FDI Policy: Two Nations Compared - Essay Example

Introduction Foreign Direct Investment (FDI) is defined as the investment outside the boundary of the investing side’s home country. FDI also suggests special type of capital flow, which includes tangible assets, technology transfer, and intangible assets like managerial skills. Hence FDI can also be defined as a form of international inter-firm cooperation controlling host country enterprises (Michi, Cagatay & Koska, 2004). Foreign investments can be in three forms – foreign direct investments, indirect foreign investments and official loans. FDI includes investments in physical assets such as plant and machinery and it is based on an equity ownership of at least ten percent (Forfas, 2002). The main types of FDI are acquisition of a subsidiary or production facility or participation in joint venture, licensing and establishing of greenfiled operations. FDI has been growing faster than the world GDP and is now a major component of foreign investment (Razin & Sadka, 2005). The effect of FDI on GDP is higher than the effect of other forms of foreign investment. Studies suggest that FDI triggers technology spillovers, assist human capital formation, creates a competitive business environment and enhances enterprise development (Tusiad & Yased, 2004). This paper will review the current policies of Ireland and Turkey towards inward FDI in connection with the law discriminating for or against foreign-owned/controlled enterprises. FDI Policy – Turkey The collapse of the state socialism in Central and Eastern Europe (CEE) was the opening of the region to FDI. FDI was crucial not only to industrial restructuring in the region but also to the overall success of the transition towards a capitalist economy (Pavlinek, 1998). Turkey was one such country which has become increasingly open to FDI since 1980 although it has yet to take full benefit of inward FDI. Turkey’s failure to attract FDI reflects the general mismanagement of the country’s economy. The economic issues that led to the failure of attracting FDI include high transactions cost of entry and operation of foreign investors. This was due to bureaucracy, corruption and red tape (Erkilek, 2003). Apart from this other economic reasons were increasing economic instability, lack of protection of intellectual property rights, lack of inflation accounting and internationally acceptable accounting standards. The legal structure was insufficient and the infrastructure inadequate. Political instability, internal conflicts, animosity towards foreign presence, fear of political domination was the non-economic reasons. Besides the structure of business in Turkey was predominantly family owned and closely controlled. Turkey was included in the EU in December 1999 but even this failed to boost the system towards inward FDI. Turkey was not the member of the World Association of Investment promotion Agencies until 2002. Turkey also maintains high tariffs on many food and agricultural products to protect its domestic producers (FTB, 2001). The import process also was very complicated. Turkey continued to lack macro economic and political stability and it was cool to foreign investors. Because of this there was no upsurge in inward FDI either from EU or from elsewhere. Turkey suffered a major economic crisis in 1990s and at the end of 1999 Turkey began an IMF supported three-year economic stabilization and structural reforms program (Erkilek, 2003). This led to a sharp drop in inflation and interest rates till the second half of 2000. It managed to enter the Kearney’s FDI confidence index but this program experienced crisis mitigated by IMF emergency package and finally collapsed in 2001. Turkey needed IMF and World Bank support but their condition was that Turkey should open itself to FDI. After the 2001 financial crisis, the Turkish government poured capital into the failed banking system and is now seeking FDI. The government debt increased over the years. Circumstances forced the country to improve its FDI environment. To a large Turkish administration was control-oriented rather than enforcement and service-oriented. Terrorist activities burdened the economy as the government was obliged to maintain a high level of military spending (Bosut, n.d.). Religious fundamentalism was also a threat. This control, lack of accountability and transparency resulted in widespread corruption in the country. After November 1992 when the country attained a single party government its policies changed towards inward FDI. The policies were no more just to please the IMF or the World Bank but to actually attract FDI. The new policy granted foreign investors full convertibility in their transfers of capital and earnings (Erkilek, 2003). They guaranteed national treatment to foreign investors and they were determined to make Turkey an attractive destination for FDI. This required a radical change in the mindset of the bureaucracy. In Turkey now the FDI prospects are brighter as the investor confidence has risen. The forms under the IMF stabilization program have helped push Turkey up the Index (Kearney, 2006). The inflation targeting strategies in early 2006 by central banks influenced the interest. Turkey now ranks seventh among the countries considering first-time investment in the next three years. The country received $2.7 billion in FDI inflows in 2004 which was a 56 percent increase over the previous year. Italian investors rank Turkey number one for FDI investments, ranking the country ahead of India and China. While Turkey enjoys the 11th place in the banking sector among the telecom and utilities investors it ranks twelfth. It is also considered a viable platform for the automobile sector in Europe. General Motors (USA) plans to restart its productions facilities in Turkey while Hyundai is expanding its base in Turkey to meet the growing demand in Europe. FDI Policy - Ireland In Ireland high tariff barriers and the intention to promote indigenous manufacturing prohibited foreign ownership of firms from the early 1930s to the late 1950s (Barry & Bradley, n.d.). The policies had to be changed as no progress was found. The Control of Manufactures Act was replaced by a policy that systematically cultivated FDI through a zero corporate profits tax on manufactured exports, attractive exports grants and a complete dismantling of most tariff barriers within less than a decade. In the next three decades almost 60% of the gross output and 45 percent of employment in manufacturing was in foreign-owned export-oriented firms. Irish poor performance was a result of poor policy choices and inefficient institutions (Ozenen, 2006). It had a relatively low level of human capital, poor physical infrastructure and low research and development. The policies were not conducive to match the average EU levels. The low tax rate was ineffective in capital accumulation and FDI inflow. The corporate profit tax was reduced from 45% to 10% in 1981. Even though the country had low labor costs, an English language labor force and easy access to EU markets it failed to attract FDI. The country further designed the National Development Plan (NDP) which helped the investment to be planned rationally and optimally. Ireland’s inclusion in the EU and the fact that it represented the English language environment were crucial factors in attracting FDI. There were major improvements in infrastructure since 1989. The government imposed inward migration which helped prevent skill and shortages. After the formation of Community Support Frameworks (CSF) the level of EU structural funding increased (Ozenen, 2006). The objectives were to promote economic development in Ireland and make a significant contribution for economic convergence with the EU. Under the current programming period (2000-2006) Ireland is planned to receive €3.35 billion from the Structural Funds and €586m from the Cohesion Fund. Because of the EU funds, Irish administration and project implementation process improved through well established, effective and experienced public administration system. The technical problems were solved through sectorally based departments and implementing agencies. The Structural Funds and the CSF led to increased output of the economy, decreased unemployment, increased in productivity and the FDI. The key factor behind Ireland’s economic transformation over the last four decades has been the subtle but profound effect that WTO has had on the Irish industrial development (Forfas, 2002). The enlargement of the EU will greatly enhance the development of FDI in the developing countries (Barry, Hannan, Hutson & Kearney, 2005). It will allow them to compete more strongly for such investments. Hence, Ireland will have to face direct competition with the CEE countries for inward FDI. Many of the CEE countries have followed Ireland’s lead in offering low rates of corporation tax. Besides, the advanced countries do not differ from Ireland in terms of skills in labor although the labor costs in CEE countries are much lower. Because of EU expansion several of the countries will have access to high markets in the Western Europe. These countries will also enjoy equally stable macro policy environments apart from equivalent regulatory and public administration systems. At the same time the pool of FDI has increased. The Single Market Liberalization may further enhance efficiency and is expected to benefit the Ireland’s foreign owned subsidiaries. If the CEE countries do manage to divert the FDI away from Ireland the government would have to focus on cost competitiveness. The wages in Ireland has increased recently due to increased in price of housing. Despite apprehensions, Ireland is expected to receive 0.3 percent of the total gains from trade accruing to the EU15. Compare and contrast The factors that mainly influence FDI are economical and political. FDI will not flow into a country until its market approaches a certain size. Promotions offered by developing nations also have a role in attracting FDI. The FDI inflows in Ireland increased from $622.6 million in 1990 to $19033 million in 2002 whereas in Turkey for the same years the FDI inflow was $684 million and $1037 million. While Turkey was marginally ahead of Ireland in 1990, the policies in Ireland changed radically to reach $19033 million in a span of 12 years (Michi, Cagatay & Koska, 2004). Even though Turkey is included in EU, its GDP is poor compared to the EU average (Ozenen, 2006). Macroeconomic conditions are the first factor that attracts the foreign investor. Data taken from World Development Indicators (2003) of World Bank and World Competitiveness Yearbook (2003) of IMD (Institute for Management Development) suggests that while Turkey ranked 13th, Ireland was second in attracting FDI (Tusiad & Yased, 2004). Politically also Turkey ranks much below Ireland which maintains the second position. However, Turkey scores high in availability of skilled labor than its Eastern European competitors and even higher than Ireland which has been successful in attracting FDI. Turkey has high corporate taxes and low incentives while Ireland has low taxes and offers higher incentives. Turkey has lagged behind in investments in transports and telecommunications which is again a stronghold of Ireland. Turkey has yet to exploit the huge potential provided by maritime transport. As far as R&D is concerned, Ireland has not been active but comparatively Turkey’s performance and investment in the sector has been very poor. Ireland’s project selection, assessment, design and delivery methods helped it to draw FDI. Its policies on all fronts especially in infrastructure, low corporate taxes and high incentives induced FDI. Ireland has shorter programming periods and it avoided allocating expenditure to agencies. Apart from the Structural Funds, investment in the Irish education system, good macroeconomic policy, the impact of European integration on trade and investment and a positive external environment contributed to the increase in FDI inflow. Turkey on the other hand continued to remain conservative and had closely held companies. Ireland could spend the funds on upgrading the infrastructure while the funds support that Turkey received had to be used for paying debts or meeting budget deficits. Ireland’s EU involvement helped it to prioritize and plan its investments while Turkey remained closed to suggestions despite being a member of the EU. Turkey was not a signatory to the WTO Government procurement Agreement while Ireland received support from WTO. Conclusions Ireland has a global trading environment while Turkey has been reeling under political and economic instability. Despite being a member of the EU, Turkey has not been able to take advantage of its membership. Ireland has an ambitious approach in eliminating the barriers to trade and development although now Turkey has become an attractive host country to FDI inflow. The closed door policy, the family owned business, the terrorist fear kept Turkey away from FDI inflow while Ireland surged ahead due to its liberalized polices, development in infrastructure, educating its manpower and skilled labor. Ireland derived benefit from the Funds as also from the planning of the expenditure of the funds received. The two countries were in the same position until the 1990s but Ireland suddenly had a miraculous turn of events which resulted in huge amounts of FDI inflow. Turkey needs to derive lessons from Ireland to maximize from its membership of EU. 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