Necessary Considerations of a Transnational Company - Term Paper Example

? Foreign Direct Investment can have both positive and negative impacts on both the host and home country. University Date of Submission Foreign Direct Investment can have both positive and negative impacts on both the host and home country. Foreign Direct Investment is generally defined as investment of funds in a company of one country (host country), by a company of another country (home/investing/source country). A few years back, these funds were defined as direct investments in the form of buildings, machinery and equipment, but now with the changed and increased role of technology; the definition has been broadened to include investments in the form of acquisitions of management interest in an entity outside the investor’s home country. These can be in the form of outright acquisition of a firm or a joint venture or construction of a facility. It can also include an association with a local company to gain rights for attendant input of technology (P. Graham and R. Barry Spaulding, n.d.). “It was twenty years ago that the late Stephen Hymer wrote his seminal thesis on Foreign Direct Investment (FDI) and multinational enterprises (MNEs). Since then the literature on these subjects has increased substantially and taken different directions, placing the multinational firms at the crossroads of many disciplines and of many debates as well”. (A.L. Calvet, p.43) Foreign direct investments of larger magnitude have deep effects on the economy of both the entities. Here with the help of real examples, it will be discussed how these effects can be positive as well as negative. As for this purpose we are focusing on both the host and home countries separately, so the advantages and disadvantages will be considered separately as well. But for the record it must be highlighted that these advantages and disadvantages are not fixed but, on the contrary, they are relative to both the host and home countries and their collective policies. HOST COUNTRY: ADVANTAGES The biggest advantage that a host company can derive from foreign domestic investment (FDI) is the globalization of its operations. Many large countries are focusing on it, e.g. China is the largest FDI host in the developing world. To compensate for the advantages that could be derived from these foreign investments, China has undergone significant changes with respect to its policies related to the FDIs. Until the mid 1980s FDIs were focusing on the construction sector involving the construction of hotels and apartments in the tourism and service industry. In 1986 China issued a new policy which encouraged the FDI into various other technically advanced sectors. These included manufacturing enterprises whose main focus was export and some basic industries such as new materials and agricultural. After these changes approximately 60% of the total foreign investments were part of the manufacturing sector of China (Yingqi Wei, Xiaming Liu, 2001). But from 1994 onwards, the investment boom in China seemed to go downhill. The statistics for foreign direct investments in terms of projects and contractual agreements turned negative and the growth rate of realized FDI also fell. The trend continued till 1999. But then in 2000 China recovered and since then it has closely monitored the inflows and outflows related to the foreign direct investments into its entities (Yingqi Wei, V. N. Balasubramanyam, 2004). Similarly Chile has been a FDI friendly-nation in Latin America. An agency of United Nations in Chile named The Economic Commission for Latin America and The Caribbean (Eclac) reported an inflow of USD 8.03 billion making Chile the third largest foreign direct investment in South America. FDI in Chile is mostly focused in the sector of mining. A survey by UNCTAD has shown that inward FDI in the developing countries has risen from $481 billion in 1998 to $636 billion in 2006. Among China and Chile other countries benefiting from foreign direct investments include Singapore, Philippines and India in Asia and other countries of Latin America like Argentina, Brazil, Colombia, Ecuador, Mexico, Peru and Venezuela. The next most important reason for the host companies to allow foreign direct investments into its entities is the possibility of attaining modern technology, which may be they are not able to produce by themselves. There can be a lot of reasons, may be they lack the funds in general or may be it’s the expertise or knowledge due to limited educational resources. By inviting various multinational corporations they are inviting the opportunity of technical advancements as well. Along with these advancements, the gains can be in the form of realization of external economies. Generally these benefits are referred to as "spillovers". This term emphasizes on the significance of the manner in which the influence is passed on (Magnus Blostrom, 1991). This is one of the main reasons of the host countries to allow foreign investments. Because of the existence of foreign interest in the market competition is most probably increased in the host countries, which in turns forces the inefficient companies of that market to focus and improve their own resources. Multinational companies that invest in the host countries can also lead trainings for the human resources of their controlling interests in the host companies. These trainings than in return can be available to the market in general, leading the whole market to derive advantage from these trainings. In practice, this happens because of the labor turnover that leads to the transference of the human resources from the foreign firms to the domestic firms. In some cases, the domestic firms just start focusing on their productivity to match those of the foreign firms. Several studies have revealed that there are more training conducted by foreign firms than the domestic ones in the market where the competition lies, leading to better trained employees of the foreign firms comparatively to those of the domestic ones (Gonclaves, 1986). The major impact of FDI in the host countries is not directly related to the investing companies. It is more likely the result of the host countries trying to attract investing countries for investments. This is actually attained by designing policies that will enhance the human resources of the host companies. Once the investing companies are attracted they are further enhanced through trainings. Like in China, the human resources are more educated because of its focus on mandatory education. This leads to higher foreign direct investors for China than any other country in Asia. One of the many positive impacts of Foreign Development Investment in the host countries is the poverty reduction. When a home country invests in a developing host country, its investment leads to strengthening the economy of that host country. It leads to investments in assets and increased job opportunities. According to a press release, in 1997 the 100 largest non-financial MNC’s (Multinational Companies) employed six million people in their foreign affiliates. (UNCTAD, 1999). DISADVANTAGES: After World War II, many colonized countries gained independence, and to them the foreign direct investors were just another form of colonialism. So many governments of those countries regained control of all their assets and operations which were controlled by foreign elements at that time, leading to all the factories and mines being run as nationalized organizations. Thus the fact arises that it is always the duty of the host country to bind the extent to which an investing country can invest in its resources so that it does not feel threatened by its existence. It will be its responsibility to govern that the investing company follows its environmental control and the rules and regulations, which are set to oversee the social and political environment of the country. In some countries it has been seen that they are more partial towards the Greenfields investments as compared to the general mergers and acquisitions (M&As) between its entities and the investing companies. In the eyes of many authors it may be justifiable as well. As Moosa ,I, A, 2002 argued in his book that M&As are not as beneficial as the Greenfield foreign direct investments because their productivity yield is not competitive and mainly they may threaten the job securities of the human resources of the acquired entities as well as the existence of some beneficial activities. Furthermore he argues that if mergers take place in sectors like media they may seem like a risk to the culture of the host country too. Krugman (1998) notes that sometimes the investing companies take advantage of a crisis to gain control thus he asks: “Is the transfer of control that is associated with foreign ownership appropriate under these circumstances? Those is, loosely speaking, are foreign corporations taking over control of domestic enterprises because they have special competence, and can run them better, or simply because they have cash and the locals do not? . . . Does the fire sale of domestic firms and their assets represent a burden to the afflicted countries, over and above the cost of the crisis itself?(Paul Krugman, 1998)” Following these ideas, India has recently announced some new rules and regulations, concerning foreign direct investment in the pharmaceutical companies. A few of them include the requirement of approval from, Reserve Bank of India for up to 100% of FDI related to Greenfield investment, and up to 100% of the FDI for Brownfield investment in any of the pharmaceutical companies from the government under the government approval route. Moreover under the new rules, Foreign Investment Promotion Board’s approval will be required for any merger and acquisition. Foreign direct investments may give rise to high travel and communication expenses if there are any communication gaps between the host and home countries. These gaps can be due to the difference in origins and lower educational expertise of the host country. This can lead to difficulties in the hassle free prospect of foreign direct investment. If there is monopoly in the investment preferences of the foreign direct investment, it can also give rise to dependencies on the behalf of the host country like in the Czech Republic which are under the process of discovering new options that could attract value added services like research and development in a few specified areas as biotechnology. Such focus on only a few specified industries can definitely lead to dependencies. HOME COUNTRIES: ADVANTAGES “Location economies are those that arise form performing a value creation activity in the optimal location for that activity, wherever in the world that might be (transportation costs and trade barriers permitted).Location as a value creation activity in the optimal location for that activity can have one of two effects. It can (i) enable a company to differentiate its product offering and charge a premium price or (ii) lower the costs of value creation helping the company achieve a low cost position (Tobias Kannen, 2007, p.2)”. These are two basic elements of foreign investment for all the investing companies. And these are always the focus of advantages that could be drawn form any foreign investment. Research and Development is crucial for the investing companies, because unless the whole prospect has not been evaluated properly, it can not be ascertained as to how ownership-specific advantages can be achieved by operating in the foreign countries (Caves 1982). The stronger an investor company is the greater are the chances for its opportunities for foreign investments. One of such investors is Sweden. Sweden has been ranked the fifth most multinational company on the basis of foreign investment related to GNP. And if the focus had been on the manufacturing sector only, the rank could have been even higher as Sweden investments are mostly focused on this sector, because it has established its expertise in that area and with proper research it can establish the most profitable foreign investments (Magnus Blomstrom, Ari Kokko, Mario Zejan, 2000). The greatest advantage to home countries is this that it can utilize its specialized expertise at more friendly environments with proper assessment, even despite negative economical conditions as Sweden showed in the 1920s. As despite of the slow growth in the 1920s, Sweden continued its industrial revolution through gathering technological knowledge that could help it achieve its goals without any waste of resources, and as a result, developed into a modern industrial nation (Paz Estrella E. Tolentino, 2000). The other greatest advantage to the home countries is that they can exploit cost effective and skilled resources at a much lower costs in the host countries. As its known that China being the largest populated area, has rich resources of labor with average salaries of workers. These resources are also of relatively higher quality as China has paid great attention to the education of its people. So when countries like United States of America invests their resources, United States of America being among the many investors in China, they are able to derive a larger margin of profits from operating in China then in their local markets. Another advantage is the globalization of business. For example General Motors’ has recently formed a partnership with Fiat, in order to achieve its goal of a global car manufacturer. This will lead to the cooperation of resources in both the markets of Europe and Latin America. Similarly based on mutual advantages, another partnership was formed between Mitsubishi and Volvo. Through this alliance, Mitsubishi plans on gaining competitive advantage in the international marketplace. This way all these companies are exploiting the largest market of Western Europe, in the world to gain advantage from its excellent technology and knowledge base (Hong Liu, 2001). As mentioned above, investing abroad has increased and improved the products sales and profits of many organizations. According to one survey, the majority of firms did not cut staff due to investment abroad, but rather succeeded in retaining jobs which would have been lost otherwise (Klaus Liebscher, Oesterreichische Nationalbank, 2007). DISADVANTAGES: The first thing that is normally argued by authors is the cost of investment in the host countries. As mostly because of the rules and regulations in the host countries, the investing companies have to go through a lot of formalities before they could invest thus giving rise to a cost for entering into the host country’s market. As argued by Djankov (2000) regulations set by the host countries slow down FDI and thus disfavors the economies of both the countries. Authors see these barriers as high corruption and unofficial economies. They think that the hassle of going through the procedures like the time period required for application and approval of the application and then finally the entry fee into the host country, hinder the investing companies form investing when they realize that such measurements lead to the wastage of the cost and effort. The next thing that comes into mind is the currency exposure. Investing in foreign markets can impact the currency rates of the host country thus affecting the investment value. For such reasons it is very crucial for the home countries to hedge their investments so that they would be able to cover their losses, if any arises. (Nicolas Breitfeld, 2010) Before the financial crisis, FDI was considered to be one of the major players in the global financial market. But after the crisis the World investment prospect survey generated by UNCTAD in 2009, reported that many trans-national companies (TNCs) suffered drastically the global slowdown of economic growth. Thus in order to cut costs and overcome the difficulties they were facing they pulled themselves out of the equity investments and the Greenfield investments and relied more on less risky options of partnerships and financing. Thus it’s clear that the global financial policies not only effects the ongoing investments of the investing companies drastically but also effects the prospective investment options too (UNCTAD, 2009). CONCLUSION: As mentioned before these advantages and disadvantages form the prospect of both the host and home countries are not absolute. Their effectiveness is derived from the corresponding policies of the both entities. As it was mentioned in one of the reports in UNCTAD 2000: “There are no a priori solutions to these concerns. Each country needs to make its own judgment in the light of its conditions and needs and in the framework of its broader development objectives. It also needs to be aware of — and to assess — the trade-offs involved, whether related to efficiency, out put growth, the distribution of income, access to markets or various non-economic objectives. And it needs to note as well that some of these concerns are raised by all FDI, although the specific nature of M&As may exacerbate them. Trade-offs between economic objectives and broader, non-economic ones, in particular, require value judgments that only countries alone can make. 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