Various Methods that Countries Use to Promote Foreign Direct Investment - Coursework Example

Student Name: Student Number: Unit Title: International Business (BUS202) Unit Coordinator: Assessment Task Two Essay Topic No. 2 Explain the various methods that countries use to restrict and/or promote foreign direct investment (FDI). In your opinion, is government intervention in FDI justifiable or should neo­liberal open market policy be a nation’s overarching principle? Date: 25 April 2017 Word Count: 2093 (excluding reference list and table of contents) Table of Contents References 11 Introduction Foreign direct investment (FDI) can be defined as a form of investment that involves a long-term interest as well as control by a resident organisation or individual in one country in a business that is resident in a country other than that of the foreign investor (United Nations Conference on Trade and Development (UNCTAD), 2012, p. 3; Wild & Wild, 2015, p. 440). In other words, FDI involves an individual or an organisation from one country making long-term investments in another country. Through FDI, the investors are able to exert a significant level of influence on the management of a business that is located in the host country where the investment is made (UNCTAD, 2012, p. 3). As a result, FDI involves both benefits and demerits for the host country. Therefore, countries, through their governments, may promote or restrict FDI. Based on the background information above, this essay will discuss the various methods that countries use to promote FDI. It will also discuss the ways in which countries restrict FDI. On the basis of the discussion, an opinion will be given on whether government intervention in FDI is justifiable or the neo­liberal open market policy should be a nation’s overarching principle. Various methods that countries use to promote FDI Governments promote and attract FDI because of the benefits that are associated with the concept. According to Donciu (2014, p. 17), FDI is an important component of the functioning of any country based on market principles as well as the economic development of countries. In addition, Donciu argues that FDI plays an important role given that it helps in the strengthening of the receiving countries’ economies, especially those countries that are undergoing development and helps in their transition and integration into the world economy. Further, it is argued that FDI helps in the modernisation of national economies, especially those of the developing countries, as the host countries are able to have access to advanced technologies, employment, new equipment and knowhow, and to operate at new standards that enable them to achieve high growth (Almfraji & Almsafir, 2014, p. 209; Donciu 2014, p. 17; Dunning, Kim & Park, 2008, p. 173). Countries promote and attract FDI through measures such as liberalisation of trade, tax reductions or exemptions, subsidies and the provision of other incentives that induce foreign companies to operate in a certain way (Donciu 2014, p. 18; OECD, 2010, p. 104). Donciu (2014. p. 19) has outlined a number of the specific measures that governments implement to attract FDI. The first measure is the use of policies that are aimed at making it easier for foreign firms to do business in or with the host country. The second measure is the use of policies that focus on improving import substitution. The third measure is the provision of commercial facilities and incentives to attract foreign firms. Trade liberalisation Policies that are aimed at making it easier for foreign firms to do business in or with the host country can be related to trade liberalisation. Trade liberalisation means the removal or reduction of regulatory barriers that firms have to go through in order to access the market in a given country (Hodge, 2002, p. 222). Thus, in regard to international business, trade liberalisation involves making a country’s market more open to trade or investment by foreign firms. According to the OECD (2010, p. 104), there is a strong correlation between liberalisation of trade and FDI. Specifically, the OECD notes that one extensive review of literature established that there is a likelihood of a positive relationship between a nation’s openness to investment and trade and FDI. The OECD also argues that a trade regime that is characterised with market openness adds to attracting FDI. This is because an economy that is liberal and open provides an environment that is conducive to investment and growth. A liberal and open market environment also creates conditions that are appropriate for the harmonisation of a country’s regulations and standards with international procedures and standards. The standardisation and harmonization of laws, regulations and standards regarding various operations helps in making a country’s economy more competitive and acts as a means of enhancing trade (OECD, 2010, p. 104). An open and liberal economy is also associated with positive export promotion policies, which can assist nations in diversifying their exports by promoting trade in goods where there is a comparative advantage (OECD, 2010, p. 104). There are several examples of cases in which countries have liberalised their markets in order to promote FDI. For instance, Ethiopia opened its electricity production and distribution sector to private investors (UNCTAD, 2015, n. pag.). India also liberalised foreign investment in the country’s railway sector and increased the FDI cap in the defence sector (UNCTAD, 2015, n. pag.). As well, Indonesia raised the FDI cap in several industries for power plant projects, venture capital investments and pharmaceuticals (UNCTAD, 2015, n. pag.). The aim of the various market liberalisation efforts as undertaken by Ethiopia, India and Indonesia is to make the market more open to private investors and especially foreign investors through FDI. Supporting import substitution Import substitution is an economic and trade policy that aims at replacing foreign-manufactured services or goods with locally manufactured goods or services by creating domestic industries (Liang, 1997, p. 5). That is, through the import substitution policy, a government may encourage firms to locally manufacture goods or services that would otherwise have been imported. FDI inflows are regarded an important source for the growth firms that can support domestic production under the import substitution policy (Pham, 2004, p. 89). This is because in most cases, large amounts of capital as well as a considerable level of technology may be required to set up such industries, which can be facilitated by foreign firms that engage in FDI in the country in question (Pham, 2004, p. 89). For example, Vietnam has promoted import substitution by encouraging foreign firms to establish industries in the country in sectors such as oil refining, automotive part manufacturing, petrochemicals, cement, and steel and iron manufacturing (Pham, 2004, p. 89). Use of incentives like tax reductions/exemptions and subsidies Another way by which governments attract and promote FDI as noted above is the use of incentives such as tax reductions or exemptions and subsidies (Donciu 2014, p. 18; OECD, 2010, p. 104). In this case, governments that seek to attract FDI provide inducements that make the business environment very friendly for foreign investors to invest in the country in question. For example, South Korea has enacted the Foreign Investment Promotion Act that introduces different kinds of incentives to encourage foreign investment (Kang & Lee, 2011, p. 294). Some of the incentives are outlined by Kang and Lee (2011, p. 294) as follows. The first one is a tax support policy that encompasses the reduction as well as exception of customs tariffs and local and national taxes, leasing or purchasing of public or national property, and financial assistance for promotional activities of local independent entities. Another incentive is the designation of special areas for foreign trade and investment. This makes it possible for foreign investors to present their views regarding the designation of areas where they wish to set up production plants. Another incentive is the cash grant system, whereby the government reimburses a given percentage of FDI in South Korea as part or its dealings with foreign investors. The South Korean government also provides mechanism for foreign firms to have quick access to the information that they need and to access various services promptly (Kang & Lee, 2011, p. 294). Similar strategies have been applied in Brazil, where in 1995 for instance, the Brazilian government introduced a new policy to spur local production of automotives and enhance FDI in that sector (Easson, 2004, p. 68). According to Easson (2004, p. 68), the policy was successful in attracting many of the leading automotive manufacturers in the world to invest in Brazil. Various methods that countries use to restrict FDI In today’s era of globalisation, governments of both developed and developing countries are putting in place measures to promote FDI (Dunning et al., 2008, p. 173). However, there are still some restrictions that governments implement to restrict some forms of FDI. In many cases, restrictions on FDI are implemented to protect some industries and to rein in industries such as gambling (Dezan Shira & Associates, 2015). According to Shahid (2013, p. 4), there are three main groups of restrictions on FDI inflow into any country: market access restrictions, operational restrictions and restrictions on ownership and control. Market access controls Market access controls may be in the form of total bans on FDI, minimum investment requirements, restrictions on the legal entry requirements, screening and authorisation, as well as conditions on where to locate a certain business (Shahid, 2013, p. 4). For instance, in Kenya, foreign investors are required to get approval from the Investment Promotion Centre before commencing business activities (OECD Secretariat, 2005). Ownership restrictions Ownership restrictions include the requirement for a local partner, compulsory transfer of ownership of a foreign company to locals after a specified time frame, and the requirement for a foreign company to have government-selected members of the board (Shahid, 2013, p. 4). In Kenya for example, foreign companies can buy stocks not exceeding 40 percent of a local listed company’s shares, and foreign individuals can buy only a maximum of five percent of a local listed company’s shares (OECD Secretariat, 2005). Operational restrictions and others Governments may also require foreign companies to export a certain percentage of what they produce, put limitations on repatriation of profit, and require companies to comply with local requirements (Shahid, 2013, p. 4). Opinion on government intervention in FDI In my opinion, government intervention in FDI is justifiable because while FDI has many benefits, there is also need for governments to ensure that foreign firms comply with local business regulations and do not engage in activities that put the local economy at a disadvantage. Specifically, FDI is associated with host country benefits such as access to the latest technologies, job creation, better management capabilities, growth of the market and institutions, and overall economic growth (Donciu 2014, p. 17; Dunning et al., 2008, p. 173). But at the same time, there are risks to the country that receives FDI, such as dependence on foreign companies and repatriation of profits by the companies involved in FDI (Shahid, 2013, p. 4). There is also the risk of abuse of the market by the companies that are involved in FDI, most of which are large multinational corporations with superior marketing advantages and technological capacities (Maskus, 2002, p. 196). Without government intervention, or where there is an open market policy, such companies are likely to use their position to their advantage – to the detriment of other smaller, local competitors. Therefore, governments need to intervene to protect the local economy and ensure that there is a level playing field for all firms even as they promote FDI. Notably, intervention is required to ensure that is there is a good business environment for foreign companies to operate in the local market. As well, governments have to act to get rid of practices by foreign companies that would jeopardise the local economy. Such practices include employment that is biased against the local population, abuse of the market, repatriation of profits and other activities that have a negative effect on the economy such as pollution of the environment. In essence, governments of countries that receive FDI have to intervene in order to ensure that foreign firms comply with the local requirements. Conclusion This essay has discussed the various ways in which countries promote and restrict FDI. Governments promote FDI by having policies that liberalise trade, by encouraging foreign firms to establish plants to manufacture goods or services that would otherwise have be imported, and by providing incentives that promote FDI like tax reductions or exemptions and subsidies for foreign firms. To restrict FDI, can governments impose restrictions to market access by foreign firms, establish operational restrictions for foreign firms, and require foreign firms to be owned and controlled in a certain way. It has also been opined that government intervention in FDI is required not only to promote FDI but also ensure that the activities of foreign companies do not disadvantage the local economy. Specifically, government intervention is required to ensure that foreign companies involved in FDI comply with local regulations and do not use their capabilities to abuse the market or engage in other activities that cause harm to the receiving country’s economy. References Almfraji, M. A., & Almsafir, M. A. (2014). Foreign direct investment and economic growth literature review from 1994 to 2012. Procedia - Social and Behavioural Sciences, 129, 206–213. Dezan Shira & Associates. (2015). Restrictions on foreign direct investment in Vietnam. http://www.vietnam-briefing.com/news/restrictions-foreign-direct-investment-vietnam.html/ Donciu, E. C. (2014). Promoting and attracting foreign direct investment. CES Working Papers, VI (3), 17-28. Retrieved from http://ceswp.uaic.ro/articles/CESWP2014_VI3_CHI.pdf Dunning, J. H., Kim, C., & Park, D. (2008). Old wine in new bottles: A comparison of emerging-market TNCs today and developed-country TNCs thirty years ago. In K. P. Sauvant (ed.), The rise of transnational corporations from emerging markets: Threat or opportunity? (pp. 158-182). Cheltenham: Edward Elgar Publishing Limited. Easson, A. (2004).Tax incentives for foreign direct investment. The Hague: Kluwer Law International. Hodge, J. (2002). Liberalisation of trade in service in developing countries. In B. M. Hoekman, A. Mattoo & P. English (Eds.). Development, trade, and the WTO: A handbook (pp. 221-234). Washington, DC: The World Bank. Kang, S. J., & Lee, H. (2011). The impact of foreign direct investment on labour productivity in Korea. In C. Sussangkarn, Y. C. Park, & S. J. Kang (Eds.), Foreign direct investments in Asia (pp. 287-320). Abingdon, Oxon: Routledge. Liang, H. (1997). Investment in developing countries: A thesis on the rationales of import substitution industrialization strategy. Retrieved from https://books.google.co.ke/books?id=CLWAI0Jx4AcC&pg=PA5&dq=import+substitution+definition&hl=en&sa=X&redir_esc=y#v=onepage&q=import%20substitution%20definition&f=false Maskus, K. E. (2002). IPRs and FDI. In B. Bora (Ed.), Foreign direct investment: Research issues (pp. 196-210). London/New York: Routledge. OECD Secretariat. (2005). Regulatory environment for foreign direct investment: Preliminary inventory for selected African countries. Retrieved from https://www.oecd.org/investment/investmentfordevelopment/34783838.pdf OECD. (2010). Investment reform index 2010: Monitoring policies and institutions for direct investment in south-east Europe. Paris: OECD Publishing. Pham, H. M. (2004). FDI and development in Vietnam: Policy implications. Singapore: Institute of Southeast Asian Studies. Shahid, A. (2013). Foreign direct investment, trade in services and economic growth: An introduction. In S. Ahmed (Ed.), Foreign direct investment, trade and economic growth: challenges and opportunities (pp. 1-24). New Delhi: Routledge. UNCTAD. (2012). World investment report 2012. Retrieved from http://unctad.org/en/PublicationChapters/WIR2012MethodologicalNote_en.pdf UNCTAD. (2015). Measures to promote foreign direct investment increased in 2014, UNCTAD Report says. Retrieved from http://unctad.org/en/pages/PressRelease.aspx?OriginalVersionID=255 Wild, J., & Wild, K. L. (2015). International business: The challenges of globalization (8th ed.). Upper Saddle River, NJ: Pearson Education. Read More