Foreign Direct Investment in the UK - Coursework Example

INTERNATIONAL ECONOMIC THEORY ECP001N WORK (2,274 WORDS) An Economic Analysis of Foreign Direct Investment The post war global economic climate can be characterized by significant shifts and strides in development in terms of the global economy. Part of this system is Foreign Direct Investment. Foreign direct investment (FDI) is an integral part of an open and effective international economic system and a major catalyst to development. Yet, the benefits of FDI do not accrue automatically and evenly across countries, sectors and local communities (Organisation for Economic Co-operation and Development, 2002). The definition of FDI originally meant that the investing corporation gained a significant number of shares (10 percent or more) of the new venture. In recent years, however, companies have been able to make a foreign direct investment that is actually long-term management control as opposed to direct investment in buildings and equipment (Vaknin 2007). Given the appropriate host-country policies and a basic level of development, a preponderance of studies shows that FDI triggers technology spillovers, assists human capital formation, contributes to international trade integration, helps create a more competitive business environment and enhances enterprise development. All of these contribute to higher economic growth, which is the most potent tool for alleviating poverty in developing countries Organisation for Economic Co-operation and Development, 2002). On the other hand Vaknin (2007) contends that FDI does not automatically translate to net foreign exchange inflows. To start with, many multinational and transnational "investors" borrow money locally at favorable interest rates and thus finance their projects. This constitutes unfair competition with local firms and crowds the domestic private sector out of the credit markets, displacing its investments in the process. With respect to the determinants of FDI several have been noted. Hill and Jongwanich (2009) establish that there are three determinants to it. They elaborate by stating that there are diverse motives for, and hence drivers of, FDI. An analytically useful distinction is sometimes drawn between three types of FDI, commonly termed rent-seeking, efficiency-seeking, and resource-seeking motives. In the first case, sometimes referred to as the tariff factory model, foreign investors are primarily attracted to the domestic market of the host country. Therefore, tariff protection and investment incentives are important determinants, along with a broader set of factors such as market size and growth (Hill and Jongwanich, 2009). By contrast, efficiency-seeking investments refer to those that locate in a particular economy owing to its efficiency as a production center as compared to alternative locations (Hill and Jongwanich, 2009). Resource-seeking FDI is by definition motivated by the presence of a particular resource in the host market economy, which the investor judges can be most effectively accessed via FDI (Hill and Jongwanich, 2009). 2. Globalisation, essentially, means that geographically dispersed manufacturing, slicing up the value chain and the combination of markets and resources through FDI and trade are becoming major characteristics of the world economy. Efficiency-seeking FDI, i.e. FDI motivated by creating new sources of competitiveness for firms and strengthening existing ones, may then emerge as the most important type of FDI (Centre for International Trade, Economics & Environment, 2002). Foreign Direct Investment (FDI) is not simply (or even primarily) an international transfer of capital but rather, the extension of an enterprise from its home country into foreign host country. The extension of enterprise involves flows of capital, technology, and entrepreneurial skills and, in more recent cases, management practices to the host economy, where they are combined with the local factors in the production of goods and services (Okomoh, 2004). Basing from this clearly the increase of FDI on the part of developing countries is due to the dependency of their economies on investing beyond their borders. This is a form of escape from the economic difficulties that trouble their local economies. Moreover, in the case of developed countries they do not have as many foreign direct investment due to spending cuts as well as their hesitance to open themselves to risk due to the unstable economics in the status quo. When developing countries open up to foreign direct investment this would mean the influx of resources. This is because in the context of FDI when a commercial establishment from another country engages in FDI its resources, usually money or some other commodity is forwarded to another economy/establishment. Investigating the relation between remittances and FDI is important because remittances may be identified as a signal of a larger demand as well as profitable opportunities for foreign investors in countries with significant amount of remittances inflows (Fuentes, 2009). This shows that in the aspect of financing significant opportunities lie in foreign direct investment as for those involved. This further shows the benefit as well as justification in allowing foreign direct investment. After all in the setup of globalization access as well as movement of resources is the way by which an economy or a commercial establishment either invests or gain access to resources that is needed. This movement is viable even amidst economic adversity. 3. Baldwin (2003) stated that an economically sensible way of achieving industrialization seemed to be to restrict imports of manufactured goods for which there already was a domestic demand in order both to shift this demand toward domestic producers and permit the use of the country’s primary-product export earnings to import the capital goods needed for industrialization. This suggests that despite the openness necessitated by globalization significant economic development may be had by limiting openness. But the case for globalization is not solid as well. Measuring the impact of globalization has always been marred by inaccuracy. Rodriguez and Rodrik (1999) contend that simple tariff averages underweight high tariff rates because the corresponding import levels tend to be low. Such averages are also poor proxies for overall trade restrictions when tariff and non-tariff barriers are substitutes. As for the non-tariff coverage ratios, they do not do a good job of discriminating between barriers that are highly restrictive and barriers with little effect. And conceptual flaws aside, both indicators are clearly measured with some error (due to smuggling, weaknesses in the underlying data, coding problems, etc.). Trade policies do affect the volume of trade, of course. But there is no strong reason to expect their effect on growth to be quantitatively (or even qualitatively) similar to the consequences of changes in trade volumes that arise from, say, reductions in transport costs or increases in world demand. To the extent that trade restrictions represent policy responses to real or perceived market imperfections or, at the other extreme, are mechanisms for rent-extraction, they will work differently from natural or geographical barriers to trade and other exogenous determinants (Rodriguez and Rodrik 1999). This outlines the nature of globalization wherein the inter – connectivity of economies and economic units is the medium by which growth is attained. Openness not only allows dynamism but also better access to resources and opportunities. In a study conducted by Yanikkaya (2003) openness and its implications are nuanced better. We believe that our results cast substantial doubts on the conventional view that suggests a robust and negative relationship between trade barriers and growth. In other words, all measures of trade barriers used in the study are significantly and positively correlated with growth except for restrictions on current account payments, which is negatively but insignificantly correlated with growth. Thus, our results actually provide considerable evidence for the hypothesis that restrictions on trade can promote growth, especially of developing countries under certain conditions (Yanikkaya, 2003). This establishes that growth is related to openness but the openness is not necessarily on the level as what is seen in liberalisation. The typology of openness in this context is one, which has with it restraints and strictures. These are, in fact, validated to contribute to growth. In the context of financing financial intermediaries may ease risk sharing and pooling by lowering transactions cost. Financial Intermediaries may lower cost of holding a diversified portfolio when there are fixed costs associated with each purchase (Levine, 2001). Levine (2001) establishes that in financing intermediaries which are associated with decreased openness in fact is highly. This is the case even if it is established as a form of restriction of economic barrier. All these shows that openness though related to growth it is not the same brand of openness that is in globalization. 4. Economic Openness has significantly improved the state of poverty in the global economic system. When countries began to be more involved in the globalization there poverty incidence declined. Dollar and Kraay (2001) found out that Per capita GDP growth in the post-1980 globalizers accelerated from 1.4 percent a year in the 1960s and 2.9 percent a year in the 1970s to 3.5 percent in the 1980s and 5.0 percent in the 1990s. This acceleration in growth is even more remarkable given that the rich countries saw steady declines in growth from a high of 4.7 percent in the 1960s to 2.2 percent in the 1990s. Also, the nonglobalizing developing countries did much worse than the globalizers, with the formers annual growth rates falling from highs of 3.3 percent during the 1970s to only 1.4 percent during the 1990s. Although the growth benefits of trade are increasingly recognized, many analysts are legitimately concerned about the effects of trade liberalization on income distribution. In our research, however, we document that the growth benefits of increased trade are, on average, widely shared—we have found no evidence of a systematic tendency for inequality to increase when international trade increases (Dollar and Kraay, 2001). The combination of increases in growth and little systematic change in inequality in the globalizers has considerably boosted efforts to reduce poverty (Dollar and Kraay, 2001). Dollar and Kraay (2001) further contended that the growth performance of the globalizers relative to the rich countries and the nonglobalizing developing countries suggests otherwise. The rapid growth of the globalizers relative to the rich countries means that the globalizers are narrowing the per capita income gap. 5. Political openness (democracy) and economic openness (capitalism) lead to higher levels of foreign direct investment which in turn are related to higher levels of economic growth and development (McGowan, n.d.). This establishes that there is a significant relationship between economic and political systems. Our model has the structure of a common agency problem, that is, a situation that arises when several principals attempt to induce a single agent to take an action that may be costly for the agent to perform. The government here serves as an agent for the various (and conflicting) special interest groups, while bearing a cost for implementing an inefficient policy that stems from its accountability to the general electorate (Grossman and Helpman, 1994). The model forwarded by Grossman and Helpman (1994) outlines the fact that any economic system is tied into the governmental system. The implication of this is that government policies are influence by economic conditions either directly or indirectly by economic forces. These are the same forces that directly shaped and govern any modern economic system. Grossman and Helpman (1994) stated that aggregate welfare might enter the governments objective if some representatives are civil-minded. In addition, politicians may value contributions not only for financing future campaigns, but also for retiring debts from previous elections (which many times are owed to the politicians personal estate), for deterring competition from quality challenger, and for showing the candidates abilities as fundraisers and thereby establishing their credibility as potential candidates for higher political or party office. This implies that income distribution and protection of local industries are dependent on leadership in government. These leaders in turn are affected by many factors among them economic forces. These sources of influence can either directly or indirectly shape policy – making. 6 Nishioka (2005) stated that assume that all countries have identical CRS production functions with three factors: physical capital, knowledge capital, and aggregate labour. Markets for goods and factors are perfectly competitive. There are no barriers to trade or transport costs in goods but factors are immobile across borders. Nishioka (2005) further assumed that that the distributions of factors are consistent with integrated equilibrium so that factor prices are equalized across countries. The the Heckscher-Ohlin model takes a look at output in terms of several factors such as those noted by Nishioka (2005). The model essentially tests economic performance. In particular, in the area of trade and how it distinctly affects a working economic system. It predicts that positive changes in terms of movement of goods are influenced by both tangible and in tangible resources as well as financial wealth alongside non – monetary assets. The Heckscher-Ohlin model like any economic model is borne out of economic theory that works with certain assumptions. This means that there is a significant amount of variables that are factored in collectively or treated as constants. However, this does not mean the model does not work with facts. In fact, it relies on it. Rather the question is doing it merely work with facts? In this case, the answer is no. It works with factual data as well as assumptions. However, these assumptions are still valid since in the realm of economic theory assumptions take on the value of approximations of data. This assists in the analysis of economic forces. After all due to the fluid nature of economics it is necessary to fix certain elements to assess the whole scheme. In assessing economic performance in terms of trade approximations of unaccounted for details is necessary. No economic analysis can claim that it could factor in every important detail or efficiently measure every component of the phenomenon. That is why economic model avail of assumptions, which are manifestations of the immeasurable elements in the analysis. References Organisation for Economic Co-operation and Development (OECD) 2002. Foreign Direct Investment for Development: MAXIMISING BENEFITS, MINIMISING COSTS OECD. Available at: http://www.oecd.org/dataoecd/47/51/1959815.pdf [Accessed 7 December 2010]. Vaknin, Sam, 2007. Foreign Direct Investments (FDI) - Pros and Cons. Euro College Student Union Business Forum Kumanovo, Macedonia, May 3, 2007. Hill, Hal and Jongwanich, Juthathip, 2009. Outward Foreign Direct Investment and the Financial Crisis in Developing East Asia. Asian Development Review, vol. 26, no. 2, pp. 1–25 2009. [Online]. Available at; http://www.adb.org/Documents/Periodicals/ADR/ADR-Vol26-2-Hill-Jongwanich.pdf. [Accessed 5 December 2010.]. Centre for International Trade, Economics & Environment (CUTS), 2002. Foreign Direct Investment in Developing Countries: What Economists (Don’t) Know and What Policymakers Should (Not) Do!. CUTS. [Online]. Available at: http://cuts-international.org/FDI%20in%20Developing%20Countries-NP.pdf [Accessed 5 December 2010]. Fuentes ,Pablo Antonio García, 2009. Remittances, Foreign Direct Investment and Economic Growth in Latin America and the Caribbean. Ph. D. Louisiana State University and Agricultural and Mechanical College. Baldwin, Robert E., 2003. Openness and Growth: Whats the Empirical Relationship?. National Bureau of Economic Research Working Paper 9578. Available at: http://www.nber.org/papers/w9578.pdf [Accessed 7 December 2010]. Rodriguez, Francisco and Rodrik, Dani, 1999. Trade policy and economic growth: a skeptics guide to the cross-national evidence. National Bureau of Economic Research Working Paper 7081. Available at: http://www.nber.org/papers/w7081.pdf [Accessed 5 December 2010]. Yanikkaya, Halit, 2003. Trade openness and economic growth: a cross-country empirical investigation. Journal of Development Economics 72 (2003) 57– 89. Available at: http://www.cer.ethz.ch/resec/teaching/seminar_aussenwirtschaft_wt_04_05/yanikkaya_JDE.pdf [Accessed 8 December 2010]. Dollar David and Kraay, Aart, 2001. Trade, Growth, and Poverty. Finance and Development September 2001, Volume 38, Number 3. Available at: http://www.imf.org/external/pubs/ft/fandd/2001/09/dollar.htm [Accessed 8 December 2010]. Levine, Ross, 2001. International Financial Liberalization and Economic Growth. Review of International Economics, 9(4), 668-702, 2001. Available at: http://www.econ.uchile.cl/uploads/documento/ed30c2ceae592e543ddbcb9d24a6dea7251d0d22.pdf [Accessed 7 December 2010]. McGowan, Carl B., n.d. The Relationship between Political and Economic Openness and Foreign Direct Investment. Southwestern Economic Review. Available at: http://www.ser.tcu.edu/2004/SER2004%20McGowan%20177-188.pdf [Accessed 6 December 2010]. Nishioka, Shuichiro, 2005. An explanation of OECD Trade with Knowledge Capital and the HOV model. Center for Economic Analysis DISCUSSION PAPERS IN ECONOMICS, Working Paper No. 05-06. Available at: http://www.colorado.edu/Economics/CEA/WPs-05/wp05-06/wp05-06.pdf [Accessed 8 December 2010]. Read More