Global Financial Crisis and the Financial and Political Risks of Conducting International Business - Example

GLOBAL FINANCIAL CRISIS AND THE FINANCIAL AND POLITICAL RISKS OF CONDUCTING INTERNATIONAL BUSINESS AND INTERNATIONAL DIRECT INVETSMENT Global Financial Crisis and the Financial and Political Risks of Conducting International Business and International Direct Investment 1. Introduction The current financial crisis, which came out in mid 2007, spreaded immediately to Europe and other developed countries and finally to developing nations also .It is now hitting countries all over the world including both developed and developing countries. The impact of the crisis on a country occurs through two possible channels one through the financial sector and the other through real economy including trade ,international investment and exports (International Monetary Fund, 2009). Because of the global financial crisis, there has been significant decline in the prospects for conducting international business and Foreign Direct Investment (FDI) in many countries (UNCTAD, 2008). So far, this decline has been high in developed countries than in developing countries (UNCTAD, 2009). Many industries that were very good performers historically have got affected by the decline in FDI flows. The most affected industries to date are the financial services and manufacturing industries including automotive industries, building materials, intermediate goods and some consumption goods (Filippov and Kalotay, 2009). This report discusses the impact of global financial crisis on the financial and political risks of conducting international business and FDI .Further it discusses the policy responses of national governments to these risks. The discussion focuses on the impact of global financial crisis on US automobile manufacturing industry. The automotive industry has been the most affected industry due to the financial crisis .The recession in this industry was largely felt in the US automobile manufacturing industry (Sauvant, 2008). Further, it is a solid example of the negative impact of global financial crisis on conducting international business and FDI flows (UNCTAD, 2009). This report is organized follows. Section 2 discusses the various channels through which global financial crisis affects the international business and investment with focus on US automotive industry. Section 3 discusses the policy response of the national governments to the risks associated with international business and investment. Section 4 concludes. 2. Global financial crisis and the risks associated with international business and investment The international investment has been growing tremendously since 2004 .In 2007, the World Foreign Direct Investment flows has reached a peak level of $1.8 trillion (OECD, 2008).By 2008, this growth came to an end. The global FDI flows declined to $1.7 trillion. In spite of this decline in aggregate direct investment flows, there have been region wise, industry wise and subsidiary wise variations in this decline (UNCTAD, 2009). The figures show that FDI flows in developed countries have been affected most by the crisis(25 percent decline compared to 2007) while the impact on developing country FDI flows has been limited( 7 percent positive growth). Among the industries, automotive industry has been the worst hit by the decline in international investment flows(OECD, 2008; UNCTAD, 2009).The crisis in this industry was mainly felt in US automobile manufacturing industry with the three big car manufacturers General Motors, Ford and Chryslor as three specific examples (Sauvant,2008). Two main channels through which the global financial crisis affects international business and investment are through the capability and propensity of firms to invest (Filippov and Kalotay, 2009). The capability of firms to invest is affected by the crisis since it reduces the availability of capital to the firms both internally and externally. The internal financing is reduced through the decline in profits of the firms and external financing is reduced by the low availability and high cost of capital1. Global financial crisis affects the propensity to invest through the worldwide depressing economic and market conditions and through risk aversion of firms2. Since all the business confidence indicators have shown negative projections, a worldwide uncertainty regarding the timing of recovery of crisis has emerged. Hence, many companies have implemented cost cutting programmes and reduction in further investments to avoid the worst situation. To boost the investments again, a gradual coming back of investor confidence is needed. In addition to these, the impact of global financial crisis on FDI flows differs based on the type of FDI flows3 . Market seeking FDI aimed at developed countries has been identified as the most directly affected types of FDI (UNCTAD, 2009). In the US automobile manufacturing industry, the three big car makers, General Motors, Ford and Chryslor, have started recently to manufacture special utility vehicles and large pickups which have been initially quite profitable than small cars. However, the 2003-08 energy crisis has resulted in a hike in prices of automotive fuels. This has discouraged the purchase of special utility vehicles and large pickups by the public. Hence, the profitability of these three started declining. Together with this, the industry wide credit crunch as well as the high-risk averse behaviour of these companies that emerged due to global financial crisis worsened the situation. Due to the decline the availability of consumer credit, the sales declined further. In addition, since the defaults on loans have been increasing, the banks and finance companies were extremely careful in approving car loans to consumers. Due to the fear of bankruptcy, the stock prices also fell (Sauvant, 2008). Consequently, by the second half of 2008, the big three car manufacturers have weakened. They announced cost cutting and capital spending programmes including divestments and job cuts before the bailout declared by the US government. They have decided to increase financing through the sale of assets. Thus, the US automobile manufacturing industry can be considered as a very good example of the negative impact of crisis on international business and investment (Plotkin and Fagan, 2009). 3. Policy Responses The national governments of developed nations have implemented many policy measures to deal with the negative effects of the crisis on international business and investment. These measures have been mainly intended to enhance the availability of credit throughout the economy. The controversial aspect about the policy response has been whether the plan of credit availability is entirely to national industry or to both national and foreign investors (Aaken and Kurtz, 2009). If the credit is entirely to national industry, then it will be a kind of discrimination against foreign investors. According to the new international investment treaties, this can be a violation of the commitment to give national treatment to foreign investors. However, according to the proponents of discrimination to foreign investors, these measures are needed in some cases to protect the security interests of a country. Hence, in contradiction to the pledge signed by G20 leaders on November 2008, 17 G20 members had implemented 47 protectionist trade and trade related measures (Gamberoni and New Farmer, 2009).In developed nations, these include mainly subsidies and other support packages. Estimates show that subsidies to auto industry have multiplied and are now about $48 billion (Gamberoni and New Farmer, 2009). In the case of US automobile manufacturing industry, on December 19, 2008, the US President George Bush approved loans of $17.4 billion to General Motors and Chrysler to avoid the collapse of US auto industry. The funds have been declared to be made available by the Emergency Economic Stabilization Act,20084.The newly selected Obama government was empowered to monitor the progress of automakers in meeting the conditions of loans. The new government had to decide whether to give financial assistance to them again or to force them to be bankrupt by repaying the loans. On February 18, 2009, General Motors and Chrysler approached US Government again for getting funds. The government decided to give the money again in order to avoid them becoming bankrupt. Immediately after this, both companies filed for Chapter 11 bankruptcy5 or restructuring, which resulted in job losses for millions of people. At this time, General Motors was a nationalized company with US Government (60 percent) and Canada Government (12.5 percent) having major shares and private share was only limited (Plotkin and Fagan, 2009). The measures taken by the US government have become widely unpopular (York, 2009). There are lot of public opinion against the bailout given to the three big makers. The argument against this is that if the three big carmakers were closed, then this will lead to the opening of new car manufacturing firms in US by foreign companies like Honda and Toyota. This can create new job opportunities .Thus, instead of artificially keeping the three big carmakers alive with no scope for improvement, it will be better to shut down these companies completely according to this view, based on the examples in other countries like South Korea and Japan. This will be beneficial to the economy also (CNBC, 2008; Schuman, 2008). The proponents of the bailout program however, argue that it is essential to protect the interests of the economy. Based on the estimates of job losses and GDP growth decline they argue that closing the three big carmakers will be extremely costly and harmful to the US economy (Plotkin and Fagan, 2009).However, the bailout program is actually a violation to the national treatment policy signed by G20 nations earlier. Though it is supposed to protect the security interests of the country, the three carmakers have not improved their performance after the bailout program also. Instead, they have opted for Chapter11 bankruptcy and are still facing crisis. Reports show that the crisis to the three companies occur mainly due to their improper management of products, time and money. In spite of the crises faced by these three, the Asian car companies that operate in US have not reported any such problems. They are reported to have sufficient credit and not having bankruptcy like the three big companies. Further, according to the US Consumer Reports 2006, all the 10 best cars in the country were built by Japanese Companies .In addition, in spite of the massive job losses created by the three big companies several new auto-manufacturing jobs were created by the foreign companies between 1993 and 2008(ABC News,2006). Based on the above reports and arguments it seems doubtful that the bailout program to the three big carmakers in the US automotive industry was very much necessary to protect the national interests. The crisis in the three big carmakers emerged due to their own improper business practices. Further, the discussion above shows that their performance was not always in favour of consumer interests. The reports provide indications of consumers favouring cars made by foreign companies than the three big carmakers in US. Hence, how far the bailout program and the protectionist measures have been really protecting national interests remains questionable. 4. Conclusion In this report, the impact of global financial crisis on various financial and political risks associated with conducting international business and FDI has been discussed. It shows that developed nation FDI flows are the most affected by the crisis .The impact however varies based on region, industry and type of FDI. The automotive industry is the most affected due to decline in FDI flows to date. The financial crisis affects the FDI flows through the capability and propensity of firms to invest. The different mechanisms in this regard are illustrated using US automotive industry as an example. This is a concrete example for the negative impact of the crisis on international business and FDI flows. The policy responses of the developed country national governments mainly were intended to protect domestic interests while discriminating against foreign investors. Many developed nations have implemented protectionist trade and trade related measures contradicting the pledge in G20 Summit. The example of US automotive industry questions the validity of the argument that protectionist measures are indeed necessary to protect the domestic interests. References ABC News (2006) Autos Consumer Reports Top Cars Picks All Japanese. March 2.2006 Aaken AV and Jurgen Kurtz(2009) . The Global Financial Crisis: Will State Emergency Measures Trigger International Investment Disputes?. Perspectives on topical foreign direct investment issues. No.3. March23 .US: the Vale Columbia Centre on Sustainable International Investment. CNBC(2008). No Auto Bailout: Investors May just say no Problem. November 19. Gamberoni E and Richard NewFarmer(2009)Trade Protection: Incipient but Worrisome Trends.Trade Notes. Number 37. The World Bank, March. Filippov S and Kálmán Kalotay(2009) Foreign Direct Investment in Times of Global Economic Crisis: Spotlight on New Europe, UNU-MERIT Working Paper Series 2009-021,The Netherlands, United Nations University. Financial Times (2008) US consumer confidence hits record low, 28 October 2008. International Monetary Fund (2008). World economic outlook update, rapidly weakening prospects call for new policy stimulus. November 6. Washington, DC. . International Monetary Fund. (2009). The Implications of the Financial Crisis for Low Income Countries. Washington: IMF Multimedia Services Division .March. Morgan Stanley (2008) Corporate profits: global recession intensifies downside risks, Global Economic Forum, 6 November . OECD (2008) .Investment News. Results of the Work of the OECD Investment Committee. November 2008. issue 8. Plotkin M E and David N. Fagan(2009). The Revised National Security Review Process for FDI in the US. Perspectives on topical foreign direct investment issues. No.2. January 7.US: the Vale Columbia Centre on Sustainable International Investment. Sauvant K P (2008). The FDI Recession has Begun, Columbia FDI Perspectives. Perspectives on topical foreign direct investment issues. No.1. November 22. US: the Vale Columbia Center on Sustainable International Investment. Schuman M( 2008).Why Detroit is not too big to fail?. Time Inc.. Retrieved 2008-12-23.  Stiglitz JE (2008). Towards new global economy compact: principle for addressing the current global financial crisis. A communication to the United Nations General Assembly. New York. United Nations. UNCTAD (1998). World Investment Report 1998: Trends and Determinants . New York and Geneva: United Nations. United Nations publication. UNCTAD (2008). World Investment Prospects Survey 2008–2010. New York and Geneva:United Nations publication. UNCTAD (2009). Assessing the impact of the current financial and economic crisis on global FDI flows: An update. April 2009. Advance unedited version, distributed at UNCTAD's Investment, Enterprise and Development Commission (first session), 4–8 May. New York and Geneva: United Nations. United Nations (2009). Word Economic Situation and Prospects 2009. New York and Geneva: United Nations publication. January. World Bank (2009). Global Economic Prospects 2009, Commodities at the Cross Road. Washington, DC. January. World Economic Survey (2008). World Economic Climate. April 2008. Munich. Germany: German Ifo Institute for Economic Research York B (2009). Will the GM Bailout be Obama’s Tipping Point. Washington Examiner. June 17.2009. Read More