Impact of Inward FDI on Host Countries - Essay Example

Introduction Foreign Domestic Investment (FDI) inflow has many effects on the host countries. Firms that are investing in other countries have superiority in technology, services and the quality of goods that they produce. These firms add capital stock to the host countries, which leads to an increase in the output levels of these countries. Apart from the increase in the capital stock, host countries benefit from management skills. These effects have a direct impact on the economic growth of the countries (Dunning and Lundan, 2008). Foreign firms also increase employment in these countries. However, the inflow of FDI has negative impacts such as reducing the sovereignty of a host country. Discussion The impacts of inward FDI on host countries Transfer of resources Inward FDI has various effects on host countries. Grimwade (2000) indicates that inward FDI has the effect of transferring resources whereby resources such as technology, capital and management are transferred during investment. Capital transfer increases the capital stock in a host country while the transfer of management leads to the improvement of management skills in this country. Moreover, during transfer of resources, host countries may benefit from new technologies from the foreign investors. Overall, the transfer of the aforementioned elements leads to an increment in the host country’s productive potential as it leads to the increase of the Gross Domestic Product (GDP). Host countries have witnessed substantial economic growth due to FDI. This growth, alongside other benefits, has heavily depended on various factors. The multinational corporations in host countries have raised funds in these countries through bank loans, issuing shares or issuing bonds to the investors in these countries. However, such a move has not yielded the result of transfer of capital and it has instead pushed the costs of raising capital for the firms in the host countries. Although the transfer of technology has influenced the economic growth of the host countries, most foreign firms have demonstrated reluctance in the transfer of this knowledge. Foreign firms have transferred knowledge that is irrelevant to the needs of the host countries. Navaretti, Venables and Barry (2004) indicate that some MNCs from industrialized countries have introduced capital-intensive methods in countries that require labor-intensive methods owing to abundance in labor there. Furthermore, management skills and technologies brought to the host countries may have a little benefit to their economy in case they are not passed on to the employees in the local firms. Balance of payments and trade Buckley and Casson (2002) reveal that through inward FDI, host nations have been able to enjoy positive effects on their balance of payments in the short run. The inflow of foreign capital has benefited the capital account of balance of payments, with the current account improving due to a decrease in imports or an increase in exports. Foreign companies also face the need to import various parts and components from their parent companies during their early stages. Moreover, there is a possibility of large inflows emanating from the foreign countries pushing the exchange rates, which renders the exports less lucrative and increases competition. Appreciation in the exchange rates may have the effect of attracting speculative capital inflows, which may push the rate further and lead to its overshooting. In case the central bank wants to prevent the rise of the rate through selling currency to foreign money holders, there will be an increase in the supply of money, which culminates into inflation. In the end, there will be an outflow of FDI when the parent companies are paid dividends and interest payments (Jones, 2005 ). Employment Dicken (2007) highlights that inward FDI has the effect of increasing employment in the host countries. This is a direct effect of FDI as the foreign firms in these countries are able to employ workers who might not have attained any form of employment prior to the entry of the foreign firms. The increase in employment is also an indirect effect since the foreign firms fashion linkages with the local firms. In the light of this, in case the foreign firm purchases parts and components locally, employment will increase in the sectors related to the supplying of the goods. Service industries in the host countries also benefit from the foreign firms’ presence. As new workers start spending their income on goods and services that are produced locally, employment will further increase in the host countries. However, the entry of the foreign companies may displace jobs and ostracize local firms, making it difficult for the creation of new jobs, which converges to unemployment. In case the foreign firms invest in countries where there is labor shortage, then the main effect is to increase wage rates as the employees are drawn away from other companies. Since multinational corporations pay higher rates than the local companies, there will be difficulties for the local companies not capable of paying the same rates and they will be unable to attract the workers. Nevertheless, in case the foreign companies, using labor imported from home, exhaust the vacancies, employment will not be affected (John and Gillies, 1996). Labor relations The entry of multinational corporations may negatively affect the labor relations in the country. This is because in case the foreign company imports the practices of its home country on employment, there will be the odds of increased friction between the employees and the managers of the subsidiary company. Ietto-Gillies (2012 ) indicates that in Europe, US companies had initially refused to enter into negotiations with trade unions and refused to allow these trade unions to play a part in their operations. Such instances may lead to the emergence of a disruption through strikes or an industrial action by the workers. Given the ease with which a multinational corporation is able to transfer its productions operations to other countries, it is possible for the corporation to subject its workforce to unfair conditions. Workers in the host nation may be forced to undergo longer hours or receive lower wages with the foreign firm threatening to transfer its production to other countries. However, this ability is often exaggerated, as it is costly. Moreover, transferring a production to another country may conflict with the strategy the company has assumed on a global front. In imposing such a move, employment may be reduced in one location, hence the company may be forced to invest elsewhere. Competition in the market of the host country The entry of the foreign companies into a country has the effect of raising competition levels in the market of the host country. In case a single firm that is dominating the local market or a small number of firms enjoy the market power, then prices will be brought down and managers will face the task of increasing efficiency and lowering costs. In poor countries, competition from a foreign firm may lead to the closure of the local firms and a subsequent decline in the number of competitors. Foreign firms have a likelihood of enjoying economies of scope, economies of scale, and superior technology among other services. Furthermore, foreign firms may engage in price-cutting and lowering the cost of their products to a price that is below the one established in the market in order to oust the rivals (Peng, 2010). The means of entry of a foreign firm is influential in determining how competition in the host country is affected. In case the entry is through a Greenfield venture, local firms are likely to face a favorable competition as the market concentration decreases and the number of firms increases. In case the entry is through acquisition, the concentration in the market will not be reduced. In case the government of the host nation pursues anti-trust policies, the market outcomes will be affected. In case tough laws on competition exist, foreign firms will face increased difficulties when trying to gain dominance in the local market, as they will be compelled to engage in practices that are non-competitive (Piggott and Cook, 2006). Effects of FDI on the autonomy and sovereignty of the host country Dunning and Lundan (2008) indicate that foreign firms reduce the independence and sovereignty of the host nation. The dependency on foreign firms, especially in small countries, makes the government face many constraints with regard to the policies they will pursue. Moreover, the governments of these countries may adopt policies which are dictated by the foreign firms instead of the policies that are for the wellbeing of the public. In these countries, it becomes increasingly difficult to operate macroeconomic policies in case multinational corporations play a vital role in the operations of the country. Monetary policy may be rendered ineffective if foreign firms obtain funds from their home countries. Analogously, the foreign firms may circumvent the fiscal policies through the manipulation of transfer prices. This manipulation may render the policy on exchange rate ineffective, thus making it unable to influence trade flow. Furthermore, the government may decide to attract foreign investment and faster growth at the expense of economic independence (Piggott and Cook, 2006). Policy measures for host countries to maximize the net benefit from inward FDI Some of the government policies are the main determinants of foreign direct investment (FDI) spillover. One of the major examples is a host government policy towards the foreign direct investment within the country. However, there are various dimensions of characterizing a FDI policy: the degree to which the ownership of foreign investment is constrained to either specific sectors or the economy at large; the degree to which decisions in business over foreign investors are constrained; and formal and informal requirements for carrying out various activities in host countries (Blomstrom, Globerman and Kokko, 1999). One of the policies that discourage FDI in a hot country is a form that can close off channels for spillover benefits (Blomstrom, Globerman and Kokko, 1999). These are benefits mainly from foreign technologies that rely on the physical presence of foreign investors. In addition, these policies highly reduce the contestability of industries of the host countries – especially the countries with relatively higher levels of industrialization. Evidence suggests that the contestability reduction will lead to the reduction in incentives for firms that are domestically owned. This will eventually lead to the exploitation of foreign technologies that are available from other channels other than from FDI. On the contrary, equivocal implications of policies that are designed to regulate foreign investors’ behaviors are very difficult. These are policies that require MNCs in order to transfer technology easily to host countries. This is because they will enhance spillover benefits through enriching applicable technologies in host countries (Blomstrom, Globerman and Kokko, 1999). Trade policy is also used by host countries to maximize net benefits because it has an indirect potential that has greater influence on spillovers. This is because an open regime over imports encourages capture of foreign technologies in various ways. First, it helps facilitate the importation of technologies that are embodied in intermediary inputs and capital goods in host countries (Blomstrom, Globerman and Kokko, 1999). In addition, it helps stimulate an increase of competition among domestic industries. This assists in encouraging foreign industries to transfer technologies to their host countries affiliates at a higher rate. On the other hand, this will help domestic owned firms to capitalize on foreign technologies that are available and appropriate (Blomstrom, Globerman and Kokko, 1999). Therefore, this policy offers a potential form of ambiguity that encourages host countries to engage in spillovers. However, host economies will discourage FDI spillovers in the long run due to the low economic growth and less accumulation of technical proficiency of human capital in host countries. Technology policy is also essential in maximizing net benefit of host countries because it has the potential of impact on FDI spillover benefits. In addition, this policy helps encourage economic performance in host countries by enhancing capabilities of technologies in local firms. Through this policy and through the appropriate use of other factors of the economy, firms constantly increase their capabilities to exploit foreign technologies in host countries (Blomstrom, Globerman and Kokko, 1999). Another higher potential aspect of technology policies is protection of intellectual properties. This is because various technology industries in host countries believe that secure property rights are very important conditions of a valuable technologies inflow. This is because characters in the system of a country under intellectual regime of properties have significant impact on the flow of FDI. In addition, such a policy also raises the quantity and quality of technologies supplied by foreign affiliates. Conclusion In summary, the inflow of FDI has numerous effects on host countries. These effects are both negative and positive, with the main effect being the overall growth of the economy of a country. Through the transfer of resources such as technology, capital and management, a country will definitely attain higher levels of economic growth. Foreign firms can also have a negative impact on the host country as they can limit the sovereignty of a particular host nation. In addition, the existence of spillovers efficiency benefits calls for the reactions of government policies which seem to be clear manifestations of externalities. This, in particular, requires aggressive actions of the government in order to encourage foreign direct investments. The most effective method is the application of cost-effective knowledge to capture a spillover of FDI. Reference List Buckley, P. J., & Casson, M. 2002, The Future of the Multinational Enterprise: 25th Anniversary Edition, Palgrave Macmillan, Basingstoke. Blomstrom, Magnus, Steven Globerman and Ari Kokko. "The determinants of host country spillovers from foreign direct investment: review and synthesis of the literature." September 1999. 27 July 2012 . Dicken, P. 2007, Global Shift: Mapping the Changing Contours of the World Economy, SAGE Publications Ltd, London. Dunning, J. H., & Lundan, S. M. 2008, Multinational Enterprises and the Global Economy, Edward Elgar Publishing, Cheltenham. Grimwade, N. 2000, International Trade: New Patterns of Trade, Production & Investment, Routledge, London. Ietto-Gillies, G. 2012, Transnational Corporations and International Production: Concepts, Theories and Effects, Edward Elgar Publishing, Cheltenham. John, R., & Gillies, G. L. 1996, Global Business Strategy, Cengage Learning EMEA, Chelmsford. Jones, G. 2005, Multinationals And Global Capitalism: From The Nineteenth To The Twenty-first Century, Oxford University Press, Oxford. Navaretti, G. B., Venables, A., & Barry, F. 2004, Multinational Firms In The World Economy, Princeton University Press, Princeton. Peng, M. W. 2010, Global Business, Cengage Learning, Mason. Piggott, J., & Cook, M. 2006, International Business Economics: A European Perspective, Palgrave Macmillan, Basingstoke. Read More