The Concept of Foreign Direct Investment, Worldwide Patterns of FDI - Coursework Example

Running Head: FOREIGN DIRECT INVESTMENTS Foreign direct investment Name Course Lecturer Date FOREIGN DIRECT INVESTMENT Introduction The concept of Foreign Direct Investment (FDI) is today considered a basic dictum in the contemporary global economical environment and a manifestation of internalization. With tremendous outburst in communication technology and transpiration along with trade liberalization and revolution in investment regime, economies among nations are undoubtedly becoming more integrated as financial capital, cross border flow of trade and investment continue to grow (Desai et al, 2004, p. 2733). The focus of internationalization of business has shifted from just trade to factors of production. Manufacturing, assembling and sourcing outside home countries is rapidly gaining momentum today that before. International production via foreign operations is set to exceed by far the exportation of goods between nations. FDI is becoming increasingly important and receiving much attention from governments and Multinational Corporations. At the same time, the world had witnessed significant changes in the trends and patterns in the flow of FDI. The motives of Trans-National Corporations have moved from the traditional market seeking approach to more strategic and efficient asset seeking approach (Markusen, 2002, p.77). Production within the host country is no longer strictly related to market size or the resource base of the economy. The principle driving force behind such production is the comparative cost factor. Forms of international investment have remarkably changed from wholly owned to non-equity or low equity forms of participation and from Greenfield investment to acquisitions and mergers. Along with these waves, the hegemony of developed countries as recipients and sources of FDI is slowly eroding and being replaced by their developed counterparts especially East and South-East Asia. The purpose of this paper is to trace the trajectory behind the prevailing patterns and trends in the global FDI. Worldwide patterns of FDI Overall trend of FDI Goldstein and Barton (2010, p.604) point out that FDI has experienced tremendous growth over the past decades more remarkably than international trade. FDI flow hit its peak in 1996 with a tremendous increase in inflow by about 10% to around $ 349 billion while the outflow rose to $347 billion which was about 2% increment. FDI inflow grew by 10.3% which exceeded the growth in nominal values of international trade and world GDP which expanded only by about 4.5% and 6.6% respectively. FDI stock reached about $3.2 trillion compared to the previous $2 trillion in 1993 and $1 trillion in 1987. Assets and sales of TNCs are rapidly growing than gross fixed capital formation, world GDP and exports. Today, about 44,000 TNCs with almost 280,000 foreign affiliates have active operations through a wide variety of investment channels as well as equity and non-equity link-ups. The present trend in FDI suggests that the world is in the midst of a FDI revolution and transformation following a decline in FDI flow that now seems to be fully recovered as in the previous years (Borga and mataloni, 2001, p.256). The first FDI boom to have ever been experienced in the world occurred in 1979 to 1981. The boom which occurred after the second oil crisis during the end years of 1970s was led by major oil producing countries; it was however short-lived. The largest recipients of FDI, at that time, were the United States followed by Saudi Arabia; major oil producers. FDI outflow boom was led by the United Kingdom and Netherlands which were home to major petroleum TNCs. The second FDI boom was experienced in 1986-1990. This period experienced emergence of many countries as recipients and sources of FDI, most notably Japan which became the world largest outward investor. Flows in investment were, to a large extent, influenced by increased protectionist pressures which were accelerated by rapid economic growth of FDI liberalization and adoption and development of telecommunication and information technologies (Nicoletti et al, 2003, p.3). The 1986-1990 FDI boom actually a phenomenon of the developed countries. The prevailing boom began in 1995 and is majorly attributed to China’s entrance as the major recipient of FDI and the emergence of Latin American countries on the inflow side and Germany, France and some developing countries on the outflow side. FDI outflows Volumes in FDI outflows have demonstrated an upward trend in both developing and developed countries since 1991. Developed countries have increased investments in foreign trade to about 85% of all direct investment outflows. Nevertheless, increase in direct investment among developing countries is increasing at a higher pace than developed countries. UNCTD (2007, p.6) describes this trend of the developed countries as a sheer dominance in shaping global patterns of FDI outflows. The notable abundant outflow of FDI from developed countries is associated with internationalization and ownership advantages possessed by the investing firms. Most of the Multi-National and Transnational Corporations, major actors in FDI, in the world are located in these countries. Andelj (2011, p.53) notes that 87 of the 100 top TNCs and 88% of foreign assets are located in the United States, EU and Japan. MNEs from developed countries do have technological superiority which provides them with plausible ownership advantage over local companies in their overseas facilities. Besides that, they have well defined Research and Development (R&D) intensity increasing their proportion of sales. Researchers across the globe have identified a very close linkage between R&D intensity and overseas production by firms. Furthermore, technological innovation that results from R&D often motivates FDI. This occurs as a result of the company’s desire to protect this technological innovation through internationalization rather than risk unauthorized diffusion through licensing. Among all developed countries, the Triad (US, EU and Japan) account for about 90% of both outflows and inflows. EU remains the largest home country as 60% of the total outward fund from developed countries originates for it. Currently, the United States is the home country with the largest investments abroad followed by the United Kingdom. Claessens et al (2001, p.563) assert that the major cause of high US FDI outflows is the sustained economic growth in many of the countries in the world. Large and growing consumer markets as well as favorable economic growth prospects in developing countries have encouraged increased interest from TNCs in the United States. However, the US has experienced fluctuations in FDI outflows probably due events of economic crisis causing sluggish economic growth. An example of FDI outflow in the US occurred in 1996 when it dropped to 43% from 50% in 1995. Other countries leading in foreign investments include Japan, Germany and France. South, East and South-East Asia is the leading region of FDI outflow among developing countries. In 2009, it accounted for 89% of FDI outflows among developing countries. Other countries which dominate this list include Hong Kong, China, Taiwan and Republic of Korea. Hong tops the list due to the fact that 28 out of the 50 TNCs from developing countries are located in the country which accounts from two-thirds of the foreign assets. The general increase in FDI from developing countries is attributed to a number of factors. They include response to restrictions by developed countries, search for natural resources, increased cooperation among themselves and back-up support from governments (Palmade and Anayiotas, 2004, p.104). Most of the third world countries that pioneered outward investment such as Singapore, Taiwan and Hong Kong are resource poor. World Bank (2004, p.12) suggests that their main inducement to foreign investment is due to the increasing need to secure stable resource supplied at reasonable prices. As industrialization intensifies, developing countries are faced with the main challenge of exportation of manufactures to the industrialized nations. There are two fold effects of this growth in exports. First, their national corporations lose their GSP3 (generalized System of Preference) status and second newer restrictions were experienced in their exports. Growth constraints created by recession faced by advanced nations which caused emergence of trading blocs between them and inaccessibility of markets paved way for regional cooperation to take momentum in developing countries especially in Pacific and Asian regions. Among these efforts of cooperation include emergence of highly dynamic private entrepreneur class, governments interventions to encourage continued growth, well trained workforce and rising and high share of manufactures to total exports (Patterson, 2004, p.90). FDI inflows Major recipients of FDI are developed countries receiving about 60% of the world’s total FDI inflows. However, that this trend is steadily decreasing as the share of developing countries is increasing steadily. Menon (2006, p.421) notes that trends of developed countries are constantly fluctuating and sometimes stagnant compared to those of developing countries which have a steady increment. The high percentage of developed countries in FDI inflow share is caused by a number of causes. Investments in foreign countries, is in most cases, market seeking. Developed countries provide markets that not only big but also with strong effective demand. According to Erdener and Shapiro (2005, p.431), a country’s GDP is a sufficient measure of market size thus a significant determinant of FDI inflow in a particular nation. Besides that, developed countries have lower perceived risk in doing business in terms of political turmoil as compared to their developing counterparts; which further induces a firm to invest in a developed country with confidence. Many developed countries through the OECD have committed themselves to liberalization of direct investment among member states and they are subjects to powerful declarations on Multinational Enterprises and International Investment. OECD key principle in business matters is that a foreign controlled company should be treated equally as local companies in areas such as access to local capital, taxes and government procurement (OECD, 2002a, p.23). Currently, the US is the largest host country of FDI. In actual fact, the US absorbs every four dollars spent on FDI in the world. FDI inflow within US was stimulated by the continuous growth of its economy and its favorable effects on profitability. In addition, the United States is a long known hub of technological and science developments which attracts technologically hungry investors from all over the world. An example is the Silicon Valley which is dominated by Taiwanese and Korean investors who are essentially interested in advancing their home countries technologically. The large scale inflow of FDI into developing countries which are more predominant in southern region of Asia, is associated with increasing capabilities of the region as a growth centre that has the ability to absorb a great deal of increased capital flow as well as increased intra-region investment. The market seeking motivation of international companies entering China and its endorsement as a socialist market economy is the main reason for the sudden surge in FDI inflow into China. Multinational companies have been attracted to China as a potential market due to its large population. In addition, the economic growth of China has increased tremendously due to its purchasing power. Its manufacturing output is the fastest growing among the largest fifty economies. Besides its large market size, China has attracted investors because of its rich source of resources. For instance, China has received major investments in oil and coal explorations and productions with almost 20% of these FDI being US owned FDIs (Dunning, 2006, p.140). Lau (2003, p.841) asserts that there is also a dramatic change in the attitude of developing nations towards FDI in the recent decades; which has also contributed to increased growth in their FDI inflow. They now have a renewed faith in the possibilities of market economy which is demonstrated by privatization of many state owned companies as well as liberalization and deregulation of markets experienced in the past two decades. Another reason why developing countries are participating in FDI is because of the ongoing globalization and integration of international productions across boarder by multinational corporations. Contemporary economic growth of created assets such as intellectual capital, technology and organizational competence, housed in MNEs, is another reason why developing countries have embraced investments from foreign countries. Currency flow and the reduction of domestic influence The global policy environment has witnessed tremendous changes that have subsequently affected responses policies involved in international trade and investment. These changes include conflicts among developed and developing countries, reduction in domestic policy influence and weakening of international companies. Dicken (2003, p.378) maintains that events in international markets and domestic economies of individual countries are inseparable which occurs as a result of currency flow. Domestic policy measures are greatly affected by global market forces. Policies within countries have been reviewed according to the demands of the international business arena as well as those of other countries that are stakeholders. Most industries are now under the rule of international policies as Multinational Corporations continue to make way in these nations. More importantly, exports and imports, which are classified as currency flows, have played a major part in influencing the working of domestic policies (Lawrence, 2002, p.32). Formulation of domestic policies by local governments had been limited to a large extent by the relationship of global and domestic financial flows. Changes in interest rates by powerful banks affects the international flow of capital in a country and this could probably reduce or totally change domestic policies. This further explains why national governments are becoming gradually powerless in developing and implementing policies that would be effective to their economies. Some nations have however, gone against this principle by establishing policies that favor their country and defy international principles and policies. This has detrimental effects on the particular company as it is barred from participation in the international realm which deprives it of competition advantages. Increasing currency flow has presented policy makers with a whole new challenge as expertise takes centre stage in the operations of these activities. This has consequently led to segmentation of domestic economies which are rather difficult to manage and control. It is worth noting that even with small segments of the domestic economies are prone to international policies. In order to restore domestic policies influence, governments have adapted strategies of restricting negative influences of global trade through establishment of trade barriers, tariffs and regulations on imports (Chakrabarti, 2001, p.107). Conclusion Indeed, trends in FDI have changed significantly over the last few decades. In the contemporary business world, FDI is considered as a clear manifestation of nations efforts to internationalize. FDI has increased by far beyond international trade, exports and world GDP. The new era of FDI revolution has witnessed a radical increase in the number of Multinational and Transnational Corporations that have overseas operations. The first FDI boom occurred in the late years of 1970’s was experienced by oil producing companies which attracted international investors and had capital ability to invest in other companies. The second boom came amidst advanced telecommunication and transportation capabilities which saw the entrance of many countries into the field of FDI. The third boom which is still prevalent took place in mid nineties, has major players as developed countries. FDI outflow has registered constant growth in the past few years. The major foreign investors are the developed countries which have capital advantages and other resources. The motive behind foreign investment is the increasing economic growth in many countries which has encouraged advanced nations to invest in developing nations. Major recipients of FDI are also developed countries. This is because they provide large markets in addition to a large wealth of technological knowhow. Developing countries have also been active recipients of FDI inflows especially countries in the Southern part of Asia. China tops the list of countries with increased FDI inflows due to its large population and potential growth of its economy. Increasing globalization has also witnessed loosening of domestic policies as nations pave way to international policies. Currency flows which occur as a result of imports and exports is predominant controlled by global market forces which keep reduces the power of domestic governments in making policies for their countries. 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