Foreign Direct Investment - Term Paper Example

Foreign direct investment Table of Contents Introduction 3 Importance of FDI 3 Impact of FDI on the economics of a region 4 Inward and Outward FDI 6Modes of FDI 7 Lessons from inward investment 7 Introduction Foreign direct investment involves acquisition of managerial control in a company. The threshold of this form of ownership is 10% or more in UK. This varies across countries. With the liberalization of the various global economies in Africa and Asia this form of investment has grown considerably. Foreign direct investment (FDI) facilitates the interaction of two firms and economies with varying economic differences. The foreign investors invest their funds with a long term perspective to exploit the cheap labour costs, strategic advantages, rich natural resources, market etc of another economy. In short this form of investment involves investing within the firm but outside the region. Importance of FDI This form of investment provides the necessary capital required by some developing economies which might be difficult to generate through domestic means. Besides the financial resources the foreign direct investment also provides the opportunity to make use of sophisticated and latest technology. It has been seen that the companies with no prior experience face problems in the import of such technology as this is deemed to be risky as well as expensive. With time FDI imparts a number of benefits to the host country that was hitherto not available. This includes upgrading of industrial operations, transferring of advanced technology, training the labour force, introduction of developed methods of accounting & modern management, developing the trading and finance related networks and up gradation of telecommunication related services. In sectors like services FDI uplifts the competitive strength of the host country by increasing the productivity of financial resources. Besides this the FDI’s also undertake infrastructural developments in some regions. This helps in attracting new investment. FDI alters the comparative advantages of a country through the transfer of technology (Lipsey & Chrystal, 2007). Besides bridging the gap that exists between fund requirement and domestic savings, FDI investment brings with it several benefits in the form of employment growth, technological knowhow, and better accessibility to goods & services. The capital flows of this form of investment are stable in the sense that it is invested in assets relating to long term. Moreover this form of investment improves the production efficiency of the domestic businesses. This paves the way for employment creation and increased productivity (Medina Arango, n.d.). Impact of FDI on the economics of a region The manufacturing industry in Wales is dominated mostly by the foreign companies. Towards the middle of 1990s the region started attracting internet and call centre services mainly in Cardiff area. Besides this there was an increase of foreign funding in business and financial services which diversified the composition of FDI in Wales. Over the last few decades foreign direct investment has enabled the economic growth and development of Wales. Nearly 11% of the region’s full time job employment in the private sector is offered by foreign companies. In terms of percentage this figure might appear to be less, however, the importance of FDI is apparent from its contribution towards the economy of the region. The latest ABI Statistics shows that the workforce in the foreign companies comprises 43 percent of the production sector employment in Wales. This implies that every other production worker in the region works in a foreign enterprise. Of the 140 large enterprises in Wales, 87 have foreign ownership. The employment in the manufacturing sector of foreign enterprises has remained relatively stable in comparison with the region’s manufacturing employment which witnessed a loss of approximating 25 percent during the last decade. Large merger and acquisition deals have contributed to the sector’s strong performance as FDI routed through such deals has shifted ownership of the businesses to the foreign investors. Between the years 2006-2007 the acquisition related deals safeguarded 2000 jobs. The employment in foreign owned manufacturing (FoM) has shown a downward trend however the share of such enterprises in employment has increased from 36 percent in 1998 to 43 percent in 2008. The manufacturing sector in Wales is economically dependent on the foreign investors. The extent of this reliance has increased much more than what it was ten years ago. A look at the historical development of the region reveals that the share of overseas manufacturing companies in Wales has witnessed a number of changes over the years. In the year 1994, nearly one fourth of the employment in the foreign manufacturing sector was in electronic and electrical engineering industry. There has not been any significant change in the plant numbers, however, the electronics sector currently account for 15 percent of the employment of the overseas owned manufacturing companies. For some of the industries the wages in the overseas sector is approximately 40 percent higher as compared to the domestic sector. As a result of this there has been a shift of high-skilled employees to the foreign enterprises. The move from the domestic to the foreign companies is also on account of the loss of jobs in domestic companies (Holz & Roberts, n.d.). Inward and Outward FDI Wales has successfully attracted inward investment in the 1980s and 1990s. The region gained around 15 percent of the jobs and inward investment in UK. This has had a positive impact on the region’s economy with respect to generation of employment, export earnings and capital formation. An empirical study conducted by Graham highlights that there was a shift in US from “net outward position” to “net inward position” due to the defensive behaviour of the European firms. The FDI clustering in specific areas is on account of the firms defensive policies. Most of the inward investments in UK were in the form of merger and acquisition deals. The strategic investors viewed UK as an important cross-border target. Nearly 45 percent of the inwards investment in the country in the year 2006 was on account of the acquisitions like acquisition of Spanish Telefonica’s acquisition of O2, acquisition of BAA by Spanish conglomerate Ferrovial and acquisition of BOC. This shows that Spain accounted for nearly one third of the FDI inflows in the country (Holz & Roberts, n.d.). According to the study conducted by Gorg (2002) the outward decisions relating to FDI in US were impacted by the tax rates & index relating to ‘firing cost’ of the employees in the host country. A low rate of tax and production costs is regarded as a significant ‘pull factor’ by the companies. On the other hand ‘firing costs’ tend to have a bad impact on the locations decisions of FDI. This cost includes restrictions with regard to recruitment and firing of employees, compensation and redundancy payments etc. Modes of FDI The factors encouraging FDI are location related advantages, ownership advantages and internalisation. FDI is generally of two forms- Greenfield investment- This involves establishing a new firm. Mergers and acquisitions- This involves a partial or complete purchase of an already existing firm. Bothe the above forms can be again classified as Horizontal FDI and Vertical FDI. Vertical FDI is an investment strategy by way of which the production costs of the parent company are divided by allocating the same to countries with low cost. The motive behind Horizontal FDI is to acquire an access to a strategic market. In horizontally motivated FDI, a company wants to reproduce a specific activity where it enjoys a competitive edge. By way of this the company wants to exploit its special capabilities and competence. This also enables the company to take advantage of any untapped overseas market. Besides this the company can enjoy the economies relating to large scale production (Naughton, 2006; Holz & Roberts, n.d.). Lessons from inward investment The benefits associated with FDI investment have prompted the governments of many countries to relax their foreign investment norms. FDI can play a crucial role in the infrastructural and the overall development of an economy. However this form of investment has its set of limitations as well. As the main motive of their investment is ‘profit’ they may exit an investment if there is a doubt in the realisation of gains. This has especially come to the fore during the recent times with some of the FDIs like Bosch and Dell announcing job cuts and closure of units. Bosch plans to close down its plants in South Wales in a time frame of two years. The company officials are trying to reorganise its production facilities and secure the permanent jobs in its Spanish factories. The company management is anticipating deterioration in production in 2010 and 2011. In the absence of new business opportunities the company plans to reduce the workforce. This sudden outflow of business operations of FDI can have a serious impact on the employment of the region. With the FDI accounting for the highest employment in Wales in the manufacturing sector the sudden flight of FDIs can become a serious concern for the government. Reference Holz, R. Roberts, A. No Date. EMPIRICAL INVESTIGATION OF FOREIGN DIRECT INVESTMENT IN WALES Sponsored by: Welsh Assembly. Available at: http://wales.gov.uk/docs//dfm/research/090701foreigndirectinvestmenten.pdf [Accessed on January 14, 2011]. Lipsey, G.R. Chrystal, A.K. 2007. The importance of foreign direct investment. Oxford University Press. Available at: http://www.oup.com/uk/orc/bin/9780199286416/01student/interactive/lipsey_extra_ch26/page_23.htm [Accessed on January 14, 2011]. Medina Arango, E.O. No date. Importance of FDI in the development of Emerging Countries Application to Colombia and the Philippines. Available at: http://www.paclas.org.ph/PAPERS/Arango.pdf [Accessed on January 14, 2011]. Naughton, B. 2006. Foreign Direct Investment (FDI) and Globalization. Available at: http://www.scribd.com/doc/2651676/Foreign-Direct-Investment-2006 [Accessed on January 14, 2011]. Bibliography Hussein, A.M. 2009. Impacts of Foreign Direct Investment on Economic Growth in the Gulf Cooperation Council (GCC) Countries. Available at: http://www.bizresearchpapers.com/27.Mua..pdf OCD. 2002. Foreign Direct Investment for Development. Available at: http://www.oecd.org/dataoecd/47/51/1959815.pdf Read More