Foreign Direct Investment & MNCs - Essay Example

Introduction Multinational Corporations and Foreign Direct Investment play an important role in shaping the modern world. Over the period of time, the spread of multinational corporations or MNCs across the globe made it possible for the governments to attract investment. A firm is considered as a multinational corporation if it has a subsidiary in a second country and most of the large MNCs have multiple subsidiaries in different countries. Foreign direct investment is one of the ways through which MNCs expand into other markets and invest into subsidiaries. This expansion can be either through mergers & acquisition or outright development of Greenfield projects. The expansion of the existing subsidiaries can be another way through which MNCs can actually increase their outward foreign direct investment in their host countries. What is critical to note however is the fact that MNCs make decisions to expand through FDI is basically aimed at achieving higher returns in future and repatriating the same to the parent company. The underlying factors as to why MNCs actually engage into the FDI can either be demand based or cost based. MNCs have to make a tradeoff between the overall risk and reward and as to whether entering into a new market could provide them desired benefits or not. As such the decisions of the MNCs for FDI are based upon various factors. This paper will discuss and argue about the inward FDI which MNCs brought into any country and will explore it from the perspective of Europe and specifically United Kingdom. Foreign Direct Investment & MNCs FDI is a sort of direct investment made by a company in another country for production or business purposes. It can either be achieved through the buying the target company, expanding through creation of a new business or even further expanding the business in current market. Considering the overall diversity of the nature of FDI, it therefore can be defined in different ways. There has been a consistent increase in the FDI at the global level with over $1.5 trillion FDI flows were recorded during 2011. Such large amount of FDI flows suggest that despite the global recession, MNCs are looking for new markets to not only reduce their risk but are looking for new markets. Larger MNCs like McDonald, GM, and Shell are simply looking for new markets in order to diversify as well as reap into new markets. For host countries, inward FDI by MNCs not only result into technology and external spillovers but it bring in new management practices as well as procedures to upgrade the level of skills of domestic managers. (Driffield and Love,470) Broadly speaking, foreign direct investment includes merger and acquisitions between two companies, initiating Greenfield Projects as well as investment of companies funds loaned to various subsidiaries by the parent organizations. From the perspective of macroeconomics, FDI is a part of the national income of a country and is often included in the investment portion of the national income. FDI, in national income accounts, however is taken on the net basis by deducting the inward and outward investment made. The debate as to whether FDI can result into technological as well as economic environment within the country may remain questionable. However, the patterns followed by different countries suggest that one policy may not fit into for the overall economic progress of all the countries. The varying patterns of economic growth showed by countries like China and Ireland or even Asian Tigers portray a completely different story of how FDI can help country for economic progress. It is also critical to note that the overall contribution made by inward FDI towards the economy of a country may not provide immediate results. The actual and real economic and technological benefits of inward FDI through MNCs takes place over a period of time. FDI can be explained through two important ways of inward as well as outward FDI. Inward FDI occurs when a country or company invests into a host country. Outward FDI however is the opposite of FDI wherein a country or a company makes an outflow of funds from its parent country to the host country. FDI is therefore a direct investment activity which improves the productivity within the host country of the MNC. As such the overall importance of FDI through MNCs is important however, debate is still on regarding the overall importance of the same. One of the ways through which multi-national corporations actually grow and prosper is to serve as many markets as they can and over the period of time, MNCs have replaced exporting as a direct method of servicing many markets at once. (Andraz and Rodrigues,270) There have been many empirical studies on the impact of inward FDI on the host countries and how MNCs can actually contribute towards such development of any country. The overall results of these studies however are mixed with very little signs of how the convergence in their results can actually take place. One of the obvious reasons for the inward FDI and its impact on the host countries is the technology transfer and assumption that through technology transfer, higher quality goods and services can be produced at relatively low cost or in higher volumes thus benefiting the host country however it may be relatively become more competitive for local industry of the host country. Host countries also benefit from the creation of new capital stock because MNCs bring in new investment into the country. Why MNCs engage into inward FDI The earlier theory of why firms go international and engage into FDI activities are based upon the FDI actually provides an outlet for surplus capital when profits are actually driven down by the competition. Marx however, argues that the tendency of having lower profits as well as the threat of underconsumption actually leads the firms to decide to move internationally and enter into such markets. However, post 1945 scenarios indicated a greater FDI exchange between the MNCs operating in developed countries. Earlier theories therefore failed to explain this phenomenon. It was however, later argued upon that the MNCs actually enter into international markets in order to increase their market power. Further, new start-up firms also engage into inward FDI to consolidate and increase their capacity. Another important reason as to why MNCs engage into inward FDI is the concentration within their established markets. In order to further expand and create further markets for themselves, MNCs tend to invest into monopolies so that they can concentrate in different markets. (Buckley, Clegg and Wang,25) The decision for inward FDI and purchase or acquisition of firm specific assets also depends upon the exchange rates. It has been suggested that the MNCs tend to prefer that the currency of the host country depreciates which actually help them in purchasing assets at relatively lower prices. FDI decisions of any MNC therefore also depend upon it evaluates the overall exchange rate scenario within the host country. Currency depreciation plays an important role in determining as to how an MNC is actually going to enter into any host market while considering other factors also. One of the key reasons as to why MNCs actually engage into inward FDI is not just to have control and ownership but rather also look for global production as well as network externalities which can offer them opportunity to further extend. MNCs also engage into inward FDI in order to exploit the various market imperfections which exist in other global markets. These imperfections therefore offer MNCs an opportunity to earn abnormal returns due to their timely decisions to enter into such markets. (Hejazi and Pauly,285) Achieving and exploiting economies of scale by relocating to foreign locations is another important method through which MNCs actually enter into other markets. Economies of scales can be achieved when an MNC can actually diversify its total cost by producing more. Economies of scale results into lowering of costs and increasing profitability of the firm therefore MNCs tend to focus on finding out markets which can offer such opportunities to achieve and exploit economies of scale. It is also critical to examine those taxation policies both at the host as well as parent company level also play an important role in deciding as to whether MNCs can engage into inward FDI. Bilateral tax agreements between the parent as well as host countries play an important role in helping MNCs decide as to whether they are willing to invest or not. Though there is a little evidence that the bilateral tax agreements aimed at reducing double taxation can have significant impact on the decision making process of MNCs however, it still makes a difference. It is also because of this reason that the countries often extensively pursue MNCs to enter into those markets where both the parent as well as host countries have the bilateral tax agreements. The recent trends of internationalization of supply chains, networked production as well as improved transportation as well as communication has also made it relatively easier for MNCs to focus inward FDIs in such markets which offer probability to earn higher returns. It is also critical to note that countries like China faced a unique inward FDI phenomenon wherein MNCs entered into the Chinese markets for the purpose of exporting. China has been used in order to manufacture the products at cheaper prices and subsequently exporting the same to their host markets. MNCs therefore may also look for markets to use them as outlets for manufacturing purposes to take advantage of their cheap raw materials as well as low cost labor. The overall impacts of FDI on the host countries however, are relatively different due to different factors at play. There are many research studies outlining the differences between these impacts on larger scale. Inward FDI can have positive, negative or even neutral impact on the economy of the country. Besides having positive impact on the economy of the country, ensuring technology transfer, strengthening human capital of the host country, MNCs and inward FDI can also result into institutional corruption in the host countries. Countries where there are relatively higher levels of regulations to follow when an MNC decides to bring in FDI may face higher level of institutional corruption due to this reason. (Chen and Chen,152) It is also critical to note that the foreign share of production is consistently increasing due to participation of MNCs through their foreign subsidiaries. Host countries therefore also offer MNCs the incentives to affiliate their production with the local firms in order to increase the role of domestic firms in overall production and tradable of the country. It is also mostly because of this reason that the host countries alter their laws in order to classify MNCs bringing in FDI as the local firms to provide them further benefits. One of the key reasons as to why host economies offer such incentives occurs when host economies can easily assess the probability of gaining higher social returns as compared to the cost involved. If social returns of inward FDI by MNCs exceed the total costs, host economies become relatively more open to allow MNCs to enter into their markets. Inward FDI in UK UK is one of the largest economies in Europe and is also the largest receiver of FDI in the region. Though UK’s economy is going through difficult economic situation however, it still is one of the significant players in the market. During 2011, over 31 billion pounds were invested by MNCs in UK though this figure is relatively less than what was invested during 2010. UK’s regulatory environment is relatively same for both the MNCs as well as the local businesses therefore MNCs basically have the choice to make investment into any sector of the economy they wish to. This indicates that UK is relatively unique economy with low restrictions and more investment friendly environment. The largest sector which received inward FDI was the financial services sector in which countries like America, Spain and Belgium consistently invested in the recent past. Netherland has also remained one of the top investors in the financial sector of the country. It therefore clearly shows that the flow of foreign investment is mostly directed towards the services sector rather than in the manufacturing sector. Further, most of the MNCs belong to developed countries which are investing in the country. Developing countries like China and India therefore is not featuring into the overall list of top countries making inward FDI in UK. It is also important to note that new sectors such information technology, bio-science as well as renewable energy are some of the emerging sectors where inward FDI can flow in future. With renewed focus on the bio-medical technologies, automotive as well as the renewable energy sectors are becoming important sectors for MNCs to operate. UK has an established market for the research and development therefore industries such as ICT as well as life sciences can offer really good opportunities to tap into the human capital of the country. Since UK is also a service based economy therefore MNCs can get an easy access to skilled and trained human resources who can be utilized for the research and development projects. International firms like Orange (France Telecom) have heavily invested into telecommunication sector and expanding fast into other areas of the business also. Since UK is a market based open economy therefore it is relatively easier for MNCs to move their capital in and out of the country. Since UK is also part of EU therefore by entering into UK market, MNCs can get access to the EU market also. UK therefore offers a unique opportunity to invest into other countries also. Conclusion Globalization has made it relatively easier for international firms to enter into international market. MNCs do this by either partnering with the local firms by exporting or they can also enter into such markets through inward FDI. Inward FDI therefore represents that part of the investment which is made out into a host country in order to developing manufacturing and business infrastructure. There are various reasons as to why MNCs actually enter into global markets and more importantly they focus upon expanding their market power and concentration into regions where they are not already present. Inward FDI tend to create technology transfer as well as help economies to improve their human resource base. Apart from this, MNCs also enter into other markets in order to tap into cheaper resources, raw materials or simply want to develop new markets. UK is the largest country in EU to receive highest level of Inward FDI from rest of the world. Though the figures in 2011 are relatively lower than what were in 2010 however, UK still is the largest country to received inward FDI. Some of the sectors where MNCs have invested included financial sector, automotive, life sciences, creative arts as well s renewable energy. UK has a established base of research and development which offers MNCs a ready-made access to a highly skilled labor force to engage into sophisticated and advanced research and development. Works Cited Andraz, Jorge M. and Paulo M.M. Rodrigues. "What causes economic growth in Portugal: exports or inward FDI?" Journal of Economic Studies 37.3 (2010): 267 - 287. Buckley, Peter J., Jeremy Clegg and Chengqi Wang. "The Relationship Between Inward Foreign Direct Investment and the Performance of Domestically-owned Chinese Manufacturing Industry." Multinational Business Review 12.3 (2004): 23 - 40. Chen, Yufen and Jin Chen. "The impact of FDI on regional technological capabilities: evidence from China." Journal of Knowledge-based Innovation in China 1.2 (2009): 143 - 158. Driffield, Nigel and James H. Love. "Linking FDI Motivation and Host Economy Productivity Effects: Conceptual and Empirical Analysis." Journal of International Business Studies 38.3 (2007): 460-473. Hejazi, Walid and P. Pauly. "Motivations for FDI and Domestic Capital Formation." Journal of International Business Studies 34.3 (2003): 282-289. Read More