Factors affecting Foreign Development Investments - Research Paper Example

Final Project (ENG230) Today, more and more worldwide known companies prefer to operate in foreign markets through two distinct strategies of internationalization, that is, exports or foreign direct investment. However, there are numerous issues that challenge foreign direct investment (FDI), and that is why some firms have opted to stay away from foreign direct investment. Some of the reasons include financial volatility, problems with capital inflows, contagion, export processing zones, investment and labor, environmental issues and inequality caused by globalization. This paper will discuss some of the reasons why firms choose to invest abroad, issues about changing production because of foreign investment, reasons why FDI is increasing, factors influencing foreign direct investment, attempts to enhance foreign investment and reasons why large companies would not invest abroad. Finally, it will offer some recommendations to ease these challenges. Table of Contents 1. Abstract………………………………………………………………………….1 2. Introduction……………...……………………………………………………...3 3. Analysis………………………………………………………………………….4 1. Reasons for Investing Abroad…………………………………………...4 2. Issues about Changing Production because of Foreign Investment…….5 3. Reasons why FDI is increasing………………………………………….6 4. Factors Influencing Foreign Direct Investment…………………………7 5. Attempts to Enhance Foreign Investment……………………………….8 4. Reasons Why Large Companies Would Not Invest Abroad…………………….9 1. Financial Volatility………………………………………………………9 2. Contagion………………………………………………………………..9 3. Capital Inflows Problems……………………………………………….10 4. Investment and Labor…………………………………………………...11 5. Export Processing Zones………………………………………………..12 6. Inequality Due to Globalization…………………………………………12 7. Environmental Concerns………………………………………………..13 5. Conclusion and Recommendations……………………………………………..13 6. Works Cited…………………………………………………………………….15 Factors affecting Foreign Development Investments 1. Introduction Internationalization refers to the process of expanding enterprises in international markets. Over recent decades, there has been an increasing level of internationalization in every kind of industries, which has led to a rapid growing interest in gaining and maintaining competitive advantage on new international trade arenas (Casillias et. al., p26). As a result, today more and more worldwide known companies prefer to operate in foreign markets through two distinct strategies of internationalization, that is, exports or foreign direct investment (Conconi et. al., p13).Internationalization theory postulates that production by one company as opposed to many companies is much beneficial and this is one of the major reasons why most company would rather extend its operations to different location (internationationalization). (Bayraktutan& Yusuf, 23) In providing accounts why internationalization has survived in unlikely environment, suggests that technological transfer among the Multinational Corporations has played a key role in that, most of the developing countries are not able to access modern technologies that are associated with large production. This makes it possible for the Multinational Enterprises (MNE) to get access to such developing nations because of their financial muscles. 2. Problem Definition This thesis aims to investigate the world’s largest companies’ decision whether to internationalize through foreign direct investment into highly uncertain foreign markets or not. 3. Solutions The objective will be followed by the inquiry which deals with the question of how these companies should behave in terms of entry mode, subsidiaries and activities performed. The paper especially has the purpose of assessing how Multinational Enterprises deal with uncertainty once the decision of establishing an FDI has been reached. Analysis Reasons for Investing Abroad In order to understand why large companies decide to internationalize through foreign direct investments (FDIs) into highly uncertain foreign markets, it is vital to understand why the firms decide to invest internationally (Barrell and Nigel 1770). There are numerous reasons why firms opt to venture into foreign markets. These reasons are also the same as to why the firms decide to expand in their local countries (Easson 19). They include market seeking, strategic seeking, resource seeking and efficiency seeking. Firms might go in a foreign country to look for new markets for their products (The Levin Institute 1). The top owners or executives of a firm might comprehend that their goods and/or services are unique or superior to the rivalry in international markets and try to profit from this chance (Easson 19). Another incentive for market-seeking happens when producers/manufactures have saturated sales in their local market, or when they deem that international investments will lead to much higher income than further investments locally (Barrell and Nigel 1770). This is usually the case with high technology products. As Asiedu (107) noted, the least size of market required to maintain technological growth in some industries is, at the moment, bigger than the biggest national market. Also, put simply, a firm might find it less expensive to produce or manufacture its goods in a foreign based subsidiary – for the goal of selling it either in the foreign market or at home (The Levin Institute 1). The foreign based facility might be able to attain less costly or superior access to the vital factors of production (i.e., labor, land, natural resources and capital) than at home. Firms might want to invest in other firms internationally to assist create strategic assets, like new technology or distribution networks (The Levin Institute 1). This might entail the creation of partnerships with other foreign companies, which specifically focus on a number of aspects of production (Moran et al. 34). Finally, multinational companies might also want to restructure their international holdings in response to wider financial changes. For instance, the establishment of a fresh free trade agreement might swiftly produced a facility positioned in one of those nations more competitive, as a result of the accessibility for the facility to reduce tariff rates in the group (The Levin Institute 1). Changes in exchange rates might as well transform the profit calculations of a company, making the company to amend the distribution of its resources. Issues about Changing Production because of Foreign Investment A concern brought up by Moran et al. (39) and Easson (52) is that firms in well-off countries (large corporations) are closing their greater cost domestic production operations and sending them to developing nations, where they can benefit from the lower incomes and, for instance, less warning environmental laws. This is known as outsourcing. This is assumed to lead to a switch by firms from local manufacturing toward a much greater dependence on imports, and cause greater joblessness locally. Moran et al. (39) and Easson (52) argue that employees in foreign nations might be exploited due to this changing production, and that relocating production operations in international destinations reduces the competitiveness of the local economy. Whereas it might be true that a number of firms have shifted their manufacturing facilities for these aims, and the origin of manufactured products consumed in U.S. has changed significantly to foreign sources, these forms of investment actions contains just a small percentage of the entire investment (The Levin Institute 1). It is evident that manufacturing is not the only sector aimed at by huge companies (De Mello 135). Of course, the truth that such a vast percentage of the sales arising from U.S. FDI happen among developed nations, or that foreign manufacturing is overpoweringly applied for consumption local to that nations, does not signify that concerns on FDI in developing nations are of no effect (OECD 5). Nevertheless, when people think about the powers influencing globalization together with the choices to invest in international production, these figures can aid in keeping matters in check (The Levin Institute 1). Also, foreign investment can raise worries of a rather more patriotic nature. Foreign investment, especially when it concerns control of major sectors of a country’s financial system, individual firms, or even landmarks like buildings, can cause alarms, which foreign entities might be taking control of resources, which are vital to a country’s identity or yet security (The Levin Institute 1). This can cause doubts that the foreign investors might not have the best interests of the local society in question (De Mello 135). These doubts concerning foreign control are very serious in developing nations, even though even well-off, developed nations are not resistant to these issues (The Levin Institute 1). In the 80s, for instance, numerous Americans became anxious concerning foreign investment into the U.S. (Graham and Spaulding 1). The sale of famous American landmarks like Rockefeller Center, which is based in New York, to investors from Japan, made a lot of Americans deem that they were losing tenure of their own economy. Reasons why FDI is increasing There are numerous reasons why large companies are shifting to foreign direct investment such as advancement in technology, higher returns, financial liberalization and the fall of the Berlin wall (The Levin Institute 1). Today, people can do business more easily across long distances because of the advances in transportation and telecommunication. Telecommunication infrastructures such as satellites can handle over a millions phone calls at a time. Factors such as emails, fax machines and the reduction in cost of flying have aided significantly to the rise of foreign direct investment (The Levin Institute 1). Also, in the 80’s and the 90’s, a couple of nations in East Asia started to face huge financial growth rates. These nations had built their unique growth on a foundation rooted in greater incorporation into the global market. In particular, they started underlining export-led growth (The Levin Institute 1). Finally, in the early 70s, the U.S. went off the earlier system of permanent exchange rates among foreign currencies. Additionally, many limitations were removed on the flows of global capital, making it much easier for both local and foreign investors to buy foreign securities. As from that period, the U.S. has been in the front position of efforts to eliminate remaining restrictions on the movement of global capital (The Levin Institute 1). Factors Influencing Foreign Direct Investment The factors influencing foreign direct investment not only relate to the overall economic or financial position of a country, but also to financial policy choices assumed by foreign regimes. These are aspects, which can be extremely political, as well as controversial. Investors normally look at numerous factors, which relate to how they can operate in the foreign land (The Levin Institute 1). The factors are normally the rules, as well as regulations, relating to both the entry and operations of international investors (Graham and Spaulding 1). They also look at the ways foreign affiliates are treated or considered compared to locals of the host nation. Another factor is the effectiveness and functioning of the markets in which they wish to settle (Graham and Spaulding 1). Foreign investors also look at business facilitation measures like incentives, investment promotion and enhancements in amenities, as well as other measures to ease the cost of operations (The Levin Institute 1). For instance, some nations erect special export processing zones (EPZs) that might be free of duties and customs, or provide unique tax breaks for fresh international investors (The Levin Institute 1). Another factor that direct investors look at is the restrictions (Graham and Spaulding 1). Aside from these factors, investors also look at interest rates, general macroeconomic stability, exchange rate stability, general strength of the international banking system and general microfinance stability (The Levin Institute 1). Every large company considers these issues a lot and, depending on how they view them, they might choose not to invest in that country. Attempts to Enhance Foreign Investment Various policies of potential target nations of investment get close scrutiny from large corporations that are willing to invest in that county. Therefore, numerous global agreements have been formed to particularly tackle these issues (Graham and Spaulding 1). The issues include national treatments, expropriation, domestic contents, free transfer of funds, as well as dispute settlement (OECD 19). National treatment has been the main element of a majority of agreements on trade in products and is a vital matter, as well, that pertains to foreign investment. Normally, such provisions guarantee that large corporations, together with their subsidiary firms, are treated the same ways as the local corporations (Graham and Spaulding 1). Another restriction that is, at times, imposed on large corporations willing to invest abroad is domestic content requirements (OECD 19). These requirements necessitate for the buying of a certain share of intermediate products from the host nation. Such requirements are maybe the most widespread type of intervention by regimes on foreign investments, and Barrell and Nigel (1770) consider that they are the most dangerous aspects of financial development. Finally, dispute settlements normally dictate the procedures, which have to be followed in case disputes arise between host regimes and foreign investors (OECD 19). They make sure that the regulations are followed and that settlement might be reached through mutual consent. Reasons Why Large Companies Would Not Invest Abroad The reasons why a large company would shy away from investing in an international market are financial volatility, problems with capital inflows, contagion, export processing zones, investment and labor, environmental issues and inequality caused by globalization (The Levin Institute 1). Financial Volatility Because of declining profits and more difficult access to banks plus poor temporary financial growth prospects, large companies are thinking of other options than on foreign direct investment (OECD 21). Nevertheless, the situation could grow in the future as economic and financial crises offer chances for firms to buy foreign assets at fairly low costs (Barrell and Nigel 1773). Firms also appear to be dedicated to long-term investments in abroad countries; even though foreign direct investments flows have reduced, foreign direct investments stocks have not (OECD 21). Companies from emerging countries and economies, which are enriched with natural resources, are turning into a rising source of foreign direct investment, as well. Lastly, particular industries may be compatible for dodging the crisis (Graham and Spaulding 1). According to The Levin Institute (1), these incorporate industries in life sciences, transport equipment, agro-food, personal services, business services, energy and information and communication technologies, environmental conservation and chemistry.  Contagion Contagion closely relates to volatility. In essence, when large corporations choose to flee one market, the consequence of all investors following one another might lead to significant economic crises in some nations, which, before that, seemed to be significantly sound (OECD 23). Whether or not contagion was a genuine phenomenon has been unclear since the Asian Financial Crisis, with some critics, such as De Mello (134); Easson (65); Lim (42) and Moran et al. (39), claiming that there was, by no means, a “domino effect,” which lead to the capital flight from financial systems with healthy essentials (Graham and Spaulding 1). Nevertheless, the Asian Financial Crisis might have made large firms willing to invest in Asian markets to take a much closer look at the essentials of various countries, and, in effect, catering as an alarm to investors that their positions had been riskier than earlier thought (Graham and Spaulding 1). This review could have led to capital fleeing some markets, which had earlier been considered as low-risk, steady destinations for international investment. Capital Inflows Problems Provided the issues explained above, it is evident that abrupt outflow of capital might be very harmful (The Levin Institute 1). The capacity to deal with capital inflows is maybe the more relevant problems these days. Large capital inflows may enhance weakness to outer shocks and changes of market sentiment. In a way, the capital outflows and inflows issues are two sides of the coin. Lim (54) cited the case of Thailand’s nonintervention of capital inflows as instances of the hazard. Till the 80s, Thailand had limiting policies circulating real estate investment (Lall 67). Nevertheless, under pressure from the U.S. Treasury and the International Monetary Fund, the Thai regime eased up its investment policies, eradicating limitations on credit for real estate. An over-capitalized local market (i.e., one with excess investment capital chasing too few actual opportunities) led to many very risky and, at times, badly organized investment projects (The Levin Institute 1). Investment and Labor The impact of investment and globalization on labor brings up numerous concerns with regards to job security, wages, as well as working conditions (Asiedu 109). In the United States 92 presidential elections and particularly during the campaigns, candidate Ross Perot eminently affirmed that the “sucking sound” employees in America were going to hear in the near future would be from United States jobs relocating to Mexico due to the abolition of investment and trade barriers in the NAFTA contract (The Levin Institute 1). In fact, a significant number of United States jobs have been eradicated, particularly in the textiles industry, since firms have channeled their production abroad in search of less expensive labor (Graham and Spaulding 1). The financial basis behind this debate is very easy: when capital mobility goes up, the labor field is deprived, because it is essentially less mobile (Graham and Spaulding 1). Large corporations can, hence, pick and decide where to set up their faculties, rooted in which nations will grant the lowest costs. Export Processing Zones Normally associated directly to general worries about labor and globalization are the practice of offering certain kinds of tax, as well as other regulatory exceptions to large corporations through Export Processing Zones (EPZs). These bodies are special arrangements that are established to uphold export industries (The Levin Institute 1). In a lot of cases, host countries will invest in a lot of infrastructure to assist in guaranteeing more reliable water supplies or electricity that might not be universal (Lall 67). However, labor advocates argue that these bodies assist in evading national labor laws, that employees in the EPZs are not permitted to organize, and that they get very low wages (Lall 67). Such arguments might serve as a warning to large corporations that are willing to invest in a nation that uses EPZs to run their international trade affairs (The Levin Institute 1). Therefore, some of the corporations might not be willing to invest in that country. Inequality Due to Globalization There is a significant discussion among economists concerning the level to which globalization—and particularly the liberalization of investment and trade—might raise inequality (Barrell and Nigel 1785). The least wages might also be declining in industries fruitlessly trying to rival with fresh imports, whereas more paying export industry jobs are rising in number but still remain busy to the fairly unskilled labor force (De Mello 150). These changes, brought together, suggest that economies are channeling a much higher premium on expert workers (Barrell and Nigel 1785). This establishes pressure to shell out higher wages to expert workers, while reducing the value of lower-skilled employees. This is one of the key reasons why large corporations choose not to invest in some nations; because they do not want to be categorized as causing inequality (De Mello 151). The net end result internationally has been a considerable rise in inequality, both between nations, as well as inside them. Environmental Concerns Finally, some large organizations are worried that the environmental impact of globalization is serious. It is considered that the global firms rely on unlimited resource supplies, constant supplies of less expensive labor, as well as ever-growing markets (Asiedu 118). Critics argue these objectives have been given priority over public health and conservation of nature (Casillias 320). The world is, therefore, close to an environmental collapse plus the recent levels of international production are shaky (Asiedu 118). Another relevant problem is that numerous advanced countries are in a position to circumvent environment regulations in their nations by setting up production amenities in nations, which do not have severe environmental regulations (Casillias 320). This occurrence has been classified as a “race to the bottom” in ecological standards as nations fight to draw more foreign capital and maintain domestic investment (Easson 89). Conclusion and Recommendations There are basically four advantages to foreign investing: currency valuation, diversification, taxation and decreased risk. The financial system is recurring in nature, with times of contraction and expansion. These cycles can be worldwide, industry-specific or restricted to a particular geographic location or country. By investing internationally, the risk of being affected by a slump in the market is eased. Even in case of a global recession, there still are good chances for development in firms, which offer products and services needed to meet genuine wants. This paper had discussed the reasons as to why large firms might not choose to internationalize through foreign direct investment into highly uncertain foreign markets. The reasons include financial volatility, problems with capital inflows, contagion, export processing zones, investment and labor, environmental issues and inequality caused by globalization. It is vital that governments address these issues because, as discussed in the paper, foreign investment is very significant to any country. Works Cited Asiedu, Elizabeth. "On the Determinants of Foreign Direct Investment to Developing Countries: Is Africa Different?" World Development 30.1 (2002): 107-119. Print. Barrell, Ray and Nigel, Pain. "Foreign Direct Investment, Technological Change, and Economic Growth within Europe." The Economic Journal 107.445 (1997): 1770-1786. Print. Casillias, Jose et al. “An integrative Model of The Role of Knowledge in The Internationalization Process.” Journal of World Business 44.3 (2009): 311-322. Print. De Mello, Luiz R. "Foreign Direct Investment-Led Growth: Evidence from Time Series and Panel Data." Oxford Economic Papers 51.1 (1999): 133-151. Print. Easson, A. J. Tax Incentives for Foreign Direct Investment. The Hague New York: Kluwer Law International, 2004. Print. Graham, Jeffrey P and Spaulding, Barry R. Understanding Foreign Direct Investment. (FDI). N.p, 2004. Web. Lall, Sanjaya. Attracting Foreign Investment: New Trends, Sources and Policies. London: Commonwealth Secretariat, Economic Affairs Division, 1997. Print. Lim, Ewe-Ghee. Determinants of, and the Relation between, Foreign Direct Investment and Growth: A Summary of the Recent Literature. New York: International Monetary Fund, 2001. Print. Moran, Theodore H, Edward, Graham M and Magnus, Blomström. Does Foreign Direct Investment Promote Development? Washington, DC: Institute for International Economics Center for Global Development, 2005. Print. OECD. Foreign Direct Investment for Development Maximizing Benefits, Minimizing Costs. Paris: OECD Publishing, 2002. Print. The Levin Institute. Factors Influencing Foreign Investment Decisions. N.p, 2014. Web. Read More