International Trade - Prof Joanna Payago - Theotoky - FDI - Assessment Answer

International Trade Assignment

Assignment Task

Introduction

FDI (Foreign Direct Investment) refers to the net flows of investment made by non-residents in a foreign country. Foreign direct investment can be made in different ways, such as controlling ownership of a business enterprise, development of new facilities in a foreign country, mergers and acquisitions or investment in equity or shares of a foreign firm (Moran, 2012). FDI is generally categorized in two types, i.e. inward and outward. Inward FDI refers to the investments that are made by foreign entities in a given economy or nation and outward FDI refers to the investments that are made by an economy abroad (Moran, 2012). Javorcik et al (2011) argue that such cross-border FDI and investments have become extremely important and crucial for countries because they not only help in bringing in more capital in the country for higher economic development, but also helps economies in being able to gain access to more resources and technologies. Total FDI across the world increased by almost 25% in the year 2015 lead to total of around $1.7 trillion (OECD, 2016). While FDI is considered an integral factor responsible for the growth of developing countries around the world, some experts argue that MNEs (multinational enterprises) tend to often exploit the FDI for their individual gains. Hence, the essay presents a critical review to explore if FDI contributes towards development of developing nations or if it is exploited by the MNEs.

There are several discussions surrounding the impact and benefit of FDI for developing countries and nations. The FDI has become a key source of growth and development for developing countries because it helps firms in these countries in gaining access to capital that helps them in increasing their financial performance, which results into higher economic growth. Though Becker and Sivadasan (2010) argue that free capital flows are usually preferred and considered to be better investment options for developing nations and that it is safer than free capital flows because unlike FDI, free capital flows can be retracted at the time of crisis or any other economic issue. And the fact that developing countries have liberalized their policies and relaxed their rules has made it easier for foreign entities to invest in them. This can be established with the help of example of South Africa. As discussed by Sanfilippo and Seric (2016), factors such as existence of vast reservoirs of natural resources, size of domestic economy and cheap labor are some of the key factors that have attracted lot of FDI in South Africa. However, the actual inward flow of investments has increased only in the last few years or decades. Sanfilippo and Seric (2016) argue that the legislative uncertainties of the country have been major deterrent of inward FDI in South Africa, but the recent Protection of Investment Act that has improved safeguards for foreign investments, thus improving and increasing inward FDI. Increase in inward FDI has led to significant growth of Gross Domestic Product (GDP) in South Africa, accounting for almost 2.5% increase in GDP in 2012 (Adom and Amuakwa-Mensah, 2016). Shahbaz et al (2013) carried out a quantitative analysis of impacts of FDI on South Africa’s economic growth and has led to the conclusion that FDI has been a major contributor to the country’s economic growth and its mining sector.

According to Tomohara and Takii (2011), maximum benefits of FDI on developing countries are observed when the inward investments are made in the manufacturing or production facilities of these nations. They explain that inward investments not only provide direct capital and higher money to companies for improved and enhanced manufacturing practices, but also help firms in these developing economies to gain higher access to new technologies, innovation and enhanced managerial practices. Developed countries and nations usually have better technologies and better managerial practices and hence their investments in developing countries help manufacturing firms in these nations in being able to improve their technological innovation and inclusion for being able to become more competitive in nature (Doytch and Uctum, 2011). The benefits of inward FDI have been largely observed in the manufacturing sector of India. As discussed by, inward FDI in the Indian health sector has resulted into massive growth in the health sector of India and has helped in reducing costs of medicines and medical devices (Sun et al 2012). ADAMA Agrochemicals, which has spent almost US $50 million in India, has led to massive improvement in research and development and manufacturing facilities in the country, which has led to reduction of imports of medical devices, thus causing reduction in costs of the same. Hence, such increase in inward FDI in India has led to massive improvement in its manufacturing sector and facilities.

Inward FDI also helps in making the developing nations and countries much more competitive in the international markets. Luo et al (2010) explain that FDI leads to mergers and acquisitions of small companies in developing countries by bigger international firms, thus leading to higher competitive advantage of the developing firms in the international markets. Local firms in developing nations can become competitive by improving their operations and manufacturing practices with the support of foreign entities who invest in them (Luo et al 2010). Though it can be argued that the working conditions and styles of companies would differ in host and home countries and hence the strategies adopted by the investing firms in host countries would not be suitable for their growth, Lu et al (2011) have presented a contrasting view. Lu et al (2011) discuss that the foreign firms are becoming more responsiveness towards local needs and offering local incentives to companies, thus contributing towards their growth and competitiveness.

This can be confirmed and explained with the help of China. According to the data presented by Li et al (2015), China has received around 20% of all the FDI given to developing countries. The investment opportunities that exist in the country and also the fact that its market and economy has been growing continuously have led to significant increase in total inward FDI in the nation, which now contributes to almost 2-3% of total GDP of the country. As explained by Salike (2016), inward FDI has led to enhanced ability of local companies to improve their manufacturing operations by the adoption of modern and international technologies. The fact that some of the biggest companies like Apple also have their manufacturing operations in China shows that Chinese firms have been able to improve their technologies and resources to be able to achieve and gain higher competitive advantage in the international markets (Peng, 2012). These discussions thus confirm that inward FDI tends to benefit developing countries to a large extent, but at the same time it is also argued that MNEs tend to exploit such FDI, thus causing more harm than good to these nations.

As discussed by Chaudhuri and Mukhopadhyay (2014), FDI made by multinational companies in developing nations is not done for the growth of these developing economies, but for their personal growth and profitability. Most of the capital invested by MNEs in host countries tends to go back to their home countries in terms of profits, thus resulting no net benefit to the host country. MNEs tend to develop their markets and financial performance with the help of direct investments made in developing countries. Total cross-border mergers and acquisitions by MNEs increased to almost $339 billion and according to Wei and Yu (2015), these multinational companies are looking at cross-border M&As for increasing their profits and not for helping the growth of developing firms. Jansky et al (2013) have explained this with the help of the example of one of the biggest MNEs of the world, i.e. Apple. Though the Apple’s FDI and manufacturing operations in China have resulted into higher growth of China and enhanced access to technologies, most of the capital goes back to the company in form of profits. Apple is exploiting its ability to invest in China to earn higher profits and thus is not really focused towards contributing to the nation’s growth.

Jadhav et al (2016) have also presented similar discussions and explain that developing countries allowing MNEs to set up their manufacturing plants and operations at lower tariffs and subsidized costs to promote their capital inflow. Liberalization of trade has further led to lower tariffs and lower costs for companies to invest and set up plants in developing nations like China and Brazil and hence the MNEs tend to exploit these facilities and tend to leverage upon cheap labor and lower tariffs for personal profitability. The determinants of FDI have paid special attention to and established cheap labor and import-export and FDI tariffs as some of the key factors that determine and extent to which direct investment is made by a firm. Hence, the MNEs tend to exploit the available resources and capabilities of developing firms to be able to maximize their own personal profits. Jansky and Prats (2015) argue that since the domestic companies of developing economies do not have the required resources or capabilities to match the excellence of these MNEs, the concept and process of FDI tends to get exploited by multinational firms to a large extent. In fact, there have also been several discussions regarding the implementation of restrictions and barriers for MNEs to exploit and use natural resources and IP of host countries for their own profitability.

Another factor highlighting the exploitation of inward FDI in developing countries by MNEs is that FDI by MNEs tends to lead to lower demand and lower revenues of the firms in host countries. While on one hand, MNEs tend to help in improving the overall competitiveness of local firms and companies to a large extent by providing them access to capital, advanced technologies etc., Ha and Giroud (2015) argue that spillover effects are often observed between the local firms and the MNEs. As explained by Ha and Giroud (2015), spillover effects usually tend to occur between the MNEs and local firms from the same industry and local competitors who are not able to compete in the increasing competitive environment tend to get crowded out by these MNEs. This has been established by Aitken and Harrison (1999), who carried out a study of 4000 companies in Venezuela and led to the conclusion that as FDI increases in the industry or country, overall productivity of these companies tends to go down. Perri and Peruffo (2016) even explain that the spillover effects are usually gradual and indirect in nature and hence the exact exploitation by MNEs cannot be determined. For example the Tegal metalworking industry of Indonesia has demonstrated that the industry was dominated by local SMEs (Small and Medium Enterprises), but they did not have access to the latest technologies and hence entry of new international firms via FDI in the industry led to massive reduction in sales of these firms, thus leading to lower revenues of the domestic market. Thus, instead of benefitting and supporting the local firms, FDI and its benefits tend to get exploited by the MNEs.

It can be concluded based on the above discussions that inward foreign direct investment is definitely beneficial and contributing towards the growth of developing nations and economies. FDI helps the developing nations in not only receiving capital so that the economy can grow and expand considerably, but also helps in providing higher access to technologies and other resources to manufacturing firms in these countries so that the overall GDP and productivity can increase. However, it has been found that MNEs often tend exploit the availability of low tariffs and cheap labor in developing countries for maximizing their profitability. It can be hence said that the developing nations need to evaluate and tighten rules and regulations of FDI to ensure that the local firms do not suffer because of such foreign investments.