Worldwide Patterns of Foreign Direct Investment - Coursework Example

Discuss the Worldwide Patterns of Foreign Direct Investment (FDI) and Explain How Currency Flows Have Contributed to the Reduction of Domestic Policy Influence Introduction This short essay, seeks to explore how contemporary Foreign Direct Investment (FDI) trends with a special interest on how FDI’s triggered currency flows have contributed in the emergent reduction of domestic policy influences on international investment. From the outset, it is important to note that this paper supports and propagates as fact, the emergent scenario in which FDI’s currency flows have largely contributed to the reduction of domestic policy influence. It is the central believe of the paper that FDI has in recent times achieved much in integrating regions and nations into trading blocks and markets, featured by lesser and lesser domestic policy control of international investment The subject of discussion shall be Foreign Direct Investment, its patterns and practices, and how the need for increased FDI inflows has influenced FDI needy nations to reduce policy barriers for the international investors as an incentive. In many instances, foreign investors, be they nations, organizations, business interests or financial institutions, abhor those nations with restrictive investment policies and prefer instead, countries that allow a maximal return on their investments to bloom with as little domestic interruptions as possible (Gionea 2005, pp. 224). FDI has had the greatest hand and influence in the changing domestic policy on international trade (Barton &Fisher 1986, pp. 567 – 603). This essay shall first discuss FDI from a management perspective before highlighting the contemporary patterns of FDI and discussing the perpetual growth that FDI has experienced in recent years, as an integral part of international business and investment. Further, the essay will discuss the role of FDI in modern international business practices, and how the domestic policy of a nation interacts with that nation’s FDI growth. An important sections of the discussion also shall be how national/jurisdictional governments influence FDI in their nations. Towards the end of the discussion, the essay shall highlight the way forward for FDI as well as a review of how foreign control is perceived in most FDI realizations. Foreign Direct Investment (FDI) According to Gionea (2005, pp. 222), Foreign Direct Investment (FDI) can be defined as the purchase and or acquisition of assets, resources or significant stock (amount of ownership) in a company located in another country as a strategy of gaining control of the company’s management. Unlike portfolio investment whose manner of ownership does not involve gaining management control to any degree, Gionea says that FDI targets management control (2005, pp. 222). According to Gionea, FDI takes center stage in the management of the companies invested in, to the extent that most local companies and investments can be controlled by foreign interests in their strategic operations, investment decisions, productions costs, market competition strategies, repatriation of profits and other important management functions of a company (2005, pp. 227). Whenever a country allows FDI to be a measure of economic development, they have in turn given foreign interests the permission and mandate to run/manage the local firms in such a way as shall be mutually beneficial (Gionea 2005, pp. 227). Most FDI sources are interested in managing their investments themselves, and will rarely take a back seat to watch as the companies they have invested in be managed by others (Williams 1982, pp. 348; De Souza & Stutz 1997, pp. 99 – 105). While portfolio investors are willing to keep out of the company’s management as long as there is favorable performance, FDI sources only invest in what they can manage towards ends that they have predetermined before making the investment. It is this management trait of FDI that makes it a controversial, sensitive and even feared facet of international investment (Barton & Fisher 1986, pp. 567 – 603; De Souza & Stutz 1997, pp. 99 – 105). It is distinct from financial aid, from economic stimulus packages, from multinational businesses and similar international investment paths, mostly, by virtue of its making management control a central ingredient of the investment decision (Young 2004, pp. 50 – 75). Patterns of FDI According to Gionea (2005, pp. 222), in a like manner to international trade, FDI displays some very distinct patterns. However, of interest to this paper is where such patterns are displayed currently. The developing nations in Southeast Asia, Latin America and Africa had prior to 2000, experienced low inflows of FDI (Gionea 2005, pp. 222). The trend has however been reversed and FDI has in many of this nations become a boost to economic growth. The Commonwealth of Independent Nations and Southeast Europe have registered an all time high in FDI flows beginning 2006 (Gionea 2005, pp. 222). The greatest gains were in the nations that newly entered the European Union. It emerged as a trend that FDI flows favored regional integration (reduction of jurisdictional policies) such as created by the EU in Western, Central and Eastern Europe (Gionea 2005, pp. 222). One common characteristic of the nations that have recorded high flows of FDI has been a relaxation of domestic policy influence. Even in these countries, the FDI did not flow into regions with policies that predominantly advocated for standard wages and other labor restrictions (Gionea 2005, pp. 222). The greatest amount of FDI was in areas with skilled and well-educated workers in plenty, opportunities for raw material resources in abundance as well as policy regulations that interrupted foreign investment at the minimum (Gionea 2005, pp. 222). The Growth of FDI in International Business As it has emerged from the discussion of foregoing sections of the essay, FDI favors the notion of common and integrated markets with less and less domestic restrictions of ownership and or trade (De Souza & Stutz 1997, pp. 99 – 105). The world is currently edging towards globalization, marked by numerous regional integrations towards common world markets (Smith & Walter 2003, pp. 73 – 86; De Souza and Stutz 1997, pp. 99 – 105). This is perhaps the greatest reason why FDI has been on perpetual growth since the 1990’s. In the early years of the 90’s decade, FDI grew at 20% annually but on the second half of the decade, FDI inflows had reached an annual rate of 40% (Gionea 2005, pp. 222). Although the three first years of this decade registered a decrease in FDI inflows due to poor economic growth globally, few privatizations and tumbling stock markets (Gionea 2005, pp. 222). However, on the path to global economic recovery, the stable national economies (Wells and Ahmed 2007, pp. 87), better economic performance and impressive corporate profits saw the FDI sour in 2004 to reach over $648 billion, over $946 billion by 2005 and $1.3 trillion by 2006 (Gionea 2005, pp. 222). This growth was primarily driven by two elements of FDI namely, globalization and mergers and acquisitions of international businesses (Gionea 2005, pp. 222). There was a time that production factors were static and almost immovable across national and regional borders (Gionea 2005, pp. 222). In the 1940 – 1970 decades, land, capital equipment, natural resources, financial capital or labor could not be moved across national borders. In this period in time (1940 – 1970), nations strived to create trade barriers that favored their own investments and protected them from the exploits of foreign nations (Gionea 2005, pp. 222). Most companies that had to market their products internationally found barriers erected in almost every corner. The only way that such international companies could enter new markets and avoid the imposed barriers against importers was to invest in these markets and become local producers (Gionea 2005, pp. 222). Today however, all these factors except land, which may also be redeemable in different areas, can be easily moved across borders with relative ease (Gionea 2005, pp. 222). Finance capital is being transferred across continents using wire transfers and other means that utilize no physical movement of resources (Smith & Walter 2003, pp. 73 – 86). International investors and financial institutions are now very willing to finance numerous corporate exploits, expansions and optimization across the globe (Smith & Walter 2003, pp. 73 – 86; United Nations 2008, pp. 33). Consequently, international capital flow has increased and become a norm in modern international business (Young 2004, pp. 50 – 75). Within no time, FDI became the best alternative to international investors. This prompted many nations to see the potential benefits of FDI and in response; they tried to attract even more FDI (Vousden 1990, pp. 27 – 54). Beginning with the Uruguay round of negotiations, GATT initiated a move to reduce trade barriers in national front as a way of attracting even more FDI in the member nations (Gionea 2005, pp. 222). According to Gionea (2005, pp. 222) a reduction in national trade barriers became a blessing for many multinationals. Companies started to transfer their manufacturing plants to the most suitable places (where there was labor, less domestic policy influence, raw material availability etc) to produce their products more efficiently and in more productive a manner, and then to export such products to the international markets (Gionea 2005, pp. 222). What transpired from this trend was an immense FDI inflow into emerging markets, low-cost economies and newly industrialized nations of the world. Globalization soon became a reality (Gionea 2005, pp. 223). The perpetual growth of globalization has seen even some progressive companies in emerging markets initiate their own FDI to other nations most notably, those in Taiwan, according to Gionea (2005, pp. 223). It is in this environment that FDI has grown in reaps and bounds. Cross border M&A’s (international merger and acquisitions) have also in this development, exploded in value and increased in frequency, thus underlying what Gionea calls ‘long-term growth in FDI’ (2005, pp. 223). Since 1990, M&A activity contributed and ever increasing portion on national and global GDP, rising from 0.3% in the 90’s to 8% (Gionea 2005, pp. 223). By 2000, international mergers and acquisitions had peaked their value to over $1.15 trillion (Gionea 2005, pp. 223). This means that cross border M&A currently accounts for over 3.7% of contemporary market capitalisation in all stock trading in the globe (Gionea 2005, pp. 223). Cross border M&A activity emerges from the desire of many companies to enter new geographical markets (Gionea 2005, pp. 223) such as the Chinese computer giant, Lenovo’s acquisition of the American computer legend, IBM’s computing division as an entrance strategy to North America. Other motives include increasing their global competitiveness (Houser 2009, pp. 3-4), to reduce their research and design costs, amplify productions, ease distribution and acquire a global corporate footprint or image (Gionea 2005, pp. 223). Domestic Policy and FDI International business has its major hindrance being the market imperfection of trade barriers (Gionea 2005, pp. 226). Many companies prefer to invest directly in country rather that to sell their products through export arrangements since, trade tariffs imposed by nations on all imported products is prohibitive (Bouzas & Keifman 2003, pp. 163). Instead of having to pay the high tariffs, such companies will simply invest manufacturing capital to such regions, thus skirting around the tariffs and becoming local producers (United Nations 2008, pp. 8). A good example is how the North American Free Trade Agreement imposes high tariffs on anything that does not originate from within the US, Canada and Mexico (Bouzas & Keifman 2003, pp. 163). According to Gionea (2005, pp. 226), Korean manufacturers were hindered by the high tariffs charges imposed on their products by NAFTA and had no choice but to turn to FDI. The Korean manufacturers interested in the NAFTA market opted to invest directly in Tijuana, within Mexico, and instead of selling exported goods in the region, to manufacture and sell the same products locally, thus escaping the high tariffs (Gionea 2005, pp. 226). The FDI sources are themselves seeking regions with minimal domestic policy influences while at the same time, nations are realizing the potential benefits of FDI (including employment, technology transfer, mechanization or local industries etc) (Gionea 2005, pp. 226). The interested nations are thus creating numerous economic incentives to attract as much FDI as is possible (Williams 1982, pp. 348). The net result of this converse interplay is increased FDI flows at a global level. Nations in need of FDI, most notably the developing nations and the emerging economies, use permissive domestic policy to attract foreign investors (Vousden 1990, pp. 27 – 54). Consequently, therefore, as more nations appreciate and seek for FDI, the world has seen a progressive reduction in domestic policy’s influence on international trade (Bouzas & Keifman 2003, pp. 162). As shall be discussed in later sections of this essay, FDI is an attractive path towards economic development for many regions, as investors and investing interests seek better investment opportunities beyond the saturated markets of the West (Vousden 1990, pp. 27 – 54). It also emerges that even the developing nations themselves, have been hunting for more and more FDI, since the more currency inflows that such countries attract, the better their economies become (Young 2004, pp. 50 – 75). The resultant impact has been a global understanding that FDI is a requisite pursuit of any nation and that the best way to attract FDI is to reduce domestic policy influence (Yao & Yueh 2006, pp. 33). In this way, FDI has managed to achieve indirectly, what years of lobbying, strategizing and negotiations have failed to do, that is, reduce national trade market barriers and integrate regions and the globe at large, to a singular market with less or no barriers for interested investors, irrespective of their origin (Young 2004, pp. 50 – 75). Domestic policy, what Gionea calls government policy, changes over time as governments try to encourage or deter FDI (2005, pp. 236). The FDI receiving (host) and the FDI outgoing (home) nations change their policies to promote or hinder FDI in various ways and for various reasons (Gionea 2005, pp. 226). It is not only the host countries that adjust their policies to attract FDI (Gionea 2005, pp. 226). In fact, some host nations may wish to protect their resources, to protect local producers or to control repatriation of profits to other nations by suppressing FDI (Gionea 2005, pp. 226). And just like host nations can and do adjust domestic policies to suit their ends, home countries can adjust domestic policies either way depending on their agenda (Gionea 2005, pp. 226). The home countries may wish to promote exports, create more employment locally and improve balance of payments instead of transferring their investments abroad, thereby passing legislations to hinder outgoing FDI (Gionea 2005, pp. 227). They may however seek to diversify, to acquire rare resources, to increase foreign income, to stabilise their economy and to compete on a global level, thus promoting FDI through policy adjustments (Gionea 2005, pp. 227). Such domestic policy adjustments may take the form of economic incentives, infrastructural development, tariffs etc (Gionea 2005, pp. 226). Jurisdictional Government and FDI Important to this conception of how domestic/government policies affect FDI, is an appreciation of the role that national governments play in FDI flows (Vousden 1990, pp. 27 – 54). In all instances, the actions, strategies and objectives of national governments have important and trend-changing implications to international business dealings (Gionea 2005, pp. 238). No matter how financially endowed, strategic and innovative a company is, the national government can thwart its efforts and frustrate its operations or encourage their investments depending mostly, as Gionea notes, on the philosophies that predominate the home culture and the agenda of the host government (2005, pp. 238). The reason why governments always seek to control FDI is because FDI flows impact greatly the economic health of a nation, in both the home and host nation (Gionea 2005, pp. 238). A particular nation’s government may seek to attract more and more investment as already discussed above, and thus strive to create a conducive local environment for international business players locally. Such initiative may take the form of passing pro-economic growth legislation, enhancing a stable local regulatory environment (Wells & Ahmed 2007, pp. 87), promoting and funding better local infrastructure etc. (Gionea 2005, pp. 238). Gionea notes that, since national governments across the globe are increasingly competing to attract FDI, there has been a trend that is becoming more and more attractive to FDI (2005, pp. 238). This is going hand in hand with an attempt by many governments to create regional free trade zones with other governments, thus advancing the notion of globalisation, integration and common markets (Yao and Yueh 2006, pp. 33; United Nations 2008, pp. 8), another favourable factor in FDI development as discussed earlier in the essay. By entering into regional bilateral trade agreements, government hope to attract more and more FDI, since FDI thrives in areas with little or no domestic policy influence (United Nations 2008, pp. 8). The Way Forward for FDI It is evident from the foregoing discussion that FDI is progressively becoming the major arm of international business and that the growth of FDI is determined by the trends in domestic policy enactments, which seek to either promote or curtail FDI flows. As companies across the world make decisions on where to locate their production plants, back-office services, logistics and distributional offices, the environment created by domestic governments is becoming increasingly important as a determinant factor (Gionea 2005, pp. 238). It is thus apparent that FDI is on a growth curve that is reliant on the increased reduction of domestic policy influence in international business (Gionea 2005, pp. 238). As nations across the globe appreciate and seek for FDI, the world has seen a progressive reduction in domestic policy’s influence on international trade. It also emerges that even the developing nations themselves, have been hunting for more and more FDI flows (inwards and outwards), since the more currency inflows that such countries attract or allow, the better their economies become in terms of foreign income and stable long-term investments (Wells &Ahmed 2007, pp. 87 - 96). The resultant impact has been a global understanding that FDI is a requisite pursuit of any nation and that the best way to attract FDI is to reduce domestic policy influence (Vousden 1990, pp. 27 – 54). Gionea notes that, since national governments across the globe are increasingly competing to attract FDI, there has been a trend that is becoming more and more attractive to FDI (2005, pp. 238). It is the deductively conclusive opinion of this paper that, FDI is headed for even greater growth as globalisation and market integration become the mainstay of international business, and alongside such growth, the world will experience an increasing rate and frequency of reduction in domestic policy influence in FDI interests (Spar 2003, pp. 46 – 51). Foreign Control in FDI Implementation Many host nations and their governments express concerns that FDI, despite generating great benefits in infrastructure growth, skills development, generating employment, increasing market competitiveness etc (Gionea 2005, pp. 233; Houser 2009, pp. 3-4), have some adversely negative impacts. At times, when most of the local industries feature more and more FDI, the industry begins to be driven by international factors rather than the local market factors (Markusen 2002, pp. 21 – 23). FDI as noted in the introductory sections of the paper has one of its central traits being the management control that FDI sources assume of their investments (Gionea 2005, pp. 222). As such, as nations attract more and more FDI players, most of the companies in such nations operate under foreign control (Gionea 2005, pp. 235). The net effect of this scenario is that the local populations and government feels that the companies are controlled abroad and thus negatively affecting the local economy (Madura 2006, pp. 457 – 486). Such companies may price their products to extents that make the local products uncompetitive (such as lower prices that local manufacturers cannot match) or that locals cannot afford (such as high prices in products not otherwise available in the local market). Besides pricing, locals also express concerns when much of the profits made by these multinational companies are repatriated back to their home countries, thus affecting the balance of payments in the host nations. In many instances, such multinationals are accused of exploiting the local resources and taking the profits home (Vousden 1990, pp. 27 – 54). The scenario is made even worse given that, to attract such FDI players, governments initially lower taxes for their employees, exempt them from tariffs and offer other economic incentives that end up benefiting the FDI players than the host nations, especially when all the profits are repatriated back home (Bouzas & Keifman 2003, pp. 163). There are companies that also employ a high number of expatriate professionals and only employ locals more manual, low-skill jobs (Markusen 2002, pp. 21 – 23). This reduces the employment benefits that such FDI is expected to generate in host nations (Vousden 1990, pp. 27 – 54). Such negative impacts of FDI are however controllable with simple legislative requirements such as requiring certain percentage of profits to be invested locally, certain percentage of employees to be locals, certain percentage of products to be made locally etc (Madura 2006, pp. 457 – 486). However, as discussed already, the more of these domestic legislative attempts to control FDI results to the FDI being transferred to other more permissive nations (Vousden 1990, pp. 27 – 54). This means that countries are increasingly becoming permissive and allowing the FDI players to operate without the restrictions (Vousden 1990, pp. 27 – 54). Conclusion Conclusively therefore, it is evident from the discussion of this paper that FDI has in recent times achieved much in integrating regions and nations into trading blocks and markets, featured by lesser and lesser domestic policy control of international investment. FDI flows have influenced how nations influence international business players locally, especially as demonstrated by their efforts to reduce policy barriers for the international investors as an incentive for more and more FDI. This is because foreign investors abhor those nations with restrictive investment policies and prefer instead, countries that allow a maximal return on their investments to bloom with as little domestic interruptions as possible. Consequently, FDI has had the greatest hand and influence in the changing domestic policy on international trade. References Barton, J & Fisher, B 1986, International Trade and Investment: Regulating International Business, Sidney: Little Brown, pp. 567 – 603. Bouzas, R & Keifman, S 2003, Making Trade Liberalization Work, London, Institute for International Economics, pp. 162 - 164. Available at De Souza, A & Stutz, F 1997, The World Economy, Third Edition, Sidney, Pearson Education, pp. 99 – 105. Gionea, J 2005, International Trade and Investment, “Foreign Direct Investment”, Chapter Seven, Sidney, McGraw-Hill Australia, pp. 220 – 243. Houser, P 2009, Congressional Testimony: Ensuring US Competitiveness and International Participation, New York, Peterson Institute for International Economics, pp. 3-4. Madura, J 2006, International financial management, London, Cengage Learning, pp. 457 – 486. Markusen, J 2002, Multinational Firms and the Theory of International Trade, Massachusetts, Massachusetts Institute of Technology, pp. 21 – 23. Smith, R & Walter, I 2003, Global Banking, Second Edition, Sidney, Oxford University Press Inc, pp. 73 – 86. Spar, D 2003, Managing international trade and investment: casebook, New York, Imperial College Press, pp. 46 – 51. United Nations, 2008, Globalization for Development: The International Trade Perspective, United Nations Conference on Trade and Development, New York: United Nations, pp. 8 - 86. 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