Concepts and Frameworks Related to FDI - Dissertation Example

 Concepts and Frameworks Related to FDI Introduction The term foreign direct investment is regarded as direct investment in production by a company of a certain country into another country with the aim to expand the business in the target company. The foreign direct investment is used to different forms of investment activities. In the common terms foreign direct investment includes mergers and acquisitions, reinvesting profits gained from off shore operations and building of new facilities. In calculation of GDP, investment is an indispensable factor. However, direct investments do not take into account investment through purchase of shares. The types of foreign direct investment include horizon, platform and vertical. The first type of investment arises when a certain firm duplicates the activities in the home country at the same value chain stage through foreign direct investment in another host country. When the firm shifts in different value chains vertical foreign direct investment takes place. The assignment will focus on the concepts and the frameworks that play a part in inflows of FDI. Discussion will also be provided on the factors that have the capability to affect FDI and data on the recent FDI figures for the selected countries will be taken into consideration. The countries selected for the discussion are Brazil, India, Russia, China, Japan and United States. A relevant time period will also be taken under consideration. Concepts and frameworks related to FDI The Heckscher-Ohlin is a general equilibrium model of international trade. The main idea behind the model is that countries will engage themselves in exporting those products which uses abundant and cheap resources while import those products which use relatively scarce resources. The comparative advantage of a country is determined by the factors of production like land, labour and capital (Leamer, 1995, p. 39). Countries enjoy comparative advantage in those goods which uses relatively abundant resources available locally. The profitability of the goods is determined by the costs of input. The model assumes the presence same technology existing between countries ie. It assumes the production technology to remain identical. The model introduces variations in labour productivity. Capital is also privately owned in the model. The production of output under the model must have constant returns to scale while same price persist between the countries under consideration in the application of the model (University of Rochester, n.d. p. 2-3). To explain the observed pattern of international trade the product life cycle theory emerged. The theory suggests that in the early phases of the product life cycle the labour and other factors of productivity required to produce the product originates from the place where the product was invented. But after the product comes into existence and becomes available in the world markets the production of the products gradually shifts away from that place. The model generally applies to the products that serve the high income groups. The five stages of the product cycle theory are introduction, growth, maturity, saturation and decline. In the first phase new products are introduced with the view to meet local needs while new products are exported to some similar countries where it is expected the demand for the product will be same as the host country and the income pattern of the residents are similar as well. In the second phase the product is produced elsewhere and introduced in the local market to cater the growth of that market. Therefore production shifts to other countries on the basis of production costs. In the third phase the producer offering goods at lower costs wins while the industry contracts. The fourth phase is that of stability where the market condition saturates and there is no possibility to increase sales further. In the last phase the market for the products are available only in the developing countries when the demand declines in the developed ones. The OLI paradigm is a mix of three various theories relating to FDI. The ownership advantages are usually intangible and it is possible to transfer within enterprises at low cost. The advantages have the capability to raise the level of revenues or lower the costs that sets to offset operating costs in abroad location. The additional costs of a corporation operating in a foreign country are imperfect information regarding the local market conditions, diversities in culture and legal environments and increased communication costs for operating at a distance. The location advantages are of prime importance in determining the host country for the corporations. The country specific advantages can be classified into three categories. The economic advantages consist of the qualities as well as the quantities of production factors and scope or size of the market. The specific government policies constitute the political advantages and influence the inward flows of foreign direct investment and international production. The distance between the home and host country are included in the cultural and social advantages. The model of Porter’s diamond states that a nation has the ability to create advanced factor endowments like upgraded technology, efficient labour and government support. The determinants of national competitiveness have been explained with the help of diagram as follows. The ingredients that lead to national competitive advantage are availability of skilled resources, information that can be used by the firms to take the decision regarding the opportunities to pursue, the objectives of the organisations, the idea of the organisations on invention and innovation (The Manager, 2001, p. 1). The local market can provide more market exposure for a product than the foreign market and the local firms tend to devote more attention towards development on that product and therefore when the firms begin to export that product it enjoys some comparative advantage. In the figure above the effect of one point depends on the other. It can also be sated that the system is a self-reinforcing one. The government’s role in the diamond system is to encourage the companies so that they can attain higher revenues and increase their performance. Before discussing about regional competitiveness it is important to discuss about the broader notion of competitiveness which has both micro level and macro level perspectives. At the firm level a clear notion of competitiveness exists which is based on the ability of the firms to compete and gain profit. At the firm level the competitiveness of the firm depends on the consistency of the firm to produce good quality products and offer them at affordable prices in the open market. To sustain the filed the firms must need the minimum requirements, and more competitive a firm is more is the ability of the firms to gain market share. The firm that goes on to remain uncompetitive will be thrown out of business. At the macro level the notion of competitiveness is more strongly contested. The central goal of the economic policy is to improve the regional competitiveness. The lack of commonly accepted definition opposes the concept of competitiveness at the macro level. According to Krugman national competition is a dangerous obsession and it is incorrect to make an analogy between nation and firms. The success of one firm depends on the failure of other firm while in case of competitiveness between nations the success of one nation is correlated with the destruction of opportunities for other and trade between two or more nations is not a zero sum game. Krugman states competitiveness as growth in the national living standards which is determined by the rate of growth in productivity. Competitiveness of a nation is described to be the capability of nation to produce goods under free and fair market conditions that satisfies the wants of the international markets and simultaneously increases the real income of the citizens. The competitiveness at the national level depends on the performance of the economy to shift the productivity activities which can generate high levels of real wages. The term competitiveness is associated with rising standards of living, expansion of job opportunities and the capability of the firm to maintain the international obligations. Competitiveness is only the ability of the firm to sell abroad but also to maintain trade equilibrium (Garden , n.d., p. 1-4). Factors affecting FDI It is believed that attractiveness to FDI for developing countries is the drift towards globalize invention and promotion. The multinational enterprises considered the developing countries to be profitable investment ventures in 1990s and therefore the period witnessed a flow of FDI. Experts are of the opinion that the shifts in the process of globalization drastically changed the motivations for FDI in developing countries. It is not sufficient to offer promising markets to drive in FDI but it is necessary for the policy makers to strive for location attractiveness. The policies that pave the path for favourable investment climate are in line with the creation of location precise assets required by FDI. The importance of location determinants of FDI have changed. It can be said that the traditional determinants of FDI have not disappeared but the importance is taking the declining curve. More importantly the size of the national markets has declined. At the same time the differences in cost between locations and the quality of infrastructure have gained importance (Binsaeed, 2009,pp. 1-4). There are certain regulations adhered to certain countries that limit the flow in of FDI. A regulation from the part of the government can act as a disincentive for the organizations and they may initiate to look out for other opportunities excluding that country. The political steadiness is also significant in attracting FDI. Political turbulence will lead to flying away of the investment ventures and companies are always concerned in operating the business effectively and efficiently. FDI inflows in recent years The diagram below provides the evidence of the flow of FDI on the countries under consideration. The above figure shows the flow of FDI for counties like China, India, Brazil, Japan, United States, European Union and the rest of the world. It can be seen from the diagram countries like Brazil, India and Russia experienced highest flow of FDI. The period that has been taken under consideration is 1990 to 2011. The horizontal axis depicts the years while the vertical axis shows the flow of FDI in million dollars. The peak has always belonged to the first group of countries followed by China. The flow of FDI reached at its peak in the year 2000 while the next big leap has achieved in 2007. There has been a substantial difference between flow of FDI between the European Union and United States. Close competition in attracting FDI exists between rest of the world and other developing countries. The countries of Brazil, India and Russia extended the lead in the later stages of 2000s while they were almost in line with China in the initial stages of 1990. Japan and other developed countries showed intense competition. The flow of FDI in the European Union has not been constant. In the decade of 1990s the flow was low as in other countries but the flow got higher in 200. In fact in 2000 the flow was at its peak. The flow declined in the middle phases of the decade till returning to the upwards sloping curve in 2007. Since then the flow has not remained constant. It again took the declining curve in 2008 to 2010 and increased again in 2011. The flow of FDI in United States increased in 2000 as was the case for European Union. It can be seen from the diagram that rest of the world strengthened their policies of attracting FDI in the years of 2001 to 2011. In 2011 the countries included in the rest of the world succeeded a taking a major gap with the countries of European Union, United States and some other developed regions. With the view to attract FDI in India the cabinet committee of Economic Affairs approved the proposal to review the policies regarding to FDI. The changes in the policy will increase the inflows of FDI in India at the same time will make investments easy and attractive. According to the new guidelines passed the proposals of foreign investment amounting to more than 12 lakh INR will be taken care by the CCEA while the investments below that stipulated amount will be cared by the Finance Minister. It has also been decided that foreign investments that have the prior approval from the FICB then they will not require fresh approvals (Arbeit, 2007, p. 4). The President of Brazil has devoted much of his time in influencing the international community and presented Brazil as a safe destination for foreign investment. It should be noted that the President has adopted the capitalist policies without ignoring the social welfare of the country. The President appointed the former worldwide president of BankBoston who maintained the conservative fiscal policies and tried to ensure the commitment of the country to protect contracts. Brazil also intends to invest in other countries which will provide worldwide presence of Brazil in the global market. The finance minister made an announcement of a program named as “invest now” which provides return value for the paid amount in federal taxes by the organization operating in that country (Kirton and MvConkie, 2012). The IFDI law in Russia was passed in 1999. The law provides equal rights for the foreign as well as for the Russian investors although there are presences of some exceptions that act as the barrier to foreign investment. The various decisions of the Russian government also decide the climate of investment. Special laws and government decisions can also bring in barriers for the foreign investors (Kuznetsov, 2010, p. 2). Before the emergence of the market institutions China took the initiative to open up foreign investment in coastal areas and focussed in attracting manufacturing FDI. By the end of 2009, the FDI in services increased thrice from that of 2000 while FDI in manufacturing increased 81 percent. The country has been open for FDI in almost all services. The decentralized approval of for FDI in the country creates opportunities for healthy competition for FDI among the home industries but can be a cause for corruption (The World Bank, 2010). In spite of the support shown by the elected officials in Japan the foreign investors willing to invest in Japan have to face substantial amount of barriers. The Foreign Trade control Law prevents the foreign investors from acquiring majority stakes in the companies of Japan. The foreign investors willing to make direct investments in the country are required to submit the file to the Ministry of Japan or to the concerned Department and they hold the right to regard or disregard the investment plans (Knowledge@Wharton, 2009). The government of United States tends to follow an open policy towards foreign investments. There are some strategic sectors in the country that protects the foreign buyers. The government also encourages the companies residing in that country to make investments overseas and make establishments of new markets which will open up job opportunities for America. In rare circumstances a country can disregard a foreign investment when it feels the investment will bring undue influence. Most of the tensions over IFDI revolve around the concern over some strategic industries in European Union. Recently focus has been provided towards infrastructure and on banking sectors. In terms of the direction of the recent FDI flows into the European region almost two thirds of the total flows were directed towards the countries like France, Spain, Hungary, and Germany. The recent years have witnessed rapid growth of IFDI although it remained marginal in terms of volume. The MNEs willing to enter into the emerging markets of energy and telecommunication has not been successful. EU follows a multilevel structure of governance which provides an interesting arena for the analysis of FDI policy. The FDI regime in the EU for each member is decided at the national level and the regime of FDI is implemented through the mode of bilateral agreements. The responsibility of the government is to provide social security to the residents (Bellak, Leibrecht and Stehrer, 2008, pp. 3). The common forms of instruments that aim to restrict FDI are restrictions on ownerships, obligatory screening and procedures of approval. There are some other policies that are not directly related to FDI but can play a part in restricting the FDI. It is important to make careful evaluation of the formal and informal instruments of FDI. The World Trade Organization prefers the mode of transparent tariffs over other methods of protectionism. There have been some cases of restricting FDI in the member states of EU with the use of the existing regulations of FDI. Comparing the methods of restricting FDI, Germany leads the table as in introducing new policies that act to restrict FDI flows (Clifton and Díaz-Fuentes, 2010, pp. 578-585). Conclusion The discussion revolved around the implications or the importance of FDI for some selected countries. The frameworks related to FDI that has been considered in the assignment are Heckscher-Ohlin, product cycle, OLI paradigm, Porter’s diamond and notions of the ‘competitiveness’ of countries and regions. 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