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Costs and Benefits of Foreign Direct Investment (FDI)

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Published: Thu, 18 Jan 2018

FDI

1) General Information About FDI

Foreign direct investment (FDI) can be defined by saying: If an investor takes place in far from their home country with purchasing a firm in the landlord country’s border. According to “The Organization of Economic Corporation and Development (OECD)”, If a foreign investor has more the ten percent of the local company, this means that the foreign investor has control on the local company.

One different description suggests that, basically, a company from one country’s doing a substantial investment into structure a plant in a different nation.

Foreign Direct Investment plays an important part in global entrepreneurs and businesses. The FDI can easily provide a firm with new business environments and markets, cheaper production facilities, usage chances of newest technologies, cheaper financing and skills.

FDI mobility slacked up in 2011 after a short time interval of improvement in 2010. FDI leakage around the world raised in 2011 with around 11% to USD1558 billion contraversely to 24% increase in 2010 and stayed splendid under the most high degree in 2007 ($2190B).

There is an significant difference between FDI and foreign portfolio investment (FPI). Foreign portfolio investment means investing of individuals, companies, or policy makers of a nation in foreign fiscal tools (for example government bonds, foreign stocks). making an important wealth piece in a foreign entrepreneurship is not involved. Evaluating the FPI level is more different that evaluating the FDI level and these two of them focus very distinctive topics.

There are two strategic kinds of FDI:

1) Horizontal foreign direct investment : If FDI is made in way which in same sector as a company have activity in at home. To give an example for Horizontal Foreign Direct Investment, we can say that If Ariston makes investment on Caribbean and Scandinavian nation it can be countted as horizontal foreing direct investment. Authorities suggest that studying on horizontal foreign direct investment may be very helpful to understand the vertical foreign investment.

2) Vertical foreign direct investment: If a company or multi national establishment (MNE) supplies production resources for a company’s local transactions, or this kind of foreign direct investment can take place with selling the final product of a local company in their company’s country.

After briefly defining the foreign direct investment, now on next part, we will be studying on benefits and costs of the foreign direct investment for a country.

2) FDI: Benefits for Economy of Host Country

In order to get more positives from FDI freely, improving countries have started to dilate and make more suitable laws and FDI policies and attempted to reach most suitable arrangement to get interest the FDI makers. Professors of economy who supports the liberal market perspective suggest that the gain of FDI to a landlord country so preponderate the costs that practical nationalism is an ideologywhich has been unable to imply.

Four determined benefits will be studied on this part for the landlord country: effects on resource – transfer , the effect on employment, effect on balance of payments, and the aspect of competition.

2.1) Effects on Resource – Transfer

Foreign direct investment can add great amount of value to a landlord economy with providing cash and capital, innovative technology, and governance sources that might the directly invested country does not have and with the help of three important resource the country’s economy’s expanding rate can be increased. That type of source transport can contribute to the stimulating the fiscal expanding of the landlord economy. There are three elements in Resource – Transfer Effect, which are Capital, Technology and Management.

2.1.1) Capital

When we get to talk about the capital, multinational enterprises (MNEs) spend money and make investment for long term basis, get into jeopardy and use their corporate identities only when the projects makes money well. After the free capital transfer across nations regulations, capital-holders are very likely to seek highest rate of return. It causes that the countries which are in need of capital, try to attract MNEs to invest. A lot of MNEs , with the help of their big size and financial strength, get accesibility to fiscal instruments and opportunities which may not be ready to use to company’s of landlord nation. These funds are likely to be ready to use for MNEs. That situation is caused by the multi national enterprises’ popularity, huge MNEs more easily access to money from capital markets than host country firms would. That situation helps MNEs to invest their money to host country and get higher return rate with the help of the MNEs, the host country gets the investment.

For example, after the seeing that definition we may think, as an example to capital transfer, the efforts of Turkish government to find a partner for their tele communication company of Turk Telekom. That partnership was thought as an opportunity to grow for that company mentioned.

One professor suggests three general advantages of FDI on capital, these are ; 1)company presidents have less risk with the help of free flow of capital around the world. With the different financial instruments, president can distribute the risk. 2) If the money and capital markets become worldwide, that situation increase the quality of capital and money governance and management, gathers more modern regulations. 3) With the integration to international system of capital flowing, country’s governments must have some limit to make bad policies.

2.1.2) Technology

If a company wants to grow, must be able to use and follow technology very well. That sentence is generally approved by the authorities. Technology can create a movement and mobility in the economy which may be able to facilitate economic improvement and industrialization. There are two different ways of effect of technology to take place in landlord country. Both of the are very valuable and can not be ignored. Technology may take place in a process of production or it can take place in final product (for example., smart phones we use). Although, there are too many nations which do not have enough technology and innovation, they also have to have their own research and improvement for their economic growth. Last sentences is also specifically accurate for less improved nations.

It is evident that the having appropriate technology has a great amount of corelation with being improved country or not. If a country has enough technology, they can directly evacuate their technology to different country and make great money. Because technology is an expensive resource.

Technologies which are taken from improved countries are more willing to bring modernism and liberalism to the landlord country.

2.1.3) Management

Foreign expertise for management which are gained by FDI is very helpful for the landlord country. The mentioned benefits take place with different ways. First, the investing MNE can train the host country’s citizen to expertise on their respectively occupation. This way is thought to be cheaper. Secondly, the investing MNE can bring their own employees from their company’s nation and with making this, the invested company’s brunch may has already trained employees to manage the business in landlord company. These benefits sometimes get less if the mentioned benefits are unique for the investing MNE’s company. That problem cause ineffectivity in managemenet and governance of the landlord’s branch of the company. With creating suitable management team is accepted to increase the efficiency of the company and also the landlord country’s nation’s management traditions.

For this concept, one of experienced professor offers three benefits in managerial way. Such as more accurate training and high level of regulations can help to increase effectiveness of managemenet, being skillful on investment possibilities can be increased by entrepreneurial soul, the employees who get training, takes arising externalities.

2.2) Employment Effects

Employment is effected by foreign direct investment (FDI) directly and also indirectly. Facilitating of employment is most important effect of FDI in the countries with high working power but having less capital to invest. This kind of impact takes place when the MNE hires a lot of host country’s citizen. This is the direct effect of employment. The indirect effect of employment is creating jobs in domestic resource provider as a outcome of FDI of the MNE and increased local spending.

Some argue that that not all the “newly created employments” established by FDI shows net additions in employment. For example; If we think about FDI by German chemical company in the Greece. , some argue that the employment established by this FDI have been less than break even with creating employment lost in chemical companies from Greece, which have started to lose market share to foreigner chemical investor. As a result of this kind of substition effects the real number of the employment which is created by FDI of the German chemical company may be less than it is expected.

That employment effect helps and creates leverage for the investing MNEs when the MNE and the landlord country’s government negotiate about a conflict. Create employment is always important task for a government.

2.3) Balance of Payments Effects

Balance of Payment is a country’s balance-of-payment is the difference between the payments to and receipts from other countries. FDI can have beneficial and negative effects on a country’s balance of payment. FDI s effect on a country’s balance of payment accounts is an significant regulation topic for most landlord policy makers. There are three possible balance of payments outcome of FDI.

  • Initial Capital Inflow

If a MNE invest directly on a country, that multi national enterprise gathers their own money to spend and invest.

  • Substitute for Imports

If a MNE produce goods in a country and If these goods were imported earlier, this kind of situation will look good on balance of payments.

  • Inflow of payments from export of goods and services

If a MNE produce goods in a country and If these goods are exported, this kind of situation creates good values on balance of payments.

3) Costs of the Foreign Direct Investment

Three costs of FDI concern host countries. They arise from possible adverse effects on competition within the host nation, adverse effects on the balance of payments, and the perceived loss of national sovereignty and autonomy.

3.1) Adverse Effect on Competition

This aspect basically be summarized with saying;the MNEs which directly invests to another county.may have “too much” power and kill off competition. Even though the landlord country’s government seems to be satisfied with the positive effects of the FDI, sometimes they start to have some concerns with the gaining or being too much strength of foreign investor can cause deadly effect on the competition. Eventually, the foreigner investor or the MNE can become the monopol in sectors of landlord country’s economy. This kind of concerns take place in countries which have small amount of big companies operate locally.

3.2) Adverse Effect on Balance of Payments

This aspect can be summarized with saying; when a foreign subsidiary imports a substantial number of its inputs from abroad, there is a debit on the current account of the host country’s balance of payments.

The landlord country’s company’s balance of payment possibly effected adversely with two concepts showed below.

  • The money and capital generated by the FDI will not be staying in the landlord country’s account forever. Eventually the MNE which invested on landlord country, will take their money and takes their home nation.
  • If a foreign group member country imports great amount of production from abroad, the figures will take place on landlord country’s debit account in balance of payments accounts.

3.3) Does the FDI cause loses in national independence?

National sovereignty problems are caused by the having too much power for a foreign multi national enterprise. Some argue that a foreign multi national enterprise with great amount of economic and governmental power would be too active on the landlord nation’s internal businesses. Some take this idea forward with saying that If a county lets a multi national enterprise to have too much power and also be monopol in an sector, that company can be depend on the MNE’s country mediately.

For example, If a country’s monopol natural gas provider were foreign, in an conflict situation between MNE’s country and landlord company, that MNE can cut the natural gas out.

Conclusion : Critical Discuss on Benefits and Costs of FDI on Emerging Markets

With the light of these all information, all we all understand that foreign direct investment can be tricky for different countries. Effects of the FDI for different countries may be different as well. As we’ve seen that even though there are significant benefits in foreign direct investments, FDI also have some costs for the countries. In this conclusion section, we are going to discuss these tricky things for the emerging markets briefly.

In order to FDI be beneficial for a country, the country must have a enough working power to facilitate necessary working power, must have suitable regulations which provide good environment for capital to flow freely, countries should have a condition that the MNEs’ power on the economy does not threaten the countries’ national sovereignty, and the countrıes have to suitable balance of payments values because FDIs may have big amount of influence on these values. That influence may be beneficial but it may also be costly.

Some of the emerging markets countries such as Turkey and South Africa are in need of capital badly. FDI provide some of these necessities but the problems of that transactions are according to economy’s situation the money flow can be costly more and other disadvantage of that is these FDI are not in the country to stay. The MNEs which provide FDI can decide to leave the country and take back their invested capital from the country. That kind of situation may create a huge problem for country. As we all see that, a country should not depend to FDI too much.

Before demanding the FDI from the MNEs, countries must make their research very solid. As we’ve seen that too much FDI can cause some problems.

The graph below shows the FDI distribution to emerging market countries (EMC);

References

  • Feldstein, M. (2000) Aspects of Global Economic Integration: Outlook for the Future. National Bureau of Economic Research.Cambridge, Massachusetts: NBER Working Paper No.7899
  • Romer, P. (1994) The Origins of Endogenous Growth. Journal of Economic Perspectives , 8(1),3 22.
  • Lall, S., Streeten, P. (1977) Foreign Investment, Transnationals and Developing Countries. London: Macmillan.
  • Aaron, C. (1999): The contribution of FDI to poverty alleviation. Singapore: Ther Foreign Investment Advisory Service.
  • Dunning, J. (1961) The Present Role of US Investment in British Industry. Moorgate and Wall Street
  • 1990-2002, Balance of Payments Statistical Yearbook, IMF

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