Why There May Be Greater Potential for FDI Activity in China Rather than India - Essay Example

Why There May be Greater Potential for FDI Activity in China Rather Than India Introduction Traditional neoclasical TNC theory indicates that FDIs are typically pulled by market forces for goods and production aspects such as labour costs and technology.1 In this regard, the TNC should have technology, and know-how that is more sophisticated than found in the host state. In addition, FDIs are also drawn to market size and market possibilities abroad. According to neoclassical theory, the efficiency seeking dynamics of TNCs and thus FDIs drives development as FDIs are drawn to places where their resources can be more efficiently invested.2 TNC theories therefore inform that FDIs may be attracted to India as a result of its relatively lower labour costs, lower political risks and its closer proximity to developed OECD states. China on the other hand, may appeal to FDIs as a result of its large consumer market and its more impressive trade with developed OECD countries.3 This paper conducts a comparative analysis of FDI appeal in India and China with a view to demonstrating that there may be greater potential for FDI activity in China rather than India. In order to demonstrate the greater potential for FDI activity in China, this paper analyses TNC theories and the determinants of FDI inflows and outflows and examines these determinants in the context of India and China’s economy. This paper is therefore divided into three parts. The first part of this paper provides an analysis of TNC theories and the determinants of FDIs. The second part of this paper examines India’s economy and the final part of this paper examines China’s economy. TNC Theories and the Determinants of FDIs Since the 1960s several theories of TNC have emerged helping to explain the factors that weigh in favour of or against TNCs investing abroad.4 Traditional neoclassical theory usually represented by eclectic or OLI theories (ownership, localization and internalization advantages) are typically used to explain and predict the “determinants of FDI”.5 The eclectic theory arose out of J. Markusen’s reconceptualization of John Dunning’s neoclassical theory of investment and trade. Dunning’s neoclassical theory takes the position that FDIs are selected by TNCs as a result of a “combinations of transport costs, factor endowments and country size.”6 Eclectic theory explains why a company would elect FDI as opposed to producing locally and exporting locally produced goods abroad and where the TNC would most likely direct its FDI. In this regard, Dunning’s eclectic theory identifies the “why, where and when/how decisions in terms of ownership, locational and internalization (OLI) advantages”.7 (See Table 1 below) Table 1 Eclectic Theory of TNC’s FDI Activities Ownership Advantages Locational Advantages Internalization Advantages Enterprise specific advantages. Includes the drive to obtain a competitive edge and the need to benefit from opportunities for investing when those opportunities arise. Country specific advantages. Aspects of a country what might make it appealing to foreign investment. Firm benefits such as the ability to forego “external markets and transaction costs” linked to production.8 Buckley and Chauri offers a simplistic interpretation of the eclectic theory of TNC’s decisions to direct FDIs. According to Buckley and Chauri, based on “location specific endowments”, firms with the more significant opportunities for and arising out of FDI activities will “be the most competitive in foreign markets”.9 More importantly, advantages depend entirely on the specific traits of the country, enterprise and the industry. For example the ownership advantages of iron industries in Japan will differ from that of South Korea’s. Essentially, Buckley and Ghauri explain that: Enterprises will engage in the type of internalization most suited to the factor combinations, market situations and government policies with which they are faced.10 Locational advantages are premised on the presumption that location advantages are not exactly the same in all markets. In this regard, the economic, political and market “imperfections or government policies of countries” have an impact on where TNCs direct FDIs.11 In other words, consumer behaviour, market conditions and government policies and how those factors will change over time are relevant locational advantages. The internalization aspect of the eclectic theory takes the position that the firm derives an advantage by expanding across borders and that this is more efficient than using other forms of market entry (exporting or licensing) if location and ownership advantages are present.12 The eclectic theory therefore takes into account a number of factors that logically explain when, how and where a TNC may direct FDIs. It is therefore distinguished from other theories such as the product cycle theory which only takes account of a specific situation in which a TNC is attempting to introduce a new product.13 The eclectic theory takes account of a number of wide ranging factors that conceivably fall within the paradigms of ownership, location and internalization advantages. India’s Economy and the Potential for FDI FDI inflows in India from 2001-2002 to 2008-2009 increased from approximately US$6 billion to close to US$38 billion. This increase is attributed to economic reforms liberalizing the economy since the 1990s and the “gradual opening up of the capital account”. The opening of the capital account permitted FDI activities in virtually all sectors.14 However, as a result of the global financial crisis, there were decreases in FDI flows from 2009-2010, although the decrease was comparatively “moderate”. According to the Economic Times however, FDI inflows reached a record US$50 billion in 2011-2012 for India and represents its “highest since investments were opened up in 1996”.15 Data compiled from records published by India’s Ministry of Finance and Commerce reveal that FDI inflows in India have progressively increased over the years (see Table 2 below). Table 2 FDI Inflows in India From 2000-201216 Most of the FDI inflows in India are concentrated among six Indian states with little or no FDI activities elsewhere in India.17 Dhingra and Sidhu conducted a study using the Exploratory Factor Analysis to determine what factors influence the disparate FDI inflows in India. The results of the study indicated that there are four factors influencing FDI inflows: The individual state’s financial or economic stability.18 In this regard, the ability of the consumer market to support the TNC appears to be a decisive factor and accords with the eclectic theory of locational advantage. In particular, Dhingra and Sidhu found that states attracting FDI inflows in India were those states in which the economic situation was relatively strong and the population was represented by a large number of tax paying individuals with a “high share of the country’s GDP” and there was the capacity for establishing the infrastructure necessary for operating a business.19 The state was at a high level of human development in terms of literacy, income, corruption was minimal or non-existent and the state was entirely competitive.20 This aspect of FDI inflows in specific Indian states is consistent with the ownership advantage espoused by eclectic theory of TNCs and their FDI activities and directions. Market size.21 This aspect accords with the localization advantage as it specifically points to market seeking efficiency and thus market and economic conditions. Physical “infrastructure”.22 This factor is consistent with both ownership and localization aspects of eclectic theory as it speaks to both localization advantages and ownership advantages in terms of market and economic conditions (localization) and the need to gain a competitive advantage (ownership advantage). In another study conducted by Sinthqnia and Gupta on the determinants of FDI in India, it was found that the main determinants were GDP, inflation and interest rates, patents, growth of money and foreign trade. The study was conducted by identifying and analysing macroeconomic factors. The study found that the economic reforms introduced in 1996 had a positive influence on FDI inflows in India. However, GDP and inflation is unevenly distributed across India and explains the high concentration of FDI inflows in six Indian states.23 It therefore follows that since economic growth and development are uneven in India, ownership and localization advantages are not present in most of India and therefore are insufficient to justify internalizing advantages which lead to FDI decisions for the benefit of all of India. Sloan-Rossiter conducted a comparative analysis of three Indian states in which FDI outcomes were significantly different. The states studies were Tamil Nadu, Karnataka and Kerala. Karnataka and Tamil Nadu have seen significant economic development and an increase in FDI inflows since 1996 while Kerala has seen very little FDI growth. The differences in these outcomes are explained by political reforms and economic liberalization. While Karnataka and Tamil Nadu have implemented “pro-market reforms”, Tamil Nadu has remained passive “due to ideological and rent-seeking resistance by communist parties and beneficiaries.”24 Again it would appear that according to the eclectic theory of TNCs, locational advantages and ownership advantages are lacking in a number of Indian states and present in some. Those with locational and ownership advantages motivate FDI activities and those without, do not. Pradhan, Abraham and Sahoo argue that labour costs and skill is a factor explaining FDI flows in India.25 Pradhan, Abraham and Sahoo focused their analysis on the manufacturing industry in India and argued that TNCs come to India with the ability to offer improved working conditions, training, technology and higher salaries and are therefore able to hire the country’s most highly skilled workers at salaries lower than those in their respective home states.26 This analysis accords with the eclectic theory and demonstrates the coming together of ownership, localization and internalisation advantages as a motivation for TNCs to engage in FDI activities in India. USAID in its analysis of India’s economy explains why FDI inflows in India are unbalanced. According to USAID, although India’s FDI inflows are relatively good and have shown a marked improvement over the last two decades, it lags behind most of emerging Asia, although slightly. Although India is far more advanced in democratic reforms and human rights principles compared to the rest of Asia, peace and security remains problematic in India. Moreover, there is a tendency to ignore human development policies in India. Although India introduced economic reforms those reforms are uneven and the business environment “ranks in the lower third of the world.”27 Although India eliminated tariffs, it has “regressively imposed regulatory laws that reduced trade liberalization.”28 T hus, India’s FDI inflows are not as impressive as they could be and this underperformance, although impressive and improving, is a result of restraints hindering localization, ownership and internalization advantages for TNCs across India. The same factors motivating FDIs to India are motivating FDI outflows out of India: seeking efficiency abroad. In this regard, since the reforms of the 1990s, India has witnessed a significant increase in FDI outflows.29 China’s Economy and FDI Determinants China has experience a significant and consistent increase in FDI inflows and by 2004 bypassed the US to become the world’s largest receptor for FDI inflows.30 In 2002, China’s FDI inflows “were 28 times higher than in 1986. During this period, China’s “share of global FDI inflows” grew from 1.4% to 8.1%.31In the meantime, China’s GDP grew to 10.2% annually between 2000 and 1007 and is expected to “surpass the United States in GDP by 2030.”32 For the same period, India’s GDP grew to just over 7% annually.33 China’s FDI inflows show a persistent increase each year (for example, See Table 3). Table 3 China’s FDI Increases for the Year 2010 over the Year 200934 In 2008, China was projected to receive US$ 82 billion, but exceeded expectations and in doing so received more than US$90 billion (see Table 4). Although India experienced its best FDI inflow growth rate for the year 2011, it lags behind China. Table 4 China’s FDI Inflows for 200835 China’s open market economy reforms introduced since 1978 have generated significant economic returns for China. Income per capita has increased five times over pre-1978 figures. China’s first and most important target is the reduction of poverty. Privatisation has shifting GDP sources toward non-state businesses which facilitates 60% of the country’s GDP. As reported by the IMF: A driving force for this exceptional growth performance has been the increasing openness of the economy, especially to trade and foreign investment (FDI). Indeed, attracting FDI has been a key pillar of China’s opening up policies.36 There are a number of factors explaining the appeal of China to FDIs. First and foremost, is the fact that China is home to the world’s largest consumer market.37Moreover, strong and persistent economic growth, human development, the removal of barriers to new market entrants, property and labour reforms have combined to improve the potential for FDI growth. China has systematically implemented laws over time that has responded to barriers to FDI inflows and has ensured that FDI inflows remain persistent and strong in terms of upward growth trends.38 The eclectic theory informs that given the factors that contribute toward FDI growth in China indicate that China’s large consumer market is perceived as an opportunity to capitalize on ownership, localization and internalization advantages. Moreover, China’s presence on the global market demonstrates that it provides a unique opportunity for TNCs to compete in the global market.39 Conclusion Based on the conceptual framework of the eclectic theory of TNCs, China’s localization, ownership and internalization advantages, provide motivations for TNCs to direct FDIs China’s opportunities are spread across China. In India, opportunities for FDIs are unevenly concentrated across 6 states indicating that pro-FDI regulations and laws are unevenly distributed across India. With TNCs persistently investing in China on account of larger and more widespread opportunities for reaping returns on localization, internalisation and ownership advantages, China is expected to continue to outperform India’s FDI performances. Although India has experienced improvements in FDI inflows over the last few decades, it still has a long way to go to break even with China. Bibliography Ali, S. and Guo, W. 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