The Nature of Foreign Direct Investment - Case Study Example

The Nature of Foreign Direct Investment Number and Number Number of Words: 2,026 Introduction Foreign direct investment is referring to a country’s long term foreign investment which often includes issues related to joint-venture, stock investment, and the act of transferring technology and business expertise (Central Intelligence Agency 2011). Regardless of the nature of foreign direct investment is inward or outward, it is most likely that the global business transactions through the foreign direct investment could result to either positive or negative net foreign direct investment inflow. Upon reading the case study of Dell in Limerick and Bosch in Cardiff, this study will focus on discussing about the nature of foreign direct and indirect investment including other related factors that makes the regional development authorities able to tie foreign direct investment to locality and difficulty to exit from the region. As part of identifying the advantages and disadvantages of direct and indirect foreign investment, this study will analyze the impact of foreign direct investment on employment, technology and economies of scale. Based on the case of Dell in Limerick and Bosch in Cardiff, the lessons behind regions that are relying on inward investment as promoter of economic regeneration will be tackled in details. Nature of Foreign Direct and Indirect Investment According to Moosa (2002, p. 1), foreign direct investment is defined as “the process whereby residents of one country (the source country) acquire ownership of assets for the purpose of controlling the production, distribution and other activities of a firm in another country (the host country)”. The only difference between foreign direct investment and portfolio investor is that the investors behind a foreign direct investment is more interested in long-term control and benefits of conducting a business in another country (ibid). This is not true in the case of portfolio investors since this group of investors is not interested in gaining control over the business but only in stock market (Economists View 2007). By nature, foreign investment can either be direct or indirect. The nature of direct foreign investment is that the spending of money for an investment is tangible such as the act of purchasing a foreign company’s shares or buying a house in another country for investment purposes. Eventually, foreign investors who buy foreign corporate shares may end up buying out the other company through merger and acquisition or entering into joint venture in order to gain control over a business in another country (Direct Foreign Investment 2011). Indirect foreign investment is a form of intangible investment such as in the case of investment fund, securities, and private equity wherein the money invested on either property, shares and/or bonds (Viljoen and Sibiya 2008, p. 67). Since investment fund, securities and private equity is easier to liquidate, the investors of foreign indirect investment are less likely to become affected of investment profit and/or losses. Factors that make the Regional Development Authorities able to Tie Foreign Direct Investment to Locality Yet Difficult to Exit Case of Dell in Limerick Dell is the world’s top 2nd manufacturer of computers next to Hewlett Packard. One of the reasons why the regional development of authorities of Poland was able to convince Dell to move its manufacturing base from Limerick in Ireland to Lodz in Poland is because of the benefit of lower operational costs as a result of cheaper minimum wage of diversified workforce, the proximity of Polish city to Dell’s future target consumers which includes the Central and Eastern European market, and Poland’s offer of tax incentives to foreign investors within its special economic zone (Gergely and Jones n.d.). There were rumours that the Polish Government offered Dell €52.7million worth of state aid package just to convince Dell to move away from Ireland (RTE News 2009). Based on the rule set out by the European Commission, it is “illegal for any member state to provide aid to a firm for a new project because this practice could cause disproportionate distortion of competition in the European Union’s internal market” (Smyth 2009). For this reason, the European Commission conducted a formal investigation concerning the aid package of €55 million that was awarded to Dell in exchange of shifting its main operation from Limerick to Lodz (ibid). Despite the European Commission’s effort to conduct formal investigation, it is difficult on the part of the regional development authorities to exit from its foreign direct investment negotiation with Dell since the cost of establishing the manufacturing firm in Lodz has already amounted to €190 million back in January 2008. Because of the issue on sunk cost, pulling out the manufacturing plant of Dell in Lodz could only cause more serious economic problems on the part of the company, the community in Poland, and the entire European Union. Case of Bosch in Cardiff As a result of globalization, millions of companies within developed countries are unable to compete within the global markets. Bosch Group, a company that manufactures alternator for motor industry, was facing serious operational down grade because of 45% and 65% decline in its sales and profit back in 2009 and 2010 respectively (Blake 2009). In line with this, the remarkable loss in sales and profit was triggered by the unexpected economic recision that has been taking place for quite some time. To prevent business closure, Bosch considered foreign direct investment as a solution to its business problem. In line with this, the company decided to move to a more lucrative business environment by transferring its operations to Hungary (Blake 2009; Blake WalesOnline 2009 b). Similar to the main reason why Dell decided to move its plant in Limerick, Bosch considered moving to Hungary because of the benefit of cheaper cost of generator (Blake 2009; Blake WalesOnline 2009 b). In exchange of shredding off more than 300 employees in its source country, Bosch could take advantage of lower operational cost and better market opportunity in Hungary and nearby markets (Blake WalesOnline 2009 b). Advantages and Disadvantages of Direct and Indirect Foreign Investment Advantages Specifically in developing countries, the promotion of foreign direct investment could promote the economic development of each country by increasing the available domestic capital, transfer of new technologies, creating new market and marketing channels, increasing demand for higher production level, and the creation of more employment opportunity (Mayer-Foulkes 2009). Because of improvements in the use of technology and enhancement of existing management skills on the part of the managers (Yingqi and Balasubramanyam 2004, p. 1), business in host countries could take advantage of economies of scale because of the higher demand in production level. Other than increasing the existing production demand, foreign direct investment could also create ownership, location, and internalization paradigm advantages in developing countries. It means that foreign companies can take advantage of having better access to natural resources, cheaper pay on highly skilled workers and more productive manpower and infrastructure facilities within the host countries (Yingqi and Balasubramanyam 2004, pp. 1 – 2). As a result of tighter market competition, the quality of goods and services that are manufactured and offered by the manufacturing and trading sectors also increases (Moran, Graham and Blomström 2005, p. 4; Yingqi and Balasubramanyam 2004, p. 2). Once the investment capital, demand for products and services, and employment opportunity increases, economic growth within a developing country is possible. Disadvantages The problem with continuous growth in foreign direct investment can be noted with the negative economic effects on the part of the source country where large-scale manufacturing firms are operating (Mayer-Foulkes 2009; Minihan 2009; RTE News 2009 b). Because of the process of shifting the main production line, distribution and other related business activities to the preferred host country, there is a strong possibility that this particular business strategy could lead to serious economic problems on the source country especially when it comes to significant increase in the rate of unemployment (RTE News 2009 b). Mayer-Foulkes (2009) explained how the promotion of foreign direct investment could result to long-term decrease in interest rates, incidence of housing bubble, and destabilization of the financial system on the part of the affected countries. The problem with long-term low interest rates is that more people will be encouraged to invest their money in business (Mayer-Foulkes 2009). When this happens, investment market can be saturated in the long-run. When economic development continue to strengthen, high inflation rate or significant increase in the prices of goods and services is likely to take place (Silvia and Iqbal 2009). It means that high inflation rate could hurt the financial status of below-average wage earners. There is a saying that history repeats itself. In line with this, the regional government of Poland should consider the economic consequences of having a very low interest rates because this particular economic aspect could lead to global housing bubble similar to what happened in the case of the United States, Australia, Britain, China, France, Italy, Spain, Russia, and some parts of the Eastern European countries (Economic Reason 2008; The Economist 2005). Aside from causing financial problems to ordinary taxpayers, the huge number of job loss within the source country may trigger the need for the source country government to publicly announce economic recession (Minihan 2009). Lessons behind Regions that are relying on Inward Investment as Promoter of Economic Regeneration Most of the large-scale companies that had invested a lot of money on foreign direct investment are most likely to cut down on operational costs once it has gained control over the business in host country. In line with this, foreign direct investment could lead to significant increase in unemployment rate not only within the source but also the host country (Mayer-Foulkes 2009; Minihan 2009; RTE News 2009 b). Although foreign direct investment is commonly considered as an effective economic strategy that could promote sustainable economic development (Smyth 2009), it is wrong for a region to heavily relying on inward investment as a promoter of economic regeneration because of the long-term destructive effects of foreign direct investment could cause severe destabilization over the region’s economy especially when it comes to the development of high inflation rate, housing bubbles, poor financial stability, and worst economic recession (Direct Foreign Investment 2011; Minihan 2009; Silvia and Iqbal 2009; Economic Reason 2008; The Economist 2005). Given that there are advantages and disadvantages associated with foreign direct investment, large-scale firms should carefully study the pros and cons behind each of direct foreign investment opportunity before deciding which region or country to invest (Direct Foreign Investment 2011). In the case of the government in regional authorities, it is necessary to learn more about when and how to control the promotion of foreign direct investment to avoid facing the economic consequences associated with high inflation rate, housing bubbles, poor financial stability, and worst economic recession (Direct Foreign Investment 2011; Minihan 2009; Silvia and Iqbal 2009; Economic Reason 2008; The Economist 2005). Fiscal policy through the regional government intervention with regards to taxes and foreign investors can be used as the main control in foreign direct investors. In case there is a need to control the number of existing foreign direct investors, the government can simply increase taxes on foreign investors to discourage them from investing within the region. This is necessary when the regional inflation rate is already very high. On the other hand, decreasing taxes on foreign investors could encourage more foreign direct investments to enter the region. By doing so, the regional government could easily solve problems related to unemployment rate. Conclusion For the purpose of lower operational cost and better market opportunity, the case of Dell in Limerick and Bosch in Cardiff decided to enter foreign direct investment in Lodz in Poland and Hungary respectively. However, excessive foreign direct investment could weaken the regulatory standards within each region in terms of its investment pattern. In order to balance the advantages and disadvantages of direct foreign investment and avoid increasing the gap of economic inequalities between two countries or two regions, regional government should control excessive promotion of foreign direct investment even though there are economic advantages associated with inviting foreign companies to do business within the regional host. By doing so, regional government could avoid facing long-term economic consequences related to decrease in interest rates, incidence of housing bubble, and destabilization of the financial system. *** End *** References Blake, A., 2009. MP urges Welsh Assembly Government to save Bosch. Irish Times. Blake, A., 2009 b, October 8. WalesOnline. Bosch’s Miskin automotive parts factory could face job losses or closure. [online] Available at: [Accessed 4th January 2011]. Central Intelligence Agency, 2011. Stock of direct foreign investment - at home. [online] Available at: [Accessed 4th January 2011]. Direct Foreign Investment, 2011. Foreign Direct Investment Facts and Myths. [online] Available at: [Accessed 4th January 2011]. Economic Reason, 2008, January 3. The Housing Bubble is Global. [online] Available at: [Accessed 4th January 2011]. Economists View, 2007, January 30. FRB Dallas: Does Foreign Direct Investment Help Emerging Economies? 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