For What Reasons Do Host Countries Intervene in Foreign Direct Investment - Coursework Example

FDI College: Name: Students ID: Date: Course Name: Unit Code: Time: Instructor: Introduction The World Bank (2000) defines Foreign Direct Investment (FDI) as “investment made to acquire a lasting management in an enterprise operating in a country other than that of the investor.” In general, the accepted FDI threshold lies between 10 – 25 per cent of a company’s shareholding in a foreign country. In the present day, global developments, especially, the ever-more globalisation of the international market that enable organisations to incur low costs of production elsewhere and to gain a larger market share due to ever-increasing competition as well as increased acquisitions and mergers are the main drivers of FDI. Economic literature suggests that FDI is a vital component of the global financial system. Countries regard it is a key vehicle to economic development as it supports human capital development, job creation, investment, technology advancement, and poverty reduction, among other benefits. Indeed, the levels of FDI have been growing up across countries all over the world (UNCTAD, 2013). However, global FDI does not mount up without consistent human intervention across countries, sectors as well as local communities. Countries institute national policies to attract, control or repel FDI. In light of this, this paper delves into the reasons that necessitate intervention in FDI for both host and home countries. Also, the paper investigates whether such involvement is defensible. Host Country Intervention in FDI Host countries could intervene in FDI either to support it, control it or renounce it. Host country supportive intervention measures include; financial initiatives and (low taxes, tax waivers or low interest rates), and infrastructural improvements (seaports and road construction, improvement of telecommunication networks), among others. The countries could as well control or renounce FDI through investment restrictions (restricted ownership of companies) or place performance targets (export targets, local production targets, and technological targets), among other measures (Lipsey, 2004). Host country intervention in FDI has been felt mainly within the past two decades. According to the UNCTAD (2013) data, the amounts of FDI inflows have been constantly increasing and continued to set records within this period apart from the period after the 1997 Asian financial crisis and the 2008/9 global financial crisis that saw a slowdown in FDI inflow. Figure 1: FDI Inflows by Region and Economy 1990-2012 in Millions of U.S Dollars Source: UNCTAD (2013) There are two key reasons as to why host countries intervene in FDI: (1) Balance of Payments Control; and (2) Obtain Resources and Benefits. 1) Balance of Payments (BOP) Protection As regards the Balance of Payments (BOP), host countries aim to boost their domestic economy by protecting the BOP and reducing the desire for imports while increasing exports. The governments have got to make sure that BOP remains within favourable levels and does not become worse off. This arises from the reality that when FDI flows into the countries, they boost the BOP levels, however, profits generated from FDI may be sent home directly thus reducing BOP. Governments may require the foreign companies to supply the local market so as to reduce imports; hence improve the BOP. Also, this move will boost the exports from local companies which will increase exports and boost the country’s BOP (Lipsey, 2004). Justification This intervention to control the FDI can be justified through the linkages connecting FDI and foreign trade flow. According to the OECD (2002), as countries become more developed and achieve a middle- or high-income status, FDI inflow enables them to be further integrated into the international economy by stimulating and enhancing foreign trade flows. The OECD (2002) considers a number of factors as the greatest contributors. They include improvement and reinforcement of global networks of associated companies along with a rising value of overseas subsidiaries in Multinational Corporations’ (MNCs) strategies for product distribution, sales as well as promotion. There is a great divergence in empirical evidence as regards FDI’s effects on host country foreign trade flows from country to country. However, the OECD (2002) states that consensus is emerging that the FDI and foreign trade flow linkage ought to be perceived in a wider perspective rather than the express impact of investment on imports and exports. For instance, developing countries are expected to benefit from FDI’s long-term contribution to integrate the host country more directly into the global economy. This may well incorporate increased imports along with exports. This is to mean that trade and FDI are more and more equally recognised as strengthening channels for cross-border interaction. 2) Obtain Spillovers and Other Resources Governments also intervene in FDI to enable the host country to effectively tap the spillovers and other resources arising from FDI activities. These include; technology transfer, management knowledge and skills, human capital development, and reduction of poverty, among others (Lipsey, 2004). Justification Technology transfer has been identified as the central channel through which MNCs may well fabricate positive externalities in the host country. MNCs usually invest in extensive corporate research and development (R&D). Their level of technology is by and large different compared to that available in the host country, so MNCs are expected to engender substantial technological spillovers. Technology transfer and diffusion work through four interconnected channels: vertical linkages; horizontal linkages; movement of skilled labour; and internationalisation of R&D. Empirical evidence of positive spillovers in the case of vertical linkages, particularly, the “backward” linkages with local suppliers in host countries has been highly corroborated (Lipsey, 2004). FDI has also been touted to reduce poverty in the host country, especially in the developing world. FDI leads to improved economic growth; hence, peoples’ living standards improve due to the increase in GDP, improvement of technology and productivity. Jobs are also created and people earn more incomes. Research shows that higher incomes in developing countries by and large profit the poorest fragments of the populace proportionately. The positive effects of FDI on poverty reduction are stronger once FDI is deployed as a means to build up labour-intensive industries and where it is affixed in the adherence of MNCs to national labour laws and international labour standards (OECD, 2002). Home Country Intervention in FDI Home countries could intervene in FDI either to support it, control it or renounce it. Home country supportive intervention measures include; insuring their MNCs assets abroad, special tax treatment, providing and guaranteeing loans, and persuasion of other countries to support FDI, among others. The countries could as well control or renounce FDI through restrictions such as high taxes on incomes earned abroad and sanctions on specific nations, among other measures (Falzoni & Grasseni, 2005). Home country intervention in FDI has been felt mainly within the past two decades. According to the UNCTAD (2013) data, the amounts of FDI outflows have been constantly increasing and continued to set records within this period apart from the period after the 1997 Asian financial crisis and the 2008/9 global financial crisis that saw a slowdown in FDI outflow. Figure 1: FDI Outflows by Region and Economy 1990-2012 in Millions of U.S Dollars Source: UNCTAD (2013) There are two key reasons as to why home countries intervene in FDI: (1) Balance of Payments and Jobs Protection; and (2) Increase Competitiveness and Offshore ‘Sunset’ Companies. 1) Balance of Payments and Jobs Protection When MNCs invest in a foreign country, it sends resources there; hence, the home country is left with a smaller quantity of resources. Seeing as there are fewer resources that can be used in development as well as the exploration of fresh investment openings at home, the home country’s BOP may well be affected negatively. This is because the export potential will be cut down. In a similar way, MNCs will create jobs abroad which will replace that jobs that would have been created if they invested at home (Moon, 2005). Justification Economic literature indicates that both horizontal and vertical FDI substitute various earlier home country production as well as exports. It may as well be inclined towards promoting exports of intermediate goods from the home country to the new subsidiaries abroad. These two effects are likely to have different impacts, depending predominantly on how FDI affects total sales decision that may well lead to later inflows of capital in form of repatriated profits. These have an effect on the home country’s BOP (Desai et al., 2005). Moreover, vertical FDI may well substitute various production activities originally situated in the home country. The effect of this on home country employment depends on how the FDI influences the MNCs total sales. If the MNCs utilise lower factor costs in a foreign country, the vertical FDI makes the MNCs more competitive locally as well as overseas. This boosted competitiveness may cut down imports or raise exports and may generate enough employment opportunities to balance the earlier proxy effect. For example, a study conducted on Sweden found out that FDI affected home country exports along with employment positively. This was because the overseas subsidiaries on average resulted in huge increases in foreign market shares and export of intermediary goods (Braconier & Ekholm, 2000). 2) Increase Competitiveness and Offshore ‘Sunset’ Companies Home countries, through foreign MNC operations will be able to expand their international presence. This will boost their global competitiveness, if the MNCs utilise low cost factors in foreign countries to produce products they then put up for sale in the international market. Also, fostering FDI is a means of having control over industries using obsolete technologies, ‘sunset’ industries. Such industries can be of value to the home country if allowed to go international (Barba & Castellani, 2004). Justification Home countries direct FDI to industrially flourishing countries, such as the BRICS and the wider Latin America, so as to benefit from the expected high proceeds. Through cross-border mergers and acquisitions (M&As) home countries boost their international presence and competitiveness. If MNCs engage in vertical FDI, they are likely to increase their competitiveness. Sweden remains a classic example of how FDI can improve the home country’s competitiveness. In the late 1980s, the Swedish economy was worked up. With a limited supply of skilled labour and overvalued currency, Sweden’s export capacity was down low. However, following the 1992-1994 financial crisis, the country undertook extensive reforms that improved its production competitiveness. There was a similar structural impact linked to the country’s FDI. At the time the Swedish competitiveness was frail, Swedish MNCs moved their desirable operations to foreign countries. As soon as the country’s competitiveness got better, the desirable operations moved back (Braconier & Ekholm, 2000). Also, ‘sunset’ industries may find way to poorer countries which fit their technology which can be used there to produce goods and make sales then repatriate profits back home. In addition, in poorer countries they may have ample time to make innovations and improve their technology with time through training. This will be of benefit to the home country if they stumble on original innovations (Moon, 2005). Conclusion FDI is a vital component of the global financial system. Host countries employ different measures to control FDI inflow to protect their BOP and to tap the latent spillovers and other benefits. Home countries, as well, employ several measures to have command over FDI outflow to protect their BOP and local employment and to boost their global competitiveness. Economic literature shows that respective intervention is justified given the existing empirical evidence (Desai et al., 2005). References Barba, N.G. and Castellani, D. (2004). Investment Abroad and Performance at Home: Evidence from Italian Multinationals. CEPR Discussion Paper No. 4284, Centre for Economic Policy Research, London. Braconier, H. and Ekholm, K. (2000). Swedish Multinationals and Competition from Highand Low-Wage Locations. Review of International Economics, 8: 448-461. Desai, M.H., Foley, C.F. and Hines, J.R. (2005). Foreign Direct Investment and the Domestic Capital Stock. NBER Working Paper 11075, NBER, Cambridge, MA. Falzoni, A.M. and Grasseni, M. (2005). Home Country Effects of Investing Abroad: Evidence from Quantile Regressions. Mimeo, Bocconi University, Milano. Lipsey, R.E. (2004). Home and Host Country Effects of FDI in R.E. Baldwin and L.A.Winters, eds., Challenges to Globalization, University of Chicago Press, Chicago. Moon, H.-C. (2005). Outward Foreign Direct Investment by Korean Firms. Mimeo, Seoul National University, Seoul. Organisation for Economic Co-operation and Development (OECD). (2002). Foreign Direct Investment for Development: Maximising Benefits and Minimising Costs. OECD Publications Service, Paris, France. (UNCTAD). (2013). World Investment Report. Retrieved May 1, 2013, . World Bank. (2000). World Development Report 2000/2001: Attacking Poverty. Washington, D.C: World Bank. Read More