Foreign Direct Investment Unit - Essay Example

Foreign Direct Investment Unit Foreign Direct Investments (FDI) entails an investment by a foreign company or entity in a particular country. The firms make its investments in facilities so that they are able to invest or produce in the foreign country. FDI does not encompass the investment in foreign financial instruments (Indirect investments). The firm that engages in a FDI becomes a multinational enterprise; this can occur through two main ways. Firstly, the enterprise can acquire or merge with an existing enterprise a foreign country. Through this mechanism, the laws of the two countries from which the two enterprises originates from are adhered to. Secondly, the foreign enterprise can establish a greenfield investment in which there it is a complete new start-off in the foreign country. Having laid the foundation of FDI, this paper shall examine the theories that underlie it, and its cost and benefits in relation to statistics of Ghana as provided by the World Bank. The data obtained from World Bank concerning the percentage of GDP that is contributed by the FDI in Ghana has been very dynamic since 2009. The figures have indicated that foreign investment have been contributing a stagnant percentage to GDP for the four years (2009-2012). In 2009, 9.1% of GDP emanated from FDI, there was a reduction a year later to 7.9% in 2010. It then went up to 8.1% in 2011 and stagnated there in 2012. This trend can be attributed to a number of economic factors. The theories of FDI explained below provides a basis for description of such scenario as that of Ghana (The World Bank 2013). There are many theories that have been put forth to explain FDI and its economic basis which can be translated to the case of Ghana. Before engaging further, there are important concepts that ought to be understood. FDI flow refers to the amount of FDI that is undertaken over a given period of time. The World Bank uses the concepts of outflow and inflow of FDA in referring to the flow of FDI out and into Ghana respectively. In addition, the understanding of the reasons why firms engages in FDI as opposed to other market entry strategies is very important. It helps us pinpoint the economic implications of FDI as an economic strategy. Several theories have attempted to explain FDI. In this paper, we shall put into perspective four major theories of FDI and their relationship with the FDI in Ghana. However, these are not the only theories that attempts to describe FDI. Firstly, we will look at the oligopoly theory of advantage, which tries to explain vertical FDI. This theory points out to the dominance that is exhibited by big firms towards dominating the market; the trade barriers hinder smaller firms from venturing. In order to remain monopolistic, the large firms works at their best to ensure the entry barriers continue to be enforced. This is because new entrants are likely to increase competitiveness at the expense of the growth of their organization to levels that they are able to colonize the entire market. The rate at which a firm grows is the determinant of the capacity in which it will achieve as well as the ability to capture the market. This trend is seen as a defensive strategy by a firm that capitalizes on its growth to protect its stake and promote further growth (Calvet, 1981 p 43). This theory has been used to explain this phenomenon as exhibited by large firms. The oligopoly theory has been witnessed in Ghana where companies such as Coca Cola and Pepsi have completely dominated the market at the expense of the local producers. However, in order to foster competitiveness, Ghana had attempted to liberalize the trade regimes. Apart from the oligopolistic approach, FDI can also be described based on theory of monopolistic advantage. This theory takes into consideration of a foreign firm that exhibits competitive advantages over the local firms based on the economies of scale and utilization of superior technologies as well as knowledge. Some of the multinationals such as Coca Cola have dominated the world of beverages courtesy of the strong brand and the lack of worthy competitors especially at the local levels. The knowledge that has been used in developing the products has been patented, hence making it difficult for any other firm to produce a replica. The firm has the capacity to develop product differentiation hence captures the entire market. The ultimate result is that the FDI rises hence the investor organization is capable of maximizing its profitability. It also happens that the use of newer technologies facilitates reduction in the cost of production as compared to the local producers that use old technologies that are not cost effective. The resultant is that the foreign enterprise with superior technology will have a competitive advantage (Morgan & Katsikeas1997). Ghana has not experienced much of the impacts of this monopolistic theory courtesy of the liberalized FDI regime, privatization of public entities, addressing the concerns of the investors as well as the promotion of investment. Another important theory is the product life cycle model theory. FDI is influenced by the life cycle of a given product. This theory establishes the relationship between the monopolistic approach of product and the time that the product remains competitive in the market. This theory ensures that a given innovative product gets into the home market and gets to the growth stage where the product gets a monopolistic advantage not only for local consumption but also for export. The resultant is that the firm will consider developing a foreign enterprise to take advantage of the preexisting product growth. This theory helps foreign enterprises capitalize on the superiority of their products (Calvet, 1981 p 43).. It is not always the case that the foreign enterprise will produce from the host country. The product can be exported if that is the best alternative. The mining sector is one of the lucrative income generators in Ghana. FDI interests in this sector began in the 1980s, with foreign companies such as Ashanti Gold Fields, GoldFields Ltd, Teberebie Goldfields ltd, Ghana Australian Goldfields Ltd among others declaring interest in gold exploration. The decline in the commodity is causing a decline in FDI (OECD 2002). The eclectic paradigm is another theory that influences foreign direct investment. The theory was proposed by Dunning in 1977, it tries to analyze the FDI and organizational issues that have a relationship with production Ghana. The theory provides three variables that affect the company’s analysis in establishing whether to have direct foreign investments or not. The underlying assumption in this theory is that there will be avoidance of transactions when there are lower costs of internal transactions. Three advantageous aspects must be clear for a successful engagement in a foreign country. First, there should be advantages that are derived from the location of the company in the foreign country (location advantages). Ghana is a spectacular location based on its strategic location in west Africa and also the fact that it is one of the most economically developed countries in Africa and is endowed with resources (oil, gold and cocoa). Secondly, the firm should consider having a foreign investment on its own capacity instead of getting into agreements with foreign firms (Internalization advantages). Old mining and other companies in Ghana have opted to go on their own instead of engaging the local companies. Finally, there should be a unique competitive advantage that is exhibited by the product or the company that wants to venture into a foreign country. Products such as cocoa and gold have a huge demand hence the viability of establishing the foreign companies in Ghana pays off. This type of advantage should exceed the disadvantages of competing with the local companies (ownership advantages). FDI comes with costs and benefits for the country in which a given foreign enterprise comes from. Ghanaian-based foreign enterprises have added several benefits to their home countries. These benefits have emanated from three main broad sources; first, the foreign exchange that gets into the home country is beneficial since it boosts the capital account of the balance of payment of that country. In addition, the current account can also benefit if the foreign enterprise creates a higher demand for exports from the home country. Secondly, the home country would also stand to benefit from the employment effects that arise as a result of the foreign enterprise’s presence in a foreign country. The foreign company can opt to transport some of its workforce to the host country where they will be able to earn and invest back in their country. Alternatively, the export products from the home country provide a good opportunity for creation of more employment opportunities, which is highly beneficial to the home country. Finally, the exposure to foreign markets exposes the foreign enterprise to many skills that facilitates its competitiveness and the capability to improve on its position. These skills would entail improved management skills and technologically developed products and processes. Such skills can be taken back to the home country to facilitate the development of the local enterprises. Such an effect is tantamount to reverse-resource transfer effect. Apart from the accruing benefits to the home country, foreign direct investments come at a cost to the home country. One of the major costs that the home country has to incur is in the balance of payments, which may be affected in various ways. The initial capital outflow to the foreign country geared towards providing financing for the enterprise is a cost that is borne by the home country. It is also costly in terms of current account in situations where the FDI acts to replace the direct exports that were initially directed to the host country. Another cost implication as a result of balance of payments comes through the current account in circumstances where the location is the reason for establishment of the firm in a foreign country. On the other hand, the employment effects can also present cost implications to the home country. When the FDI is implemented as a substitute for local production, a number of locals will stand to lose their jobs at the expense of the foreigners in the host country. Though there may be a few experts getting jobs with the enterprise, there are a number of people who will lose their jobs due to the reduced export of goods. The costs that are derived from the home countries to foreign enterprises appears as benefits Ghana. The resource transfer effect is one of the main benefits that Ghana has continued to derive from FDI. This occurs as a result of the assets that are transferred from the home country. In addition, FDI provides capital supply to the host economy as well as management resources as well as technology that could not have obtained if such did not happen. The government benefits in a great way as a result of the taxes that are levied against the locally produced goods. In addition, they are able to get benefits from the levies that are paid through import duties for raw materials. There is also a great benefit from employment; in this case, Ghanaian citizens get jobs in the foreign enterprises at the expense of the home country. The presence of the foreign enterprise in the host country creates jobs directly as well as indirectly to the people in the host country. This results to increased income for the population hence a rise in the living standards. There is also a benefit that emanates from the effects of balance of payments, in this case, the foreign exchange that went to another country remains locally. In addition, the presence of foreign firms fosters competitiveness with the local firms, which is advantageous for the overall growth of the economy (Nourbakhshian, et al 2012). While there are benefits that are derived by Ghana through FDI, costs also ensues. The first result of presence of a foreign enterprise is increased competitiveness. Some of the local firms have suffered from the competition courtesy of the advanced technologies, management skills, and strategies by the foreign enterprise. Such a situation may create a scenario where the market is made a monopoly. On the other hand, the host country can suffer from the effects of balance of payments. This can be contributed by the outflow of earnings to foreign countries while there is much reduced earnings as a result of sourcing inputs from the foreign country. There are also concerns on the basis of the sovereignty of the host country since most of the decisions will be made by the parent company which may not be at the interest of the host economy. References Calvet, A.L (1981), "A synthesis of foreign direct investment theories and theories of the multinational firm", Journal of International Business Studies (pre-1986), vol. 12, no. 000001, pp. 43 Dunning, J. H (1977) “Trade, Location of Economic Activity and the MNE: A Search for an Eclectic Approach.” In Bertil Ohlin, Per-Ove Hesselborn, and Per Magnus Wijkman, eds., The International Allocation of Economic Activity. London: Macmillan. Morgan, R.E. & Katsikeas, C.S (1997), "Theories of international trade, foreign direct investment and firm internationalization: a critique", Management Decision, vol. 35, no. 1, pp. 68-78. retrieved from http://search.proquest.com/business/docview/212053865/EC400DEB29C54E21PQ/1?accountid=45049 Nourbakhshian, et al (2012), The Contribution of Foreign Direct Investment into Home Country’s Development, Vol 3, No 2, retrieved from http://www.academia.edu/1174673/The_contribution_of_Foreign_Direct_Investment_into_home_countrys_development OECD (2002), The role of foreign direct investment (FDI) in the mining sector of Ghana and the environment, retrieved from http://www.oecd.org/countries/ghana/1819492.pdf Owusu-Antwi, G., Antwi, J. & Poku, P.K (2013), "Foreign Direct Investment: A Journey To Economic Growth In Ghana - Empirical Evidence", The International Business & Economics Research Journal (Online), vol. 12, no. 5, pp. 573. Retrieved from http://search.proquest.com/business/docview/1418721038/1AD8E61719704F75PQ/2?accountid=45049 The World Bank (2013), Foreign direct investment, net inflows (% of GDP), retrieved from http://data.worldbank.org/indicator/BX.KLT.DINV.WD.GD.ZS/countries/1W?display=default Read More