Main Aspects of Foreign Direct investment - Essay Example

Foreign Direct Investment Contents Introduction 3 Impact of FDI in the global economy 3 Theories of FDI and their applications 4 FDI in China 6 FDI in South Africa 9 Conclusion 13 Reference List 14 Introduction Foreign direct investment (FDI) is defined as an investment made to acquire lasting interest in enterprises operating outside of the economy of the investor. The FDI relationship consists of a parent enterprise and at least one affiliate out of its home country. The parent firm implies business strategies in production, marketing and finance through its affiliates. FDI (Foreign Direct Investment) gained a critical position in the world economy after World War II. During the initial period, seeking resource was the major motivation, which subsequently transformed into market-seeking investment. Apart from a substantial growth in the FDI volume, there was an overall reduction in primary goods concentration as well as increase in production and manufacturing of knowledge based products across developed economies. In addition, FDI also resulted in important organizational changes such as, international business activities, development of vertical international investment and establishment of horizontal multinationals (Blonigen, 2005). The objective of the present study is to evaluate the inflow of FDI in two emerging nations China and South Africa. While China has garnered substantial attention and interest from investors in terms of FDI, South Africa is slowing becoming a favourite place for FDI in the African continent. The study has analysed the overall impact of FDI in the economy of world though extensive literature surveys and article reviews. The study has also analysed the important theories related to FDI and their overall impact in the pattern of investment in China and Africa. Impact of FDI in the global economy Various evidences have supported the concept that FDI enhances competitiveness of regional and local companies. Positive evidences were founded in Indonesia and Mexico. Similarly, Smarzynska (2002) mentioned that supplying international customers proved to be beneficial for the local Lithuania suppliers. Increasingly, companies are attracting FDI to their home nations, as it is perceived to positively impact the host country’s social environment and is helpful in improving general economic scenario of these developing nations. FDI is expected to increase technology transfer, productivity, know-how, managerial skills, international manufacturing and production networks and external market access, besides reducing unemployment. Spill over of technologies to regional companies was more supportive of economic growth, rather than national investment. Third world and emerging nations (TWN), such as, China and South Africa, have been able to successfully utilize foreign investment opportunities in order to carve a growth path for their internal social and economic environmental factors. The major factors that enhanced attractiveness of these third world nations were less costly human resource and low cost of raw materials. Advantages for the host countries included introduction of international products as well as technologies adjusted to suit local factors for production, manufacturing and distribution. So, small-scale manufacturing and production units were greatly benefited by imported technologies brought through FDI (Noorbakhsh, Paloni and Youssef, 2001). A recent concept proposed by Dunning (2000) suggested that successful FDI is not a one-off activity; rather, it is a combination of resource flows, stimulated by inter-relationship as well as interaction between host economy and the investor and depends on investor’s changing motivations (Moosa 2002). Over time, investors faced numerous challenges as well as opportunities, in terms of exploiting location advantages, due to changing economic conditions as well as legal and political interventions from host countries. For instance, World Bank has been implementing policies and guidelines in order to encourage business friendly environment for investments, particularly in emerging nations such as, China and South Africa. As a result, investments policies liberalized due to acceptance and popularity of FDI as well as motivated newcomers and fairly smaller industries to invest in these emerging nations, which were previously dominated solely by larger enterprises. Theories of FDI and their applications 1. Product-Cycle Model According to this model, development in technology leads to enhanced products features, thereby increasing country’s competitive advantage. Domestic demand can result in innovation and in a similar manner, international demands can facilitate exports. As such, foreign investors are likely to organise distribution and production of goods in locations where state of technology is constantly changing. Hence, widespread and strong growth stage in the product life cycle of a company can stimulate foreign investments (Chowdhury and Mavrotas, 2006). For instance, apart from flexible government policies and legislations, efficient macroeconomic policies have also attracted foreign investments in South Africa. Similarly, there has been a rapid growth in terms of regional business opportunities and domestic markets in China, which has attracted FDI. 2. The hypothesis of Hymer-Kindleberger According to the above hypothesis, when foreign companies invest in a country’s domestic firms, they suffer certain disadvantages such as, market knowledge and communication. In such situations, these international investors must gather company-specific competencies before foreign engagement. Similarly, FDI does not only imply capital transfer, but also includes transfer of intangible assets such as, skilled personal, business techniques and technology. Imperfections in the global markets forced companies to seek opportunities in other emerging markets (Moosa, 2002). Two fundamental determinants, influencing success or failure of FDI, are ownership and location of firms. The overall social and infrastructural environment of China is considered higher and more advanced compared to other Asian developing nations. China has been focusing on development of service and products, which are not only cost-effective, but also technologically advanced. Especially, in case of consumer electronics industry, China has carved a niche for itself with foreign investors. This has attracted the foreign investors and thus, China has been able to increase GDI inflows in the country. Similarly, level of flexibility of South Africa, is considerably better than many developed nations in western part of the world. All the above reasons have created a positive perception about South Africa among investors as a potential foreign market. 3. Oligopoly and Monopolistic theory According to the oligopoly theory, entry barriers are created by big multinational firms as smaller firms are not able to compete in markets. The major advantages of those bigger firms include superior financial and technological strengths. Apart from that, overall production of local firms is comparatively lower than bigger MNCs, further demeaning strengths of the smaller firms. Also, this theory suggests that constant innovation, growth and new market penetration is essential for maintaining competitive edge in the global market. According to Monopolistic theory, foreign MNCs possess advanced technology, superior knowledge and economies of scale, giving them advantage over regional and smaller firms. For instance, in case of China, higher number of food retail, coffee chains, restaurants and e-commerce companies are investing in China. It has also been noticed that companies who have tried to invest in manufacturing or production have met with numerous challenges and some also had to pull out business activities from the country. Similarly, in South Africa, FDI is majorly in manufacturing and mining as these are dominated by bigger international firms. FDI in China FDI in influenced by factors such as, cultural distance, business atmosphere, local government policies, foreign business treatment, stage of economic development, and degree of openness. The total FDI inflows to China in 2013 were about 10.76 billion dollars, which is around 16 percent more from last year. This proves overall attraction of China as a nation for FDI. While there was a steep decline in manufacturing investments, majority of newer foreign investments were directed at the service sector (Tong and Yu, 2002). Figure 1 FDI inflows in China (Source: Money control, 2012) An emerging or growing host market is considered as a beneficial and profitable investment opportunity. Over past few years, increase in economical measures such as, GDP (gross domestic product), GNP (gross national product) and per capita income, of China have been noticed. So, investors need to consider overall market demand of China while planning for further FDI investment. Availability of cheap labour, land as well as natural resources attracts the highest number of FDI investors (Sun, Tong and Yu, 2002). In case of China, abundance of a variety of resources is the major advantage to FDI investors. Among them, most significant is the cheap human resource. The overall margin in terms of labour cost is substantially lower in China when compared with that of countries such as, US and Europe. Also, China has abundant energy resources such as, oil and coal. Other resources that render China an attractive host for FDI investment are iron, land and natural minerals (Buckley, Clegg and Wang, 2002). Thus, companies investing in these resources have been highly benefiting so far. With the FDI and trade policies becoming stricter and more stringent, foreign companies are facing difficulties in establishing investment plans in China. So, a dramatic shift can be seen in terms of FDI investment in China, which is from manufacturing to service. Firms that already have invested in China and plan to increase the same can seek opportunities in service, e-commerce, IT and knowledge industries. The electric paradigm or OLI approach, established by Dunning, can be used to analyse the nature of FDI in China. OLI (ownership, location and internationalization) are the three aspects fundamentally responsible for FDI and other international market entry decisions made by an organisation (Moosa, 2002). According to ownership advantage, firms successfully establishing international market entries possess specific firm level competencies. While location advantage determines the place of investment, international advantage indicates mode of operation during foreign market entry (Chung, 2001). A positive relationship has been found between the infrastructural developments in a country and flow of FDIs from international investors. For instance, countries with better transport facilities, by means of road, rail and water, attract higher FDI investments. China has been investing hugely in infrastructural activities. China has also been able to capture a significant amount of market through its electronic goods. Besides that, skilled and semi-skilled labour has been constantly enhancing the inflow of FDI in manufacturing and production sectors in China (Gao, 2003). The country has recently implemented strategy for developing its export promotions, which proved to be extremely beneficial in drawing higher FDI. In addition, export policies have also helped China in implementing economic reforms as well as encouraging trade promotion. Several bilateral agreements in terms of trade and export, such as, reduction in tariff barriers, have attracted various foreign investors (Cheng and Kwan, 2000; Zhang, 2002). Even so, many investors face issues and challenges due to shortfall in appropriate resources, technology or human resource. For instance, lack of advanced technology and skilled resources have resulted in fewer foreign investments in China’s metal smelting sector. Most of the metal smelting firms in China are local, employing local resources and traditional equipments. At the same time, sectors such as, food, electronics, timber products, printing and textile, have been receiving major share of FDI investments in China. As a consequence, wide gap can be identified, in terms foreign investors’ sector and location preferences. Majority of foreign investment in China come from Japan and western counterparts such as, America and Europe. This can be attributed to barriers for entry for smaller investors who find it difficult to survive in an overcrowded market, marked with indigenous services and products and severe competition. As a result, China is mainly characterised by FDI from large corporations from Japan and West (Wei, 2005). There has been an increase in overall production capability, but overall per capita income of the country in low, thereby creating difficulties for foreign companies. Major disadvantage comes in the form of qualified labour and technology gaps. The unequal investment discussed above is also a disadvantage, which limits overall growth in the country. Even in present scenario, foreign companies are not allowed 100 percent ownership in China, creating barriers to entry. Other barriers include non-tariff measures, administrative enforcements and traditional mechanisms and legislation procedures for managing market economy (Zhang and Felmingham, 2001). On comparing China with two geographically opposite nations like, United States and Japan, few interesting observations were made. China and United States were found to be similar in aspects such as, masculinity and uncertainty avoidance. This suggests the changing business trend of Chinese firms towards more risk taking strategies. This can be attributed as one of the reasons behind increasing foreign investments from United States and other American nations. Apart from being geographically close, China and Japan also share similar attributes, in terms of pragmatism and indulgence. Similarly, in order to avoid business failures and increase FDI inflows in the country, China has been highly pragmatic, meaning that they have the ability to adapt to different traditions and cultures. Thus, huge investments opportunities have been coming in Chinese soil in last couple of decades. FDI in South Africa According to Hofstede analysis, South Africa gives strong emphasis on individualism. Inequalities of wealth and power have grown over years and most of the cultural indicators are high, in case of South Africa. High masculinity suggests great differentiation in gender and a male dominating society. A very similar approach can be seen in American society and as a result, majority of recent investments have been from America. Appointments and business meetings in South Africa are always on schedule time, again reflecting similarity with the American Society. Business deals are slow and careful and any rush might harm the relationship among firms. South Africans also prefer win-win business opportunities. While establishing business in South Africa, investors should make strategies to persuade the audience or local firms by emphasizing on tangible benefits such as, bonus, profits or product merchandisers. Also, providing career benefits to local workers and employees can ensure positive perception among local counterparts as well as a supportive environment for foreign investors (Alden and Vieira, 2005). Similarly, a comparison of South Africa with an eastern nation, such as, Japan, has revealed interesting results. Huge cultural gap exists in aspects such as, uncertainty avoidance, pragmatism, indulgence and individualism. So, business investments through mergers or acquisitions between these two nations might be a failure, unless supported by huge training and cultural programs. FDI investments in Africa are increasing at the rate of 7 percent every year. The total FDI inflows were estimated to be 56 billion dollars in 2013, out of which nearly one-fifth was in South Africa. To be exact, total FDI inflows increased to 10.3 billion dollars in 2013 for South Africa, whereas other African Nations such as, Ghana and Nigeria, experienced declining FDI activities (Sulaiman, 2014). Figure 2: FDI flows into African Countries (Source: UNCTAD, 2013) Major motivators for FDI inflows were Greenfield investment, occurring in sectors such as, oil and gas, metals and minerals, communications technology, financial services, consumer products and infrastructure. According to the electric-paradigm shift, attractiveness of South Africa in terms of its location have enhanced over last few years. Even so, huge gap still exists between investors who have invested in South Africa and those who have not yet established their business. There has been instability in case of FDI investment in South Africa. The major reasons that prevent foreign investors from establishing business South Africa are recurrent unrest among labour, frequent strikes, lack of skilled and professional workers, illegal activities and rising crime rate. As a result of increasing exploitation of South African resources by foreign investors, the South African government have set numerous rules and policies regarding FDI specific to the country. FDI is currently acts a major external force for economic development and growth in the nation. International investment are welcomed provided they offer developmental and growth benefits to the nation. The overall approach towards FDI has been liberal and open in nature (Lewis, 2001). Figure 3 Macroeconomic Indicators (Source: Ernst & Young, 2013) Many African nations have been able to manage their economies better than the western counterparts. There has been a significant decline in national debt burden, budget deficits and debt levels. Diversification of sectors is another reason, which investors need to consider, while increasing their business activities in South Africa. The nation is increasingly shifting its focus from primary activities such as, manufacturing, to services, technology and knowledge based sectors. Hence, eccentric theory of international advantage has been satisfied by South Africa’s growing economy and has started to attract foreign investors. Infrastructural investments can be regarded as an important factor for establishing location advantage for foreign investors. Electricity and logistics are considered as biggest infrastructural gaps, challenging those investing in South Africa. However, the gap has been narrowing down due to increasing infrastructural projects in the nation. Most of these infrastructural projects are transport and power related, suggesting that the government of South Africa is trying to attract foreign investments. Figure 4 Infrastructure Projects Flow in African Nations (Source: Ernst & Young, 2013) Other factors that can be attributed for growth of FDI investments in South Africa are ease of conducting business by ways of quick insolvency resolutions, easier process for paying taxes, investor protection and easier access to trade across borders. Also, steady growth in educational levels as well as human development has transformed South Africa as one of the favourite African destinations for FDI. Conclusion The above discussion has been able to foreground various findings. Foreign investments have been playing an influential role in developing and emerging economies. These nations are perceived as an opportunity for investment by the western counterparts. In general, big multinationals look into factors such as, location, opportunity and international advantages, before making any FDI decisions. Nonetheless, the nature of FDI in developing nations is highly fragmented, confusing investors as well as their perception regarding opportunities and threats. For continuous growth in foreign direct investment, policy liberalization is an important aspect, followed by advancements in infrastructure and technology. While foreign investors help emerging nations in terms of economic growth, unity and friendship, local governments should ensure that natural and human resources of the host nation are not being misused. Reference List Alden, C. and Vieira, M. A., 2005. The new diplomacy of the South: South Africa, Brazil, India and trilateralism. Third World Quarterly, 26(7), pp. 1077-1095. Blonigen, B. A., 2005. A review of the empirical literature on FDI determinants. Atlantic Economic Journal, 33(4), pp. 383-403. Buckley, P. J., Clegg, J. and Wang, C., 2002. The impact of inward FDI on the performance of Chinese manufacturing firms. Journal of International Business Studies, 33(4), pp. 637-655. Cheng, L. K. and Kwan, Y. K., 2000. What are the determinants of the location of foreign direct investment? The Chinese experience. Journal of International Economics, 51, pp. 379-400. Chowdhury, A. and Mavrotas, G., 2006. FDI and growth: what causes what? The World Economy, 29(1), pp. 9-19. Chung, W., 2001. Mode, size, and location of foreign direct investments and industry mark ups. Journal of Economic & Organisation, 45, pp. 185-211. Dunning, J.H., 2000. Globalization and the Theory of MNE Activity. New York: Martin’s Press Inc. Ernst & Young, 2013. Africa 2013: Getting down to business. [pdf] Ernst & Young, Available at: < http://www.ey.com/Publication/vwLUAssets/The_Africa_Attractiveness_Survey_2013/$FILE/Africa_Attractiveness_Survey_2013_AU1582.pdf> [Accessed 27 May 2014]. Gao, T., 2003. Ethnic Chinese networks and international investment: evidence from inward FDI in China. Journal of Asian Economics, 14(4), pp. 611-629. Lewis, J. D., 2001. Policies to promote growth and employment in South Africa. Southern Africa Department: World Bank. Money control, 2012. Mecklai graph: China FDI inflow down 3.8% in Jan-Sept YoY. [online] Available at: [Accessed 27 May 2014]. Moosa, I. A., 2002. Foreign Direct Investment Theory, Evidence and Practice. New York: Palgrave Macmillan. Noorbakhsh, F., Paloni, A. and Youssef, A., 2001. Human capital and FDI inflows to developing countries: New empirical evidence. World development, 29(9), pp. 1593-1610. Sulaiman, T., 2014. South Africa was continents top FDI recipient in 2013. [online] Available at: < http://www.reuters.com/article/2014/01/28/africa-fdi-idUSL5N0L23YF20140128> [Accessed 27 May 2014]. Sun, Q., Tong, W. and Yu, Q., 2002. Determinants of foreign direct investment across China. Journal of International Money and Finance, 21, pp. 79-113. Tong, S.Q. and Yu, S., 2002. Determinants of Foreign Direct Investment across China. Journal of International Money and Finance, 21(1), pp.79-113. UNCTAD, 2013. Foreign direct investment to Africa increases, defying global trend for 2012. [online] Available at: [Accessed 27 May 2014]. Wei, W., 2005. China and India: Any difference in their FDI performances? Journal of Asian Economics, 16(4), pp. 719-736. Zhang, K.H., 2002. Why does China receive so much foreign direct investment? China & World Economy, 3, pp 49-57. Zhang, Q. and Felmingham, B., 2001. The relationship between inward direct foreign investment and China’s provincial export trade. China Economic Review, 12, pp. 82-99. Read More