Intervention in Foreign Direct Investment - Essay Example

Intervention in FDI Student’s Name Course Professor Date Introduction Throughout 1990s, FDI expanded rapidly. The first half of the decade witnessed a 20% growth per year and inflows grew to 40% per year in the last half of the same decade (Jakobsen & Jakobsen, 2011). The current growth in FDI is faster compared to global trade and production. The rising growth of FDI results from globalization trends and increased merger and acquisitions. FDI is one type of flow of capital across international boundaries. In turn, it promotes home countries to have a form of international assets majorly for subsidiary controlled by home-country Corporation (Wijeweera, Villano & Dollery, 2010). For host-country, FDI is perceived as promoting a set of activities like production, sales, employment, purchase and use of fixed capital and intermediate goods as well as research efforts that advance the economy. This paper attempts to understand the reasons why government in host countries and from home countries intervenes in the free flow of FDI. Additionally, it will conclude by pointing out on whether such interventions are justifiable. Rеаsоns for hоst соuntriеs’ intervention in FDI According to Gammeltoft, Pradhan & Goldstein (2010) governments of host countries to intervene in FDI flows are to protect the balance of payments (BOP). Generally, the government attempts to balance the country’s demand on foreign currencies and foreign countries claims for its currency. In most cases, in countries which import more that its exports, trade balance tend to be deficit. The deficit is counterbalanced by funds earned for FDI. FDI boost the balance of payment in two ways; increasing the country’s export products and re-investing the profit in the country. However, direct investors who send profits that they make locally back to their parent companies at home lead to a decrease in the balance of payment. Surplus or deficits lead to imbalances with greater concerns about deficits for that matter. Any country that has deficit builds up an increased debt. Additionally, its assets are increased owned by foreign firms. In turn, host countries switch to protectionism in order to correct such imbalances. As Herzer (2012) argues, host country intervene on FDI matters as way to avoid the extent to which they stifle host-country growth due to tendency to displace local firms and obstructing domestic technological progress. Sometimes the government reacts by providing direct subsidies through offering cheap loans and lump-sum payments to local firms. The intention to provide with such subsidies help promote the competitiveness of domestic firms and protect jobs. Continued investment in technology assets increase a country’s competitiveness and productivity. The government raises control measures to allow local industry to grow and compete with other mainstream industries or those in foreign countries. The motivation to intervene in FDI allow for control the incidence where infant industries die before reaching its age and size of sophisticated infrastructure, manufacturing skills and competing at global market. Host countries use policy instruments to restrict or promote FDI. Most host countries encourage FDI to increase their productivity, create employment opportunities, increase exports, introduce new industries and technologies and raise the rate of economic growth. However, FDI has several effects on host-country that lead the government to intervene. One major way is by imposing ownership restrictions where foreign firms are restricted from investing in cultural industries or business that are vital to national security (Lin, 2010). Other countries create instrument like performance demand to influence how foreign company will operate in the country. The most common intervention that promotes FDI in host countries is government policy to grant foreign companies incentives in terms of lower tax rates. The governments can waiver taxes for a period of time for local profits. Some other countries offer low interest loans to attract foreign investors. Other governments promote FDI through improvements of local infrastructure to support activities like shipping, road transport and telecommunication systems for communication purposes. Herzer (2012) further observes that, the government of host countries intervenes in FDI as an attempt to control foreign investors’ tendency to depress wages in host countries. In most cases, foreign investors relocate their manufacturing units to geographical markets where they can reduce their recurring budgets, mainly from salaries and monthly wages. In turn, the exploit helpless workers in the host countries who are seeking for employment to facilitate their bottom line in increasing revenues. Ultimately, foreign investors can accounts for the highest percentage of employment in the host country, the tendency to exploit workers through lowered wages affect the country’s economy and people’s standards of living. The governments intervene for the profit made by foreign investors to be distributed in a manner that would benefit the host country (Reiter & Steensma, 2010). Wijeweera, Villano & Dollery, (2010) points out that, host countries’ governments intervene in FDI in order to promote local skills and management which trickle down to local firms. Governments of host country legitimately restrict foreign investors to send money back to parent companies so as to grow the infant industry in the country to a mature job market. Foreign investment creates a great opportunity for the transfer of skills across international boundaries. In turn, governments in host countries limit the number of expatriates that works and carry out management roles in foreign companies. By having a sizeable number of its locals in various industries, the governments boost employment, the development of technical and non-technical skills which promote the growth of domestic firms and increase the country’s competitiveness. One typical example of contribution of FDI to the development of local skills and domestic industry is the competitiveness of Huawei, a Chinese-based domestic company. Huawei has risen to a level of international company, competing with other multinational corporations in technology industry (He & Mu, 2012). FDI has recently been accelerated by rising carbon taxes in home countries. The desire to control industrial pollution has seen many developed economies having a strict regulatory environment. Companies evade rising taxes by relocating to developing economies where regulatory environment is friendlier. The host governments then intervene in FDI to control excessive pollution activities that might affect the country in the long run. Rеаsоns for hоmе соuntriеs’ intеrvention in FDI As Gammeltoft, Pradhan & Goldstein (2010) argues, home countries perceive FDI as a factor that lower the balance of payment; mostly when profits abroad are not returned. Sending resources out the home country affect the economy and its competitive advantage over other countries. Governments in home countries intervene on FDI due to this major reason. In most cases, foreign firms tend to borrow money from their home country for their foreign investments efforts. In turn, the movement of money to foreign firms affects the country’s balance of payment. Most private firms go into debt to finance extra production. Investing in foreign countries send money out and lowers the balance of payments. In cases where the profits are not returned home to parent companies but are only used to facilitate continued investments in foreign countries, home countries suffers due to imbalances. FDI also damages the balance of payments due to its tendency to take the place of the nation’s exports. Outgoing FDI can ultimately damage the country’s economy. Home-country exports decreases. FDI does not also account for home-country factor demand and in the long-run, the country might find itself importing more as its citizen considers investing abroad. Majorly, relocating money, assets and skills from home country reduces the export capacity of the country. Intervention through restrictions and protective duties allow home country to retain its manufacturing power. It is also intended to restrict other countries to attain a similar degree of development. In turn, such countries can act by negotiating with other countries to promote free trade to promote its exports and reduced duties to domestic corporations exporting to other regions. In home country, intervention is meant to correct the tendency of FDI to depress employment and wages at home due to moving production abroad. In turn, it replaces jobs at home due to increased outgoing investments. Manufacturing sector is necessary in promoting diverse forms of employment. However, when firms reduce the level of their production in home country in favor of cheaper production in foreign markets, it leads to loss of jobs. Furthermore, it affects the payment rates by lowering the competitiveness of the country’s job market. As Lu, Liu & Wang (2011) argues, home country governments intervene on FDI attempt to limit its effects on national economy. They in turn impose differential tax rates as a way to charge foreign income higher compared to rates on income earned in domestic markets. Some countries impose outright restrictions or sanctions for its foreign firms to invest in some nations. As Du, Lu & Tao (2012) observes, home governments that promote FDI may intervene by insuring investments risks in foreign countries and thus encourage outbound FDI. Some firms a guaranteed the loan they take from various financial institutions and so they increase confidence in foreign investments. Additionally, they can increase amount lending to firms that pursue foreign investments. Other countries offers tax breaks for profits made abroad or negotiate with the firms on the best tax treaties to avoid affecting firms’ FDI objectives. Lastly, home countries may apply political pressure to persuade host countries or other nations with prospective economy to relax restrictions on FDI in order to promote the good environment for FDI for their firms. Arе thеsе intеrvеntiоns justifiable? Every country secures its sovereignty and an intervention to restrict foreign firms to invest in some sectors is justifiable. This is because, a sector like tourist require less technological assets for its growth and maintenance. The government then secures it to avoid the incidences where profits are sent back to home countries affecting the economic growth of the host country. Security sector is another sensitive area where the interest of the host government can be affected if foreign firms deal with sensitive technology. For the purposes of regulating the interests of different groups in the country, host government must regulate the production and distribution of firearms, military training and skills (Lin, 2010). Some of the incentives offered by host countries are very logical as they ensure that FDI promotes the greatest level of output to the national economy. For instance, improvement of local infrastructure benefits the country in the long-run even if the foreign firms may withdraw their operation later. The host countries reveal a higher bargaining power over foreign firms and can dictate an array of terms that will contribute to the bottom line of economic improvement and growth. Another incentive like lowering interest rates for loans given to foreign firms is justifiable depending on the state of the country. First, if a host country has a very large market and aims at reducing massive exports. Second, a host country with great resources and whose citizens living conditions are higher can offer such loans to increase its development and competitiveness. An attempt to lower tax rates on foreign firms is applicable for countries with higher rates of unemployment, poor technology and little resources to boost its economy. Additionally, if the country has poor skilled and national talents, they do not have many options other than lower taxes for foreign firms. In the long run, they benefit even though not to a greater extent. The move by host countries to encourage FDI is mostly justifiable for countries that have low population and restricted resources for efficient industrial operations. In turn, they promote mutual benefits through FDI as they help the host countries by solving unemployment problems, promoting skills and reduce the extent of imports. Home countries that restrict foreign direct investments and dictate where such FDI should be directed are mostly driven by fear of competition. No restrictions are justifiable unless the country in which the foreign firms intend to invest in is instable and risky for nationals of home country to work in or due to pervasive corruption (Du, Lu & Tao, 2012). The tendency of home country to offer FDI incentives to their firms can be geared purely leveraging market opportunities more so if FDI goes to countries with good institution (Kolstad & Wiig, 2012). In other cases, FDI has been used by western nations to relocate industrial operations from their home to reduce the impacts of pollution. Instead of transference of resources they tend to relocate problems. References Du, J., Lu, Y., & Tao, Z. (2012). Institutions and FDI location choice: The role of cultural distances. Journal of Asian Economics, 23(3), 210-223. Gammeltoft, P., Pradhan, J. P., & Goldstein, A. (2010). Emerging multinationals: home and host country determinants and outcomes. International Journal of Emerging Markets, 5(3/4), 254-265. He, X., & Mu, Q. (2012). How Chinese firms learn technology from transnational corporations: A comparison of the telecommunication and automobile industries. Journal of Asian Economics, 23(3), 270-287. Herzer, D. (2012). How does foreign direct investment really affect developing countries' growth? Review of International Economics, 20(2), 396-414. Jakobsen, J., & Jakobsen, T. G. (2011). Economic nationalism and FDI: The impact of public opinion on foreign direct investment in emerging markets, 1990-2005. Society and Business Review, 6(1), 61-76. Kolstad, I., & Wiig, A. (2012). What determines Chinese outward FDI? Journal of World Business, 47(1), 26-34. Lin, J. Y. (2010). Six steps for strategic government intervention. Global Policy, 1(3), 330-331. Lu, J., Liu, X., & Wang, H. (2011). Motives for outward FDI of Chinese private firms: Firm resources, industry dynamics, and government policies. Management and Organization Review, 7(2), 223-248. Reiter, S. L., & Steensma, H. K. (2010). Human development and foreign direct investment in developing countries: the influence of FDI policy and corruption. World development, 38(12), 1678-1691. Wijeweera, A., Villano, R., & Dollery, B. (2010). Economic growth and FDI inflows: a stochastic frontier analysis. The Journal of Developing Areas, 43(2), 143-158. Read More