FDI and Economic Growth - Article Example

FDI and Economic Growth Foreign direct investment (FDI) is defined as a long-term investment by a foreign direct investor in an enterprise resident in an economy other than that in which the foreign direct investor is based. The FDI relationship, consists of a parent enterprise and a foreign affiliate which together form a transnational corporation (TNC). In order to qualify as FDI the investment must afford the parent enterprise control over its foreign affiliate. The UN defines control in this case as owning 10% or more of the ordinary shares or voting power of an incorporated firm or its equivalent for an unincorporated firm. In the years after the World War II global FDI was dominated by theUnited States, as much of the world recovered from the destruction wrought by the conflict. The U.S. accounted for around three-quarters of new FDI (including reinvested profits) between 1945 and 1960. Since that time FDI has spread to become a truly global phenomenon, no longer the exclusive preserve of OECD countries. FDI has grown in importance in the global economy with FDI stocks now constituting over 20% of global GDP. In the last few years, the emerging market countries such as China and India have become the most favoured destinations for FDI and investor confidence in these countries has soared. As per the FDI Confidence Index compiled byA.T. Kearney in 2006, China and India hold the first and second position respectively, whereas United States has slipped to the third position. Types of FDI Greenfield Investment: direct investment in new facilities or the expansion of existing facilities. Greenfield investments are the primary target of a host nation's promotional efforts because they create new production capacity and jobs, transfer technology and know-how, and can lead to linkages to the global marketplace. However, it often does this by crowding out local industry; multinationals are able to produce goods more cheaply (because of advanced technology and efficient processes) and uses up resources (labor, intermediate goods, etc). Another downside of greenfield investment is that profits from production do not feed back into the local economy, but instead to the multinational's home economy. This is in contrast to local industries whose profits flow back into the domestic economy to promote growth. Mergers and Acquisitions: transfers of existing assets from local firms to foreign firms takes place; the primary type of FDI. Cross-border mergers occur when the assets and operation of firms from different countries are combined to establish a new legal entity. Cross-border acquisitions occur when the control of assets and operations is transferred from a local to a foreign company, with the local company becoming an affiliate of the foreign company. Unlike greenfield investment, acquisitions provide no long term benefits to the local economy-- even in most deals the owners of the local firm are paid in stock from the acquiring firm, meaning that the money from the sale could never reach the local economy. Nevertheless, mergers and acquisitions are a significant form of FDI and until around 1997, accounted for nearly 90% of the FDI flow into the United States. Horizontal Foreign Direct Investment: investment in the same industry abroad as a firm operates in at home. Vertical Foreign Direct Investment: is of two kinds: 1) backward vertical FDI: where an industry abroad provides inputs for a firm's domestic production process 2) forward vertical FDI: in which an industry abroad sells the outputs of a firm's domestic production FDI can also be categorized based on the motive behind the investment from the perspective of the investing firm: Resource Seeking: Investments which seek to acquire factors of production that are more efficient than those obtainable in the home economy of the firm. In some cases, these resources may not be available in the home economy at all (e.g. cheap labor and natural resources). This typifies FDI into developing countries, for example seeking natural resources in the Middle East and Africa, or cheap labor in Southeast Asia and Eastern Europe. Market Seeking: Investments which aim at either penetrating new markets or maintaining existing ones. FDI of this kind may also be employed as defensive strategy; it is argued that businesses are more likely to be pushed towards this type of investment out of fear of losing a market rather than discovering a new one. This type of FDI can be characterized by the foreign Mergers and Acquisitions in the 1980's by Accounting, Advertising and Law firms. Efficiency Seeking: Investments which firms hope will increase their efficiency by exploiting the benefits of economics of sale and scope and also those of common ownership. It is suggested that this type of FDI comes after either resource or market seeking investments have been realized, with the expectation that it further increases the profitability of the firm. Typically, this type of FDI is mostly widely practiced between developed economies; especially those within closely integrated markets (e.g. the EU). Ireland comfortably tops the league out of 111 countries as the most desirable place to live, according to the Economist Intelligence Unit's The World in 2005 index report. It successfully combines elements such as the fourth-highest GDP per head in the world, low unemployment, political freedom, stable family life and high community standards. With economic growth estimated at 5% in 2004, Ireland continues to attract investment in a wide range of activities from manufacturing to e-business in sectors as diverse as IT, software, pharmaceuticals, medical technologies, financial and international services. Investors have been attracted by a corporate tax rate of 12.5% on all trading activities and a business-friendly environment, where skills, research and knowledge, and a high quality infrastructure are combined with innovation and flexibility. The availability of key human resources has been vital in attracting inward investment; Ireland's young population is highly educated, flexible, responsive and creative. The education system pursues a collaborative approach with business and industry. IDA Ireland - the government agency responsible for attracting overseas investment - is encouraging more innovative and knowledge-based investment. This means increasing higher value-added activities in the manufacturing sector and adding corporate level innovation such as research and development, shared services, logistics and supply chain management functions. During the 1990s, the Irish economy boomed. Rapid output and employment growth resulted in a sharp rise in the ratio of employment to population, which played a major role in closing the gap in living standards between Ireland and the rest of the European Union (EU). Substantial inflow of foreign direct investment (FDI)-mainly from the United States-reduced the economy's dependence on agriculture and low- productivity industries. The Irish economic success story has attracted considerable international interest. Even though the economy slowed dramatically in 2001, the transformation of the 1990s is still worthy of scrutiny. (Brendan Walsh). Dr. Michael Cuddy , Dean of Faculty of Business, National University of Ireland, Galway discusses the reasons for companies to engage in FDI. The companies seek resources (physical and human), They seek market following and a customer following.. They look for an export following. Engaging in FDI facilitates acquiring technological managerial and organizational skills resulting in efficiency. It is a strategic motivation. FDI helps to overcome trade barriers and risks are diversified. Most importantly there is a scope for short term profit maximization. Ireland is an immediate attraction for FDI because of its saving source, direct output, and backward linkage. Employment creation is Ireland's forte and management skills are of an optimum level. Technology transfer is another reason to attract FDI. Ireland stands for balance of trade and balance of payment. Taxation revenue also attracts FDI. Furthermore Ireland has executed certain policy measure to attract FDI. The most import of the these policy measures is seen in taxation - corporation tax, repatriation of profits, patent royalty tax exemption, capital allowance, expenditure on scientific research. Financial incentives include grants for capital, employment s, training, research and development. Read More