Foreign Direct Investment for Developing Countries - Essay Example

Foreign Direct Investment in Developing Countries Introduction Foreign direct investment helps in the open andalso effective international economic system. FDI is one of the leading catalysts to development and growth of worlds economy. One of the most chronic problems among the developing countries is the fact that they do not have enough or adequate finance to make investments in their countries. This has led to most developing countries and to a large extends developing economies and those still in transition to divert they attention to FDI as the main source of economic development. Chaudhuri and Mukhopadhyay (2014, p. 10) say that FDI is one of the key options for economic growth of developing countries. However, it is not all developing countries that are open to FDIs. The FDI helps these economies in terms of foreign capital in form of direct and also some cases indirect investment. Most of developing countries initially depended on loans from international financial institutions and banks but this started changing in the 80s when international banks started experiencing financial constraints. This forced most developing countries to shift the approach and change their investment policies in such a way that will be attractive to stable forms of foreign capital. The advantage of FDI is that developing countries easily get foreign capital without high risks that can be tagged to the debt. According Marchick and Slaughter (2008, p.2) governments have been reviewing their economic policies as an effort to attract MNCs through FDIs into their countries. It is important to note that FDI is directly affected by multinational companies (MNCs) who are the main participants. With that consideration, then we can easily conclude that factors that affect MNCs also affect FDIs. The capital flow from MNCs is directly injected to FDIs. Most of the times, the MNCs tend to expand their activates to foreign companies for several reasons which include; exploitation and utilization of economies of scales, utilization of particular advantages and at times very unprecedented reasons like just because their main competitors are actively involved related practices. Equally, governments are in competition to attract more FDIs in their nations. They do this by changing and at times compromising some of the key factors in their economic policies. Examples of such factors include corporate taxes, domestic labour market conditions among others. With all these activities surrounding FDI, MNCs have to be very analytical before making investments in such countries. There are determinants which are considered to priority to them. These determinants together form part of the benefits and risks. The determinants range from political, economic to social. Depending on the economic operations of the MNC, they have to analyse the potential market and put all necessary measures. Determinants of FDIs in developing countries Market Size Leonard (2005, p. 669) agrees that market size is a key factor for FDIs especially when other factors like political risks are weak. The market size of a country can easily be related to the size of the economy which translates to the country’s GDP or GDP per capita. This is particularly the main determent for horizontal determinants. For vertical FDIs this might be irrelevant. FDI is likely to go to countries that have with larger and quickly expanding markets. They also consider the purchasing power of the country. FDI go to countries that posses the potential to make higher returns and profits for the investments they make. Econometric studies have been done to compare a series of countries between their market size and FDI. It was found that the size of the GDP directly affects the market size. Infrastructure development Infrastructure can be categorised in a wide range of dimensions from ports, railways, roads, institutional development and even telecommunication systems in place. Any location that has a well developed infrastructure tends to have a productive investment. This in returns stimulates the FDI flows. Anytime the FDIs are measuring infrastructure they take into account two aspects of infrastructure. One, they consider availability as well as reliability of the infrastructure. Infrastructure is of no use if it is unreliable. Important to note is the fact that poor infrastructure can be seen as both an obstacle and an opportunity to FDI. To most developing countries, poor infrastructure is a major challenge. On the other hand, investors and MNCs encourage governments of developing countries to allow and permit FDI to be more involved in the infrastructure sector as a way of boosting their infrastructure. According to UNCTAD (2005, p45) Kenya was one of the most attractive developing countries in the 70s but due to deterioration in the infrastructure, and economic policies, there was decrease in investors. Openness of the economy The ratio between a countries trade that is the sum of imports and exports to the country’s GDP is mostly used to measure and determine the openness of a countries economy. FDI is affected by the openness of an economy but this largely depends on the investment. If an investment from FDI is more relied on seeking new markets for its products and services, trade restrictions will definitely work for the FDI positively. However, for other investments that are based on exports of services and goods from the host country may prefer economies that are more open. This is because increased imperfections that come along with trade protection tend to translate to high transaction costs related to exporting. According to Jiang (2013, p.65) says that a countrys openness can affect FDI in multiple ways. When a country has lower import barriers, stimulate vertical FDI while lower export barriers will stimulate vertical FDIs. An example of is given by Collins (2013, p.33) who says that the openness in the Brazil market has made it the leading FDI investment in the Latin America. The country is more open to FDI than even the cross-border trade in service. Cost of labour and productivity Sahoo, Nataraj and Dash (2013, p.170) illustrate how cheap labour and productivity attracts FDI inflows. The MNCs seek cheap labour and at the same time skilled labour. These two aspects combined will lead to productivity. Anderson Consulting, Indian Institute of Technology, Indian Institute of Management and Lucknow (2003, p. 75) explain that in India, the labor cost is very low but the productivity level is equally low. This partially neutralizes the advantage of cheap labor. Most FDIs have opted to look for other options that will give them cheap labor as well as productivity. Low cost of labour would definitely attract FDI. However, there is no particular system than can be used to determine the cost of labour. There are those that argue that an analysis of the wage would help come up with the cost of labour. It is quite obvious that cheap labour is very importance and hence will attract multinationals. The role of the wage to determine the cost of labour however has not clearly seen to affect the FDI. But FDI that are likely to involve industries with labour-intensive and export-oriented investments have been found to out much attention and consideration to this factor. In circumstances when the cost of labour is almost insignificant the aspect of skills of the available labour force come into consideration and this has an impact on FDIs. Growth There has been controversy on which economy is best to invest in. The contentious issues have been that rapid growing economies have little opportunities for profits and investments unlike economies that are growing slowly or completely not growing. The positive impact of a growing economy of FDI is that the growth ensures that the environment is relatively conducive for business. Factors like infrastructure and policies tend to have been streamlined. The problem with slow or dormant economies is that there is a chance that the investment may lack market or may not be viable in the host country. According to Chaudhuri and Mukhopadhyay (2014, p. 14) one of the most important factors for FDIs seeking new markets, is the growth within the targeted market. FDIs want to go to economies that are experiencing growth. These apply to both developed and developing economies. On countries with bigger market size, faster economic growth has an opportunity to provide better competitive environment. Taxes Every country has developed and set its own corporate tax incentives. The corporate taxes mostly tend to impact on FDI flows. According to Knauer (2008, p.6) high corporate taxes can easily discourage potential investors from coming to a country. The taxes will affect the FDIs depending on whether the investment is to operate within the host country or the investment will focus on exportation. There different rates imposed on importation, exportation and generally the other taxes like the VAT on basic inputs that may be used. Benefits International trade integration and investment One of the main trade-related benefits from FDI in developing countries is found in the long-term contribution to incorporating the host economy more closely and actively to the world economy in ways that would include higher imports and also exports. During this process, there are factors that are in play. These factors include development and strengthening of global network that are connected to such enterprises. Technological transfer Balasubramanyam and Wei (2004, p. 26) argue that technological transfers through FDIs is still arguable as all the recent studies have only been case-studies. However, FDI not only invest in business and commercial activities, but to facilitate their activities, the FDI invests allot in technology. Most of developing countries have made little development in terms of technology. FDIs transfer technology to developing countries with diffusion with work. The extent to which these technological transfers reach is variable depending on sector of investment and the particular context. Most MNCs take facilitate the training and technical assistance and other information. Human capital enhancement The presence of FDIs in a developing ensures that the people in the country get opportunities to work and therefore improve their living standards. In addition, when individuals get jobs from MNCs subsidiaries their human capita is increased and improved through the training and on-the-job experience they acquire. According to Varuna (2010, p. 241) argues that human capital is not developed by FDI but rather, human development attracts FDI and inflows from FDI enhances human capital. The MNCs subsidiaries also may improve the human capital through operations and transactions with other enterprises like the suppliers. Generally, the enhancement in human capital is much related to other entrepreneur participant and conditions. Competitive business environment The presence of FDIs and MNCs creates a suitable for competition in the market which in return is a benefit to the citizen as these competitions provides better services and products at favourable prices. The presence of international enterprises creates domestic competition which effectively creates or builds productivity and also a more effective and efficient resource allocation. Enterprise development The presence of FDIs directly impacts development of enterprises within the developing country. Existing enterprises make effort to improve efficiency and as well lower the costs and this in return leads to new activities. When FDI invest in companies that existed before, they tend to bring changes in management as we as governance. FDIs come with new policies, operational systems among others. All these are aimed at improving the services and productivity of the enterprises. Risks Harmful environmental Impacts FDIs bring MNCs that may be involved in industries dealing with extraction and this may cause environmental pollution and degradation. With developing countries that have not been able to implement proper policies, the environmental pollution and degradation is a very like possibility. Nonetheless, this has not been always the case especially considering the fact that FDIs tend to bring in technology that is favourable to the environment unlike what might be in place in the developing countries. Over-dependence on FDIs and MNCs According to Bradford and Cheru (2005, p.58) there is too much overdependence of developing countries of FDIs and this puts their economies in danger. Countries that have failed to develop their own economy in the name of attracting foreighn investors are at a risk of economic crisis. FDIs cannot be the ultimate solution for development problems in developing countries. The governments of developing countries are likely to put so much attention to FDI and ignore or neglect making investments for their own nations out of the many benefits that come from FDIs. Countries that are incapable of raising funds for making investments locally are unlikely to be the beneficiaries of FDIs. As the FDIs make investments in developing countries, the governments of host-countries have a key role to play to ensure that the country benefits from the investment by transferring the funds from the investments to other areas like education, infrastructure, improve the business and health sector. Social disruption In some cases, the presence foreign investors and corporate can cause deterioration of basic social values of the people of the host countries. Such values as labour standards can be seen to degrade the value imposed on individual’s ability. Low labour standards not only affect the people in the host countries but also the investors who raise their concerns regarding their reputation and image in other parts of the world. The rest of the world is likely to view the investing company as taking advantage over low cost labour to manipulate people. According Dunning and Lundan (2008, p. 295) to the presence of FDIs in a country has other effects to a country. One of them is social disruption. Despite the many economic benefits that come along with FDIs, the social systems are also at a risk of being eroded. One factor behind this is the rapid commercialization. This commercialization brings about compromise of social values. The fact that FDIs goes to areas of low cost of labour, the other implication of this is seen where the people providing this cheap labour see themselves as worthless. Competition for the national market The coming of foreign investors is most of the times seen as a threat to the domestic investors. As an effort to much up with the foreign investors, the situation is easily transformed into a competition for the national market. Many may consider this as an advantage but this also helps the domestic investors improve their services and improve in the investments they have made. Conclusion The FDIs play a crucial role in growing small economies particularly those of developing countries. The decision for MNCs on whether to invest or not to invest in a country largely depends on factors that may not necessarily be economic in nature but also social and political factors which are referred to as determinants. Determinants vary from country to country depending on how much the government of host country wants to attract the FDIs. In general, MNCs will be attracted to areas that prove to bring them more benefits in the shortest time possible. The decision to go a developing country comes with benefits as well as risks that accompany the benefits. For that reason, the MNCs need to carry out an analytical review of potential areas to ensure that the benefits outdo the risks. Working closely with governments of developing countries can be very helpful to MNCs. This is important because ones the interests of the two parties are known; they can both work closely to ensure that their mutual benefits and interest are protected. In conclusion, both FDIs and the developing countries need each other. The idea of economic globalization has a central role within FDIs as MNCs expanding their markets globally and venturing into new waters. All these aspects facilitate the growth of global economy and more so the economies that are developing or in transition. The governments of developing courtiers have a key role to play in encouraging FDIs. The countries should work on improving and amending their economic policies as well as their foreign policies which play crucial role. Foreign policies and economies do not only protect the developing countries also ensure security of investments made by MNCs. Reference list: Chaudhuri, S., & Mukhopadhyay, U. (2014). Foreign direct investment in developing countries: A theoretical evaluation Thomas M. Leonard, T. (2005). Encyclopaedia of Developing World Psychology Press: New York Marchick, D. M., & Slaughter, M. J. (2008). Global FDI policy: correcting a protectionist drift New York, Council on Foreign Relations. UNCTAD (2005). World investment report 2005, 2005 New York, UN Jiang, Y. (2014). Openness, Economic Growth and Regional Disparities the Case of China Berlin, Heidelberg, Imprint: Springer. Collins, D. (2013). BRIC States Outward Foreign Investment Oxford, OUP Oxford Sahoo, P., Nataraj, G., & Dash, R. K. (2013). foreign direct investment in South Asia: policy, Impact, determinants and challenges Anderson Consulting, Indian Institute Of Management, Lucknow, & Indian Institute Of Technology (Chennai, India) (2003). Indias manufacturing sector: policy framework New Delhi, Academic Foundation Knauer, A. (2008). Impact of international taxation on FDI location choice München, GRIN Verlag GmbH Balasubramanyam, V., & Wei, Y. A. (2004). Foreign direct investment: six country case studies Cheltenham, Elgar. Godara, V. (2010). Pervasive computing for business: trends and applications. Hershey, PA, Information Science Reference Chaudhuri, S., & Mukhopadhyay, U. (2014). Foreign direct investment in developing countries: A theoretical evaluation Read More