International Business Theories. Outward Foreign Direct Investment from China - Essay Example

?Assessment task 2: Individual Essay Essay Topic In recent time, outward Foreign Direct investment has been significantly increased from China and India. Discuss the factors responsible for such a growth. Do you think International business theories (OLI and IDP) adequately explain the reasons for outward Foreign Direct investment? Introduction It is said that no country is an island. The fact behind this saying is made evident in several theories including economic theories. For instance it is out of this realization that several countries and regions of this world are forming organizations and unions that seek to bridge the borders that hinder the easy flow of investment from one country to the other; allowing that investors of other nations have free access to do business and trade in other countries. A number of such organizations and associations of the world that foster free movement of investment for economic purposes can be mentioned. Some of these include the Gulf Countries Cooperation, Middle East and North African Organization, European Union and Economic Community of West African States. The freedom for other foreigners and foreign businesses to do business and invest in other countries bring to fore the discussion on foreign investment. Foreign investment comes in different forms, depending on what is involved in the investment. The differences in investment packages has over the years resulted in economic terms such as foreign indirect investment, outward foreign direct investment and inward foreign direct investment. Today, economic scholars seem more comfortable, discussing the phenomenon of flow of investment from one country to another as just foreign direct investment. On the whole, Graham and Spaulding (2005) give a classical definition to foreign direct investment as “a company from one country making a physical investment into building a factory in another country.” This was indeed the definition that was formerly associated with the term foreign direct investment. Graham and Spaulding (2005) explain that when the investment was in the form of portfolio investment, it was considered as indirect investment. As mentioned earlier, today, rapid growth and change in global investment patterns have resulted in a situation whereby economic scholars are not very particular about the kind of investment made but give generalized definition to foreign direct investment. To this end, Graham and Spaulding (2005) explain that “the definition has been broadened to include the acquisition of a lasting management interest in a company or enterprise outside the investing firm’s home country.” There is no denying the fact that China and India remain some of the world’s largest attracters of foreign direct investment; specifically outward foreign direct investment. This paper is therefore dedicated to researching into the general trend associated with foreign direct investment from those two countries in relation to how international business theories adequately explain the reasons for outwards foreign direct investment in those two countries. Overview of outward Foreign Direct Investment from China By definition, China is one of the most celebrated countries that enjoy “a type of investment that involves the injection of foreign funds into an enterprise that operates in a different country of origin from the investor” (Economic Watch, 2011). Simply put, China enjoys massive foreign direct investment. Without saying the least, recent survey conducted by the United Nations has proved that investors rank China as the world’s first most important destinations for foreign direct investment over the 2010 to 2012 period (Asia Briefing, 2011). The implication of this top spot is that China enjoys and benefits from outward foreign direct investment like no other nation in the world. Indeed the success of China as the top ranked dates far back as Shaukat and Wei (2005) notes that “China is by far the largest recipient, and in 2004 surpassed the USA as host destination. It has consequently attracted an increasing attention from multinational businesses.” China’s success story today is attributed to an opening up policy the country adapted in the late 1970s to its economic trading format. Quantitatively, China attracted US$ 53,510 million in 2003 and US$ 60,600 million in 2004. Percentage wise, the percentage of Gross Fixed Capital Formation was fueled by 8.2% of FDI flows and 34.9% of FDI stocks as a percentage of GDP in 2004 (WTO, 2005 and Asian Development Outlook2005 in Keshava, 2006). Today, the rates and values are even larger. In the World Economic Prospects to 2011 released by the Economic Intelligence Unit (2007) it is reported that “China will remain in 2007-11 by far the main recipient of FDI flows, with almost 6% of the global total and 16% of projected inflows into emerging markets.” Close behind China in all these outward foreign direct investments is India. India has also over the years performed tremendously well in her outward foreign direct investment trend. This is because the same survey by the United Nations that placed China first among the most prospective countries to receive foreign direct investment placed India second (Asia Briefing, 2011). What was most impressive was that India was able to overtake several other economic giants including the United States and Brazil from previous surveys. India’s performance has been sustained over the years. For instance Quantitatively, India attracted US$3420 million in 2003 and 4374 million US$ in 2004. This represent high rise in percentage change. On the input of foreign direct investment on general economic performance of India, percentage the percentage of Gross Fixed Capital Formation was fueled by 3.4% of FDI flows and 5.9% of FDI stocks as a percentage of GDP in 2004 (WTO, 2005 and Asian Development Outlook2005 in Keshava, 2006). Two interesting patterns prevail with the outward foreign direct investment of China and India. In the first place, Asia as an economic community continues to ensure the approval of world investors as a preferred destination and this dominance of Asia have continued for years. The second pattern is that the rate of investment has increased over the years. The graph below is a survey from the UNCTAD that confirms these fact and interesting trends. Overview of International business theories related to Foreign Direct Investment OLI Paradigm The OLI paradigm is very paramount in the discussion of foreign direct investment. Propounded by evolved by John Dunning, emeritus professor at the Rutgers University (United States) and University of Reading (United Kingdom), the OLI paradigm combines three major theories of foreign direct investment. These combined theories are Ownership Advantages (or FSA - Firm Specific Advantages), Location Advantages (or Country Specific Advantages - CSA) and Internalization Advantages (IA). Because of the combination of different theories, the OLI paradigm is commonly referred to as the eclectic theory of foreign direct investment. Under the owner advantage model, John Dunning establishes that “since merely abroad firms have to pay "costs of foreignness", they must have other methods to earn either higher revenues or have lower costs in order to able to stay in business” (Invests and Income, 2009). Without such methods in place, the foreign investing companies may not succeed because they will not be in a position to compete with local industries. Second under this theory which is local advantage, John Dunning touches on the preparedness of local markets to create local advantages that will make their markets preferred markets for investors. This is because in the absence of a local advantage to grow, investor would only be cultivating ‘rice on rocks’. Finally, Internalization Advantages is mentioned as another component of the OLI paradigm. With this, Harvey (2011) explains that internalization advantage constitutes “conditions that allow a corporation to exploit the failure of an arm's length market to deliver goods or services efficiently.” To this effect, investing companies are enshrined to take advantage of the pitfalls of prevailing companies. Later in the discussion, it shall be argued if the markets in China and India present all the three grounds that attract foreign direct investment. Investment Development Path Theory Like the OLI model, the IDP was also propounded by John Dunning (1985). The full meaning of IDP is investment development path. As the name implies, the investment development path is a procedural and analytical assessment of the implementation of specific investment stages to be followed by countries in the foreign direct investment pursuit. To this end, Minxiong LIAO (2011) states that “according to the IDP theory of Dunning, a country which is net recipient of foreign direct investment will become a net source of FDI by passing five stages.” Over the years, the investment development path, which provides a framework to understand the dynamic interaction between foreign direct investment (FDI) and economic development have seen tremendous revision and changes (Narula and Guimon, 2010). The different revisions that have been attached to the investment development path focus on current changing trend in the global economic environment. Studies by Narula and Guimon (2010) “argues that studies based on the IDP should adopt a broader perspective, encompassing the idiosyncratic economic structure of countries as well as the heterogeneous nature of FDI.” By and large, this argument has generally being accepted and adopted by economic scholars and gurus. These changes have however not changed the core concept based on which the theory was originally propounded by its founders. What has rather happened is that there has been the enlargement of the basis on which assessment of individual nations to the adherence of the investment development path is measure. For instance it is advocated the assessment encompasses an understanding of the “complex forces and interactions that determine the turning points in a country’s IDP, and to more explicitly acknowledge the role of historical, social and political circumstances in hindering or promoting FDI” (Narula and Guimon, 2010). How International business theories (OLI and IDP) explain reasons for outward FDI of China and India The tremendous performance of China and India with regards to their foreign direct investments has been explained by different reviewers and researchers. On the whole there are several factors that have attributed to the successes of these two countries in the attraction of foreign direct investment. Recent economic research work have however been dedicated to the use of the OLI paradigm and the investment development path theory to explain the successes. On the Investment Development Path, research has shown that China has climbed steadily on the ladder; reaching the third out of fifth stage. The authenticity of this position have been established by many economists including Marton and McCarthy (2009) who used annual data for the period 1979 to 2005 and a fourth order single variable polynomial function instituted. Their findings are published in the Journal of Asia Business Studies. At the third stage, the growth of outward Foreign Direct Investment flow is said to begin to approach the rhythm of inward flow (Minxiong LIAO, 2011). The question for argument therefore remains whether or not China and India have really showed via their economic undertakings that their outward foreign direct investment flow is beginning to flow inwards. In China for instance, it is said that the functionality of foreign direct investment is not centralized. Rather, it is confined to non-coastal regional companies. As far as companies in the coastal regions are concerned, mezzo-economic basis, which is a central component of the IDP has shown that companies “have been involved in a certain reconfiguration of OLI advantages which has incited them significantly to invest abroad” (Minxiong LIAO, 2011) it must not be forgotten that companies in the coastal region have a concentration of market-oriented companies. On the part of India, there have been several researches to test the IDP hypothesis of the country in relation to the country’s recent surge in outward foreign direct investment. One of the researches concluded by Brennan and Verma (2009) and published in the International Journal of Emerging Markets show that “India’s sharp rise in investment since 1991 has followed the gross domestic product driven development and that its NOIP fails to fails to exactly match the stylized IDP model.” Indeed the comparison between the situation in China and India makes it very difficult to firmly conclude that the investment development path may be sorely responsible or accountable for the upsurge of outward direct foreign investment from the two countries. Even though to a large extent, there are evidence of adherence of the investment development path by both countries; especially China, India in particular attributes most of her developments over the years to other models and factors other than religious adherence to the path. Evidence of this is seen when the research by Brennan and Verma (2009) conclude that India has paid much attention to the growth of her gross domestic product as a way of attracting foreign direct investment rather than substantive following of the IDP. In a recent diplomatic visit, “Nirupama Rao, India’s new ambassador to Washington, says that India is open for business” (Feigenbaum, 2011). It is true to say that China is also ready for a similar business blast. The question to be asked therefore will be, ‘why will investors in America and other parts of the world want to continue doing business with China and India?’ It has been noticed that the OLI paradigm tries to investigate explanations to this question. Trying to explain reasons for the success of outward Foreign Direct Investment from China and India using the OLI paradigm would demand that all three components of the theory are discussed. The components thus are ownership advantages, location advantages and Internalization Advantages. Starting with location advantage, it is reported that “Although a lot of interest among foreign investors in China emerged after 1979, large FDI inflows did not occur in the initial period because of the poor infrastructure” (OECD, 2000). This point stresses the importance of location advantage to the attraction of outward direct foreign investment. Under political advantage, a survey conducted by Walder (2002) and published in the American Sociological Review indicate that the political decisions taken by a particular country affects foreign investor decisions in a number of ways. Using China as a case study, the author points to the impact of employment wages on foreign investor decision. Taxes and political instability are all identified as political decisions that have influenced the foreign investor electability of China and India. The table below compares the various taxes of charged in China and India in relation to other countries who also perform relatively well in foreign direct investment but fall below China and India in rank (China and India are ranked first and second respectively). The tax margin will help in drawing conclusion on whether or not political advantage has any influence on outward foreign direct investment as propounded in the OLI paradigm. Country Corporate tax in % Rank among the 10 countries (higher the better) China India Brazil United States France Germany Spain Italy South Africa United Kingdom 25 30-40 34 15-35 33.33 30-33 30 31.4 28 28 10th 1st 3rd 2nd 4th 5th 7th 6th 8th 8th Source: Worldwide Tax (2011) The table does not give a clear cut confirmation to the fact that corporate tax as a political decision influences the outward foreign direct investment to a country. This is said with India, Brazil and the United States in mind. This is because the three countries India, Brazil and United States are ranked by the UNCTAD as having the second, third and fourth best foreign direct investment respectively. However, these countries are among the first three countries with the highest corporate taxes. China on the other hand proofs confirmatory to the OLI paradigm on political advantage as it has the lowest corporate tax among the ten countries discussed. It could be concluded therefore that taxes are not stronger variables based on which foreign investors may make decisions on countries to invest in as far as political advantage is concerned. Perhaps, these investors consider economic and socio-cultural advantages rather than political advantages when looking at the location advantage of China and India. This is because both economically and socio-culturally, China and India have very large labor and customer base that makes business in any sector very viable. On internalization advantages, research conducted with China and India as delimitations and scope have revealed that the theory does not apply in all aspects of industry. For instance in the construction industry, foreign investors from both countries attribute the achievement of internalized advantages to other external factors. This realization was brought to light in a survey conducted by Low Sui Phenga and Jiang Hongbina (2006) and published in the Construction Management and Economics Journal. Below are some of the facts that were drawn from the survey with regards to internalization advantage. (1) A firm is likely to perform well in terms of its ownership advantages when it has a significant advantage on its reputation and its accessibility to resources when compared with local contractors; (2) A firm may be expected to achieve better results in terms of its locational advantages if the large number of competitors from China in the host countries becomes its most important consideration; and (3) A firm that conscientiously avoids or reduces information search and business negotiation costs would tend to perform well in terms of its internalization advantages. These results extends the argument as to whether or not the internalization advantage is very central in the decision that foreign investors take in deciding which countries to invest in. Finally, China and India place a lot of ownership advantage on cheap labor and raw materials for manufacturing companies. This makes it possible for investing foreign companies to invest and still be sure that they shall enjoy a balanced ownership advantage. Adele (2011) points out that “ownership advantages are those that enable particular firms to grow and diversify more successfully than others at home or abroad.” Once this advantage is ensured, companies it “gives rise to higher revenues and/or lower costs that can offset the costs of operating at a distance in an abroad location” (Invests and Income, 2009). In the long run, companies are assured that even when they seek for such low cost, they will still have potent markets to make profits. It is valid therefore to associate the ownership advantage to business investing from China and India. 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