Foreign Direct Investment - Assignment Example

Foreign Direct Investment al Affiliation) Table of Contents Table of Contents 2 Definition of Foreign Direct Investment 3 Why do countries seek FDI? 3 Advantages of FDI 4 Disadvantages of FDI 4 2. Theoretical Background 5 3. Types of FDI  6 By motive  6 By Target 7 By Direction:  8 By Entry Mode 8 4. Methods of FDI 9 5. Factors affecting investment decisions 10 6. Cost and Benefits of FDI 11 Benefits to the Host Country 11 Benefits to the Home Country 12 Cost to the Host Country 12 Cost to the Home Country  12 Bibliography 13 1. Definition of Foreign Direct Investment FDI involves the ownership of entities abroad for production, research and development, access of raw materials and other resources. According to many economists, FDI is considered superior to other forms of capital inflows because FDI enables the transfer of technology contrary to other forms of inflows that neither attains this through the trade of goods nor financial investments. Besides, FDI promotes the competition in the domestic input market. According to Baer and Sirohi (2013), recipients of the FDI can gain from the employee training mechanisms that accrue from the operation on new businesses. As such, FDI contributes to the development of human resources unlike other capital inflows. In addition, the profits generated from the FDIs are a contribution to the corporate tax. Therefore, FDI contributes to the economic development of the host country. Why do countries seek FDI? Primarily, countries seek FDI due to the technological benefits that boost production mechanisms in several sectors across the economy. FDIs also create adequate employment opportunities, thereby enhancing the economic growth prospects of the host country. FDIs, nonetheless, increase the quality of products within the market, hence giving the consumers a wider range of products from which they can choose (Reddy, 2012). As highlighted below, the inflows are influenced by the prevailing economic conditions. The 2007-2009 financial crises affected the global FDI inflows through subjecting prospective foreign investors to the risk of encountering losses upon investment amidst the prevailing harsh economic situations. Figure 1: the Global FDI inflow (http://www.oecd.org) Advantages of FDI FDI is responsible for stimulating the economic development of a target country. Besides, the FDI enables companies to enjoy the benefits that accrue from larger markets in the global economy. Therefore, FDI ensures that industries capitalize on their sales through international presence. While at it, FDI creates new employment opportunities, thereby increasing the income and the purchasing power of people within an economy. This leads to economic growth (Burkhanov, Allaberganova and Khudoykulov, 2015). As stated earlier, FDI presents a boost in the human capital resources, through sharpening the knowledge and competence of the cross-border workforce. Many companies also benefit from the tax incentives in their respective business fields. Apart for the development of knowledge, FDI enables the transfer of resources in form of technology, skills and raw materials, hence limiting the disparities between the organizational revenues and costs. Disadvantages of FDI FDI can hinder the domestic investment by offering excess competition. In addition, the risk of political instability threatens to destabilize the operations of foreign investments. The FDIs have the potential of being detrimental to the exchange rates of the host and home countries. In some instances, the expenses of FDI require massive financial strength, hence highlighting the economic non-viability of FDIs upon the onset of failure. 2. Theoretical Background The theory by Stephen Hymer aimed at analyzing the concept of foreign investments from an approach that envisaged the firm’s viewpoint. He highlights the differences between the direct investments and the portfolio investments. He bases his arguments on the tenets of control, further stating that direct investments present firms with higher levels of control in comparison to the portfolio investments. He argues that the FDI involves more than the transfer of financial resources does for the home country to the host country. However, he asserts his argument on the fact that FDI involves the transfer of resources as well as finances. The above viewpoints led to the proposal of three determinants of FDI according to Hymer. First, the firm-specific advantages illustrates that FDI increases the ability of a domestic investor to boost its competitive advantages even after the depletion of the resources (Saraçi, 2014). As such, FDI is primary in eliminating the market imperfections. Secondly, FDI enables companies to collude and share markets with rivals in a bid to remove the conflicts arising from stiff market conditions. The propensity to formulate a risk mitigation strategy through internationalization is an argument that Hymer used to illustrate how firms construct internationalization strategies based on their decision-making characteristics. Furthermore, he highlighted three characteristics including long-term strategy, day-to-day supervision and management decision coordination. 3. Types of FDI  No single definition exists as an application across all the types of FDI. Therefore, several academic communities have created a set of definitions that define the different types of FDI. Primarily, the major types of FDI include categorizations along target, motive, direction and entry modes. By motive  The resource-seeking motive of an FDI aims at exploiting the comparative advantages of a country. For instance, companies that seek to increase their energy resources would exhibit attraction to countries that have primary resources such as oil. For instance, the investment of BP Oil Company in the Middle East represents a resource seeking FDI. On the other hand, the market seeking FDI aims at capturing the regional and local markets. Under most circumstances, companies that make this investment type are typical manufacturers of wider varieties of household consumer products (de Santis, 2014). Similarly, marketing-seeking FDIs are evident when companies dealing in supplies follow their consumers across borders. Perfect examples of the FDI include the investment by Coca Cola Beverage Company in multiple continental markets in a bid to widen its market share. Efficiency-seeking FDIs, furthermore, are aimed at establishing the efficient structures by employing critical factors such as policies, markets and cultures. Therefore, companies that prefer the efficiency-seeking FDI are characterized by their ability to capitalize on open and well-developed markets. This is evident in the creation of regionally integrated markets such as the EU and NATO (OECD, 2014). The strategic asset-seeking mechanism occurs when companies undertake acquisitions, investments and alliances with the fundamental purpose of promoting the long-term strategic objectives. These companies acquire assets in foreign firms that promote corporate long-term objectives. An example of the strategic asset-seeking FDI is the merger involving Daimler and Chrysler. By Target The Horizontal FDI involves investment by a company abroad in the same industry in which it operates at home. Primarily, the company replicates its home activities in a foreign market. For instance, Toyota assembles cars in both the home country, Japan, and in UK and US. On the other hand, the Vertical FDI involves the addition of different stages of activities in the foreign markets. The backward vertical FDI involves the investment in a foreign country’s industry in which there is provision of input for the company’s domestic production processes. To simplify, the backward vertical FDI envisages international integration along the tenets of raw materials. For instance, Boeing acquiring an aluminium manufacturer represents an example of backward vertical FDI. Besides, the Forward vertical FDI includes investments in which an industry abroad sells the outputs of the company’s domestic products. Under this FDI, the firm replicates its domestic identity within the foreign market. A perfect example is the operation of Volkswagen in the US market (Brouthers, Gao and McNicol, 2008). Judging from the graph below, the underdeveloped economies are subject to resource-seeking FDIs, as depicted in the case of Africa’s exploitation of minerals and petroleum. However, the developed economies attract FDIs in form of efficiency seeking, through the efficient systems that make business flexible and manageable. Figure 2: Industries attracting the most FDIs based on regions (http://unctad.org) By Direction:  Inward FDI occurs when the foreign capital is invested in the domestic resources. This includes the direct investments by the non-residents within a foreign country. For instance, when launching a branch within the Chinese market, giant American fast food company McDonalds employed local Chinese employees and contracted local farmers with the supply of food and ingredients. The outward FDI, on the other hand, involves the direct investment abroad by the home countries (Johnson, 2011). This is backed by the government incentives, as is the case of Toyota backed by the Japanese government to operate in foreign markets amidst the risks involved in these markets. By Entry Mode The Greenfield investments entail the investment into a foreign country in which the company does not have previous physical offices or locations. This name borrows its meaning from the literal idea of setting up a construction on a green field, such as a forest or farmland. This is rampant in most developed countries, as witnessed in the introduction of Honda into the UK market. On the other hand, the Brownfield FDI is a form of foreign takeover, in which a company acquires an existing foreign company (Saraçi, 2014). For instance, the acquisition of Jaguar Land Rover by Tata illustrates an example of Brownfield investment. While at it, the mergers and acquisitions involve partnerships between companies with the aim of capturing more market share. This is extensive for companies that are entering diverse and volatile markets that have preferable tastes and preferences, despite having high competition. 4. Methods of FDI The wholly owned subsidiary is a form of company owned by another company. Under this form of FDI, a foreign company could venture into a domestic market through the purchase of all the assets and liabilities of a company that exists within the domestic market. In such situations, the parent company, mainly the foreign company, holds all the common stock belonging to the subsidiary company. On the other hand, the acquisition of shares in companies with similar products is an FDI method that involves the purchase of a portion of the total value of a company’s stock (DeGennaro, 2013). Under this, the foreign company is enlisted as a shareholder within the domestic company. Through this method, foreign companies are entitled to the investment decisions made by the company, and use this information in analyzing the market trends. Thirdly, acquisitions involve business transactions between unrelated parties based on the terms established by a particular market in which each entity operates upon its benefits. The foreign company purchases the liabilities and assets of the target local company. Unlike the subsidiary that retains the branding of the subsidiary company, the acquisitions involve total overhaul of the entire business operations. On the other hand, mergers are a form of FDI that occur when companies agree to merge into a single company in a bid to create business synergies. Alternatively, joint ventures are an FDI form that represents contractual agreements between two or more companies with the purpose of undertaking business operations based on the capital formation in sharing profits and losses accrued from such undertakings. The joint ventures differ with partnerships on the lack of continuing intentions exhibited upon the execution of the core business mandate. 5. Factors affecting investment decisions The main factors that influence FDI touch on the policy frameworks that differ across countries. The rules and regulations that govern the entry and operation of foreign investors determine the investment decisions made by foreign companies. The standards of treatment subjected to foreign investors play a central role in influencing FDI, especially when these standards are compared to those of the local investors (Anyanwu and Yameogo, 2015). The efficiency and functionality of the local markets affect the FDI, as investors require flexible and efficient markets. Besides, markets that have adequate measures that facilitate businesses, such as incentives, promotional mechanisms and social amenities often attract more FDI, as is the case of EPZ. Other factors such as the national economic growth rates, interest rates, stability of the exchange rates and the stability of the financial service systems affect the investment decisions made by foreign investors. As illustrates in the graph below, the regional balance indicates trends that echo the arguments above. Consequently, while other OECD regions are experiencing higher FDI inflows, the European region lags behind mainly due to the stringent measures that discourage FDIs. Figure 3: effect of government incentives on FDI (http://unctad.org) 6. Cost and Benefits of FDI Benefits to the Host Country The host country enjoys an influx of technological and managerial skills form the FDIs. Besides, FDIs create employment opportunities for the citizens in host countries. The FDI enables the host country to increase its export capacity, hence earning more revenue to the country (Szanyi, 2012). The investment of foreign companies into the host country presents competition within the industries, hence prompting the improvement of the quality of goods and services within the economy. Benefits to the Home Country The outward FDI presents the home country with recommendable job opportunities. As such, the export of resources and technology enables the home country to create more skills to fill the gaps within the industry, hence creating employment. The profits of the foreign firm, nonetheless, return to the home country while the domestic producers benefit their countries. Cost to the Host Country FDIs can paralyze the domestic production through the introduction of superior technological capabilities in the market. FDIs can alter the economic health of the host nation through the provision of cheap products that reduce the value of exports from the host nation. This can be detrimental to the inflation rates as well as the exchange rates. Cost to the Home Country  Investing in a foreign country deprives the home country with the employment and capital resources at the disposal of the company (Szanyi, 2012). Massive FDIs limit the domestic competition, hence prompting the reduction of positive competition within the home country. In conclusion, FDIs influence the employment and general economic health of the home country. Bibliography Anyanwu, J. and Yameogo, N. (2015). What Drives Foreign Direct Investments into West Africa? An Empirical Investigation. African Development Review, 27(3), pp.199-215. Baer, W. and Sirohi, R. (2013). The Role of Foreign Direct Investments in the Development of Brazil and India: A Comparative Analysis.Kyklos, 66(1), pp.46-62. Brouthers, L., Gao, Y. and McNicol, J. (2008). Corruption and market attractiveness influences on different types of FDI. Strat. Mgmt. J., 29(6), pp.673-680. Burkhanov, U., Allaberganova, N. and Khudoykulov, K. (2015). Problems of attraction of foreign direct investments in Uzbekistan. Spanish Journal of Rural Development, pp.59-64. de Santis, R. (2014). Foreign Direct Investments - FDI. SSRN Electronic Journal. DeGennaro, R. (2013). Direct Investments in Securities: A Primer. SSRN Electronic Journal. Johnson, L. (2011). The Impact of Investment Treaties on Governance of Private Investment in Infrastructure. SSRN Electronic Journal. OECD, (2014). International investment struggles. FDI IN FIGURES. [online] Available at: http://www.oecd.org/investment/investment-policy/FDI-in-Figures-Feb-2014.pdf [Accessed 23 Nov. 2015]. Reddy, D. (2012). Foreign Direct Investments in Indian Pharmaceutical Industry. PARIPEX, 2(2), pp.81-83. Saraçi, A. (2014). Origin of Foreign Direct Investments. MJSS. Szanyi, M. (2012). Foreign Direct Investments in Small Business of Transition Economies. SSRN Electronic Journal. UNCTAD, (2015). World Investment Report 2014. Investing In The SDGs: An Action Plan. United Nations Conference On Trade And Development. [online] Available at: http://unctad.org/en/PublicationsLibrary/wir2014_en.pdf [Accessed 23 Nov. 2015]. Read More