Implications of Foreign Direct Investment in the Growing Market Economy of Cyprus - Case Study Example

Implications of Foreign Direct Investment in the growing market economy of Cyprus

Table of Contents

Introduction3

Dunning’s Eclectic Paradigm of FDI3

The Motivation for Foreign Direct Investment in Cyprus6

Impacts of Foreign Direct Investment on Cyprus’ Economy9

Success stories13

Conclusion14

Reference List15

• Introduction

Globalization is the process of business transformation where firms start operating on a global scale and international boundaries become blurred. There is a free flow of capital, commodities and services across territorial boundaries of the countries. The markets do not remain localized anymore, they start to expand. It is not a painless process since it may hurt smaller economies as there can be issues with them in optimizing their potential (Wells, Shuey, and Kiely, 2001). This integration of markets can be done through various means, but one of the important mechanisms is Foreign Direct Investment (FDI), a channel through which a firm in one country invests in another country’s firm. It can be done by the purchase of new firms in another country or by mergers or inventing funds in the other company and acquiring its ownership rights. Sometimes firms also engage in building their own industrial set-up (Neuhaus, 2006). Based on the recent trend it has been a trend that developed economies are investing in developing or growing economies to gain comparative advantage (Kowalewski, et al., 2008).

Cyprus is a Mediterranean island with a population of 0.86 million (Investment Gateway, 2016). The country has a high-income economy with a high rank on human development index. The purpose of this paper is to examine the motives of Multinationals for entry in Cyprus, by making use of Dunnings OLI framework, and by discussing the potential implications of inward FDI on the Cypriot economy.

• Dunning’s Eclectic Paradigm of FDI

John H. Dunning proposed his theory of Eclectic Paradigm, also known as OLI-model or OLI-framework, to understand why a firm will engage in FDI and how the entire transaction will occur. This theory is based on internalization theory which states that a firm will choose to invest within the intuition when the transaction costs are higher than the internal cost (Dunning, 2000). Similarly, in order to take FDI, according to Dunning, the firm considers three advantages-

• Ownership-advantages: If a country has higher comparative advantage, it is most likely to be engaged in foreign production. Ownership advantage can be in the form of trademarks, entrepreneurial skills, returns to scale and production technique.
• Location-advantages: It has lot of impact on the working of a firm. If the firm has found that a particular economy is offering benefits like natural resource, cheap labour and legislative relaxation like, tax exemptions; then the firm has higher chance of investing their gaining more competitive advantages.
• Internalization advantages: if the firm finds it more advantageous to exploit its core competencies, higher the chances of foreign direct investment rather than either licensing or getting into joint ventures (Dunning and Lundan, 2008).

Figure 1: Advantages to the Firm

(Source: Dunning, 2000)

Figure 2: Advantages of OLI-Framework

(Source: Dunning, and Lundan, 2008)

Four types of FDI initiating competitive advantage for the FDI are –

• resource-seeking
• market-seeking
• efficiency-seeking
• knowledge-asset-seeking

It is with these four strategies that multinational enterprises (MNEs) try to acquire greater power in global market.

• The Motivation for Foreign Direct Investment in Cyprus

Cyprus enjoys the location advantage and functions as a connecting hub for Europe to Central and Eastern European countries, Asia and the Far East. It happened after Cyprus successfully became a member of the European Union from May 2004. By the end of this year, the Republic of Cyprus is supposed to enter into the system of euro common currency (CBS, 2016).

Cyprus is a country of small domesticated markets and its situation between three continents making it an ideal location for international business (Cyprus Law Digest, 2012). The corporate tax rate in Cyprus, is one of the lowest - 12.5% (CYSTAT, 2016). A wide range of tax exemptions are also offered in dividends, dividend income and profits from overseas permanent establishments. Cyprus offers liberalization in FDI, by allowing 100% FDI participation and protecting free investment (CBS, 2016). Another attractive feature in Cypriot tax system is that exemptions are also provided on royalties paid from the country (Investment Gateway, 2016). Its double tax avoidance treaty network makes business much more viable in terms of profit. The legal system is sound and efficient with transparency in regulations along with a sound business infrastructure (Georgantopoulos and Tsamis, 2012).

This is an island of qualified professionals, who are multi-lingual, offering their service in law, accounting and banking sector of the economy. The island has the highest tertiary education within European Union, 39.2% for the age group of 25-64 (Investment Gateway, 2016). The stern vigilance of the Central bank of Cyprus renders its banking system its much needed stability (CBS, 2016).

Figure 3: Annual GDP growth of Cyprus

(Source: The World Bank, 2016)

Figure 4: Percentage change in GDP growth

(Source: CIPA, 2016)

The growth data of Cyprus shows after certain initial shocks, Cyprus’ is again on track of high growth and is expected to achieve further increase in the GDP by 1.7% in 2017 with lower average unemployment rate when compared to EU, currently at 12.6% (Sarris, 2016). Cyprus offers a great package to the tourists all over the world. It has sub-tropical climate with beautiful sandy beaches and high mountains. Apart from tourism, nautical and agro tourism, sports offer a great deal of investment. The economy is well enriched with high-income earners. The country is served by well connected networks of sea, air and modern roadways (Farmaki, et al., 2015). The costs of the factors of production are comparatively low. The cultural similarities with Russia and UK earn the country with higher investment from these regions (Trading Economics, 2016). According to the latest data on tourism, there is growing prospective in this sector, data from January 2016 shows an increase of 2.5% over previous year’s data (CYSTAT, 2016). In lieu of this the large-scale projects in hospitality sector is coming up in the country. The Research and Development and Innovation is subsidised in the country by Cyprus government with tax exemption till 2016.

Chinese investors have shown much interest in Cyprus owing to its new “Citizenship-by-Investment” programme, which allows people living outside EU, can acquire citizenship status upon an investment of €2million in a state-company or €5million in FDI (Pashiardis, et al., 2009). Cyprus’ Exclusive Economic Zone (EEZ) in the Mediterranean Sea has large deposits of oil and natural gas attracts industrial giants in energy sectors, like Total and Eni to engage in further discovery and exploration. Cyprus is has risen to the position of being second-largest in Ship Management Centre in the world and it is also second largest merchant fleet in EU. Another key development, was the launch of Cyprus’ first-ever Science and Technology Park (STP) providing a wide range of research and development in the fields of finance, banking, designing (Cyprus profile, 2016).

Figure 5: Economic factors for Cyprus

(Source: CIPA, 2016)

• Impacts of Foreign Direct Investment on Cyprus’ Economy

Foreign Direct Investment is beneficial to the host country in a number of ways-

• MNEs owing to their financial base have accessibility to easy borrowing from the market which is not available to small domesticated firms.
• Technological knowledge can be a great stimulus to any business. Foreign Direct Investment brings the state-of-art to the host country, which can further help in research and development (Moon, 2015).
• Efficiency can be increased through higher degree of competition in the domestic market. Foreign competition though can deter the growth perspective of the host country, yet a healthy competition can secure the objective of efficiency.
• FDI result in more job opportunities to the host country.
• It also helps in reducing price disparities (Moon, 2015).

Some of the disadvantages are-

• It may affect the investment proportion of the country which is investing, as its capital is directed elsewhere.
• Any political change can harm the terms of FDI for both the countries, affecting exchange rates for the countries (Verdin, Heck, Heck, 2016).
• FDI needs heavy investment requiring huge capital, but the result of such an investment is not always economically viable.
• Acquiring controlling power of the market in the host economy leaves the host country vulnerable for exploitation (Verdin, Heck, Heck, 2016).

The economy of Cyprus has welcome foreign competition by imitating their practices and keeping their business in close vicinity of the MNEs, the domestic entrepreneurs have participated in making the economy efficient by maintain the quality of their product. These small firms even undertake a certain level of research development to remain technologically viable and to keep their position in the market. Cyprus is an emerging economy in need of more qualified professionals to carry on this developing spree. As their mentor, these freshly graduate youth needs the guidance and experience of the MNEs to be their mentors. The knowledge transfer really improves the economic viability of the host country as well (Peng, 2016).

Exploitation is definitely a threat for the economy where Foreign Direct Investment takes place; Cyprus has experienced it as well, with the advent of MNEs in their economy. Lowering of prices resulting in crippling of domestic producers who found themselves out of business as their financial status was in no position to support them. The rules and regulation of the country is very supportive to the FDI, even though they don’t pose any limit to the retrenchment of profit to their home country (Investment Gateway, 2016). MNEs are not interested in re-investing in what existed; they only want to reap the economic benefit out of their own investment without accounting to the economy of Cyprus (Country Profiler, 2016). Domestic monopolies have been replaced with MNEs’ monopoly in Cyprus. Cyprus needs to generate a free flowing path which will transfer the knowledge thus acquired from the MNEs investments. The result of recession in the economy of Cyprus was rising unemployment rate, 16.0% (Trading Economics, 2016), but in the past years there has been a significant fall in the Unemployment rate, showing improvement in the economic conditions.

The recession raised many questions to the possibility of job creation through FDI, as it was noticed that MNEs were paying less than the domestic businesses as trade-union laws were irrelevant to them (Farmaki, et al., 2015). In spite of such allegations FDI have contributed to the substantial effort in creating job for the population of Cyprus enhancing its social progress (Country Profiler, 2016). The big projects undertaken to rejuvenate the tourism industry is a promising example. The casinos are contributing towards state revenue. The discovery is hydrocarbons will act as a catalyst, is making Cyprus a prominent energy centre in the Mediterranean. Even though FDI increases foreign dependence which might lower the chances of the host country to explore its own natural reserve, the huge investment that enters the host country makes it more economically viable (Cohen, 2007).

FDI contributes to the removal of price disparities and also brings the world market at the door step of the host economy. Cyprus realized the benefits in entering into global economy and therefore has opened its economic boundaries (Michaelides and Orphanides, 2016).

FDI though brings a healthy competition to the host country, can also harm the domestic market by stealing away their market share (Cohen, 2007). On the advent of recession in Cyprus, domestic firms found it very difficult to secure their financial base. Due to liquidity problems in the banking sector, while MNEs had larger resources at their disposal- less expensive import of inventory, excess capacity in the factories- can offer lower prices with a wider range of products to the customers; eroding the already slim consumer base. These scenarios call for government intervention to support the private sector of the Cyprus’ domestic economy. When re-investment of profit is made in the host economy, growth can be seen in its various sectors contributing substantially in the RandD, which in turn will enrich the profit of the investing firm in a cyclical manner. The opening of market for the host-economy benefits in expanding its trade and bringing in new businesses, stabilizing the balance of payment while improving the export and import ratio for the country (Liebscher, 2007).

Figure 6: Economic Forecasts for Cyprus

(Source: European Commmission, 2016)

The government of Cyprus provides a conducive environment for FDI with multiple protection and exemptions. The investment in the form of purchase of shares and bonds in the firms of Cyprus has brought about a very reliable source of funding in Cyprus. FDI also covers a large chunk of Public debt for the country (Ministry of Finance, 2016). FDI has significantly contributed to the reduction in unemployment; the country’s unemployment rate has reduced from 16% in 2015 to 14.6% in 2016 and is expected to fall further to 13.3% in 2017 (Country Profiler, 2016).

• • Success stories

Lidl is a German based grocery wholesale which set out to invest internationally after 1990 and has its store in Cyprus as well. Chrysovalantis Karagiannis, Managing Director, Lidl (Cyprus) has commented that Cyprus provides a stable economy with good infrastructural base making it a very attractive market in European Union. He further mentioned that Lidl was able to enter Cyprus as the company’s philosophy and works ethics were similar to the local work culture. Lidl could also identify the consumer behaviour of Cyprus’s economy allowing it to serve the customers in a better way (CIPA, 2016).

Amdocs Development limited is one of the largest multinational corporations engaged in the field of research and development in Cyprus. It has been operating since 1997, currently employing 750 people including accountants, programmers, and finance and operation staff.  Amdocs Development Centre caters many customers situated in Central and Eastern Europe, North America and Asia. The company is trying to develop new industrial products along with rejuvenating existing products (CIPA, 2016).

Uniteam Marine was established in Cyprus in the year 1986 by Gerhard Ruether. A few factors played in favor of Cyprus like its geographical location in the Eastern Mediterranean, effective and protective English legal system, presence of double tax treaties, qualified workforce and supportive banking system. Uniteam Marine has started its journey with only 30 cadets in 1978 and currently they are having more than 200 trainees in various departments. These trainees are provided with proper training before joining on various subjects including, Maritime English, Vessel Resource Management and Bridge/Engine Room Team Management, Leadership, Ship Handling and Stability, etc. (CIPA, 2016).

• Conclusion

Cyprus owing to many of its natural advantages has become an important centre of investment. The country takes pride in its infrastructure which is very conducive to large businesses. Cyprus’s government has lent a hand in supporting the FDIs with appropriate protective rule and regulations. The economic crisis of 2013 has put a question mark to Cyprus’s stability, yet the growing perspective with modern business conducive environment of Cyprus keeps the hope high for the country’s growing economy. MNEs have penetrated the market of Cyprus in order to exploit market and price economies. The natural resource base of Cyprus has attracted many business giants to seek an entry in market of Cyprus. The benefits of FDIs are not devoid of its costs; yet the studies show that the gains are definitely outweighing its cost. The funding from FDI is now an important source of finance for the big developmental projects undertaken within the territory of the country. Cyprus is on the path of turning its granted advantages into competitive advantages.

• Reference List

Central Bank of Cyprus- CBS, 2016. Economic Indicators. [Online] Available at: <http://www.centralbank.gov.cy/media/pdf/AnnualEconomicIndFeb16Eng.pdf > [Accessed on 16April 2016].

Cohen, S. D., 2007. Multinational Corporations and Foreign Direct Investment: Avoiding Simplicity, Embracing Complexity. Oxford: Oxford University Press.

Country Profiler, 2016. Cyprus 2016 Country Report. [Online] Available at: <http://www.cyprusprofile.com/en/country-information/overview> [Accessed on 15April 2016].

Cyprus Investment Promotion Agency - CIPA, 2016. Invest Cyprus. [Online] Available at: <http://www.cipa.org.cy/en/media-center/recent-statistics> Accessed on 16April 2016.

Cyprus Law Digest, 2012. Foreign Direct Investments in Cyprus. [Online] Available at: <http://www.cypruslawdigest.com/topics/foreign-investments/item/151-foreign-direct-investments-in-cyprus > [Accessed on 16April 2016].

Dunning, J.H., 2000. The eclectic paradigm as an envelope for economic and business theories of MNE activity. International business review, 9(2), pp.163-190.

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Dunning, J.H. and Lundan, S.M., 2008. Institutions and the OLI paradigm of the multinational enterprise. Asia Pacific Journal of Management, 25(4), pp.573-593.

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Farmaki, A., Altinay, L., Botterill, D. and Hilke, S., 2015. Politics and sustainable tourism: The case of Cyprus. Tourism Management, 47, pp.178-190.

Georgantopoulos, A.G. and Tsamis, A., 2012. The interrelationship between money supply, prices and government expenditures and economic growth: A causality analysis for the case of Cyprus. International Journal of Economic Sciences and Applied Research, 5(3), pp.115-128.

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Kowalewski, O. and Weresa, M.A. eds., 2008. The role of foreign direct investment in the economy. Mering: Rainer Hampp Verlag.

Liebscher, K., 2007. Foreign Direct Investment in Europe: A Changing Landscape. Cheltenham: Edward Elgar Publishing.

Michaelides, A., and Orphanides, A., 2016. The Cyprus Bail-in: Policy Lessons from the Cyprus Economic Crisis. Singapore: World Scientific.

Ministry of Finance, 2016. Cyprus Central Government Debt. [Online] Available at: <http://www.mof.gov.cy/mof/pdmo/pdmo.nsf/All/F0C650FEBD5E4C11C225788D00208D2A/$file/CY%20Qrt%20Bulletin%20Q4_2015.pdf> [Accessed on 16April 2016].

Moon, H., 2015. Foreign Direct Investment: A Global Perspective. Singapore: World Scientific.

Neuhaus, M., 2006. The Impact of FDI on Economic Growth: An Analysis for the Transition Countries of Central and Eastern Europe. Berlin: Springer Science and Business Media.

Pashiardis, P., Georgiou, M. and Georghiou, M., 2009. Cyprus. In Informal Learning of Active Citizenship at School. Berlin: Springer.

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Sarris, M., 2016. Cyprus in the Eurozone. In The Cyprus Bail-in: Policy Lessons from the Cyprus Economic Crisis. Singapore: World Scientific.

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Verdin, P., Heck, N. V., Heck, N. V., 2016. From Local Champions To Global Masters: A Strategic Perspective on Managing Internationalization. Berlin: Springer.

Wells, G. J., Shuey, R., and Kiely, R., 2001.Globalization. New York: Nova Publishers.