Foreign Direct Investment Confidence Index - Essay Example

25 November 2006 Foreign Direct Investments The world is becoming much more globalized during the past one hundred years due to numerous technological advances in communications, such as the internet. Another factor influencing this globalization is the introduction of foreign investments. During the post World War II years (1945-1960), the United States cornered the market for new foreign direct investments, responsible for seventy-five percent. (Wikipedia, 2006). After the 1960's, foreign direct investments (FDI) have increased at a steady rate, with FDI stocks making up twenty percent of the world's Gross Domestic Product (GDP). Currently, China leads the world in foreign direct investments. What exactly are foreign direct investments, and why have they increased so steadily What factors make foreign direct investments such a popular global occurrence A foreign direct investment, as the name states, involves corporations who invest long term overseas. There are four types of FDI's for business corporations to choose from. The most commonly preferred for more corporations are mergers and acquisitions. They involve a transfer of assets from the originating corporation to the one which is foreign based. (Wikipedia, 2006). Greenfield investments are investments or expansions for a new corporation. There are two forms of vertical foreign direct investments which involve backward vertical FDI and forward vertical FDI. Backward vertical FDI involves an out of the country business which provides resources/assets to a domestic business. Forward vertical FDI involves a business abroad that sells the amount produced of a business's domestic production(s). A.T. Kearney Inc. is a global management consulting firm that is an active member of the Global Business Policy Council. This council aids and advises head executives on geopolitics, macroeconomics, technological changes, and macroeconomics worldwide (A.T. Kearney, 2006, p.1). A.T. Kearney spent over seven years surveying numerous head executives from over one thousand corporations worldwide for their opinions on future FDI growth and objectives. The companies and their executives that were surveyed comprise seventy percent of the cumulative FDI. In December 2005, A.T. Kearny published their findings in their FDI Confidence Index. The survey was comprised of sixty-eight countries that contribute ninety percent of the global FDI (A.T. Kearney, 2006, p. 2). They selected the top twenty-five countries according to their FDI confidence. These countries were ranked by a score given from zero to three. Scores closer to three was given to those countries with the highest amount of FDI confidence. For example, China received the highest FDI confidence rating for a score of 2.197. Why would China be interested in foreign direct investments A country such as China is interested in FDI's to improve the economic state of its own country based on the numerous benefits of foreign enterprise investing. There are many advantages and attractions for foreign markets to invest in one of the worlds largest and growing markets. China's population was estimated in 2005 at over 1.3 billion people. It holds a large share of twenty percent of the world's total population estimated at 6.5 billion people. (Prasad, Eswar & Wei, Shang Jin,2005). Many multinational corporations will choose to invest in densely populated countries such as China. Companies will choose China because their own country lacks a sufficient labor supply. The cost of China's labor force is dramatically low in comparison to other surrounding Asian countries. Many foreign direct investors have found this cost effective and have created and brought millions of jobs to China. The US, a country which owes the majority of its yearly population growth from immigration, would find China to be a valuable source of manpower as well as an ever increasing and developing economy. On the other hand, the population growth has become so overwhelming high for China that the government has had to intervene. They enforced the "one child per family" rule in 1979. It was meant as a temporary means to limit the population's growth, but it is still in effect today. It has not affected the entire population of China to any large extent because it has not been enforced in all areas. A corporation may select a certain country for it's abundance of natural resources. A multinational country may choose to do so due so based on their own lack of resources in materials in their own country. Even though China is one of the largest countries in the world it still imports a large majority of natural resources. China is unable to provide natural resources such as crude oil and iron for itself. Economic development zones (EDZ) were created by China's central government in order to bring in more foreign direct investments. These zones spread quickly throughout the country in which almost every county in China had created economic development zones. In 2003, the Ministry of Land Resources conducted a survey of 24 provinces. This survey showed that seventy percent of Chinas total 6,866 EDZ's were misused, which amounted to about 24,700 square kilometers of land misuse. (Norton, Patrick M. & Chao, Howard, 2001). In response to this study, China's government canceled almost five thousand of its economic development zones in August 2004. This stopped development on 1,300 square kilometers of land. As a result, this has affected the land allotment for foreign based industries. Many Chinese government rules and regulations are the largest deterrents against foreign direct investments. Foreign-invested enterprises (FIE) as well as domestic enterprises have both increasing benefits due to FDI's. Domestic enterprises provide inputs and distribution for FIE's. Less developed nations in Africa, Latin America, and Asia are attracted to more a highly developed country like China. China has easy access to updates in information technology, which attracts many overseas businesses. Smaller sized corporations may also choose to introduce themselves to China's large and growing markets. These corporations can expand globally and improve their company's potential by obtaining more customers to increase their profits. Overall, it becomes more cost effective for them because they are able to reach more people for the same (or less) cost. Corporations could choose the benefit of another country's cost and production effectiveness. This will result in a decrease in overall costs to their company the end result being more profit. Many investors may select those countries which have less stringent government rules and regulations for private corporations. Some governments may even provide tax cuts or incentives for new businesses investing within their country. These foreign investment ventures by corporations open up countries for trade and investments. For example, The North American Free Trade Agreement (NAFTA) eliminated the trade and investment barriers between Canada, the United States, and Mexico. During the 1980's, China and India signed an agreement to further develop their economic and trade relations. During the early 1990's, China focused on liberalizing its policies regarding FDI's and trades. This opened up more interaction and investments between China's neighboring countries. Still, many countries have stringent policies and choose not to allow as much freedom for outside investments. FDI's may be most beneficial for newly developing countries because it will bring more financial capital to their economy. It can improve their Gross Domestic Product (GDP), and its overall investments for that country. It can rejuvenate a countries economy by increasing the employment rate, raising salaries, and improving its waning market areas. (Gardiner, 2000.). There is a wider range for competition within international markets which may mean lower costs to the consumer. The countries in Asia make up twenty-five percent of all the FDI cash flows. China is one of the most favored countries for FDI due to the growth in many of its sectors such as: telecommunications, manufacturing, financial or non-financial services, and wholesale/retail. It offers an inexpensive but very well educated workforce, strong growth rates, and increasingly high consumer populations (A.T. KEARNEY, 2006, p. 26). In 2004, China received $60.6 billion in FDI's. China has been very proactive with improvements on its nation's: infrastructure, logistics, regulatory barriers, and global reforms to further improve its FDI. (A.T. Kearney, 2006, p. 4). Despite the fact that China refused most of foreign investments from 1949-1976, it now currently heads the world in FDI's. The intense growth of China's FDI was encouraged from its entrance into the World Trade Organization (WTO) in December 2001. As a result of this, China's economy grew by 9.5 percent in the second half of 2005. (A.T. Kearney, p. 70). The total economic growth for that same year was ten percent, and it is expected to dramatically increase in future years. Since then, China has been a key attraction for capital-intensive enterprises. This has a great significance and influence on other foreign investors as well. The average net of foreign direct investments increased from $38.5 billion to $43.8 billion. There has been a dramatic increase in the capital account balance for FDI since then. Between the years 1998-2000, the average capital balance was three million US dollars, and it dramatically increased to average of fifty-five billion US dollars during 2001-2003. (Norton, Patrick M. & Chao, Howard, 2001). Beginning in 2003, the Chinese government stepped in to control industries which were thought to be growing too fast. They were concerned primarily with the real estate, cement, steel, and aluminum industries. (The US-China Business Council, 2005). Despite being curbed by the government, China received 1,529 Greenfield foreign direct investment projects. This country attracts over sixty percent of global manufacturing, knowledge management, and distribution and logistics. These three business functions are responsible for the bulk of a countries investment income. In 2005, China received $72,406,000 in FDI; $317,873,000 was received in FDI stocks which is 14.3% of their total Gross Domestic Product (GDP). (United Nations Conference on Trade and Development, 2006). China's FDI's are predicted to grow for 2005-2006, with larger scale introductions of new industries relating to: entertainment, retailing/wholesaling, trading and distribution, and direct sales. China's regulatory framework also plays a key role in attracting FDI. Between the years of 1983-1985, the tax rates on foreign investment incomes and loan rates were reduced by fifty percent. (Prasad, Eswar & Wei, Shang Jin, 2005). Recently, the China Securities Regulatory Commission has given permission for foreign corporations to buy Chinese firms. Their aim is to make mergers and acquisitions easier and faster. Mergers and acquisitions are the most common forms of foreign direct investments. Corporations, mainly in capital intensive industries, prefer to take advantage of its government regulatory incentives, large labor force and consumer markets, advanced technologies, and future growth potentials. Unfortunately, there is the downside to foreign direct investments involving mergers and acquisitions. There are a few reasons why some multinational corporations would prefer not to put foreign direct investments into China. One reason is that many Chinese companies will not provide easy access to their personal and publicly available financial records. Any record in regards to a company's pending litigations, rights to land or property, and securities over assets are usually unreliable, if at all available. (Norton, Patrick M. & Chao, Howard, 2001). A second reason why mergers and acquisitions could be unappealing is that the investment(s) must be approved by an examination and approval authority (EAA). The EAA will not likely inform the applicants as to when they will be approved. As a result, it is increasingly difficult to for foreign multinational companies to close on a Chinese merger and acquisition deal. Foreign direct investments greatly influence a country's: economic strength and prosperity, technological advancements, regulatory environment, and employment rates. Mergers and acquisitions investments make up the majority of all foreign direct investments in China. The most dominant reason to encourage and accept more FDI's would be to improve China's economy by bringing in more revenue. China's population and technologies are growing at a dramatic rate. These are just a few of the benefits involved in foreign direct investments. Hopefully, more countries will decide to become active participants in the worlds growing economy through beneficial foreign direct investments. Existing leading countries can continue to develop even more globally by broadening their FDI scope resulting in more international investments for well rounded benefits. Who knows what may lie in store for these China and its foreign enterprises Hopefully, other countries will find China as a possible source and influence for foreign investments over the next decade or century. Bibliography A.T. Kearney. (2006) FDI Confidence Index [online]. Chicago: A.T. Kearney Inc.: Marketing and Communications. Available from: http://www.atkearney.com/shared_res/pdf/FDICI_2005.pdf [Accessed 24 November 2006]. Encyclopedia of Business. (2006). International Competition [online]. [n.p.]: Thomson Gale. Available from: http://www.referenceforbusiness.com/encyclopedia/Inc-Int/International-Competition.html [Accessed 24 November 2006]. Gardiner, R. (2000) Foreign Direct Investment: A Lead Driver for Sustainable Development [online]. London: UNED International Team. 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Available from: http://en.wikipedia.org/w/index.phptitle=Foreign_direct_investment&oldid=89127118 [Accessed 24 November 2006]. Read More