Should Countries Promote or Restrict Foreign Direct Investments - Assignment Example

Should countries promote or restrict Foreign Direct Investment? FDI aimed to exploitation of natural resources, manufacturing and services. Globalisation is the defined as “closer integration of the countries and peoples of the world which has been brought about by the enormous reduction of costs of transportation and communication, and the breaking down of artificial barriers to the flows of goods, services, capital, knowledge and (to a lesser extent) people across borders”. (Dr. Vazquez D., 2009A) Globalisation has dissolved national borders and turned the world into a global village. A relevant effect of globalisation is the presence of an organisation in number of countries in addition to its birthplace. This has changed the scenario of global business significantly. Multinational enterprises have come into existence which have their operations and existence located in more than one country. These are organisations that have control over assets, factories, mines, sales offices in two or more countries. (Dr. Vazquez D., 2009E) Flow of capital from one nation to another may occur in two different ways: the direct route or the Foreign Direct Investment and the indirect route or the Foreign Portfolio Investment. A definition by the Bureau of Economic Analysis states foreign direct investment as “an investment in which a resident of one country obtains a lasting interest in, and a degree of influence over the management of, a business enterprise in another country”. (Assessing Trends and Policies of Foreign Direct Investment in the United States, July 2008) The reasons behind FDI are many and depend upon a range of factors that guide the business model of the investing company. The widely accepted theory to analyze the investment motives have been provided by John H Dunning. Popularly named as the Eclectic theory, it is a combination of three sets of advantages that must be present for a company to invest abroad. First is an ownership-specific advantage (O), which states the advantages the company would gain over similar firm or countries in the market. Second is a location specific advantage (L) that determines the region where the firm invests. Finally, the internalization advantages (I) explains the need and benefits to invest against the option of obtaining the same through trade relations. Considered together, these factors define the OLI framework on which eclectic model is based. (Chorell H. and Nilson E., 2005) According to data published by US department of commerce, investments by US firms abroad in 2007 figured at $333 billion. Counter wise, the volume of foreign investment in US real estate and business amounted to $237 billion in 2007. The importance of FDI can be gauged by the fact that the Organization for Economic Cooperation and Development (OECD) has taken measures to ensure steady flow of investment through special agencies. (Jackson J.K., August 2008) The concept of foreign direct investment is one of the most complex and intricate topics of modern economics. The complex structure of flow of investment between transnational corporations (TNC) can be classified into two categories; outward investment by domestic firms and inward investment by foreign firms. In certain cases, however, the government of a country might take a totally opposing stand as far as allowing of FDI is concerned. It is generally believed that an economy with the exposure to inward investment will enjoy a better growth than countries that stay away from investment. The discussion becomes interesting if the data for 30 years in World Bank Economic Outlook 2007 is considered. According to this report, the growth in economies as a result of globalization has been positive, but has been unfortunately accompanied by a widening gap between the rich and poor nations. Since 1990, inequalities have widened 6 times between countries and about eight times within a country. (Dr. Vazquez D., 2009A) This fact bears testimonial to the allegation that globalization has aggravated inequalities in global distribution of income and wealth. The previous discussion gives rise to a very critical concern as to whether countries should go for promoting FDI or not. The answer to this cannot be given in a linear fashion considering the multidimensional aspects that encompasses foreign investment. The role of state becomes important at this juncture. In a free market economy the benefits of investment does not reach all the strata of the population uniformly. More often the very capitalist nature of FDI imbibes a profit motive in the direction of its movement. It is in this situation that the State assumes an increasingly important role. Globalization gave rise to the myth of fading states where the unification of countries were thought to make a boundary less world with the state having no role to play. Peter Dicken in his book ‘Global Shift: Reshaping The Global Economic Map In 21st Century’, argues in favour of the role of the state in present economic scenario. The regulatory framework of the state in controlling foreign investment can be classified into four categories. First, the government can “screen out” those investments which are not directed towards meeting of national economic and political aspirations. FDI may be actively discouraged in certain sectors that are of importance to the sovereignty of the host nation. The government is also instrumental in controlling the degree of openness of a particular sector towards foreign capital depending on its sensitivity. Second, foreign firms pose threat of competition to domestic firms who might be operating on lower technologies. The government may encourage or discourage FDI depending on whether the investment will add to the competitiveness of the local companies. The state, in its own power, is in a position to design policy that will monitor spillover of technology. This is particularly important since there is a considerable debate on the fact that transnational economies do not transfer significant technology outside their own country. It is of particular importance that taxation policies are so designed that the host economy benefits from the corporate tax yield of the foreign firm. The TNCs are also keen in remitting their profit abroad. In a nutshell, state governments must ensure that there remains a proper balance in the flow of outward capital in form of tax and profit, which would have otherwise benefited the host country. (Dicken P., 2003) This analysis serves as a guiding force in deciding the fate of FDI. Capital being the engine of growth, FDI is desirable in those sectors of a nation which are pivotal to its development. On the other end of the spectrum, State must actively restrict FDI in not-so-strategic sectors, which does not strengthen the economy or pose a threat to the ecological/economic balance of the host. The period post second world war has experienced cyclical variations in global economic activities. The period from early 1950 to 1970 experienced an impressive growth, immediately led by a deep recession which lasted till 1980. This was followed by recovery through the 1980s and culminated in volatile growths of the 1990s, with some interrupting global crisis in between. The change in the growth patterns can be attributed to structural changes in which the world became multi-polar, with center of productions emerging in the peripheral regions. The transnational corporations have been significantly important in shaping the dimensions of the globe, considering that they have extraordinary powers as far as taking advantages of distribution of factors of production is concerned and their ability to switch resources as and when needed. An important factor shaping the global change would be the speed at which technological innovations took place that has influenced virtually all aspects of human life. The real effects of globalization can be felt at the local level of an economy. The local level is the point where effects of foreign investment are visible through their impact on various activities of householders. In recent times, the high technology goods have borne a key contribution in global growth. In Latin America in particular, this has become a major driver of growth. The growth in these hi tech industries was brought about by opening up of economies to free trade and foreign investment in face of not so successful government initiatives during 1970 and 80s. Outsourcing leads to movement of certain parts of the business to places where less-costly and skilled work force is readily available. It may so happen that the benefits of investment in one country might spill-over to the residents of another country. A classic case of this will be the way in which increased investments in European and US firms have changed the job scenario in countries like India and China. This change in job scenario has contributed in a significant manner to the way these Asian economies have grown. (Hill D., August 2002) The manufacturing sector is supposed to have direct benefits of foreign direct investment through increased flow of capital and import of technology through spillover effects. However, recent research in this area has shown that there is very little considerable spillover effect in the host country. Even the gains from this effect differ across primary, secondary and tertiary sectors. The weak linkages in primary and mining sectors often lead to what is known as ‘enclave development’. Secondly, rate of spillover is dependent on absorptive capacity of the domestic firms. Positive spillover is experienced by those firms having a high degree of absorptive capacity, whereas those domestic firms with low levels of initial productivity will experience negative spillover. In order to ensure Technological spillover, it must be guaranteed that the support staff of engineers and managers be hired from foreign firms. A young workforce is another requirement who would be instrumental in the process of spillover through their interactions and eagerness to learn. As such, flow of FDI in economies with low absorptive capacity might now benefit the local economy. Additionally, these manufacturing facilities may have a detrimental effect on the local ecology and the natural resource base of the country. (Hale G. and Long C., April 2006) Hence, in these cases, FDI should be discouraged. Foreign Direct Investment is also accused of creating negative impact of wages in the manufacturing sector. This might be aggravated in for female laborers. One possible argument for this phenomenon arises from the increase in supply of workforce due to opening up of boundaries. This abundance in supply will led to movement of FDI to regions where they get favorable bargain. So, FDI should be discouraged in regions where there is negative impact on the bargaining power of the labour class. (Vijaya R.M. and Kaltani L., 2007) It is estimated that the emerging economies like China will require huge supply of oil to cater the energy requirements of its growing population. In order to reduce its dependency on imports and small amounts of backup reserve, China has been investing in the energy resources of around twenty five countries. This has ranged from exploration and production activities to building of refineries and infrastructure. A major part of the investment of China has been in Sudan. In spite of having the privilege of rich resources, Sudan was unable to tap them due to lack of capital. Chinese investment was instrumental in building Port Bashir, a two million tonne terminal. Today Sudan is being considered as a major oil producing economy. Similar investments have also been done in Kazakhstan and Canadian sands. (Chorell H. and Nilson E., 2005) The major allegation against foreign direct investment is that it has fuelled erratic and sporadic growth. It has also been alleged that countries with poorer natural resources have a higher rate of growth than their richer counterparts. This phenomenon has been termed as ‘curse of natural resources’ in economic literature. The reason for this is organizations that invest in natural resources industries are often biased towards maximizing their own objectives. In fact, research shows that FDI has considerable negative effects as far the exploitation of natural resources is considered. Beneficial effects of the same can be gained if there are certain regulatory frame works that control the flow of the FDI. The proponents of FDI are countered in their opinion by nature conservationists. They are justified in their point that the six folded increase in FDI globally in the last decade has also been simultaneously accompanied by equivalent amount of environmental destruction and degradation. Economists are also concerned that the exploration activities might lead to degradation of the health of the inhabitants in and around the area of exploration. Economically poor countries often harm themselves by going for indiscriminate attraction of investments, the severe form of which comes through offering of financial incentives that have negative implications in the long run. FDI in natural resources is also due to taking advantage of countries with poor and less strict environmental standards. Lack of strict regulations makes these countries an attractive location for polluting industries. Clear examples of this can be seen in tanning industry of Brazil and phosphate manufacturers of North Africa. These are the countries which have been labeled as ‘Pollution Havens’. Hence FDI should be severely restricted if it tends to ‘use’ up the resource base in a country to generate benefit in some foreign country. (McNally R., February 2000) The healthcare services sector is a very sensitive sector as far as direct investment is considered. The idea of commercialization of healthcare services is of critical concern to the policy makers. Being a basic service, extent of investment in the same and its effects must be judged cautiously. The pricing of the healthcare service is also very crucial. It requires considerable effort on the part of government to ensure that the service does not become overpriced for a majority of the residents. There should be strict regulatory guidelines that will ensure that effects of investments are not entirely based on profit motives. This aspect must be given an upper hand even if it means curtailing a portion of foreign investments. (Richard S., December 2004) In Thailand, for example, the government has taken a highly restrictive stand as far as healthcare services are considered regarding the management of healthcare institutions by foreign companies. The financial services sector is also opened only as per requirement. It has drafted the Foreign Business Act whereby most sectors of the economy are guarded from majority stake holding by foreign bodies. However, exception to this is done only for US investors in the lines of Treaty for Amity and Economic relations. (Thailand, n.d.) Foreign investment has always evoked multiple sentiments in the minds of the people. Foreign investment is a compelling fact staring at the face of every economy today. The country specific cases discussed in this essay hold light to the fact that even in the times of financial crisis and global economic uncertainty, foreign investment in the right amount and in the right industry, plays an important role in lifting the economy from the slump. However foreign investment should not take place rampantly and indiscriminately. Foreign capital should be promoted in the cases where it enhances the growth and development of a nation and restricted when it aims to generate monetary benefits for the foreign country only. However, for the cases in between these two poles, the onus is on the state to decide, considering all possible pros and cons of the investment. References: Assessing Trends and Policies of Foreign Direct Investment in the United States, (July 2008), US Department of Commerce: International Trade Administration, retrieved March 19, 2009, from Chorell H. and Nilson E., (2005), Chinese FDI in the Oil Sector- Can They Be Explained by the Pravalent Theory on FDI? Uppsala University, Department of Economics, retrieved March 19, 2009, from Dicken P., (2003), GLOBAL SHIFT - Reshaping The Global Economic Map In The 21st Century, Published by SAGE, ISBN 0761971505, 9780761971504, retrieved March 19, 2009, from Dr. Vazquez D., (2009A), Introduction: Economic Growth and the Global Economy, MN2165: The Global Economy 2009, Class Lecture Presentation: 1164828_MN2160109, retrieved March 19, 2009. Dr. Vazquez D., (2009E), The Multinational Enterprise: Growth and Development, MN216: The Global Economy 2009, Class Lecture Presentation: 1164873_MN216_05_09, retrieved March 19, 2009. Hale G. and Long C., (April 2006), What Determines Technological Spillovers of Foreign Direct Investment: Evidence from China, Economic Growth Center: Yale University, retrieved March 19, 2009, from Hill D., (August 2002), Latin America: High-Tech Manufacturing on the Rise, but Outpaced by East Asia, National Science Foundation, Division of Science Resources Statistics, retrieved March 19, 2009, from Jackson J.K., (August 2008), U.S. Direct Investment Abroad: Trends and Current Issues, US Department of State, retrieved March 19, 2009, from McNally R., (February 2000), Foreign Direct Investment and Sustainable Development: A discussion for CSD WWF-UK CSD Brief, retrieved March 19, 2009, from Richard S., (December 2004), Foreign Direct Investment and Trade in Health Services: a Review of the Literature, retrieved March 19, 2009, from Thailand, (No Date), Office of the United States Trade Representative, retrieved March 19, 2009, from Vijaya R.M. and Kaltani L., (2007), Foreign Direct Investment and Wages: A Bargaining Power Approach, Journal of World-Systems Research, retrieved March 19, 2009, from Read More