Foreign Direct Investment and Its Impact on Economy and Ecological Issues - Essay Example

? Foreign Direct Investment and Its Impact on Economy and Ecological Issues Introduction Foreign direct investment has been an area of great debate and concern, particularly for developing countries, as it has been regarded as one of the key drivers in assisting a developing economy. Realizing the importance of this concept, this report covers a comprehensive review of the impact of foreign direct investment on economy. This review takes into account empirical evidences and other related information which particularly considers the role played by foreign direct investment in supporting the economic developments in developing world. In addition to this, the review of this impact on economic state of affairs in developing countries also considers the negative and positive impacts of foreign direct investment. Apart from this, the report also discusses how foreign direct investment influences ecological and environmental issues and takes into consideration the particular kind(s) of foreign direct investment which gives rise to such ecological and environmental issues. Before going into details of these issues, it is pertinent to understand what foreign direct investment means (Fedderke and Romm; Chakraborty and Nunnenkamp). Foreign Direct Investment Foreign direct investment refers to the investment or investments made by a corporate entity or investment institution, which operates in one country, in another corporate entity or investment institution which operates or is based in another country. In other words, foreign direct investment is an investment which comes in a country from another country directly. It is pertinent to distinguish between foreign direct investment and those investments which are indirect, as for instance, investments made by corporate entities from foreign countries in the equity of corporate entity or entities operating in the country. The nature of direct investment in local corporate entities from foreign institutions or corporate entities is such that the investor company acquires a significant extent of managerial powers in the other company (Graham and Krugman; Borenszteina, De Gregoriob and Leec). Foreign Direct Investment and Its Impact on Economy Foreign direct investment has been regarded by a number of researchers in the past as having a positive impact on the economic development of countries, where such investment takes place. An instant evidence in this regard can be put forward as an example of Chinese economy; China has been reported by the United Nations as the largest receiver of foreign direct investment in the first 6 months period of previous year 2012. The total amount of foreign direct investment received by China in initial six months of year 2012 was $ 59.1 billion, which surpassed foreign direct investment received by United States in the same period by $ 1.7 billion. This information can be directly related with the unmatched economic development which has taken place in the past few decades in China (Reuters). Since after the end of World War 2, foreign direct investment has played an important role in generating significant amounts of financial support for the developing countries. However, the flow of foreign direct investment halted after 1970 as there was an increase in the flow of investment from foreign countries in developing countries and the financial institutions particularly commercial lending institutions found their role as diminishing. However, after certain regulatory measures were taken by the bodies and respective authorities in the developing world, foreign direct investment was again allowed to gain momentum in the mid of 90s (Vo). Upon reviewing the theoretical propositions related to the impact of foreign direct investment on economic growth, it is found that there are differing views in this respect. According to the neo-liberal school of thought, foreign direct investment has a positive and direct relation with the economic development of a region. In light of this argument, neo-liberal proponents are of the view that there shall be free flow capital resources which allow economic development to pick pace. In addition to this, those who support foreign direct investment are also of the view that it enables the transference of technology from developed world to developing and underdeveloped world, which as a result boosts economic growth and result in catering environmental and ecological issues (Ciburiene and Zaharieva; Wang, Gu and Tse). According to the investment report issued by the International Monetary Fund in 1999, it is stated that foreign direct investment is a major factor in improving the economic development of a country or region, particularly those countries which are considered underdeveloped or developing due to lack of capital resources and economic activities. The report also states that foreign direct investment plays a pivotal role in bringing employment, business activities, trade, capital resources and other associated benefits. Furthermore, those who support these views state that due to shortcomings present in the market, efficiency in investment from foreign sources cannot be guaranteed due to these inefficiencies (International Monetary Fund; Bernatonyte and Normantiene). Apart from this, it is also argued that it is not necessary that all types of foreign direct investment are able foster economic growth in a country. Referring back to the investment report issued by the International Monetary Fund, it has been noted that “greenfield investment are likely to encourage development most while mergers and acquisitions (M&A), that entail a simple change of ownership can be of dubious value” (International Monetary Fund). Apart from the benefits presented by different schools of thought, there are a few which regard foreign direct investment otherwise. In this regard, it is pertinent to mention the point of view of Keynesian school of thought. The Keynesian school of thought follows that, notwithstanding the benefits associated with the foreign direct investment in a country, the impact of foreign direct investment may be different in varying circumstances. This further implies that when conditions or economic situation change, there may be difference in the impact, effect and results of foreign direct investment. When this point of view is stretched further, it is believed that the effects may even by different in a single region (Buoziute-Rafanaviciene, Pundziene and Turauskas). In this report, empirical investigation of impact of foreign direct investment on economic growth is investigated for the four major developing countries. Amongst the world’s largest recipients of foreign direct investment, BRIC countries, which include Brazil, Russia, India and China, have been on the top. Owing to this larger share of foreign direct investment, these countries have reported a phenomenal economic growth in the last decade and as a result of this increase in economic growth, the BRIC countries have been to play a significant role in the global economy. In the year 2005, the total foreign direct investment inflow in Brazil, Russia, India and China accounted for more than $ 144.57 billion. This inflow of foreign direct investment in these four countries accounted for an aggregate of 16 percent of the total foreign investment flow in the world in the year 2005 (Pao and Tsai). The review of growth in the flow of foreign direct investment and Gross Domestic Product in India in the last one and a half decade reveals the following figures. Keeping in view the figures for foreign direct investment and gross domestic product in conjunction, it is revealed that there is a positive relationship between the two; which means that when foreign direct investment increases, there is a resulting increase noted in the gross domestic product. Year Foreign Direct Investment Gross Domestic Product 1996 - 1997 2,141 388,343 1997 - 1998 2,770 410,915 1998 - 1999 3,682 416,252 1999 - 2000 3,083 450,476 2000 - 2001 2,439 460,182 2001 - 2002 2,463 477,848 2002 - 2003 4,065 507,189 2003 - 2004 2,705 599,461 2004 - 2005 2,188 721,573 2005 - 2006 3,219 834,035 2006 - 2007 5,540 951,339 2007 - 2008 12,492 1,242,426 2008 - 2009 24,575 1,213,782 2009 - 2010 27,330 1,380,640 2010 - 2011 25,834 1,729,010 Source: (Sarode) Plotting these values on a graph reveals the following trend lines for the two variables: Apart from this, the growth rates in foreign direct investment and gross domestic product during the past 15 years for the four countries in BRIC group are presented as follows: Brazil China India Russia BRICs Global Foreign Direct Investment (U.S. $ billions) 15 year growth 20.688 18.277 34.959 29.349 27.552 19.145 10 year growth 5.815 12.082 21.515 27.476 13.347 17.366 05 year growth 15.823 22.927 34.877 73.927 27.552 25.816 Real Gross Domestic Product (U.S. $ billions) 15 year growth 1.777 9.321 5.067 2.076 2.995 1.739 10 year growth 1.458 8.864 5.488 6.066 4.073 1.834 05 year growth 2.687 10.375 7.428 7.816 5.725 2.387 Source: (Pao and Tsai) These figures, when plotted on a graph, present the following trends and patterns over the period of 15 years (1992 - 2007) in the foreign direct investment growth and real gross domestic product growth: From the trends and patterns observed in above presented graphs, it is established that growth in foreign direct investment and real gross domestic product has been highest in the past five years during the period of 15 years (1992 – 2007). In addition to this, researchers in the past have also carried out empirical investigations in relation to the impact of foreign direct investment on economic well being of a number of nations. In this regard, a major work to be discussed here is of Li and Liu, which was conducted in the year 2005. In their study, Li and Liu investigated the relationship between FDI and GDP from 1970 to 1999 for 89 countries. These 89 countries included countries from both developed and developing world. A glimpse of empirical evidence gathered by the researchers in their study is presented as follows: Year FDI inflows in developed countries FDI inflow in developing countries GDP growth in developed countries GDP growth in developing countries Mean Variance Mean Variance Mean Variance Mean Variance 1970 1.14 0.67 0.75 11.26 5.33 6.94 3.32 15.87 1975 0.80 0.36 0.41 17.15 1.59 7.07 3.66 12.54 1980 0.79 0.40 1.18 4.50 3.05 2.98 1.85 36.27 1985 0.89 1.46 0.77 1.75 2.83 3.16 1.37 18.19 1990 1.75 1.80 1.57 5.79 2.72 4.18 1.56 27.83 1995 1.90 3.06 2.87 19.28 2.94 3.09 2.47 11.06 1999 2.81 4.52 3.40 16.53 2.58 2.79 0.51 13.61 Source: (Li and Liu) Based on the empirical investigations and findings in their research, Li and Liu concluded that during the period under consideration, i.e. 1970 to 1999, the relationship between foreign direct investment and gross domestic product is not the same in this whole period. The results of the study showed that from 1970 to mid 80s the relationship between foreign direct investment and gross domestic product had been negative. However, this negative relationship turned into a positive relationship from mid 80s to 1999. The study however concluded that for both developed and developing countries, the relationship between foreign direct investment and gross domestic product is positive and significant and also that foreign direct investment has played an indirect role in boosting the economic growth of countries in which it has taken place. However, apart from identifying this positive relationship between the two variables, the researchers identified a few prerequisites which they consider to be pertinent in establishing this positive relationship. These two factors, as per the research work of Li and Liu, are human capital and the ability of an economy to remain compatible with the introduction of technology and link it with its production processes. In concluding their study, researchers have further stated that existence of such prerequisites also enables the economy to remain competitive and attract further foreign investment (Li and Liu). Foreign Direct Investment and Its Impact on Ecological Issues Foreign direct investment has an impact on the environment, which is agreed by the researchers and analysts all around the world. However, there are different views relating to the impact of foreign direct investment on the environment, which includes both favorable and unfavorable effects. As far as the positive or favorable effects of foreign direct investment are concerned, it is stated that with the increase in investment in developing or underdeveloped countries and introduction of new technologies which are used in production or manufacturing related processes, these countries are able to manage and protect their environment more efficiently. Moreover, with increased investment in such countries, it is obligatory to adhere to particular environmental standards, which in turn has a favorable impact on the ecological matters. Similarly, foreign direct investment is also regarded as detrimental to environment by some. It has been argued that those corporate entities that are in search of making foreign investment look for those host countries where regulations relating to environment protection and environment friendly operations are absent or minimal, which are termed as “pollution havens”. This in turn enables them to exploit such regions by conducting such business operations which are dangerous for environment as a whole (Araya; Crespo and Fontoura; Saggi). Continuing the example of BRIC countries, as has been discussed in the previous section of this report, the empirical evidence as to the impact of foreign direct investment on environment in these countries is discussed in this section. Considering the trends noted in the foreign direct investment in the four countries as noted in the previous section, it can be assumed that the effects of such an increase in the foreign direct investment would have caused negative environmental effects in the period under consideration. However, this assumption is based on the previous discussion that foreign direct investment has negative or unfavorable impact on the environment and ecological factors (Pao and Tsai; Torlak; Singh, Chauhan and Pandey). As presented in the previous section, the information pertaining to the impact of foreign direct investment on environment of countries under consideration has been presented in the table as follows: Brazil China India Russia BRICs Global Carbon Dioxide Emission (Metric tons / Capita) 15 year growth 1.991 5.564 3.250 - 1.040 0.582 0.913 10 year growth 0.583 6.545 3.000 1.695 2.601 1.338 05 year growth 1.373 11.687 4.633 1.787 3.842 2.617 Energy Consumption (Million BTU / Capita) 15 year growth 1.972 5.916 3.477 - 0.454 0.806 0.896 10 year growth 1.160 6.812 3.376 2.214 2.737 1.181 05 year growth 2.088 11.478 5.139 2.405 3.749 2.147 Foreign Direct Investment (U.S. $ billions) 15 year growth 20.688 18.277 34.959 29.349 27.552 19.145 10 year growth 5.815 12.082 21.515 27.476 13.347 17.366 05 year growth 15.823 22.927 34.877 73.927 27.552 25.816 Source: (Pao and Tsai) It can be observed that where figures for foreign direct investment have increased in case of each of the four countries in the table above, there is a corresponding increase in the carbon dioxide emissions and energy consumption. Thus a positive relation is indicated between the increase in foreign direct investment and impact on environment and ecological state of a country (i.e. carbon dioxide emissions and energy consumption) (Pao and Tsai). These figures, when plotted on a graph, present the following trends and patterns over the period of 15 years (1992 - 2007) in the foreign direct investment growth and growth in carbon dioxide emissions and energy consumption: From the graphs presented above, it can be observed that there is definitely a relationship between foreign direct investment and environmental changes. As for instance, considering the trends noted above for Russia, it is observed that when foreign direct investment has increased, the carbon dioxide emissions and energy consumption has increased accordingly. In addition to this, it is also noted that this trend has remained similar in the three periods considered, i.e. 15 years growth, 10 years growth and 05 years growth. Similarly, there has been a consistent increase in foreign direct investment noted in case of China. With the consistency in the increase in foreign direct investment, there has been also a consistent increase in carbon dioxide emissions and energy consumption noted in China during the same period. Same patterns and conclusions have been noted for India and Brazil with respect to the impact of foreign direct investment on environment. The trends noted above in the graphs can be further elaborated by considering the following figures: Foreign Direct Investment in Brazil, Russia, India and China (1980 – 2005) The patterns noted in the diagram below shows that China has been the largest recipient of foreign direct investment in the 25 years under consideration. Whereas India has remained at the last number in this regard. The trends noted in this figure can now be matched against the trends for carbon dioxide emission and energy consumption for the four countries in the same period. Source: (Pao and Tsai) Carbon Dioxide Emission Trends in Brazil, Russia, India and China (1980 - 2005) The trends noted in the carbon dioxide emissions show that as the foreign direct investment in each country has increased (or decreased), there has been a corresponding increase (or decrease) noted in the carbon dioxide emissions. This reflects that foreign direct investment influences the emission of carbon dioxide and thus it has a significant impact on the environment. Source: (Pao and Tsai) Energy Consumption Trends in Brazil, Russia, India and China (1980 – 2005) The trends noted in the energy consumption are presented in the diagram below. The relationship between energy consumption and foreign direct investment has been observed to similar as noted in case of relationship identified between foreign direct investment and carbon dioxide emission. As noted in case of the four countries in diagram below, when foreign direct investment has increased there has been a corresponding increase noted in the energy consumption in the four countries under consideration. Source: (Pao and Tsai) The relationships identified on the basis of diagrams presented above, it has been concluded that foreign direct investment does influence the environment of the recipient countries. Moreover, a study carried out by Aliyu in 2005 found out that there is an increase in the pollution in countries which received increased foreign investments. The study included the following empirical evidences: Concentration of Pollutants 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Argentina 0.12 0.12 0.11 0.10 0.10 0.08 0.07 0.06 0.04 0.03 0.02 Armenia 0.05 0.04 0.01 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Brazil 0.27 0.26 0.24 0.22 0.20 0.18 0.16 0.14 0.11 0.07 0.04 Chile 0.05 0.04 0.04 0.03 0.03 0.03 0.03 0.02 0.02 0.01 0.00 Colombia 0.06 0.06 0.05 0.05 0.04 0.04 0.03 0.03 0.02 0.01 0.01 Indonesia 0.22 0.20 0.19 0.18 0.17 0.15 0.13 0.11 0.09 0.06 0.04 Kazakhstan 0.17 0.15 0.13 0.11 0.09 0.08 0.06 0.05 0.04 0.02 0.01 Mexico 0.34 0.32 0.29 0.27 0.24 0.21 0.19 0.16 0.12 0.09 0.05 Pakistan 0.09 0.08 0.07 0.07 0.06 0.05 0.05 0.04 0.03 0.02 0.01 Paraguay 0.01 0.013 0.01 0.03 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Poland 0.34 0.31 0.28 0.26 0.23 0.20 0.17 0.14 0.11 0.07 0.04 Slovenia 0.01 0.01 0.01 0.01 0.01 0.00 0.00 0.00 0.00 0.00 0.00 Thailand 0.14 0.13 0.13 0.12 0.11 0.10 0.08 0.07 0.05 0.04 0.02 Trinidad and Tobago 0.01 0.01 0.01 0.01 0.01 0.00 0.00 0.00 0.00 0.00 0.00 Source: (Aliyu) Carbon Dioxide Emissions Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Argentina 29,948 31,527 32,449 31,257 32,905 32,554 34,375 35,647 36,108 38,676 37,715 Armenia 0 0 1,004 759 778 930 699 883 917 822 958 Brazil 55,298 58,377 58,702 61,372 64,050 68,126 75,453 78,777 82,180 82,669 83,930 Chile 9,643 9,166 9,580 9,739 11,238 12,064 13,762 15,850 16,430 17,062 16,239 Colombia 15,268 15,263 16,561 17,215 18,077 16,112 16,217 17,273 18,100 15,252 15,955 Indonesia 45,224 43,471 49,453 53,879 54,857 50,861 68,776 68,946 53,490 55,908 73,572 Kazakhstan 0 0 68,967 58,423 53,716 45,184 37,829 34,910 33,368 30,753 33,099 Mexico 102,435 101,285 107,946 100,826 105,902 100,235 100,058 104,995 110,933 112,659 115,713 Pakistan 18,566 18,527 19,834 21,214 23,060 23,057 25,473 25,439 26,274 27,025 28,604 Paraguay 617 609 715 804 954 1,094 1,080 1,133 1,143 1,180 999 Poland 94,865 93,912 92,571 95,583 92,093 94,572 98,606 95,260 88,434 85,747 82,245 Slovenia 0 0 3,361 3,443 2,959 3,799 4,004 4,177 3,978 3,936 3,986 Thailand 26,130 31,671 34,586 38,874 43,161 49,483 55,239 57,221 50,743 53,316 54,216 Trinidad and Tobago 4,619 5,707 5,718 4,582 5,263 5,523 5,707 5,626 5,827 6,784 7,195 Source: (Aliyu) Kinds of Foreign Direct Investment Associated with Ecological Issues Organizations seek lower costs of operating and in this pursuit they opt for those areas or regions where possibilities of lowering costs, or strictly speaking “loopholes”, exist. Those manufacturing concerns, which incur substantial costs for controlling pollution and disposal of wastage, are in search of those regions where environmental regulations are not strict or entirely nonexistent. In this way, such ambitions behind foreign direct investment do have an impact on the environmental factors of investment receiving countries (OECD). To understand which kind of foreign direct investment give rise to environmental issues, it is important to understand their purpose first. Following are the three major kinds of foreign direct investment: Market Seeking FDI A great number of businesses are part of FDI due to opportunities they perceive in relation to potential markets for their products. Such type of foreign direct investment is not stimulated by the increased environmental costs and therefore organizations which are part of such investments are not actually seeking regions where they can reduce their environmental costs (OECD). Production Platform Seeking FDI In addition to market seeking objectives, investors may seek regions where they can set up their production facilities without incurring increased environmental costs. In this scenario, environmental issues are raised once production is initiated by the investors, due to lower environmental regulations (OECD). Resource Seeking FDI In case of resource seeking FDI, organizations seek such regions where resources necessary for their production requirements are relatively easily available. In this manner, organizations seeking low cost and significant amounts of resources set up their manufacturing units in such regions. This also becomes a reason for environmental pollution, as in such regions regulatory frameworks for protection of environment may not be strict (OECD). Conclusion The role played by foreign direct investment with regard to the development of economy and fostering growth in developing and developed countries has undoubtedly been agreed by a number of researchers and has also been supported by the empirical evidences reviewed in this report. However, based on the theoretical evidences discussed in this report, it has been found that apart from its positive effects, foreign direct investment may also influence the economy of a country in a negative manner. In this regard, the review of trends in the inflow of foreign direct investment in BRIC countries and the resulting economic growth has signified a positive relationship between these two variables. It has been concluded that whenever foreign investment has increased, the economic growth in the recipient countries has also gone significantly high. In addition to this, this report has also reviewed the impact of foreign direct investment on the environmental and ecological aspects. The review along with the empirical evidences stated in this report shows that there is a positive relationship between these two variables; which implies that whenever an increase in foreign direct investment is recorded, there is a corresponding increase in the carbon dioxide emission and energy consumption. This means that foreign direct investment does increase pollution in the recipient countries as indicated by the empirical evidence presented in this report. Works Cited Aliyu, Mohammed Aminu. Foreign Direct Investment and the Environment: Pollution Haven Hypothesis Revisited. Norwich: University of East Anglia, 2005. Araya, M. "FDI and the environment: what empirical evidence does – and does not – tell us?" Zarsky, L. International investment for sustainable development. Londres: Earthscan Publications, 2005. Bernatonyte, D and A Normantiene. "Estimation of Trade Specialization: the Case of the Baltic States." Inzinerine Ekonomika-Engineering Economics 2 (2009): 7. 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