Inward Foreign Direct Investment: Australia - Essay Example

INWARD FOREIGN DIRECT INVESTMENT: THE CASE OF AUSTRALIA Introduction For five years prior to 2008, most countries were experiencing steady growth in inward foreign direct investments. Since the latter part of 2008 the global economic crisis has affected investments in many countries, particularly China and the transitional economies in Central Europe. The United States, the United Kingdom, and a few other countries including Hong Kong SAR, Singapore, and Australia demonstrated resiliency by showing increases in FDI numbers. Australia, a developed country and a responsive government, has been chosen in this study because of its unique characteristics in many respects. Abundant in natural resources, it has ranked consistently high ranking in nearly all criteria of investment attractiveness. This empirical study will focus on Australias inward FDI profile and performance against the backdrop of global FDI flows. It will thus attempt to achieve some perspective essential to a better appreciation of Australias performance and potential in terms of investment growth and economic leadership in the Pacific rim. The Importance of Foreign Direct Investments Foreign direct investment (FDI), according to Lamborn and Lepgold (2005), is a type of international capital flow that transfers a firms managerial skills and knowledge abroad; it involves the creation of a foreign subsidiary, the assets of which are directly controlled by the parent company. It differs from foreign portfolio investment in that the latter involves the purchase of securities where the businesses are owned or operated by others, and which normally do not exceed 20 percent of issued capital. A distinguishing characteristic of FDIs is the fact that it does not only involve a transfer of resources but also the acquisition of control (Krugman & Obstfeld 1994). It follows that the subsidiary does not only have a financial obligation to the company but also is part of the same organisational structure. The Organisation for Economic Co-operation and Development (OECD) states that FDI "reflects the objective of obtaining a lasting interest by a resident entity in one economy ("direct investor") in an entity resident in an economy other than that of the investor ("direct investment enterprise." (OECD Benchmark Definition). It adds that the lasting interest implies the existence of a long-term relationship between the direct investor and the enterprise and a significant degree of influence on the management of the enterprise. For both developed and developing countries alike, the attraction of FDIs lies in the assumption that greater inflows of foreign investments will bring certain benefits to the national economy. It contributes to a countrys Gross Domestic Capital Formation, the Gross Domestic Product, and its balance of payments. Empirical studies done by the OECD have shown a positive relationship between FDI inflows and GDP growth, although exceptions have been noted in the case of some countries in Central Europe where GDP actually dropped. (Foreign direct investment, A lead driver). For the host countries, it can stimulate the national economy, create employment, bring in new technology and managerial know-how, and upgrade the quality of local manpower resources. FDIs are also relatively more stable as a source of capital compared to loans and portfolio investments. For the direct investor, investment creates possibilities for broader markets and control of diverse foreign productive resources. Foreign direct investment may take the form of: a) greenfield investment, by the establishment of a new enterprise abroad either as a branch of subsidiary, b) as an expansion of an existing branch or subsidiary, or c) as a merger or acquisition, through the purchase of an existing business or its assets (Cooke 1988). Multinational firms adopt different modes of entry depending on their objectives and the advantages they seek to gain. Instead of licensing their businesses or exporting their goods, they may opt to establish a subsidiary in a foreign country to take advantage of local factor endowments such as the availability of natural resources and raw materials, existing infrastructures and transport networks, low-cost manpower, and accessible markets, among others. These can be matched with the internal resources, technology and managerial capabilities available within the firm. Greenfield investments require more time and resources, whilst mergers and acquisitions are the way to go for many multinationals that are in a hurry to increase shareholder value and improve their competitiveness. Investment profile: Australia Located in Oceania, Australia is one of the most economically developed countries in the world, with a population just over 21 million occupying a geographical area equivalent to that of contiguous United States and a PPP-based per capita income of US$31,645 (2005 estimate) (Country insights, Australia, Globaledge). It is rich in mineral and agriculture resources from which it derives the major part of its export revenues. The economy is dominated by the services sector, whilst the manufacturing sector has recently leveled off to about 10 percent of the gross domestic product (GDP). Government policies that have encouraged foreign investments include reduced tariff and non-tariff barriers to trade, financial services deregulation, taxation reforms, privatisation of government-owned monopolies, and reduction of duplication and increase in government efficiency. (CIA World Factbook, September 2009). According to the Country and Business Climate Ratings by Coface, however, Australia is saddled with a heavy debt which is more than 150 percent of its national disposable income, and faces the prospect of a negative economic growth this current year. Raw material export prices are expected to affect export receipts as a consequence of price renegotiation.(Country insights, Australia, Globaledge) Competitive ranking of countries The attractiveness of a country from the viewpoint of foreign direct investors depends on the balancing of the costs, benefits, and risks associated with doing business in a particular country (Hill 2005). Such costs and risks of doing business are typically lower in economically advanced and politically stable countries. Further, the prospects of long-term economic benefits depend on the existence of a free market system, in both developed and developing countries, political stability, and the lower risks of inflation and large private sector debt. Another aspect is the ethical dimension of doing business in foreign countries, specifically with regard to human rights, labor and environment, and corruption. Globaledge (Country insights) has compiled a list of criteria by which to judge the investment competitiveness of a specific country, the most important of which are identified and described as follows. The Corruption Perception Index measures the degree to which corruption exists in the misuse of public power for private gain by politicians and public servants. Ranking 8th out of 180 countries worldwide, Australia scores 8.7 out of 10 as one of the least corrupt countries in the world. On the other hand, the Ease of Doing Business Ranking of the World Bank measures business regulations and their enforcement for the protection of investors, property rights, employment issues, and contract enforcement capabilities. Australia scores 9 out of possible 10 as one of the countries with the most favourable environment for doing business in the world. Another measure is the Global Competitiveness Report compiled by the World Economic Forum, an NGO headquartered in Geneva, Switzerland, based on published data and a survey sent to 11,000 executives worldwide. Australia recently ranked 15th out 133 as one of the more competitive countries in the world. Still another gauge is the Index of Economic Freedom reported annually by the Heritage Foundation. The index includes trade barriers, corruption, government expenditure, property rights, and tax. Australia scored 82.6 ranking 3rd, behind Hong Kong SAR and Singapore, out of 179 countries per this measure. Still another measure is the Globalisation Index, compiled by AT Kearney and Foreign Policy. Here countries are ranked by using key components of global integration in their economic, personal, technological, and political dimensions. Australia scored 8.7 out of the possible 10. (Globalisation index) Finally, and most relevantly, the Inward FDI Potential Index, compiled by the UN Conference on Trade and Development (UNCTAD). This index uses economic factors that affect an economys attractiveness to foreign investors, by tracking the impact of probably political, economic and regulatory changes on FDI plans and preferences of executives of the worlds leading companies. In this respect, Australia ranked 22nd out of 141 countries globally. (Country insights, Australia, Globaledge) A related measure, the FDI Confidence Index, has improved Australias ranking for 2007 indicating that it ranked eleventh overall. Mining and oil and gas companies appreciate Australias investment prospects. Other sectors that look attractive are the services sector which includes engineering, accounting, research, and health care. Other countries that rated high were China, India, the United States, Germany, and Brazil. The global backdrop on FDI Multinational firms, or transnational corporations (TNCs) are the largest source of FDI, estimated at 95 percent of total inflows. Most of these companies are based in industrialised countries. A large proportion of these investments go to other developed countries that include the United States, the United Kingdom, Japan, and EU (Germany, France, the Netherlands), and Canada. The following chart displays the regional distribution of FDI flows (Foreign direct investment, (Foreign direct investments, Earthsummit 2002): Fig. 1: Regional FDI Inflows in 1998 (Source: UNCTAD 1999) Some 92 percent of FDI flows came from developed countries and 72 percent went to their counterpart developed countries. Investments that reached low-to-middle income countries were concentrated in Asia and Latin America, with less proportions going to Central Europe and Africa. This skewed distribution can be attributed to the inherent advantages that locating in developed countries possess from the viewpoint of multinational firms in terms of infrastructures, human resources, and economic and political stability. Australia and the requirements for inward FDIs There are policies and procedures that a prospective investor must adhere to. Foreign investors normally acquire an Australian company either through a purchase of assets or shares, subject to a regulatory framework. If a foreign investor wishes to acquire the assets of a domestic company, approval has to be obtained from the Foreign Investment Review Board of Australia, which must be convinced that on balance the increase in foreign investments will be beneficial to the Australian economy.. (Cooke 1988). The requirements are quite lengthy and complex and may be the subject of another paper. Australias Inward FDI Performance Australia recorded US$22.27 billion in foreign direct investment for 2007 (most recent published data available). The UNCTAD WIP Survey included Australia among the top ten most attractive FDI destinations in the latest two surveys of executives of the largest transnational corporations (Stock of foreign investments). These executives cited Australias "access to regional markets, skilled labour and expertise, market size and growth, natural resources, quality of infrastructures and government effectiveness as factors favoring investment." Other factors that helped Australias favourable image were reforms in labor market and business taxation and the deregulation of finance, telecommunications, and utilities. On the other hand, the value of mergers and acquisitions during the same year was recorded at US$54.66 billion, the highest in the APEC region and besting FDI leaders China and Hong Kong SAR. Table 1 below shows more information. Table 1: Foreign Direct Investment Inflows and Cross-border Merger and Acquisition Sales by Host Economy, 2007 (1) The total stock of foreign investment in Australia stood at $1.6 trillion as of June 2007, of which 21 percent constituted foreign direct investment (the rest, 63 percent, being portfolio investments). The stock of foreign direct investment was registered at $334.5 billion as of that year, compared to $984 billion for portfolio investments. (Stock of foreign investments). The United Kingdom and the United States remain Australias biggest sources of foreign investment. The UK accounted for 24.8 percent of the total, whilst the US contributed slightly less with 24.3 percent. However, in FDI terms the US had a higher figure with 24.3 percent compared to UKs 15.4 percent. FDI stock grew by 1.4 percent in 2008, but since 2003 this had increased by a higher 8 percent annually. Significantly the EU accounted for one-third of inward foreign investments (specifically Switzerland, Germany, France, the Netherlands, Belgium, among others). Asian countries that contributed to Australias investment were Korea, China, Singapore, Malaysia, Hong Kong SAR, and Japan. (Foreign direct investment by nation) http://www.business.nsw.gov.au/aboutnsw/Trade+and+Investment/B9_foreign_invest_by_nation.htm Table 2: Stock of foreign investment in Australia by country, 2008 The mining industry of Australia absorbed most of the foreign direct investment in 2007 with total stock of $92.2 billion, or 24.5 percent of the total ($377 billion), followed by manufacturing ($67.6 billion, or 17.9 percent), wholesale and retail trade ($54.5 billion or 14.5 percent), and finance and insurance ($51.0 billion or 13.5 percent). The FDI total grew by 15 percent, with mining contributing the largest share of $11.1 billion, followed by business services, construction and manufacturing, in that order. (Stock of foreign investment). Recent FDI developments: Their implications for Australia Foreign direct investments - both greenfield and mergers and acquisitions - were growing steadily from 2003 to part of 2008. Owing to the global economic recession that began in late 2008, greenfield investments fell 18 percent, and the value of M&A deals were estimated to fall even faster. However, with the incipient economic recovery, the IMF is expecting global economic growth to be just over 3 percent compared to a negative 1.1 percent in 2009. FDI projects are expected to grow appreciably by the second half of 2010. (Emerging from crisis, FDI magazine) During the global economic recession, the countries that were affected most were the transitional economies in Central Europe, where the number of greenfield investments dropped significantly, per UNCTAD study. China, having been chalking big FDI numbers, experienced the biggest nominal drop, although not in percentage terms. The United States, the United Kingdom, Canada, Ireland, and Hong Kong SAR demonstrated their resiliency with investment growth that bucked the global trend. So did Australia. As shown in the next table, Australias inward greenfield investments grew in 2009 from 216 to 237 -- an increase of 21 projects – thus causing Australia to rank seventh overall. (Emerging from crisis, FDI magazine). Table 3: Largest increases in number of greenfield investment projects, by destination country. Source:http://www.fdimagazine.com/news/fullstory.php/aid/3253/Emerging_from_crisis.html On account of its wealth of natural resources and a favourable environment for business, Australia has shown much resiliency amid the global economic crisis by registering increases in foreign direct investments. After the initial recovery period, Australia is likely to prove its economic vitality in this regard even more. Conclusion Many developing countries vie for foreign direct investments because FDIs are deemed essential to their economic development. In fact, it is widely held that there is a significant correlation between investment growth and the growth of a national economy and the improvement in social well-being of the domestic population. The governments of the developing countries formulate and implement policies that would provide incentives for foreign firms to set up their manufacturing plants in those countries. This is accomplished through legislated policies giving tax concessions, free repatriation of earnings and capital, tax-free importation of equipment and supplies, and other incentives. These are hoped to counterbalance the perceived economic risks - in terms of inflation and foreign exchange volatilities - and political risks. Developed countries, on the other hand, do not have to formulate such policies as they attract investments ‘naturally’ because they have a viable free market system and a stable political situation. Whether through greenfield investments or through mergers and acquisitions, most developed countries – which are also incidentally engaged in outward FDIs -- attract investments not only from developed countries themselves but even from developing countries as well. Australia is an exporter of raw materials like many developing countries. It also has well-developed manufacturing and services sectors like most developed countries that have to import their raw materials. What makes a country capable of bucking the downward FDI trend during the recession, as expounded in this paper, is perhaps an interesting case study for any student of investments and development economics. 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