Multinational Business: Foreign Direct Investment - Literature review Example

? Multinational Business: Foreign Direct Investment (FDI) Introduction Globalization refers to the integration of world economies through the reduction of barriers to the movement of trade, capital, technology, and people. International business or cross cultural business has been increased a lot in recent times as a result of globalization, liberalization and privatization policies implemented in many countries. Developing and developed countries are currently competing heavily to attract foreign direct investments. Communist countries like China and Cuba were not much interested in allowing foreign companies to invest in their soil earlier. At present China is the number one exploiter of globalization and foreign direct investments. It is difficult for a country to develop properly with the help of internal resources alone. In order to mobilize the internal resources properly, foreign direct investments in the form of capital, technology and equipment are extremely important for a country. Even though a developing country may have many other sources of external finance, FDI seems to be the largest among all those sources. Even though foreign direct investments bring both tangible and intangible advantages to a country, it may develop some negative consequences also in a country’s economy and culture. According to Malik et al.( 2012), “FDI is not only considered as a healthy sign for the overall national economy but also a positive indication for the local industry considering its positive spill over effects” (Malik et al., 2012, p.230). In order to attract more FDI, a country should sign trade agreements such as GATT (General Agreement on Tariffs and Trade) and WTO (World Trade Organization). These two trade agreements have many benefits as well as drawbacks as far as the interests of a developing country are concerned. This paper analyses the definition of FDI and the positive and negative effects of FDI on a country’s economy. Definition of Foreign Direct Investment (FDI) According to Dicken (2007), “Direct investment is an investment by one firm in another firm with the intention of gaining a degree of control over that firm’s operations. Foreign direct investment is simply direct investments across national boundaries” (Dicken, 2007, p.36). In other words, foreign direct investment is a type of investment in which an enterprise transfers its capital to a foreign country for business purposes. To be more precise, foreign direct investment is the investment of foreign capital in domestic goods and services. Nestle, Starbucks, Vodafone, Exon Mobil, McDonalds, General Motors, Sony, Unilever, IBM, General Electric, Wal-Mat, IKEA, etc are some of the organizations which engage in investments in foreign countries as part of their business expansion. These companies are almost saturated in their domestic markets and it is necessary for them to find enough spaces in overseas countries for their expansion. For example, Starbucks has coffee shops, virtually in every corner of America. It is impossible for them to expand their business further in America. Under these circumstances, they will be forced to invest in overseas markets. Globalization provides them favourable climates for investments in overseas countries. Ietto-Giles (2002) mentioned that “The flow of FDI and portfolio investments across countries generates a very large amount of investment incomes going in the opposite direction” (Ietto-Giles, 2002, p.27). FDI investment incomes and normal investment incomes are traveling in opposite directions. While normal investment income circulates internally or domestically, some parts of FDI may flow out of a country. In other words, FDI has the ability to affect a country’s economy both positively and negatively. Positive effects FDI can have on host country economy Adina (2011) pointed out that “FDI have a training effect both in the national and global economy, providing the replacement and modernization of techniques and technologies, increasing production and supply of goods, improving quality and competitiveness, creating new jobs and growing the quality of life” (Adina, 2011, p. 148). FDI enables a society to access goods and services of more variety, better quality or lower prices. For example, Chinese products are comparatively cheaper in international market because of the low manpower costs in China. Consumers all over the world are getting Chinese products for lower prices now. The intrusion of Chinese products forced domestic firms to improve their manufacturing technologies and to reduce the prices of their products. Thus, FDI helped domestic firms to innovate new products and services which will definitely improve a country’s economy in many ways. Standard of life increased immensely in many country’s as a result of the increased FDI. For example, India’s economic development was slow until the 1980’s. Current Indian prime minister, Man Mohan Singh (Finance minister in 1980’s), implemented several economic reforms in India in 1980’s and 90’s under the leadership of former Indian Prime Minister Narasimha Rao. Man Mohan Singh opened Indian economy widely and did everything possible to attract FDI. At present India is one of the largest exploiters of FDI in South East Asia along with China. Moreover, Indian economy is developing much rapidly than the economy of many other countries such as America and Britain. In short, FDI brought miracles in Indian economy. The following graph clearly indicates the gross domestic product (GDP) growth in India as a result of increased foreign direct investment during the period 1987-2004. (Chakraborty & Nunnenkamp 2006, p.38) Mariana (2011) mentioned that “Potential positive effects generated by foreign direct investments (FDI), such as technology transfer, human capital formation, creating a more competitive business environment lead countries to create an investment climate more attractive to investors” (Mariana, 2011, p.41). In a recent visit to India, president Obama signed trade agreements worth more $ 10 billion. It should be noted that India is a country in which energy crisis is a big problem. India does not have the necessary technology and raw materials to exploit nuclear energy. On the other hand, America has both. America agreed to export nuclear reactors and the fuels needed to operate these reactors to India as part of the above trade agreement. It should be noted that American economy was on the verge of destruction because of recent global financial crisis. Many prominent American companies collapsed as a result of recession. The above trade agreement with India helped America to revitalize its economy in many ways. On the other hand, India also benefited immensely from this trade agreement as America helped India to remove the nuclear embargo put on them by nuclear fuel supplier group countries few decades before, because of India’s nuclear experiments. In short, FDI helped India and America immensely in strengthening their trade relationships. “Multinational companies have numerous positive effects on growth and development of the country in which they invest. These are primarily reflected in employment opportunities, fiscal benefits, transfer of technology, knowledge and skills, capital inflows and the like” (Primorac & Smoljic, 2011, p.169). As mentioned earlier, America helped India to remove nuclear embargo only because of India’s commitment in using nuclear technology for peaceful purposes alone. Moreover, India is a secular democratic country in which political climate and social situations are extremely positive. Moreover, India has enough infrastructure facilities to exploit FDI. For example, India is a country in which educated manpower is huge in number. On the other hand, America is a country which is struggling to cater the needs of professional world because of the scarcity of skilled manpower. While an American company invests in India, Indian unemployed youths will be benefited immensely since such investments will definitely create more job opportunities. Djokoto (2012) argued that “FDI and trade possess directional implications. The source of this correlation is causality from FDI to trade openness”(Djokoto, 2012, p.182). Earlier, many countries were reluctant in opening their economies for FDI because of the concerns of exploitation of domestic resources by foreign companies. However, countries started to realise that such concerns are meaningless or negligible compared to the huge benefits FDI may bring to their domestic economy. Merger and acquisition are the major strategies adopted by firms as part of their business expansion to foreign territories. However, many countries watched such activities with lot of concerns earlier. Such countries encouraged joint ventures instead of merger and acquisition. For example, “Before WTO membership, China encouraged foreign businesses to form joint ventures or wholly foreign-owned enterprises and discouraged M&A. Now China is trying to attract foreign M&A by loosening constraints regulating foreign takeover of Chinese assets” (Peng, 2006, p.26). Eckert & Frank (2005) also expressed similar opinions. “Comparing all kinds of market entry, foreign direct investment (FDI) appears to be the most appropriate mode of foreign market” (Eckert & Frank, 2005, p.55). This is because of the fact that FDI through merger and acquisition bring more benefits to a country compared to FDI through joint ventures. For example, Indian automobile manufacturer TATA group recently acquired Britain’s prestigious automobile manufacturers, Jaguar and Land Rover. It should be noted that a joint venture between TATA, Jaguar and Land Rover might not be beneficial either to TATA or to Jaguar and Land Rover. TATA may not be able to implement their business strategies freely in a joint venture as they do in merger and acquisition. Same way Jaguar and Land Rover may not be relieved completely from its debts and liabilities if they engage in a joint venture with TATA. Negative effects FDI can have on host country economy One of the major criticisms labelled against FDI is that FDI may destroy a country’s sovereignty. The intrusion of foreign firms may damage the interests of domestic firms. It is difficult for small or medium firms to survive in a heavily competitive market. Foreign firms will definitely try to reduce competition with the help of merger and acquisition strategies. Thus, many of the domestic firms could be forced to close down their operations. In short, domestic business may lose its identity because of the intrusion of FDI. It should be noted that foreign firms may not be worried too much about the destruction of indigenous business culture or strategies. For example, Wal-Mart is currently operating in many of the countries. In all those countries Wal-Mart is trying to cultivate American business culture at the expense of domestic business culture. It is difficult for the people in India or Pakistan to digest the American business strategies. Moreover, foreign firms may expand their power and authorities in overseas market and they may exploit foreign markets as much as possible. For example, British telecommunication company Vodafone recently won an income tax case in India in which they saved around $ 2.2 billion (Vodafone wins Rs 11,000 crore income tax case, 2012). Vodafone won this legal battle by exploiting the loopholes in Indian income tax legal systems. Bhopal gas tragedy can also be remembered at this juncture as an example to prove how FDI can cause raise sovereign issue in the host country. “The control of foreign investment is an important sovereign issue, especially in a country whose history of FDI includes Union Carbide and Bhopal” (A.M., 2011). Union Carbide Company which is responsible for Bhopal gas tragedy escaped from severe punishments. Moreover its CEO Warren Anderson has not surrendered to Indian authorities yet. His argument is that Indian courts do not have the power to prosecute him since he is an American citizen. In America, no cases are charged against him and he is safe. In other words, Warren Anderson is challenging the sovereignty of India. In short, even after causing huge damages in a country, a foreign firm can escape without punishments. Thus, a country’s sovereignty could be challenged by foreign firms if they are allowed to function freely Another major problem associated with FDI is related to environment. Foreign companies may not be worried too much about environmental protection when they operate on foreign soil. For example, Coca Cola recently forced to close down its operations in India’s southernmost state Kerala because of the agitations from the local public. Coke tried to exploit underwater resources at Plachimada, Kerala and as a result of those residents near Plachimada experienced huge drinking water shortage (Surendranath, 2004). In short, foreign companies can cause environmental problems in overseas countries if the host government fails to put tight control over such companies. The following graph provides a brief idea about the production of key forest products in Brazil during the period of 1990-2005. (Borregaard et al.,2008, p.5) It is evident from the graph that forest products production increased considerably in Brazil during the last few years because of increased FDI. It should be noted that increased forest products production cannot be possible without increased deforestation. Destruction of forests causes many environmental problems as we all know. “The success of FDI depends primarily on the degree of overall social and economic development of the country” (Primorac & Smoljic, 2011, p.169). In other words, it is difficult for under developed countries or countries with inefficient administration to reap the profit of FDI. In fact FDI may bring more harm than good to a country with less infrastructure facilities and poor economic, social and political situations. It should be noted that India and Pakistan are two neighbouring countries. However, India is exploiting FDI judiciously so that it is emerging as one of the most rapidly developing country in the world at present. On the other hand, Pakistan is struggling to attract FDI because of poor administration and social situations. In short, FDI can bring dividends only to developing and developed countries or countries with stable political, economic and social climates. “A recent study of 42 developed and developing countries, concluded that the effects of FDI were positive and significant for developed countries, whereas these were positive but insignificant for developing countries” (Malik et al., 2012, p.233) “After reaching a new historical record in 2007, 2 trillion dollars as a result of four years of continual growth, foreign direct investment fell in 2008 by 14% at global level” (Mariana, 2011, p.44). The above fact clearly suggests that foreign direct investment is directly proportional with the economic climate in the world - when global economy grows, FDI also grows; when global economy declines, FDI also declines. In other words, unexpected disasters can occur if a country relies only on FDI for its economic growth. “U.S. multinational companies have come under fire, particularly from labour unions, because their direct foreign investment allegedly takes jobs away from workers back home” (Stobaugh, 1972, p.118). Foreign direct investment may generate more job opportunities in the host country; however it may reduce job opportunities in the mother country of the firms. Microsoft is currently investing heavily in India and China like rapidly developing economies. Thus, it is creating more job opportunities in these Asian countries. On the other hand, it is not creating any new job opportunities in America since it is not much interested in investing further in America. Conclusions Foreign direct investment is necessary for the economic development of a country. However, the administration should make sure that foreign companies investing in its soil may not take undue advantages or exploit its domestic resources beyond certain limits. Foreign companies can bring new technology, capital and skillsets to a country; however, these companies can destroy small and medium scale industries in the host country. Modernization of techniques and technologies, increasing production and supply of goods, improving quality and competitiveness, creating new jobs and growing the quality of life are some of the advantages of foreign direct investment whereas threat to sovereignty, destruction of indigenous business culture, environmental problems etc are some of the negative effects associated with FDI as far as the interests of the host country are concerned. In short, FDI should be welcomed up to certain limit and beyond that it may bring more harm than good. 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Vodafone wins Rs 11,000 crore income tax case. 2012. Indian Express. Fri Jan 20 2012. [Online] Available at: http://www.indianexpress.com/news/vodafone-wins-rs-11-000-crore-income-tax-case/901964/ Read More