Concept of Foreign Investment - Case Study Example

Running Head: FOREIGN INVESTMENT Topic: Foreign Investment Lecturer: Presentation: Concept of Foreign Investment Foreign investment is one of the resultant aspects of economic globalization. As nations continued to advance technologically, better means of transport and communication led to the movement of investors beyond political boundaries, especially during the colonial period. Even after nations acquired independence, globalization continued to generate trade between investors and foreign countries, whereby the less developed countries were supported by the developed nations to acquire materials and equipment to utilize the available natural resources for economic development. However, the equipment needed to be supported with the necessary skills to ensure that the less developed countries were able to utilize their full potential. As economies expanded, trade grew and exchange of goods and services continued to advance. With the less developed economies possessing plenty of raw materials for industries abroad, foreign investment was inevitable as industries from developed economies sought to establish in the less developed countries where raw materials were available (Sacerdoti, 1997). The concept of foreign investment also derives its roots from the realization from industries in the developed countries that labor was expensive in the developed countries. Companies therefore sought other regions where they could make use of cheap labor and produce the same quantity as they would in the country of origin. Markets are also a major factor that facilitates the movement of industries to establish in regions where there is ready market for commodities (Charlotte, 2004). For example, foreign companies tend to invest in the third world countries where they can acquire a large market share, with few competitors. It also means that companies establish in foreign economies as a strategy to evade rising competition in their country of origin. Foreign investment therefore is a result of the rising needs of companies to enhance the accomplishment of organizational goals. As investors move in to foreign markets, they usually face difficulties depending on many factors such as political stability, barriers to trade and conflicts of interests among other hindrances. These usually present high risks to foreign investors considering the fact that it requires a high initial capital outlay to establish in a foreign economy. The stocks acquired in foreign companies may be lost if the host country fails to formulate policies that facilitate foreign investment. In case of policies focused on the expropriation of foreign companies to utilize property or premises for other development purposes, foreign organizations may face a lot of difficulties and are usually at a risk of closure and losses (Dugan et al. 2008). This is one of the problems that foreign investors face in the highly volatile less developed economies. For example, foreign investors in the African economies have been faced with a lot of challenges especially due to the high turn over of regimes which have different policies in regard to foreign investment. Some of the rulers have even led to heavy losses amongst investors through taking property belonging to investors, such as the losses incurred by foreign investors in Uganda during the tyrannical rule of Id Amin and the recent crisis caused by the unfavorable investment climate in Zimbabwe (Robert, 1997). However, the international law has provisions aimed at protecting foreign investors from losing their property. This is mainly emphasized through treaties such as NAFTA, WTO, and COMESA among others. Such treaties have been significant in protecting foreign investment, especially advocating the elimination of protectionism (Sacerdoti, 1997). Multinational companies operating under the protection of these treaties are shielded from the impact of unfavorable climate create by various regimes. However, many less developed countries usually encourage foreign investment to enhance economic development and therefore tend to offer subsidies and removal of trade barriers to encourage foreign investment. Conflict of Interests Conflicts of interest are major drawbacks for foreign investment. The host country may be focused on satisfying its development agendas through foreign investment. On the other hand, foreign investors may not be focusing on helping the less developed countries to accomplish industrial take-off. Instead they may be focused on satisfying their organizational interests through exploitation of the available resources without the host country reaping much benefit. The international law provides for the foreign investors to file complaints in situations whereby there are disputes. However, the developed countries, as (Dugan et al. 2008) argue, tend to dominate the process through the strong organizations such as the World Bank. The United States is one of the developed economies that have been identified to dominate organizations such as World Bank. The less developed and the developing economies under such circumstances tend to assume that they have been relegated to a lower level whereby their interests are unlikely to be considered. The powerful organizations are viewed as having influence in regard to foreign investment. For example, the fact that the World Bank is capable of offering an annual credit amounting to $23 billion puts the developing nations in a particular situation whereby they have to adhere to the interests of such organizations, including the IMF that tend to form cartels for offering finances for development purposes. In other words, the less developed countries will be affected by conflicts of interests from foreign countries that dominate the strong organizations which provide finances. The foreign countries have to ensure that the interests of the companies that they support are satisfied (Alexander, 2006). Due to the fact that they dominate the international organizations that offer finances to the less developed countries, a conflict of interest arises whereby the foreign investors satisfy their interests regardless of whether the host country is benefiting. In many situations, when the host country fails to present the foreign investor from a developed country with a favorable environment, the lending cartel formed by the international organizations, which are dominated by the developed countries fails to offer financial assistance for economic development. However, the host country may have different development strategies that can only be satisfied through other means other than through serving the interests of the foreign investors, which mainly tend to focus on maximum utilization of the available resources. Compulsion of the host country to accept the demands of the foreign country in order to get favors from the international organizations usually leads to depletion of the available resources, as investors focus on maximizing the utilization of available resources (Dugan et al. 2008). In the long run, the host country may lose from the depletion of resources. On the other hand, foreign investors usually face conflicts of interest in foreign countries where they establish their investments. They may invest in the sectors that the host government has interests, which leads to trade being inhibited in favor of the local organizations. This is the reason why governments impose barriers to trade even for already established foreign industries. For example, tariffs are usually imposed for various reasons. The host government may impose them to reduce foreign competition, thereby protecting the emerging as well as the inefficient local industries (Charlotte, 2004). This means that the market may be free for foreign investors, but there are no chances of growth due to the host government’s interest in the domestic market. In essence, foreign companies and local investors need to understand that their interests are common, which are aimed at facilitating economic development as well as making profits for the purpose of organizational growth. Conflict of interest leads to failure in one of the parties playing part in foreign investment. It needs to be avoided by organizations as well as governments in order to facilitate growth (Alexander, 2006). Historical development of Attitudes towards Foreign Investment Attitudes towards foreign investment are varied depending on the conception of the practice. People are usually emotional in regard to the ownership of resources in their country. Foreign investment has generated different emotions since its inception in many countries. In most of the developing and less developed countries whereby foreign investment was initiated after colonization, people initially viewed the practice as a form of neo-colonialism, hereby after being declared independent in terms of political and the social aspects, they were not economically independent, and therefore they had to depend on employment and finances from foreign organizations (Obstfeld & Rogoff, 1996). This is mainly because there are few situations in many years that companies from the developing and in the less developed economies expand their investment in developed nations. On the other hand, economic globalization which has led to the development in foreign investment has not been understood for many years, especially in the early stages of development of the business practice. People therefore have tended to have a negative attitude towards foreign investment, especially when it focuses on the establishment of companies to utilize the locally available resources (Yarbrough & Yarbrough, 2002). In other words, people and governments are made to realize that they have the economy has the potential for self sustenance, but it lacks the capability of extracting the resources to make them useful for the economy. In many circumstances, foreign investment has resulted in political enmity between economies, since after realization of the fact that a nation has the potential to steer the growth of its own industries, it tends to get rid of the already established foreign industries. The international law recognizes that foreign investors are at a risk of losing nationalization of foreign property for the local purposes, and provides for compensation of property acquired by governments from a foreign organization operating in the country (Charlotte, 2004). On the other hand, the people’s attitudes towards foreign investment especially in the developing countries have been appreciative of the trade due to the improvements in the local standards of living as a result of expansion of the employment opportunities and availability of cheap products. People tend to feel that they participate in the global business and that they have an opportunity to learn from skilled foreigners regarding better methods of production. However, there have been situations whereby workers feel that foreign companies are exploiting the local human resources for the benefits of their people abroad (Feenstra, 2003). Sentiments regarding the expansion of foreign companies locally are usually echoed by the recent wave of politics whereby people tend to feel that regimes expose local opportunities to foreign competition. This is one of the tools for campaigning against policies of the incumbents in various regimes that have been used by the opposition. Nevertheless, the attitude of people in regard to foreign investment has gradually changed as a result of the understanding of globalization and the interaction of people internationally through education and trade. It has come to be understood that foreign investment is paramount to the success of an economy. More over, people derive enthusiasm in being part of the global economy. Understanding that few human needs can be satisfied through protectionism has made it possible for nations to adhere to the policies of organizations such as the WTO and the World Bank regarding reduction of trade barriers (Sacerdoti, 1997). As Spar (2003) observes, the old practices and attitudes continue to fade as people and nations tend to embrace foreign investment as a source of livelihood for employees who work in foreign organizations. Foreign Investment and Economic Development It is important to understand that economic development in a nation is accomplished through a slow process whereby the people’s standards of living are improved as a result of increase in income, leading to a shift from low income to a high economy (Spar, 2003). In order to accomplish economic development, the government needs to ensure a favorable environment for investment especially allowing foreign capital movement in to the economy. In order for this to be accomplished, the political environment has to be conducive for foreign investors who might be scared by investing their capital in a volatile economy. In many less developed economies, population growth is usually high, leading to a large labor force with few opportunities for work. This is because there are few local industries to provide employment. Foreign investment comes in handy. It supplements the local industries generating employment for skilled and unskilled labor locally. This contributes to economic growth, as people are capable of coping with the increasing cost of living (Obstfeld and Rogoff, 1996). Local employees usually benefit through knowledge transfer from foreign employees whom they have a chance to work with. This helps the local labor force to develop advanced skills that are significant for productivity. Economic development is accomplished when an economy has a capable workforce to maintain competitiveness in the local industries. Knowledge and technology transfer are significant in economic development. More over, the establishment of foreign industries locally leads to the development of other enterprises (Feenstra, 2003). For example, small and medium enterprises providing goods and services to the employees of these companies are major income earners for the local population. This is because the workers have to use products that are not manufactured by the foreign company, such as food and drinks, services such as telephone, internet and transport among others. The foreign investors are also major consumers of products manufactured locally. They use most of the products generated locally as raw materials such as agricultural products, which benefits the local producers. The local producers usually have a ready market for their commodities. On the other hand, the byproducts from industries owned by foreign investors are used for local industries, which is important in lowering the price of commodities locally. The government also earns through taxes paid by the foreign investors, as well as the increased income taxes from the employees of these companies. Increased foreign investment in a particular country indicates the presence of a favorable environment created by the country’s regime (Alexander, 2006). Other economies tend to reciprocate by offering financial assistance through aid for economic development. The nation is also likely to enjoy foreign markets for the locally produced commodities. Infrastructure is developed where the foreign industries are developed, which is beneficial for the economy. For example, roads are developed for transportation of raw materials, air ports are developed for landing and exportation of finished products and many other developments in infrastructure. In general, the local economy benefits to a large extent from foreign investment. However, it is important to note that there are several disadvantages regarding foreign investment to the host economy. There is a likelihood of dependence on foreign companies in many aspects such as employment and government revenue through taxes to the extent that if the foreign investors withdraw, the economy is likely to collapse (Pritchard, 1996). On the other hand, the influx of foreign investors in a country leads to a rise in demand of particular services such as housing, leading to the increase in prices of the services, suppressing the local people who are unable to purchase the services. This deficit lowers the standards of living of the population. Factors influencing the flow of Investment, Political Risk and Foreign Direct Investment Multinational corporations are usually faced with risks associated with hostile foreign investment climate, especially political factors. Volatile economies are usually the most risky, although after destruction that is brought about by politics, there usually arises numerous opportunities for investment. Investment decisions need to be made considering all the characteristics of the foreign country. Companies usually tend to limit the amount of investment in politically volatile regions no matter the opportunities available for investment. Some regimes tend to change often, making it impossible to make long term goals or investments (Robert, 1997). Others interfere with operations through imposing tariffs and other barriers to trade that hinder competitiveness, especially with the intentions of protecting local organizations from foreign competition. Such interference may be disadvantageous to the foreign organization. Foreign Direct Investment is influenced by various other factors, including incentives that are offered by the host country to encourage establishment of foreign industries in the local market. Governments may exempt foreign organizations from taxes to encourage them to introduce more capital in to the local market. Generating an enabling investment climate through offering security for investors is also an important strategy of encouraging foreign investment. Insecurity is a major drawback to potential investors. Issues such as terrorism and destruction of property are the major factors that contribute to the avoidance of investing in most less developed countries by foreign companies. Government policies are important since they protect the foreign investors from drastic changes in the operating environment (Dugan et al. 2008). Foreign investors are also attracted by the presence of cheap labor and raw materials. In the developed nations, the cost of skilled labor is higher than in developing economies. However, to get the desired kind of labor in developing and less developed economies is usually difficult. The emerging economies are therefore a major attraction for foreign investors since they usually present cheap and skilled labor. This helps the foreign investors to reduce the operating costs. On the other hand, the availability of raw materials is important for foreign investors. It helps in reducing the cost of transportation from the source to the industry, especially for the investors who deal with refining of natural resources (Pritchard, 1996). For example, a UK based industry dealing in products from cash crops such as tea and coffee would minimize the transportation of raw materials through establishing in tea and coffee producing countries. Many organizations derive benefits from producing in the country where they can easily access raw materials, and export finished products to the domestic markets in the country where the main company is based. Many such organizations operate through foreign subsidiaries. Apart from raw materials and cheap labor, foreign investment is also dependent on the exchange rate. Companies tend to invest in the economies that have a strong exchange rate. It is usually an indicator of a stable economy. This is also a major factor that contributes to low foreign investment in third world countries. Foreign investors also make considerations of the adherence to the rule of law in the host country (Feenstra, 2003). If there is a failure in this, they lack confidence in regard to their rights being granted after investing. Corruption and unethical business behavior in the host country may be discouraging to foreign investors. Expropriation of property by the host government is among the issues that scare foreign investors (Sornarajah, 2004). A government that has a record of such behaviors lowers the interest of investors in the country. Strong judicial systems are significant in ensuring protection of foreign investors in a foreign country. Complexity in the bureaucracy regarding the acquirement of operating licenses may also discourage investors. Host governments need to make it easier to establish business in any sector of the economy to encourage foreign investors (Robert, 1997). References Alexander, O. (2006). Peremptory Norms in International Law. New York: Oxford University Press. Charlotte, B. H. (2004). Measuring Political Risk: Risks to Foreign Investment, Aldershot, Hants: Ashgate. Dugan C., Rubins N,. D, Wallace D. & Sabahi B. (2008). Investor-State Arbitration, Oxford University Press Feenstra R. C. (2003). Advanced International Trade: Theory and Evidence, Princeton University Press Obstfeld, M. & Rogoff M. (1996). Foundations of International Macroeconomics, the MIT Press Pritchard, R. (1996). Economic Development, Foreign Investment and the Law, London, Kluwer Law International & the International Bar Association. Robert P. A. (1997). Political Risk Analysis and Tourism. Annals of Tourism Research. Vol.24, No.3, 675-686.  Sacerdoti G (1997). Press, Bilateral Treaties and Multilateral Instruments. Journal of International Economic Law, Vol 269, pp 261-287 Sornarajah, M. (2004). The International Law on Foreign Investment, Cambridge University Spar, D. L. (2003). Managing International Trade and Investment: Casebook, Harvard Business School, USA Yarbrough, B. V. & Yarbrough R. M. (2002). The World Economy: Trade and Finance, South-Western College Publishers Read More