Host Country Controversies Regarding the Costs Versus Benefits of Foreign Direct Investment - Term Paper Example

? Host country controversies regarding the costs versus benefits of FDI BY YOU YOUR SCHOOL INFO HERE HERE Host country controversies regarding the costs and benefits of FDI Introduction Many countries promote foreign direct investment as it can lead to capital gains, labour improvements, act as a source of taxation revenue, and also improve the competitive position of the country when foreign companies transfer technology and knowledge. These are tangible gains that stem from FDI, however there is a downside to foreign direct investment that relates directly to the host country. Changing market or economic conditions occurring within the host country can have impact on whether or not the source of FDI is considered a long-run advantage. For instance, fluctuating exchange rates occurring over a stable period could lead to domestic manufacturing slowdowns, thus giving foreign competition more opportunities to outperform domestic firms. When local currency depreciates, it creates many disadvantages to the host country economically. Furthermore, enterprises that are prone to engage in corruptive activities, such as offering bribery payments for industrial protection, further erode potential revenue gains in the host country. This paper describes the costs and benefits of foreign direct investment as it pertains specifically to the host country. The impact of corruption on revenue One benefit of FDI is that host countries often promote foreign direct investment through the provision of tax incentives as a short-run strategy, due to the potential labour, capital and welfare improvements that a multi-national enterprise can provide the host country. However, in the short-run, governments are limiting their revenue-building capacity until these tax incentive programmes run their course. Further, in some nations, especially those with more power distance as measured by Hofstede’s Cultural Dimensions framework, corruption is a commonplace activity that occurs between government and the foreign investor. Corruption is measured by situations such as offering bribes to government to improve their political and contractual connections as a means to gain favour (Ionescu 2010) and also for the provision of lessened tax assessments, investment licensing and specialized permits (Al-Sadig 2009). Why is corruption a concern for the host country over the long-term? Less-developed countries that rely on foreign direct investment in order to sustain their long-run economic needs gain the benefit of capital from corporate taxation and the provision of permits and licensing contracts. When a foreign investor is able to procure special favours from governmental officials through direct bribery payments, this reduces the foreign direct investor dependency on the tangible revenue-building structure associated with these allowances. As identified, this is more commonplace in nations where there is a high power distance. Power distance is defined as social or political inequality within a nation (Mathis and Jackson 2005). Countries such as France, Mexico, Brazil and India maintain high power distance which tends to segregate higher levels of authority from lower-level employees and citizens. Nations that have political and social autocratic systems provide ample opportunities for foreign investors to engage in corruption activities which can severely reduce revenue over the long-term associated with taxation and other fees for operating business. Host countries need to consider the potential capital losses that can occur as a product of foreign direct investment and the nature of the political relationship with the investing firm before promoting its widespread encouragement. Though it is possible that these factors can be mitigated through more control-minded political policies, it is still a risk issue for the host country that can deplete significant capital production. The impact to local producers Foreign direct investment is generally considered by firms in developing nations due to the disparities that exist in talent associated with productivity, marketing and labour payments as compared to their home country of operation. Foreign-owned businesses and foreign joint ventures that invest in China, as one example, have been found to have better exporting performance than domestic firms after establishing a production facility in the local market (Manova, Wei and Zhang 2010). Occurring within the country may be limited credit availability to domestic production companies that provides domestic firms with higher trade costs in the long-run. Situations regarding the economic stability within the country and capital lending are major considerations before the political systems actively encourage foreign direct investment. When limited credit availability is a genuine issue within the host country, it gives foreign producers an advantage as they are usually able to access funding from their parent company and are thus not affected by local economic conditions like that of domestic firms (Manova, et al.). In a situation where a foreign producing firm has been given an advantage related to capital procurement, they have the resources to outperform domestic firms in distribution, marketing advertising and promotions, and also general productivity with resources to improve the production environment with more modern technologies (and other gains). The host country should consider the economic stability of the region over the long-term before putting their domestic firms at risk by foreign investment firms that are not interdependent on domestic financial lenders or credit availability restrictions. In some developing nations where foreign direct investment is encouraged, pricing strategies are significant concerns for market orientation and revenue production for the company and national host country government (Carbaugh 2009). Foreign firms often have a pricing advantage due to the low exchange rates on host currency which make foreign products in higher demand for the host country consumers (Carbaugh). In this scenario where currency values are significantly different between the host country and the point-of-origin of the foreign investor, it becomes easier to saturate the local market with foreign goods since consumers demand lower prices that are more easily achieved on foreign products. The long-run effects of this situation are diminished capital production for host country organisations and less tax revenue for the host country government. The tariff issue Developing countries, in an effort to build capital for the government, impose export tariffs for products that are produced by foreign investors and then delivered to other nations (Carbaugh). The benefit of imposing tariffs is the application of a surcharge for each piece of exported, foreign merchandise, thus representing growth in capital for the host country. The benefit of capital improvements can be applied to other governmental investments that promote better welfare for citizens. However, not all foreign direct investors establish their facilities overseas, rather they invest in management to overseas business relationships with the host country whilst still exporting their goods from their headquartered point of origin. Imposing import tariffs on foreign goods is a common strategy that affects foreign investors whether or not they establish production facilities in this foreign nation. The problem with import tariffs associated with foreign direct investment can be illustrated by a scenario within the United States. In 2002, the US government imposed tariffs on imported steel between 15 and 30 percent as a means to avoid steel products from flooding the US market from foreign producers (Blecker 2002). The imposition of these taxations was to drive more export-led growth in the steel industry. The tariffs were in response to a depreciating dollar. However, this had a trickle-down effect in the long-run. A depreciated dollar makes it more costly for tourists to travel overseas and also imposes higher inflation in the country. By adding tariffs to imported steel, it did not change the tangible demand levels for steel in other countries, thus foreign exporters simply moved their product to new markets to avoid the higher surcharges. Ultimately, the imposition of import tariffs on foreign merchandise impacted the tourist industry revenues and the short-term potential for export-led growth that led to a trade imbalance between exports and imports that still continues today. When foreign currency appreciates due to economic conditions or monetary policy, foreign firms have a difficult time selling their products in the foreign market (Carbaugh). Thus, imposing tariffs on exporting goods or foreign imports to the foreign investor have long-run consequences economically and can impact multiple industries in terms of revenue production. If foreign goods are being distributed by the foreign investor into the host country with tariff impositions, it alters the demand factors of domestic consumers that can impact political revenues as well as domestic firm strength and competitiveness. Export tariffs as a strategy to gain additional income from the foreign investor can also impact the pricing strategies of domestic firms, thus removing their competitive pricing advantages in the long-term. Thus, one of the controversies is whether or not foreign direct investment can have long-run consequences regardless of the type of revenue-building strategy imposed by the host country government. General outperformance of domestic companies Since it is usually the imbalance between currencies and capital needs that promote foreign investors to invest in another country, there is the potential for the host country to suffer negative impacts regarding domestic firm productivity and economic strength. “A technologically superior multi-national can take market share from domestic enterprises, forcing them to produce at lower output levels with increased costs” (Driffield and Love 2007: 462). It is not only technology superiority that gives foreign investors advantages, it can be found in labour and talent management, the development of marketing strategies that understand the consumer better than domestic firms, better access to cheaper distribution networks, or any variety of operational superiorities. The benefit is that the host country might be gaining extra revenue by promoting foreign direct investment, however they are essentially flooding a lesser-developed country with top talent from developed nations with well-structured management and governance principles that can easily outperform less-skilled domestic industries. Unless these foreign investors are willing to share their knowledge or build localized joint ventures, a substantial benefit when knowledge transfer exists between the host country and the company, competitive advantages in many key areas of business can create significant financial risk for the domestic firms over the short- and long-term. Conclusion Though the aforementioned do not represent all of the costs associated with FDI for the host country, they do represent the real-world realities of promoting foreign direct investment and illustrate the potential consequences to the host country. Governmental revenues are affected negatively when corruption exists and also when, over the long-run, foreign firms are able to outperform domestic firms in terms of capital procurement, marketing expertise, and many other operational imbalances that come from knowledge resources within the organisation. Tariffs, also, as a strategy involved with foreign direct investment have long-run consequences that affect industry, competitiveness and even the currency value as compared to other global currencies. It should be said that the opposition to foreign direct investment is well-supported regarding the potential consequences of allowing foreign firms to establish a base of exporting or domestic industry in the foreign nation. The most significant disadvantage comes in the form of economic insecurity and depleted capital production not so much in the short-term, but over the long-run. FDI maintains many host country risks that tend to overshadow the benefits of its promotion and encouragement. References Al-Sadig. (2009) The effects of corruption on FDI inflows, Cato Journal vol. 29, issue 2, 267-294. Blecker, R. (2002) Let it fall: the effects of the overvalued dollar on US manufacturing and the steel industry, URL: http://www1.american.edu/cas/econ/faculty/blecker/dollarpaper.pdf [last accessed 11/09/2011. Carbaugh, R. (2009) International Economics, 12th ed., South-Western Cengage Learning. Driffield, N. and Love, J.H. (2007) Linking FDI motivation and host economy productivity effects: conceptual and empirical analysis, Journal of International Business Studies vol.38, issue 3, 460-473. Ionescu, L. (2010) The differential effect of corruption on corporate political connections, Management and Financial Markets vol.5, issue 4, 202-207. Manova, K., Wei, S. and Zhang, Z. (2010) Firm exports and multi-national activity under credit constraints, SSRN Working Paper Series, URL:www.proquest.com [last accessed 11/09/2011] Mathis, R.L. and Jackson, J.H. (2005) Human Resource Management, 10th ed, Thomson-South Western. Read More