Host and Home Countries Intervene in Foreign Direct Investment - Coursework Example

Business Name Course Lecturer Date Both host and the home countries are involved with the foreign direct investment (FDI) for a various reasons. Due to the dynamism that is involved in the ways of business operations in the current age, there are many FDI that are involved (Blonigen, Davies, Waddell, & Naughton 2007). The complexities involved in their operations will mostly call for the government to intervene. There are concerns as to whether there exist justifiable reasons for the involvement of the government. There is need to establish whether the natural flow of the FDI are sustainable by themselves excluding the intervention of the governments. The government intervention can be of a restrictive nature or promotional in scope. The host government’s promotion interventions can be broadly categorized into two: financial incentives and the infrastructure improvements. Examples of the restrictions that are exhibited by the host government may be ownership restrictions and performance demands. The promotional methods by the home countries includes insurance on assets abroad, special tax treaties, loans and loan guarantees, tax breaks on profits earned abroad and the persuasion of the FDI acceptance by the other nations. The restrictions involved include imposing of differential tax rates and sanctions. (Wang, Hong, Kafouros & Wright 2012) Foreign direct investment (FDI) involves the purchase of the physical assets or a significant amount of ownership (stock) of a company in another country so as to gain a measure of management control. It’s a different concept from portfolio investment which is an investment that is not aimed at obtaining a degree of control. The reasons for FDI growth include increasing globalization, internal mergers and acquisitions, and entrepreneurship and small firm issues (Stiebale & Reize 2011). Among these reasons, increasing globalization is one main driver behind global flows of foreign direct investment. The globalization of the world economy encourages firms to use FDI as a way to create low-cost production basis. Multinationationals are also promoted to both in the advanced and the developing economies to buy businesses in other markets. (Tvaronavičiene & Kalašinskaite 2010) In the 1980s companies were able to get around trade barriers. This allowed for the firms to produce in the most efficient locations and export to markets. The international mergers and acquisitions rise and fall as the year changes depending on the condition of the national economies. As (Rugman 2013) asserts, the theories that govern the issues surrounding FDI include the international product life cycle theory, market imperfection theory, eclectic theory and the market power theory. The product theory states that a company will start to export its products and later engage in foreign direct investment as the product progresses in its cycle. Three main stages are considered in this theory. Stage one is where the buyer demands and the high purchasing power encourage a company to design and introduce a concept of a new product that is new. There are no export markets initially. However, exports increases late in this stage. Stage two is the maturing product stage where the markets, both domestically and internationally, become aware of the product existence and the value gains attached. There is sustainable demand rise that over a fairly lengthy time period. Sales begin in these nations near the end of this stage and manufacturing is established in the developing countries. The final stage, stage three, is called the standardized product stage. Here, the prices are lowered so as to maintain a sustainable sales level since competition from companies selling similar products exerts pressure. The marketing theory posits that in a perfect market, prices are as low as possible and that there is no limit to goods availability. A flaw that exists in the efficient industry operation constitutes market imperfections. FDI is thus undertaken by firms when such imperfections as trade barriers are present (Buckley, Clegg, Cross, Liu, Voss & Zheng 2007). The eclectic theory explains that firms engage in the FDI when the features of a location combine with the ownership advantages in such a way as to make a location appealing. Some economic activities due to their acquired or natural characteristics enhance the location advantage. Ownership of specific assets, such as technical knowledge, possession of a powerful brand, or management ability leads to ownership advantage. When a business activity is internalized rather than having it left to a relatively inefficient market, it is said to have an internalisation advantage. The market power theory argues that a firm will undertake foreign direct investment so as to establish a dominant market presence. (Razin & Sadka 2007) There exist management issues that surround foreign direct investment. The companies investing abroad are usually with concerns of controlling the local market activities. The local market may require a company to hire local managers or insist that all the goods produced locally to be exported. A decision should be made on whether to purchase a business that is in existence or build an international subsidiary. An investor will have a comparative advantage of having existing plant and personnel in the case of acquisition. However, factors like poor relations with the workers, obsolete equipment and an unsuitable location will reduce the appeal of purchasing activities. In such cases where adequate facilities are unavailable, the company must go ahead with Greenfield investment. (Lopez-Aymes & Salas-Porras 2008) The involved labour regulations can lead to increment of the associated cost of production. The production cost should be rationalized in such a way as to contain production costs where the locations where the product’s components can produced at the minimum cost are chosen. The presence of a local market will enable the companies to gain sustainable information about their customer’s behaviour that they would otherwise not have received had they been in their home country. They are also closely linked to their client firms and their rival firms. One of the reasons why the government of the host countries interfere with the flow of FDI is to protect their balance of payment. A nation that receives FDI aids for a balance of payment boost. The balance of payments position of a country also improves from the exports that result from the FDI’s local engagements (Rosen & Hanemann 2009). When the direct investors sends the locally made profits to their home/parent country, the balance of payments are negatively affected. When there is local investment in technology the resultant effect is increase in the in the competitiveness and the productivity of a nation. People who are endowed with management skills are brought in when the FDI are encouraged. The locals can therefore have training that will enhance their competitiveness of the firms that they operates in. many jobs are also created as a result of the incoming FDI. The host countries must strategically be able to address the counter-operations that will be as a result of their interventions. Other nations and the investor’s countries closely follow the action of the FDI. There should be assurance that not all of the resources are sent to the mother countries. The profits on the asses that are made abroad are targeted to be brought back home so as to increase the country‘s balance of payment. The outgoing FBI needs to be regulated so that they don’t eventually drain the balance of payment. (Büthe & Milner 2008) There are various policy instruments that the host government uses to restrict and promote foreign direct investments. There can be a set of performance rating that will affect the operation in the host nation. Tax incentives can also be offered by the host nations in form of a waive of taxes or low tax rates. Low interest can be offered to investors by the host nation therefore enhancing their production efficiency. Lower investments can be achieved by the host governments through making of local infrastructure improvements. These may include targeted areas such as increased systems of telecommunications, improved roads and seaports that are suitably placed to enhance containerized shipping. The country governments that host the FDI are able to impose ownership restrictions that lead to prohibitions in various sectors. Certain businesses of interest and cultural industries may be kept out of the FDI range of options. Another restriction that can be involved is a requirement that foreign investors should hold less than fifty per cent stake in the local firms. However, nations are doing away with such restrictions. The reason behind relaxing strict requirement and restrictions is due to the fact that there exists open economies elsewhere where these companies can direct their investments. These ownership restrictions and performance demands, therefore, needs critical analysis before they can be implemented. As Meyer & Sinani (2009) explains the home countries are also in intervention of the FDI flows. One of the reasons that justify for this intervention is that the FDI affects the country’s balance of payment. These effects may be on a positive measure when the profits are taken back home hence an improvement in the balance of payments. On the contrary, investments that are taken to other nations will lower the balance of payment for the parent country due to the sending away of its resources. In addition, the FDI may result to ultimately damage the balance of payment of the host country by ultimately substituting the exports. The home country will not benefit from the created jobs that result from these foreign investments. The home country will involve itself in promotion and restrictive measures. The promotional interventions include insurance cover that covers the risks associated with the investments made abroad. They will offer grants loans which encourage the firms to invest abroad. Tax breaks on profits that are earned abroad are offered or negotiate tax treaties that are specially suited to the FDI . In addition, the home country can exert pressure on other nations to have them relax their restrictions on the investments. The restrictive measures that the home country adopts include on one hand imposing of differential tax rates. These targets the income from abroad which is charged at higher rate compared to the domestic earnings. On the other hand, sanctions are imposed to prohibit investment in particular nations by the domestic firms. There is need to establish the justification of the interventions of countries on FDI. Examination should be done to see whether the promotions or restrictions makes economic sense (Hoekman & Kostecki 2009). For small economies that are open, proper taxation of domestic and foreign capital investments is highly dependent on their relative mobility. For a case of domestic and foreign capital being internationally mobile, the countries will be justified in subjecting both types of capital to equal treatment of tax. Lower taxes should be charged on capital owned by foreign residents than that of domestic owners if foreign capital is more mobile internationally (Bellak & Leibrecht 2009). There is no justification for these interventions if the markets are operating perfectly. However, the case of perfect market conditions is hypothetical and it does not apply in real market situations hence the need for the countries to intervene. Countries may opt to promote the FDI through subsidies warranty if the FDI is capable of using the supplied factors intensively. Promotions are also guaranteed if the FDI presence in the host country will generate strong spill overs and not lower the market share of the domestic firms (Harding & Javorcik 2007). Both the restrictive and promotional measures towards the FDI may be to adjust the countries balance of payment which is vital when it comes to the international trade. For instance if the home country’s balance of payment is high then the government may promote the FDI in a bid to encourage movement of resources abroad. Coherently, if the home country’s balance of payment is low then the government may restrict the foreign direct investment in order to contain resources domestically. In conclusion, as it has been observed, there are justifiable reasons for the intervention of the home and the host countries in the FDI operations. The value addition that these issues are involved with establishes the need for interactions that need governing authorities to be involved. Since the market conditions are imperfect, there are needs that arise to keep the FDI at the optimum level. This will enhance the growth of FDI following the issues such as increased globalisation and international mergers and acquisition. References Bellak, C., & Leibrecht, M. (2009). Do low corporate income tax rates attract FDI?–Evidence from Central-and East European countries. Applied Economics, 41(21), 2691-2703. Blonigen, B. A., Davies, R. B., Waddell, G. R., & Naughton, H. T. (2007). FDI in space: Spatial autoregressive relationships in foreign direct investment. European Economic Review, 51(5), 1303-1325. Buckley, P. J., Clegg, L. J., Cross, A. R., Liu, X., Voss, H., & Zheng, P. (2007). The determinants of Chinese outward foreign direct investment. Journal of international business studies, 38(4), 499-518. Büthe, T., & Milner, H. V. (2008). The politics of foreign direct investment into developing countries: increasing FDI through international trade agreements?. American Journal of Political Science, 52(4), 741-762. Harding, T., & Javorcik, B. S. (2007). Developing economies and international investors: Do investment promotion agencies bring them together? (Vol. 4339). World Bank Publications. Hoekman, B. M., & Kostecki, M. M. (2009). The political economy of the world trading system: the WTO and beyond. Oxford University Press. Lopez-Aymes, J. F., & Salas-Porras, A. (2008). Assessing nationalistic expressions of Korean companies: Korean FDI in Mexico. Meyer, K. E., & Sinani, E. (2009). When and where does foreign direct investment generate positive spillovers? A meta-analysis. Journal of International Business Studies, 40(7), 1075-1094. Razin, A., & Sadka, E. (2007). Productivity and Taxes as Drivers of FDI (No. w13094). National Bureau of Economic Research. Rosen, D. H., & Hanemann, T. (2009). China's changing outbound foreign direct investment profile: drivers and policy implications (No. PB09-14). Washington, DC: Peterson Institute for International Economics. Rugman, A. (Ed.). (2013). New theories of the multinational enterprise. Routledge. Stiebale, J., & Reize, F. (2011). The impact of FDI through mergers and acquisitions on innovation in target firms. International Journal of Industrial Organization, 29(2), 155-167. Tvaronavičiene, M., & Kalašinskaite, K. (2010). Whether globalization in form of FDI enhances national wealth: empirical evidence from Lithuania. Journal of Business Economics and Management, 11(1), 5-19. Wang, C., Hong, J., Kafouros, M., & Wright, M. (2012). Exploring the role of government involvement in outward FDI from emerging economies. Journal of International Business Studies, 43(7), 655-676. Read More