Using Examples and Case Studies Discuss and Evaluate the Impacts of Foreign Direct Investment on Host Country Economies.
Word count 2. 269words Using examples and case studies discuss and evaluate the impacts of foreign direct investment on host country economies. Introduction Foreign Direct Investments are long term capital holdings directly invested in one country by another country. These foreign direct investments can be either outwards or inwards. The outward foreign direct investment is also referred to as investments abroad and is usually supported by the government against various types of risks associated with the investment1.
It is also able to enjoy various types of incentives such as tax incentives. These are usually the investments invested by the country in to a foreign country2. The inward foreign direct investments are the investments invested by a foreign country in to the country1. Foreign direct investments can also be in the form of mergers and acquisitions, where a firm in a foreign country acquires a firm in the host country and obtains the power to make strategic decisions concerning the firm. Foreign direct investments usually result into the making of multinational corporations.
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There are various reasons why people invest in foreign countries: They do this to expand and strengthen the markets that are already in existence or to explore and exploit virgin markets with incredible potential for profits. Some multinational corporations transfer strategic assets and capital in order to optimize the market opportunities that are available in order to improve their operational efficiencies and to enjoy economies of scale3. Foreign direct investments have been viewed as a tool of driving economic growth and development in countries especially the less developed nations.
It helps such countries build up and increase their physical and operating capital, create opportunities of employment, increase the capacity of production, globalize the local economy by introducing new products and skills in to the local market through transference of technology and technical know how4. In essence the inflow of direct foreign investment in to a country is very important as it determines the Balance of Trade of a country2, which in turn is seen to be a very important indicator of the economic condition of a country.
There have been different views with regard to the impacts of foreign direct investments to the host countries. There are those who view it positively in term using the case of the Greenfield investment and there are those who view it negatively and stipulate that investors aim is to obtain cheap resources in the said countries and sell their final products expensively to incur huge profit margins4. 1. Cavusgil, S T, et al ‘International Business: Strategy, Management, and the New Realities’, Prentice Hall, 2008. 2. Morrison, J ‘The International Business Environment’, Palgrave, 2002. 3. Rugman, A M and S.
Collinson, ‘International Business’, 4th Edition, Prentice Hall, 2006. 4. Hailu, Zenegnaw Abiy. 2010. “Impact of Foreign Direct Investment on Trade of African Countries. ” International Journal of Economics & Finance 2, no. 3: 122-133. Business Source Complete, EBSCOhost (accessed March 21, 2011). The impacts of Foreign Direct Investments For most developing countries, the most important source of external capital is usually in terms of the foreign direct investments. Over the past decade foreign direct investments have drastically increased in developing nations by over 60 percent5.
The 2008 global economic and financial crisis saw global foreign direct investment inflows drop from 1979 billion dollars in 2007 to 1697 billion dollars in 2008 and a further decline in 2009 by 44%6. With the world economy at a recovery stage, it is possible that there could be increased foreign investments. There have been two schools of thought with regard to the effects of foreign investments to the host countries. One supports the investments while another looks at the negative effects of these investments to the host country.
The neoliberal economists advocate for the foreign direct investments arguing that free capital flows ensures economic and operational efficiencies. They also argue that it the capital can be able to get the greatest return across borders as it is able to be invested in the best possible venture with the optimum costs and returns. This, they argue speeds economic growth and development in the location of the investment. They also argue that in flow of capital into a country has the tendency of making the government of that country more accountable with good governance practices5.
Athukorala7 in her research was able to find that foreign direct investment in Sri Lanka had a positive impact on the overall growth of the country. It has been noted that FDI facilitates the transfer of technology from advanced countries to those that don’t have the technology, and this greatly improves the economic welfare of the host country5. An example is the transfer of the use of credit cards and ATMs. Most banks in the developing countries as recently as 2005 were still using transaction books when a customer is withdrawing or depositing money.
With international banks such as Barclays pitching camp in these economies and with it introducing the new technology of credit and debit cards, the other indigenous banks also adopted the new technology in a bid to remain competitive in a changing market. Another positive effect of these investments is the contribution it makes with regard to the development of human capital and an increase in the host country’s tax revenue5. These greatly help in enhancing development within a country. They FDI also increase the amount of investment and consumption goods within a country.
This sets the pace for development since most of these goods that multinational corporations produce are usually for export purposes. Increased export performance also helps in mobilization of the labor and accumulation of capital within the host country4. This greatly improves the trading position of the country in question by improving its Balance of Trade statement. Increased exports not only increase the productivity of a country but also provide a country with foreign exchange which in turn increases imported capital to assist in the development of a country4. . Ibid 5. Zilinske, Asta. “NEGATIVE AND POSITIVE EFFECTS OF FOREIGN DIRECT INVESTMENT. ” Economics & Management (August 2010): 332-336. Business Source Complete, EBSCOhost (accessed March 21, 2011). 6. World Investment Report, www. unctad. org/en/docs/wir2009_en. pdf, 2009, (accessed March 21, 2011). 7. Athukorala, Wasantha, ‘The impact of foreign Direct investment for Economic Growth: A case study in Sri Lanka’, 9th International Conference on Sri Lanka Studies, 092, 2003.
Foreign direct investments, unlike loans and grants given to a country, are more stable and resilient especially during economic down turns8. Changes in interest rates greatly affect the loans and grants given to a country for developments especially during economic crises. This negates the level of development achieved due to the high debt that has to be cleared. Foreign direct investments are relatively inelastic with respect to the interest rates which make them more stable even during economic down turns. Companies such Wal Mart were able to hold their ground through out the recession.
In fact there was an increased sale of ready made garments from Bangladesh, defying the global trend of reduced consumption. This has come to be known as the Wal Mart effect9. This though is not always the case as witnessed in the 2008 economic recession where some multinational companies closed down business in some areas due to the heavy operating costs. The Keynesian school of thought argues contrary to the neo liberals. They stipulate that the benefits accrued to one country due to effects of foreign direct investments may be different with the benefits accrued by another country5.
They believe that free market is not self sufficient and there is bound to be market failures since the real life market place does not exhibit the perfect competitive competition characteristic which the neo liberals used to make their conclusions. They insist that for good returns to accrue to the host country then government intervention would be required10. Government intervention in terms of subsidies and tax cut incentives, then other FDI investors will be attracted to the host country. The government can also be able to protect the local industries excessive competition from the FDI.
A good example of a successful FDI with government protection to the locals is the China experience. The Chinese government has been able to attract foreign direct investments when it was required and put on restrictions when the effects of the foreign capital inflows reached its peak11. This has seen it grow from a developing economy in to an emerging economy and will in the near future be declared a fully fledged developed economy. This case though is usually very rare for the other developing countries that are hosts due to the lack of enough bargaining power of what restrictions to put in place and what not.
Most of the foreign investors are from powerful developed nations and so have the bargaining advantage. Most of these countries attract foreign investment through incentives such as tax cuts which could lead to a reduction in government revenue which would otherwise be used for development purposes in the country5. This results to inefficiencies in the total welfare of the host country and may in the long run end up making the host country unattractive for foreign investments due to lack of well developed infrastructures. . Ibid 8. Dicken, P, ‘Global Shift: Mapping the Changing Contours of the World Economy’, 6th Edition, Sage, 2007. 9. Taslim, M A, ‘Off the Mark, The Wal-Mart Effect’, bdnews24, available at http://opinion. bdnews24. com/2010/03/23/off-the-mark-the-wal-mart-effect/ ,2010, (accessed March 21, 2011). 10. Kazlauskaite, R, & Buciuniene, S ‘The Role of Human Resources and their Management in the Establishment of Sustainable Competitive Advantage’, Inzinerine Ekonomika-Engineering Economics, 5, 2008, pp. 78-84 11.
Backman, A & Wu, X, ‘Foreign Direct Investment in China’s Power Sector: Trends, Benefits and Barriers’, Energy Policy, Elsevier, 27,12, 1999, pp. 695-711 It has also been found that the Greenfield investments have greater effects in terms of development to the host country than investments through mergers and acqusition6. In the recent past there have been increased cases of mergers and acquisition of companies rather than Greenfield investment. In 2004 mergers and acquisition activities had increased by 40% since 2000, and were being projected to continue growing at an increasing rate12. ith the globalization of the economy, Foreign direct investments have continually increased in various countries turning the world economy into a common market place. Leitao13 in his studies of the effects of foreign direct investments to the Canadian economy found that the openness of the Canadian economy to the foreign investors has seen its market size and per capita income rise steadily. The economy has also been able to attain concrete stability due to developments that have been as a result of the revenue gotten in form of tax from these investments.
He also concluded in his study that there is a positive high correlation between an increase in foreign direct investment in the Canadian economy to an increase in the level of wage rates and employment rates in that host country. This greatly shows that foreign direct investments increases employment levels in the host countries thereby rising the living standards of the nations of that country. Letto-Gilles14 points out the importance of foreign direct investment in breaking the vicious cycle of underdevelopment in the less developed countries.
These investments break the cycle of poverty and underdevelopment by complementing the host countries’ resources and increasing the amount of savings within the economy that can be used for investment purposes. An increase in the nation income of an economy largely relies on the amount of capital inflows and how its demand is elastic. In addition the spillovers to the locals resulting from technology and technical know how brought in by the investments may result to a forward shift in the productive capacity of a country7.
This implies that under a competitive market, foreign direct investments increase efficiency and economic growth in a country. It also increases the amount of output in the host country which in turn raises the wage level of workers due to the increased demand for labor. This in turn ensures equal distribution in income and a raise in the standard of living of the host country inhabitants resulting to increased economic and social welfare of the host country.
From this point of view it is truly imperative that the presence of multinational corporations in any country would most likely result to overall wellness of the country. 6. Ibid 7. Ibid 12. McDonald Jarrod, Coulthard Max & De Lange Paul, ‘Planning for a successful Merger or acquisition: Lessons from an Australian Study’, Journal of Global Business and Technology, 1,2, 2005, pp. 2-5 13. Leitao, N ‘Foreign Direct Investment: The Canadian Experience’, International Journal of Economics and Finance 2, no. 4, November 1, 2010, pp. 82-88. ttp://www. proquest. com/ (accessed March 21, 2011). 14. Ietto-Giles, G. ‘Transnational Corporations: Fragmentation Amidst Integration’, Routledge, London, 2002. The OECD-ILO conference of 2008 report15 points out that in 2006, 3% of the global workforce were working in foreign multinational enterprises which had invested in the respective countries. This represents 73 million workers which is quite a significant number. Another school of thought in the analysis of the effects of FDI to the host country is the dependency theory5.
They stipulate that the foreign direct investments in the long run impede the growth and development of the host economies. This is mainly because the benefits accrued to the host countries do not lead to accumulated wealth of the host country. Compared to the natural resources and the cheap labor that is available in most of these recipient countries, the only country that would benefit is the foreign investor nation since they would be able to not only exploit the abundant resources and cheap labor but they will also transfer it to their countries leaving the host ountry poorer than it was before the investment. This leaves the under developed host nation dependant on the foreign investor nation5. Therefore even though foreign direct investments benefit in the development of a host country, proper measures need to be put in place by the host nation to ensure that the benefits that accrues to it are essential sustainable and long lasting. Conclusion From the above discussion, it can be noted that foreign direct investments are very important for the development of any nation.
The benefits that comes along with this investments such as increased employment rates, increased wage rates, increased national productivity of the host nation, improved standards of living among others are very important for the over all well being and growth of the economy. With the globalization of the world economy, foreign direct investments are some of the things that can not be avoided by nations because it is part of the engine in the running of most economies.
In order for host economies to harvest the full benefits of these investments without hurting their economy, well put and thought strategies need to put in place especially the government to ensure proper operational efficiencies of the investments that will result to increased benefits and positive externalities to the host country. The use of tax cuts as incentives for foreign investment in a country is not the best strategy due the result it will have of reduced revenue available to the local government for development purposes.
Incentives should instead include attractive policies and terms to both the domestic investors and the foreign investors. All said and done it is beyond a doubt that with proper policies in place, foreign direct investments are very important for the development, growth and general well being of any host country. 5. Ibid 15. OECD-ILO Conference, ‘The Impact of foreign Direct Investment on Wages and Working Conditions’ available at http://www. oecd. org/els, 2008, (accessed March 21, 2011). BIBLIOGRAPHY ‘World Investment Report’ ,available at www. unctad. org/en/docs/wir2009_en. df. 2009, (accessed March 21, 2011) Athukorala, W, The impact of foreign Direct investment for Economic Growth: A case study in Sri Lanka. 9th International Conference on Sri Lanka Studies, 092, 2003. Backman, A. ; Wu, X. , ‘Foreign Direct Investment in China’s Power Sector: Trends, Benefits and Barriers’. Energy Policy, Elsevier, 27,12, 1999, pp. 695-711 Cavusgil, S. T. , et al, ‘International Business: Strategy, Management, and the New Realities’, Prentice Hall, 2008 Dicken, P. , ‘Global Shift: Mapping the Changing Contours of the World Economy’, 6th Edition, Sage, 2007.
Hailu, Z A. “Impact of Foreign Direct Investment on Trade of African Countries. ” International Journal of Economics ; Finance 2, no. 3: 122-133. Business Source Complete, EBSCOhost , 2010,(accessed March 21, 2011). Ietto-Giles, G ‘Transnational Corporations: Fragmentation Amidst Integration’, Routledge, London, 2002. Kazlauskaite, R. , ; Buciuniene S. , ‘The Role of Human Resources and their Management in the Establishment of Sustainable Competitive Advantage’. Inzinerine Ekonomika-Engineering Economics, 5, 2008, pp. 8-84 Leitao, N, ‘Foreign Direct Investment: The Canadian Experience’. International Journal of Economics and Finance 2, no. 4, November 1, 2010, pp. 82-88. http://www. proquest. com/ (accessed March 21, 2011). McDonald J, Coulthard M ; De Lange, P, Planning for a successful Merger or acquisition: Lessons from an Australian Study, Journal of Global Business and Technology, 1,2, 2005, pp. 2-5 Morrison, J. ‘The International Business Environment’, Palgrave, 2002. OECD-ILO Conference, 2008, ‘The Impact of foreign Direct Investment on Wages and Working Conditions’ available at http://www. ecd. org/els, 2008, (accessed March 21, 2011). Rugman, A M. , and S. Collinson ‘International Business’, 4th Edition, Prentice Hall, 2006. Taslim, M. A, Off the Mark, The Wal-Mart Effect, bdnews24, available at http://opinion. bdnews24. com/2010/03/23/off-the-mark-the-wal-mart-effect/ ,2010, (accessed March 21, 2011). Zilinske, A. “NEGATIVE AND POSITIVE EFFECTS OF FOREIGN DIRECT INVESTMENT. ” Economics ; Management (August 2010): 332-336. Business Source Complete, EBSCOhost (accessed March 21, 2011).