010). Nevertheless, these measures have also been restrained by the international agreements that exists that has been forged that been forged through bilateral negotiations or World Trade Organization. In addition, World Trade Organization has thus changed notions that were previously held on sovereignty of extraterritoriality and nation-states (OECD, 2002a). It seems that the interdependence that led us to be more effluent has left the business world more vulnerable. In conclusion, foreign direct investment has been considered to be a very important driver in the growth of economy in most countries. This is because different business activities are carried from the host country to different countries where new enterprises are created. The pattern in the foreign direct investment has shown tremendous changes. According obtained in the years, 1990, 2001, 2010; the foreign direct investment has increased sharply. However, the changes were observed differently in different countries. In recent times, the transition and developing countries have showed an increase in the FDI flows as compared to the developed countries. Currency flows have greatly led or contributed to the reduction of domestic policy influence. This has resulted to the policies made the policymakers and the government to be tied when making policies concerning trade in their country. This is because of the international agreements that have been made among different nations in the same or different regions. However, it is also important to note that they are a significant benefit which has been as a result of trade among countries. References Aizenman, J, (2002), “Volatility, Employment and the Patterns of FDI in Emerging Markets,”NBER Working Paper No. 9397 Cambridge, Mass.: National Bureau of Economic Research. Barton, J. (2010). The evolution of the trade regime : politics, law, and economics of the GATT and the WTO. Princeton University Press: Princeton. Borga, M. and Mataloni, J, (2001), “Direct investment positions for 2000: country and industry detail”, Survey of Current Business, July. Claessens, S, D. Klingebiel, and Schmukler, S, (2001), “FDI and Stock Market Development: Complement or Substitute? Washington; World Bank Goldstein & Barton, J. (2010). The evolution of the trade regime: politics, law, and economics of the GATT and the WTO. Princeton: Princeton University Press. Hsiao, C, (2001), Analysis of Panel Data, Cambridge, Mass.: Cambridge University Press. Johnson, H & Langley, P. (2002). Trade agreements and financial services. River Edge: N J World Scientific. Lipsey, E, (2001), “Foreign Direct Investors in Three Financial Crises,” NBER Working Paper No. 8084 Cambridge: Mass.: National Bureau of Economic Research. Markusen, J, (2002), Multinational Firms and the Theory of International Trade, Cambridge: MIT Press. Menon, J. (2006). “Bilateral trade agreements and the world trade system,” ADBI discussion paper, Tokyo: Asian Development Bank Nicoletti, G, Golub, D, Hajkova, D, Mirza and Yoo, K, (2003), “Policies and international integration: Influences on trade and foreign direct investment”, OECD Economics Department Working Papers, forthcoming. OECD, (2001a), International Investment Statistics Yearbook, Paris. OECD, (2001b), Measuring Globalisation. The Role of Multinationals inOECD Economies. Manufacturing and Services, Paris. OECD, (2002a), “Trends and recent developments in foreign direct investment”, International Investment Perspectives, Paris. OECD, (2002b), OECD Economic Outlook No. 71, Paris. OECD (2002c), “The relationship between trade and foreign direct investment: A survey”, TD/TC/WP (2002)14/FINAL, Paris. Sally, R. (2000). Developing country trade policy. Cato Journal , Vol.19. Read More