Managing Foreign Direct Investment in a Globalizing Economy - Essay Example

Running head: MULTINATIONAL CORPORATION UNDERTAKING FDI Why A Multinational Corporation undertakes FDI By ______________________ Introduction The motivations for FDI are those factors due to which a Multinational Corporation (MNC) is spurred to get involved. According to Barrell, (1997) "FDI has expanded rapidly throughout the world economy over the past two decades, helped by the removal of many national barriers to capital movements". (Barrell, 1997) But with the expansion in the economy, on one hand FDI has remained successful in providing full-fledged investment support to the East Asian countries, while on the other hand FDI has created a vacuum for the European states particularly in the area of labour. In this essay, we would be examining the following details along with the reason for why FDI occurs usually in MNCs: 1. Why investment decisions are made 2. FDI vitality with respect to theories in competitive markets. 3. The reason for the success of FDI in Asian countries and threat to Western nations. 4. What are the consequences of new policies in FDI 5. Which countries have benefited from FDI policies In reality, many international investors are seemingly small and weak. For instance, multinational firms originating from developing countries have become a visible force in the world of FDI (Wells, 1983) Small and medium-sized firms also play significant roles in outward investment (Buckley et al, 1988), which have benefited many countries, thereby ending up in predicting future threats. Theories on the Motivation for FDI "FDI is a cross-border production activity that takes place for a number of reasons. Investment decisions are affected by market size and cost differentials, with firms investing in locations with relatively low production costs". (Barrell, 1997) After grappling with the question of why MNCs engages in International production, four theories are identified that attempts to explain four motivations for FDI, named Monopolistic Advantage Theory, Oligopolistic Reaction Theory, Internationalisation Theory and the Eclectic Paradigm. Monopolistic Advantage Theory Hymer suggests that FDI occurs in imperfectly competitive markets and adopted an industrial organisation approach to explain the process of international production. Kindleberger details the nature of the monopolistic advantages that the foreign investor may possess over its domestic competitors. Thus, he indicates that these advantages may arise in the goods market to achieve vertical or horizontal integration. Kindleberger also states that monopolistic advantages may arise through the actions of government in the host country. In restricting imports, the government may inadvertently stimulate FDI. However, Caves argues that the vertically extended foreign investor does not rely on the possession of these unique assets. Its motivations for international production are to avoid oligopolistic uncertainty concerning the long-term supply and pricing of its inputs as well as to erect barriers to entry against new rivals. Hood and Young (1979) postulate that the monopolistic advantage theory fully explains the FDI made by US multinational enterprises during the post-World War II period. However, they question whether the MNC needs to possess any advantage when investing in developing countries, since it is confronted with little domestic competition. They cite the example of Japanese ventures in developing countries that are faced with few, if any, effective local competitors. (Hood and Young, 1979) Oligopolistic Reaction Theory Knickerbocker argues that a rival firm's moves into a foreign market not only could threaten the corporate earnings of the other oligopolists, but also could result in it acquiring competitive assets far in excess of those it already possesses. Thus, he posits, the defensive investment undertaken by the other oligopolists serves to maintain the balance of competition within the industry. (Barclay, 2000, p. 23) Knickerbocker postulates that it is the firms that are 'product pioneers', that is, those that develop, mass produce and mass market a product uniquely suited to the US market, which are most likely to engage in this practice. He found that firms in highly concentrated industries producing heterogeneous products such as electrical and transport equipment, and food were the ones most likely to be engaged in this parallel investment. Knickerbocker also noted that this investment prevails in vertically integrated industries such as primary metals, paper and petroleum. In the latter industries, the oligopolists checked their rivals' attempts to secure access to low-cost, reliable, raw material supplies. (Barclay, 2000, p. 23) Knickerbocker's oligopolistic reaction theory holds considerable intuitive appeal as an explanation of the motivations for FDI in the primary sector as well as some segments of the manufacturing sector of developing countries. (Barclay, 2000, p. 23) Low cost labour in this context is the best example, followed by East Asian countries like China. According to Business Asia, (Dec 2002)"Manufacturing is the industry most at threat, as South-East Asia's plants are being easily undercut by China's cheap labour and low operating costs". (Business Asia, 2002) One of the main attractions for opting FDI is to avail those sources that are not available in home countries like, cheap labour, natural resources etc. East Asian countries, particularly China is rich in surplus and cheap labour whereas labour deficiency is one of the foremost characteristics of European countries. The Internationalisation Theory The proponents of the internalisation theory posit that a firm will internalise the production of intermediate goods and services whenever their markets fail. Market failures may arise because of the absence of a futures market, the firm's inability to exercise discriminatory pricing, and information impact. Internalisation may also occur because of locational factors. It is likely to predominate when governments intervene in international markets through the imposition of value-added taxes or restrict capital movements. Differences in the income and profit taxes between countries would also facilitate the internalisation of markets (Buckley and Casson 1976). Thus, the firm will bring under its common governance and control those activities that were formerly linked by the market. The MNC is created when markets are internalised internationally. Once the MNC is established abroad, it will use its internal organisation to prevent the loss of its firm-specific advantage by maintaining control over the production and sale of final products, which incorporate this firm-specific advantage (Rugman, 1980) The Eclectic Paradigm Dunning argues that a firm, which possesses superior ownership-specific advantages over its foreign competitors and decides to internalise them, is confronted with the decision of whether to create or use these ownership-specific advantages in a foreign location. The firm's choice of locating its foreign operations is influenced by the locational advantages of a country. Dunning notes that locational advantages are not limited to the natural resource endowments of a region. They include the cultural, legal, political and institutional environment in which a firm operates. In addition, he identifies the market structure and government's legislation and policies as being locational advantages. (Barclay, 2000, p. 27) Dunning argues that the more it is in the firm's interest to use these advantages in a foreign location, the greater is the possibility of its becoming engaged in FDI. (Barclay, 2000, p. 27) One of the reasons to undertake FDI is the fact that most of the MNCs do not want to share their revenues with a local firm. Besides MNCs also wants to be the first in gaining profitability, so all they are concern is about how firms organize their production efficiently given lower costs of production abroad. (GESY, Feb 2006a) Reasons For and Against FDI The main advantage of FDI is seen in countries where there is an opportunity of penetrating into markets with an objective of increasing sales volume. These are strategic sales moves with cost effective budgets, thereby effecting economic integration. Example is that of non-European investor who tries to get access to a large market without internal barriers. External barriers include market size, political instability and in some cases advertising intensity. There are three points that goes against FDI, the foremost is the sunk cost, an expenditure that cannot be recovered if the action is reversed later. In this case the MNC has no other option than to pack up and leave. The second disadvantage is the economic environment, which is always uncertain. For example a MNC when invests in an IT Taiwanese firm, confronts to unexpected sudden loss because Taiwan itself has reshaped its SME (small medium enterprises) at the time MNC has invested in Taiwan. Therefore time factor is very crucial in FDI, as investment opportunity disappears if it is not taken immediately. Similarly it is due to this 'time' factor that countries are bound to wait, and delay takes place, for example MNCs in Taiwan, manage to satisfy clients as requested; but in China, their hands are tied because it takes some time to import raw materials. In light of the cheap land and labour cost in China, there is always a threat to FDI as China is serious about production by itself. (Chen, 2000, p. 112) With the growing trend of shifting Foreign Direct Investment (FDI) from local to multinational firms, the sector, which has benefited the most from FDI, is East Asia, which has remained most beneficial in utilizing the benefits of FDI. In this context Multinational Corporations (MNCs) have benefited East Asian economy while transforming the area of production and exports in the developing East Asian countries. (Lipsey, 2006a) Since 1979, China has been the major target for MNCs to implement new policies regarding FDI. It is due to this reason that China approved a total number of 364,000 foreign investment projects with a cumulative foreign capital investment of US$ 676.4 billion, of which US$ 348.4 billion was effectively invested. It is considered that cheap labour has a leading role in making China consequently the largest developing host economy in the world. However, the strategies of MNCs limiting the size and pattern of Chinese inward FDI have also played an important role in the development of China's economy. FDI in this context is responsible to boost up China's economy, thereby effecting the rest of the world particularly Europe. China's surplus labours where on one hand has created tremendous employment opportunities for individuals on the other hand it remains a threat to the rest of the global world. (Bulcke, 2003, p. 35) MNCs evolved in China with the aim of establishment of outsourcing bases with investment operations in China. Ofcourse, MNCs were aware that this type of investment commonly involved the relocation typically carried out in stages of labour intensive production processes, such as textile manufacturing and electronics products assembly, in order to benefit from lower production costs in China. For strategic reasons, a number of Western MNCs had also set up an early presence in China. These Western pioneers in China came to China not to take advantage of the location-bound resources, as was the case for most Asian investors, but for 'testing the water', that is, learning about how to operate in the Chinese market and preparing for a long-term involvement. (Bulcke, 2003, p. 34) Chinese Government took the utmost advantage of those FDI implemented by MNCs and extended the tax and tariff incentives for foreign companies to fourteen coastal cities, including former colonial metropoles such as Tianjin, Shanghai, Dalian and Guangzhou. The opening up of these coastal cities provided market-seeking MNCs with new opportunities and more extensive markets. They acquired access to a relatively well-developed industrial infrastructure, a larger geographic and densely populated area, a better-educated and trained labour force, more reliable transportation and communication systems and improved living conditions. Also, a number of Western MNEs were to some extent already familiar with these cities, as they had established trading and even production activities there during the colonial period. These specific location factors allowed foreign MNEs, to engage into more human-capital-intensive and local market-oriented activities. The principal motivation for these investments by Western firms during this period was mainly of a 'trade-barrier-circumventing' nature. Local production in China was intended to substitute for the export of goods from the home bases of these firms. (Barclay, 2000, p. 26) Ofcourse FDI sought its market, such as the strategies of MNCs, changing endowments of China's location factors and the FDI policy of the Chinese government. While examining the expansion and trends of Chinese inward FDI against the background of the main changes of the Chinese investment environment and the ensuing reaction of foreign-owned companies, it is realised that MNCs have evolved in FDI taking in consideration the country of origin, sector distribution, investment form and location of China's inward FDI as well as its changing characteristics. (Bulcke, 2003, p. 34) Whereas Hong Kong and Taiwanese companies of which many are involved in small-scale processing activities such as textiles initially dominated FDI in China, the world leading MNCs have been moving into China in a more extensive way. Apart from the trend towards larger projects, foreign investment has also become more spread out in a geographical sense with the inland provinces gradually taking up a larger percentage in the newly approved investment projects. (Drysdale & Song, 2002, p. 56) Although the Chinese government liberalised FDI for the purpose of import substitution, export promotion and technological upgrading, its FDI policy did not use any incentive nor any regulatory measures to influence the sectoral orientation of foreign enterprises in the early years of the 1980s. As a result of the general uncertainty about the investment environment and the lack of sectoral requirements in particular at that time, FDI was highly concentrated in certain specific service sectors hotels, restaurants, taxis, etc. and mainly took the form of short-term and flexible co-operation agreements such as contractual joint ventures (CJVs) or subcontracting arrangements. (Bulcke, 2003, p. 43) All these measures combined with the progress made in the implementation of market mechanisms in the Chinese economic system constitute the driving force of the 'guided scenario' of Chinese inward FDI during the last two decades of the twentieth century and have significantly affected the patterns and extent of FDI in China. The efficiency-seeking investment by EU MNCs in China is strongly related to the market expansion and product diversification and the learning experiences from producing in a new business environment. On one hand the efficiency-seeking FDI is often intended to take advantage of differences in the availability and costs of traditional factor endowments in different countries, on the other hand the pattern of changed investment within "Europe has made UK a major destination for inward investment, especially when compared to Germany. However in recent years France has received more inward investment than the UK, perhaps reflecting greater certainty about their commitment to European integration, as well as the impact of greater product market liberalisation. The pattern of inward investment in Sweden also suggests that recent moves there to liberalise domestic markets and deepen integration with the European Union (EU) have had a notable impact on inward investment". (Barrell, 1997) As such, it is much more linked with the resource-intensive activities and the existence of specialised. According to Business Asia, (Dec 2002) "Southeast Asian governments have long recognised the possible threat that China poses, and have made some positive steps towards countering that danger with full implementation planned by 2011. But it is not only Asia's developing members that need to address the China challenge. Japan is increasingly finding that its clout and relevance in the region is waning, superseded by a vibrant and fast growing China". (Business Asia, 2002) References Alexander Peter & Chan Anita, (2004) Does China Have an Apartheid Pass System In Journal of Ethnic and Migration Studies. Volume: 30. Issue: 4.p: 609 Barclay A. Anne Lou, (2000) Foreign Direct Investment in Emerging Economies: Corporate Strategy and Investment Behaviour in the Caribbean: Routledge: London. Barrell Ray & Pain Nigel, (1997) The Growth of Foreign Direct Investment in Europe In National Institute Economic Review. Issue: 160. p: 63 Buckley, P. and Casson, M. 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