Cost, Benefits and Effects of Inward Direct Investment - Literature review Example

? Multinational Companies Table of content Introduction 2. Inward foreign direct investment 3. Cost, Benefits and Effects of Inward Direct Investment 4. Wage Rate 5. How Cost and Benefits Are Determined By Country and Firm Level Growth and Development 6. Production Cost 7. Conclusion Multinational Companies Abstract This report reveals the significant impact that foreign direct investment has to the host countries where investments are made. This investment also targets at long term impacts on businesses that are outside of the investor. Inward foreign direct investment is also revealed in the report. It leads to capital and skill intensive which many companies have used to enhance domestic production. It also have disadvantages as well where it reduced employment opportunities and increase production cost. According to Mondy (2013) Inward foreign direct investment is seen as a spill over superior technology hence extending to domestically owned firms. Foreign -owned firms are seen as the main cause for increasing wage levels in a host’s countries and also lead to higher productivity compared to local firms. Also, the impact of inward foreign direct investment is witnessed in promoting exports of host countries. There is spill over of production skills which have transformed the economies of host countries (Mondy, 2013). Much of the impact is seen when knowledge of the world market is transferred from foreign owned firms to domestically owned firms. Introduction FDI refers to Foreign Direct Investment; the investment can be into a business or production of the country by another country or an individual of another country. This investment can either be by expanding production of existing firms in the target country or by coming up with a new business in the target country. Thus, foreign direct investment can lead to increase in production of target countries as a result of either increasing innovation in local business or by coming up with non-existing innovations (Nicholls, 2012). Investment is direct since the investor is seeking to have control over the foreign enterprise. This investment is targeted to have long term impact on business outside the economy of the investor. According to Nicholls (2012) foreign direct investment is seen as a source of external capital since capital comes from outside the country where the investment is made. In developing countries, FDI and exports are the key elements that lead to growth of this country’s economy. Countries which dominate largest part of world’s economy, for instance, United State of America are mainly foreign direct investors. Impacts of inward direct investment can either be long term or short term (Cainelli et al., 2004). Short term effects include an increase in production of existing companies. On the other hand, long term effects includes impairing local innovations as foreign investors tend to control the economy in the long run. Inward foreign direct investment It has been suggested Cainelli et al., (2004) inward foreign direct investment (IFDI) is said to encourage innovativeness on local firms, through investing in existing local business. This will encourages the use of modern technology in productivity, leading to increase in production by local firms. Cash flow in local firms will increase due to modern advanced technology. Increase in innovation levels by local firms is due to knowledge brought in by foreign investors to domestic investors. Creation of job opportunities is witnessed in local firms since there is an increase in the wage rate which makes domestic workers remain in a local firm. Outputs in local firms relatively increase due to the advancement in technical supply requirement leading to economic growth in target countries. It is also believed that investing foreign companies and individual posses’ technological superiority comparative to those of host countries. This will lead to production of high quality and cheap goods and services than what was previously available. Inward foreign direct investment has both costs and benefits to the country of destination (Piet et l., 1999). The costs and benefits of Inward foreign direct investment are as outlined below. Cost, Benefits and Effects of Inward Direct Investment In IFDI, there are both positive and negative effects. One of positive effect is an increase in capital stock to local countries which increase output levels of local products. Despite the fact that inward foreign direct investments make use of superior technology, it is believed that there is spill over of this technology to local firms (Bardhan et al., 2000). Rather than this Superior technology being retained by foreign owned firms, it spreads to local firms resulting to increase in quantity and quality of goods and services that are produced by local firms. Due to a higher level of technology, foreign -owned firms pay higher wages to domestic workers compared to domestically-owned firms due to economies of scale. This will force local firms to increase their wage rate which will make local firms incur extra cost. Wage Rate It has been argued Bardhan et al., (2000) increase in the wage rate by local owned firms are seen as an extra expense which will reduce their profits. Superior technology used by foreign- owned firm spill over to local- owned firms causing local firms to adopt the use of superior technology .In addition, use of superior technology decrease production costs. Wage rate spill over from foreign-owned firms to domestically owned-firms, can have either positive or negative effects to local owned firms. For example, wage spill over will make all best workers seek jobs in foreign-owned firms leaving lower quality workers to domestically owned firms (Fukao et al., 2008). On the other hand, effects of lower relative efficiency in production are witnessed where foreign owned-firms take almost all the market share from domestically owned firms. This leaves domestically owned-firms with low economic productions level which increases the cost of production to local firms. Inward foreign direct investments pay high wages to its employees, which can scare away potential local investors. In some situation, an entrepreneur would prefer to be employed by foreign firms rather than establishing a new investment. A research carried out in Germany by a group of economist in 2003 revealed that there is no perfect relationship between foreign direct investment and gross domestic product of a country (Fukao et al., 2008). This research argues that production spill over and wage spill over do not exist and this gives evidence of both negative and positive spill over. How Cost and Benefits Are Determined By Country and Firm Level Growth and Development Wage spill over is additional costs brought about by foreign-owned firms to domestically-owned firms. These costs come as a result of considering differences between job opportunities offered by foreign investors and those offered by local investors. Thus costs brought about by wage spill over are fully determined by firms’ level of development and also country’s level of growth. For example, domestically owned-firms are relatively smaller compared to the foreign firm; this determines level of development and growth of both local and foreign firms. Large firms are assumed to be well developed and grown compared to small firms which occupy small business premise and therefore able to better manage costs (Bardhan, 2000). Developed countries are said to pay low wages proportional to costs incurred. For example, according to Bergsten et al. (1978), U.S.A has minimal effect to wages caused by Inward foreign direct investment since few foreign investors are willing to invest in the country. On the other hand, Spain being a developing country has high wage spill over since it is not fully developed. Another cost associated with inward foreign investment is productivity cost; these costs determine the level of development and growth of both firms and countries. For example, as a result of foreign investment in Southern California, wage level was very high which lead to a high rate of employment in foreign owned firms. Consequently, number of employees in domestically owned firms decreased which meant that production cost in local firms increased as these firms attempt to maintain their level of output. This will lead to the gradual development of foreign owned firms leaving domestically owned firms under-developed which increase production cost in developing countries leading to under-growth. Production Cost Production cost is associated with technology or knowledge from foreign firms to local owned firms. Technology influence labour productivity hence determining productivity cost. However, firms that run small firms need technologies whose levels are similar to those operating large firms. Productivity cost is seen in a different perspective if foreign investors have perfect knowledge on tastes and demand of customers(Wendy et al.,1997) .on the other hand, local investors lack perfect knowledge on demand and taste and preferences of customers. This makes local firms incur more costs of production compared to foreign owned firms. A great difference in development and growth, therefore, exists where the domestically owned firm becomes under developed while the foreign owned firm becomes developed. For example, in Vunuela, foreign investor had perfect knowledge on customer demand which lead to reduced production cost. On the other hand, domestically owned firms lacked knowledge on demand and customer taste hence experiencing high production cost which hindered development and growth of local firms. Conclusion Inward foreign direct investment is clearly brought out as having both positive and negative impact on domestically owned firms. The main positive impact of Inward foreign direct investment is that it enhances innovativeness of local firms. As a result of foreign investor investing in developing countries superior technology spills over to local firms leading to innovation. Local firms will as a result try to adjust to market demand in order to curb competition brought in by foreign investors. The only way for local firms to maintain their customers is by using superior technology similar to that used by foreign firms this will lead to innovation. References Bergsten, C. F., Horst, T., & Theodore, H. M 1978, American Multinationals and American Interests. Brookings, Washington. Wendy,D.,Yue ,S.C.(1997),Multinational and East Asian Intergration. International Development Research Centre, Singapore. Mondy,A.(2013),Germany in An Interconnected World Economy. International Momentary Fund, Washington. Nicholls,D.(2012),Foreign Direct investment:Smart Approach to Differentiation and Engagement. Gower, Aldershot. Cainelli,G.,Zoboli,R.,(2004),The evolution of Industrial Districts. Physica, London. Piet,R.,Shefer,D. ,(1999),Regional Development in an Age of Structural Economic Change. Burlington, Ashgate. Bardhan,P.,Udry, C.(2000),Reading in Development Economics. Mit press, Cambridge. Fukao, K. ,Parzycki, R. (2008),Foreign Direct Investment in Japan: Multinations Role in Growth and Globalization. Cambridge University Press, Cambridge. Read More