Key Factors That Make the Emerging Market Attractive to MNEs - Essay Example

?Multinational companies play a key role in connecting rich and poor economies and in transferring capital, wisdom, thoughts and system of value across borders. The outcome of their interaction with institutions, organizations and individuals has generated positive and negative spillovers for a variety of stakeholders in both domestic and host countries. Therefore, they are treated as the focal points in the popular debate on the merits and dangers of globalization, especially when developing and emerging economies are concerned. (Narula and Dunning, 2000; Meyer, 2008). The role of Multinational companies in emerging economies was very important for both the policymakers and the MNCs themselves. The policymakers influenced the regulatory regime under which both MNCs and local business partners operate. They focused in understanding how operation of multinational firms affects the economic development and nationwide wellbeing. The anticipation that FDI will benefit the local economy has motivated many governments to present striking incentive packages to attract investors. The underlying principle was that the social repayment of incoming FDI would surpass the personal benefits of FDI and investors would take into account only the latter when deciding over investment locations. The policy debate requires scientific evidence on how and to what extent, FDI will impact the local surroundings. The impact of MNCs on host countries was still not well understood, despite having the policy relevance. (Bhagwati, 2004; Bartlett et al. 2004) This paper will take into account one particular emerging economy and find out the factors that play crucial role in attracting MNCs towards it. For this paper China has been chosen. Key factors that make the emerging market attractive to MNEs: China has a number of advantages that are country specific and are believed to be the major factors that work behind attracting FDI to the country. According to the researchers (Swain and Wang, 1995, Liu et al, 1997, Zhang, 2002) the factors that make the emerging market attractive to MNEs identified by FDI theories can be classified into three categories – Micro, Macro and Strategic factors The Micro factors relate to the advantages related to ownership of including product differentiation and the firm size. The Macro factors stress on the market dimension and the expansion of the host country, which is determined by GDP, GDP per capita, GNP or GNP per capita, as rapid economic expansion may generate large home markets and businesses. Other macro factors are taxes, political risk, rates of exchange, and so on. (Dicken, 2007) The Strategic factors relate to long-term determinants such as efforts to protect existing foreign markets, to spread out activities of firms, to uphold a grip in the host nation and to balance another type of investment. Since 1980, the GDP of China has grown between 8-9% per year. Researches were evident that the market size determined by GDP, GDP per capita, GNP, or GNP per capita has a major consequence on inward FDI. Speedy economic augmentation has created huge domestic markets and business prospects for foreign firms to invest in China. Swain and Zhang (1997) analyzed the data of FDI in China for the period of 1978-92 and have used GDP and real GDP growth rate. Liu et al (1997) using GDP, GDP growth, wages, reached to the conclusion that the size of market s the fourth most significant economic determinant for the pledged FDI in China. Their empirical results showed that the rate of growth of real GDP was significantly related to attracting MNEs in China. The direct and positive relationship between market size and inward FDI is also found by Zhang (2000) and Wei and Liu (2001) who showed that both US and Hong Kong MNEs were attracted by the large market size of China. This reflected the market-seeking motive of foreign firms to shift their focus from mainly export-oriented investments towards the Chinese markets. Therefore, most results of the empirical researches agreed with each other that market size was the most vital factor in attracting the MNEs to invest in China. The bigger the market size of region, the more FDI is likely to be obtained (Zhang, 2002). One of the important determinants of FDI was the cost factors among which labor cost has been broadly taken into account in the study of FDI. Logically though it has been said that foreign firms can take advantage of lower labor cost by investing in emerging economies, there is another thought that the transportation costs and low productivity often surpassed the cost of labor in these nations (Miller, 1993). Swain and Wang (1995) showed a positive association between the relatively cheap labor in China and incoming FDI. Liu et al (1997) argued that the low labor cost has been one of the vital economic determinants for FDI. China’s relatively low labor costs have encouraged foreign Multinationals to invest in the land of China. However, Zhang (2000) was of the opinion that the labor cost factor did not play in significant role in US MNE decision making process relating to investment in China. However, in recent times, low labor costs are still proving to be the key location factor for foreign investors in China (Wei and Liu, 2001), particularly in manufacturing industries like automobile assembly and telecommunication equipment. It was also founded that electronic apparatus and telecommunication producers in Hong Kong and Taiwan have proven mainly expert at influencing low-cost mainland Chinese workers for gaining international competitive advantage. However, the low-labor-cost advantage of China may not sustain for long as China is facing huge competition from its neighboring countries like Vietnam, Laos, and India, which are also endowed with cheap labor and have adopted a range of policies to attract FDI. Some empirical studies have concluded that political factors have not played a crucial role for firms’ decision over investing abroad (Swain & Wang, 1997 Zhang, 2002), although it has been argued by many economists that political instability in the host country have potential to discourage the inflow of FDI and most of the empirical researches have extended their support to this argument. It is said that geographic proximity of the host to the home country of investors reduces informational and managerial uncertainty, lowers monitoring and transportation costs and reduces the exposure of multinationals to risk. In theory, less is the FDI, the more the geographic distance between the home and the host country. (Wei and Liu, 2001). However, geographic distance has less influence as a determinant of FDI in China, as rapid development in communication technology mitigates distance factors. It was founded that the location of FDI projects in China, having fund capital from Hong Kong, were hugely influenced by geographical distance. In China, geographic location within the country is a concerned factor for nearby investors, however, there is no evidence demonstrating whether the location of FDI projects from western countries was related to geographic distance. The reasons might be that given the long distance between China and most western countries, the geographic distances within China seemed insignificant. (Liu, et al, 1997, Zhang, 2002) The idea that the geographic division of FDI in China was impacted by geographic location rather than geographic distance was supported by the occurrence that FDI projects funded through capital from Taiwan were mainly located in Fujian (eastern China), while Hong Kong investors selected a location in Guangdong Province (southern of China). FDI flows into China were further encouraged by the culture proximity between FDI sources and hosts (Liu, et al, 1997). This is true for both of Hong Kong-Guangdong province and Taiwan-Fujian province (eastern China) because these two pairs were not only geographically adjacent to each other, but also spoke the same dialect. There was less evidence to support the view that the cultural issues were a significant determinant of western FDI in China (Liu et al, 1997). Impacts of FDI: Various studies provide conflicting predictions concerning the effects of direct foreign investments. There has been several approaches relating to the impact of FDI including Neo-liberal, Keynesian, etc. Neo-liberals have extended a number of arguments in favor of FDI and tried to prove FDI to be beneficial for developing countries thereby contributing to development. They advocated free flow of capital arguing that it ensured economic efficiency, allowed capital to seek the highest return across the borders, fastened economic growth as the free flow of capital reduces investors risk enabling them to diversify their investment better. (Lipsey et al. 1994 ; Han, 2004 ). Pro-FDI economists asserted that the result of coming FDI was limited ability of host government to implement bad policies. Moreover, foreign flow of capital might spread the best practices of corporate governance, accounting rules, and legal traditions to LDCs. (Han, 2004 ). A number of other arguments that have been forwarded by the supporters of FDI are as follows: 1. FDI helps in enabling technology transfer through capital inputs, that could not be gained by trade otherwise (Brock, Urbonavicius, 2008). 2. Through FDI a competition can probably be encouraged in home markets of input. 3. FDI helps in contributing to human capital development as foreigners engage themselves in the training of employee. (Lipsey et al. 1994 ; Han, 2004 ). Moreover, profits from corporate taxes may be used to encourage host country’s development while investing in infrastructure for instance. FDI has an advantage over different types of other investments including portfolio or loans. FDI proved to be much more flexible in times of economic crisis. While latest events showed that at the time of recent crisis some big multinational companies such as American car producers who were largely settled in EU member states (Spain, Poland, England), were shutting down factories in Europe and thus paying little attention on huge negative economic and social distortions. (Lipsey et al. 1994; Dicken, 2007)). Although there were benefits provided by FDI but they had their circle of disadvantages also. Many scientists strongly disagree that one size fits all. That was a more cautious approach. Keynesians says that if FDI brings in benefits in one particular country, they do not necessarily do the same for other nations as well. Many things depend on prevailing conditions in receiving country. This simply implies that the effects should be different not only across countries but also within countries at different time as conditions change (Lipsey et al. 1994; Han, 2004; Dicken, 2007) ). Advocates of Keynesian approach think that there market failures have strong existence and they can ensure efficiency for the following reason: Firstly, it is not necessary that there is always perfect information. Lack of correct information can result in attraction of inadequate or incorrect types of investment. Secondly, it cn well be possible that interests of investors are not similar to that of the receiving economy. That is the reason for having government regulations. Higher level of competition may be good for the host economy, however, not always. Coming FDI may have the capacity to push out potentially more productive local business. In that case there could be severe loss of in the host country. in that case government protection of local activities should be in place. Lipsey et al. 1994 ; Han, 2004 ). The Role of FDI in Chinese Economy: Positive Effects on Economic Growth: The most prominent contribution of FDI to China was to expand its manufacturing exports. Foreign invested enterprises has enhances China’s export volumes and also developed its export structure. Though in 1980, China’s exports ranked as 26th in the world with volume of 18 billion dollar and 47% of exports as manufactured goods, the corresponding number in 2005 were 3rd in ranking with 762 billion dollar and 93% of exports as manufactured goods. In 2005, the value of exports by FIEs was 444 billion dollar which comprises of 58% of China’s total exports. (Zhang, 2006) China’s economic growth has also been pushed by FDI through raising capital formation, augmenting industrial output, creating employment and through addition of tax revenues. In the 1980s, the ration to FDI to GDI has risen up from a insignificant level to 7% in 1992and then to 17% in 1996. In total, the share of industrial output by FIEs grew from 7% in 1992 to 36% in 2004. (Zhang, 2006) FDI has helped in reducing China unemployment pressure and has contributed to government tax revenues. By the end of 2004, FIEs employed 23 million Chinese which comprised of 10% of total manufactured employment. The tax contributions from FIEs rose with FDI flow sand its share in China’s total tax revenue rose from 4% in 1992 to 21% in 2004. (Zhang, 2006) In addition, FDI has facilitated China’s transition toward a market system that started in the late 1970s which promoted income growth thereby bringing in extra gains for China. This gain stimulated the move towards marketization by presenting a market oriented institutional framework thereby contributing to changes in the ownership structure towards privatization by promoting competition and facilitating the reform of state owned ownership and hence the integration of China into the world economy was enhanced. (Zhang, 2006) Negative Effects on Economic Growth: There were economic arguments which suggested that FDI also can have negative impacts on the Chinese economy because of certain reasons like: There can be a possibility that FDI instead of closing the gap between domestic savings and investment, it can actually lower them. In long run, FDI can reduce China’s foreign exchange earnings on both capital and current accounts. Due to transfer pricing and variety of investment allowance by the Chinese government, contributions of foreign invested enterprises’ public revenue may be considered as less. Due to foreign dominance in Chinese markets, the management know-how and the technology provided by the MNCs may inhibit developing local sources of these scarce skills and resources. (Zhang, 2006) The criticism of FDI can be conducted on more fundamental levels of long term national welfare. For instance, MNCs can hold back domestic firms and exploit them by using their advantages in technology to drive out local competitors. The activities of MNCs may reinforce China’s dualistic economic structure and exacerbate income inequalities due to their uneven impact on development. MNCs can persuade government policies which in turn can affect China’s development by gaining huge protection, tax rebates, investment grant and the inexpensive factory sites and social services. MNCS can take over on Chinese assets and jobs so as to create pressure and a have a demanding position during political and economic decisions at all levels in China. (Zhang, 2006) References: 1. 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