What Is Foreign Direct Investment Economics Essay
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Published: Mon, 5 Dec 2016
Foreign Direct Investment played an important role in global business in order to face the dynamic changes of economic environment. In its classic definition, it is defined as a company is doing physical investment from a country to another country. This type of investment is call as direct investment. According to IMF, direct investment is mirror to what it refers as lasting interest by direct investor. The “lasting interest” is reflecting on the existence of long term relationship between the direct investor and the direct investment enterprise. The examples of direct investment is including build factory, invest in machinery, building and equipment.
The fifth edition of the IMF’s Balance of Payment Manual defines direct investor as the owner of 10% or more of company’s capital. This guideline is being recommended by IMF as basic dividing line between direct investment and portfolio investment. Portfolio investment is investment in securities that not interested in lasting interest and involvement in the management of a company. As a result, any non resident that holds 10% or more equity in resident enterprise will record as direct investment in Balance of Payment. FDI method can differentiate in many aspects. Among them are vertical and horizontal. Vertical FDI takes two forms which are backward vertical FDI and forward vertical FDI. Backward vertical FDI is when the industry abroad provides inputs form domestic firm’s production whereas forward vertical FDI is when the industry abroad sells the outputs of a firm’s domestic production. Horizontal FDI is when investment to host country in same foreign industry as affirm operates at home country.
Recently, the deep impact of FDI can be seen in many developing countries. FDI now played a role as major economic driver of globalization and control over most of cross border investment. The changes in technology, declining in communication cost and policies liberalization are among the factors that contribute to FDI expanded its role.
2.0 ECONOMIC IMPACT OF FDI TO HOST COUNTRY
2.1 Employment effect
The employment effects of FDI in host countries are underlie in several areas of economic elements. Those effects are including job growth, higher wages and better working condition.
The positive effects were occurred when foreign Multinational Enterprise (MNE) employed host country citizens to match their demand for workforce. This economic activity will result in new and better jobs in areas with high unemployment, productivity and better work salaries.
The relevant prior research has shown the evidence on this effect of FDI. Direct FDI has a positive impact on Pakistan employment growth. According to Muhammad Atif (2012), foreign direct investment in Pakistan has lead to positive impact on employment growth in Pakistan. The study shows that a unit increase in FDI as a percentage decrease in unemployment rate by 0.73 percent. The positive impact may come from labor intensive industries that show substantial increase in employment rate. This is due to increasing in demand for labor where many workers are needed for domestic investment in setup and running a new plant.
2.2 Economic growth
FDI is said as a powerful development tool in contributing the economy growth of host country. This growth are may contribute by the injection of capital stocks in host country, increase in productivity and creating new jobs. Chan (2000) study (as cited in Esther O, (2010) found that when a country adopts an export strategy, FDI will bring positive impact on growth. This researcher found that FDI may promote host country growth through its effect on trade.
Activities that create by FDI also lead to productivity and knowledge spill over on host country domestic firm. Productivity and knowledge spill over is arise when the productivity of locally owned firm is gain through access to the advance leading edge of technologies employed by foreign companies.
However, there are some arguments on this matter. As the foreign presences were in greater level, the negative impacts were start to apparent. These foreign companies have ability in draw the demand away from local counterpart due to the price reduction to their new differentiated and innovation products. As a result, local firm productiveness will fall because of “market stealing” activity run by foreign affiliates.
In addition, the ability of firm in host country to reap the spillover benefits is depend on the ability of local firm to absorb foreign companies know how , skills and technologies. If local firm capabilities are insufficient to appreciate the value of knowledge and technology, it will restrict them to absorb the spillover benefits. According to Galina Hall (2011), the lack of spillover effect in China was due to lack of the ability in hiring skill workers that limit the abilities in adopting new technologies.
In other words, spillover benefits are only happen to local country if the technology gap is small. Examining productivity spillovers from foreign to local firm is very crucial in understand the impact of inward FDI to host country economic growth.
2.3 Balance of payment
A county’s balance of payment is the difference between the payments to and receipts from other countries. In case of balance of payment, FDI can have beneficial and negative impact on host country.
When a company invests in foreign country, the capital inflow to that country will be use to produce the good or services that can be substitute for imported product or services. This are consider as one of positive effect of balance of payment. There is another positive effect of balance of payment when the good or service produce by host country are exported to another country. This improvement in trade balance is cause by the inflow of payments from export of goods and services by host country.
However, this beneficial impact is only gain by host country depend on several justifications. The above prediction may not true if the input used by foreign firms are imported from abroad. It also depend on whether the investment is source out of money capital borrowed in the host country and the share of profit repatriated.
On negative side, Multinational Enterprise may have too strong position in the local market and kill the competition especially from the new entrant local company. This are consider as adverse effect after the initial inflow of capital, outflow of capital may occur when a foreign form import inputs from abroad.
The strong position of Multinational Enterprise in host country are let them to hold the key decision that affect host county economy. As foreign company has no commitment to the host country, they may take decision that not favor to the economic condition of host country.
IMPLEMENTATION OF FDI BY MULTINATIONAL CORPORATION (MNC) IN SELECTING ASIAN COUNTRIES
In 1988, Myanmar changed its economy into market oriented system after the nullification of centralized planning economic system. Myanmar’s government gives permission to foreign direct investment and encourages the private sector growth. The Union of Myanmar FIL (Foreign Investment Law) was announced in November 1988 and its procedures were enacted a month later in December 1988.The MIC (Myanmar Investment Commission), which is the early to permit the authority for investment proposals, was responsible for supervising and handling the FIL (Foreign Investment Law). The foreign direct investment policy is a component/element of the total restructuring and development policy of the Myanmar’s Government. The following is main components of the policy; (a) Allocation of resources by adopts the market oriented system. (b) Encouragement of private entrepreneurial and investment activity. (c) Opening of the economy for foreign trade and investment. Since Myanmar transformed to open market system in 1988 and practiced many improvements for overall economic growth of the country. With these improvements, the decision is to appeal foreign investment had been the government’s priority and it applied the following laws and acts for investors to form business in Myanmar;(1) Myanmar Company Act (1914),(2) Special Company Act (1950), (3) Myanmar Companies Regulations (1957) ,(4) Myanmar Companies Rules,(5) The partnership Act (1932),(6) The Republic of the Union of Myanmar Foreign Investment Law ,(7) Myanmar Citizen’s Investment Law (1994),(8) The Myanmar Special Economic Zone Law (2011).
3.1 FDI in India
In 1973 Indian government set up FIB (Foreign Investment Board) and prescribed (Foreign Exchange Regulation Act) in order to control flow of Foreign Direct Investment to India. The Indian Government establishes FIPB (Foreign Investment Promotion Board) for processing of Foreign Direct Investment plans in India. The Board is the top inter-ministerial body of the Central Government that handle with plans relating to Foreign Direct Investment into India for sectors or project that do not entitle for automatic approval by the RBI (Reserve Bank of India) or are outside the parameters of the existing Foreign Direct Investment policy. The growth of Foreign Direct Investment carry out opportunities to Indian industry for technological up stages, obtaining access to global practices and managerial skills, optimizing utilization of natural resources and human competing globally with higher efficiency. In 1991, the new economic liberalization policy of the Foreign Direct Investment inflow in India for the last 14 years brings the country development in both quantity and the way India attracted Foreign Direct Investment. The Indian Government has set a comprehensive Foreign Direct Investment policy document effective from April 1, 2010. Much more, the government has allowed the FIPB (Foreign Investment Promotion Board) under the responsible of MCI (Ministry of Commerce and Industry) in India, to clear FDI plans of up to US Dollar 258.3 million. FDI as a strategic element of investment is needed by India for its endured economic growth and development through creation of jobs opportunity, expanding of existing manufacturing industries, long and short term project in the field of education, research, development and health career.
FDI in Pakistan
Pakistan has designed its investment policy in a way to make foreign investor attract by opening up the marketing and economy the potential for foreign direct investment. The first manufacturing sector was the only avenue for foreign investors interested in investing in Pakistan. Currently, the total Foreign Direct Investment in Pakistan is USD 1.57 billion. However Pakistan FDI has decline due to several factor like political instability, energy crisis, lack of infrastructure, cultural and social factors, lack of skill workforce, declining Gross Domestic Product (GDP), law and order situation, share of credit to non-government sector and high corporate tax.
FDI in Selected Asian country
In China, the evolution of FDI policy begins in 1980s due to extraordinary change in macroeconomic policy. In Sri Lanka, the separate phase has been in between 1977 -1980s.At that time, Sri Lanka begin its economic changes which encouraged private sector lead export oriented growth including an important role of Foreign Direct Investment. Pakistan starts to actually open up its liberalized and economy its Foreign Direct Investment policies getting of the end 1980. A new industrial policy package was begin in 1989 identifying the importance and role of the private sector, and a number of control measures were taken to make the business environment better in general and attract Foreign Direct Investment especially. Pakistan has signed relating agreements on the protection and promotion of investment with 46 countries to facilitate the foreign investment. Although India is being a capital resource-poor country, they were always receptive to foreign investment. The attitude towards FDI was liberalized due to the industrial policy resolution in 1980s. However, asset of policy measures were introduced to liberalize the Foreign Direct Investment of environment in the country through the new industrial policy and the new economic policy in 1991. Nowadays India has one of the most attractive Foreign Direct Investment policies in the South Asian region. The 1st and 2nd generation reforms created a conductive environment for foreign investment in India. The Foreign Direct Investment policy is also informed by the RBI (Reserve Bank of India) under the FEMA (Foreign Exchange Management Act), 2004.
The four ASEAN countries- Indonesia, Malaysia, Philippines and Thailand have been the destinations of Foreign Direct Investment since 1980s. At a time of financial crisis in Asia which occurs, the query of the suitable policies for future sustainable development and recovery is important. One of the areas of particular paramount is the treatment of foreign investors. FDI (Foreign direct investment) has played a most important role in many of the economies of the region, particularly in export sectors, and has been an essential source of foreign capital during the crisis. These four countries have all too different degrees gladly received directed investment for its contribution to exports. Thailand and Malaysia were among the most open in the developing world to foreign investment for many years. They were fast to identify the powerful role that foreign investors could take part in fuelling export-led development, and in the late 1980s they were well-positioned to draw such investment during the years of regional structural adjustment.
For Singapore, the rapid economic growth over the past 3 decades has needed the utilization of external resources, chiefly foreign capital. If they not have the resources, development and industrialization on the scale undertaken could simply not have happened. These external capital resources have taken the form of borrowing, grant, aid and foreign direct investment (FDI).
3.4 Foreign Direct Investment in Real Estate (FDIRE) in ASEAN Country
30 years ago, whole ASEAN countries except Singapore had adopted limited regulations to control Foreign Direct Investment firms in order to lighten the harmful impressions of FDI to local economies. However, in the middle 1980s after the debt crisis of 1985 and the resurgence of NIEs (Newly Industrial Economies), most ASEAN countries turned from inward to outward strategies of Foreign Direct Investment. A component of these strategies is made real estate investment and that is FDIRE (foreign direct investment in real estate).Foreign Direct Investment in Real Estate however, is quite new to the real estate sector in Malaysia and in the world alike. It is mean that cross-border investment in real estate by institutional investors did not happen until the 1980s. In China, it starts after 1978 under the open-door policies and new economic but the actual date of Foreign Direct Investment Real Estate (FDIRE) utilization in China was beginning in1997. Turkey and India were starting FDIRE in 2002. For the year 2005 to 2010, FDIRE in India was booming to eighty times than previous years. In 1993 to 1996, this situation also occurred in Thailand, it is estimate at almost 40 percent of net Foreign Direct Investment in Thailand was booming in FDI and real estate sector had changed from manufacturing to infrastructure and real estate sector.
FDI in China
In China, for past decades, Chinese SOEs (state-owned enterprises), especially huge business groups, have dominated status in Chinese Outward Foreign Direct Investment (OFDI) activities. In 2006, outward investments from State-Owned Enterprise (SOEs) had taken at almost half of Chinese aggregate stock. Due to ownership control of government, strategies of Chinese State Owned Enterprise (SOEs) are usually oriented by the macroeconomic objectives of local or central governments. As a result, SOEs could gain more partiality policies and informal or formal institutional facilities in the course of their business activities compared with other non-state-owned firms. In order to strengthen the national international competence more rapidly, the Chinese Government improved support for outward investment candidates within State-Owned Enterprise (SOEs), such as with indirect soft banking loans and direct fiscal subsidy, and various privileges in the form of foreign exchange assistance, export tax rebate and many more. This special ownership benefits hold by Chinese State-Owned Enterprise (SOEs) not only intensely apply their Outward Foreign Direct Investment (OFDI)incentives, but accelerates the increasing of their capacities and resources to attract in overseas extension, which can allow them to undertake bigger costs and risks in overseas investment or overcome certain disadvantages in host markets.
ARGUMENTS AGAINST ALLOWING FDI
It cannot be denied that there are numerous benefits that can be obtained by developing countries that acknowledge FDI. However, FDI may also bring with it some negative impacts concerning the political, cultural and economic circumstances of the adopting country.
As a result, these countries have tried to restrict, and even resist FDI because of these national sentiments and concern over foreign economic and political influence. Developing countries that have a history of colonialism would fear that FDI may result in a form of modern day economic colonialism, exposing the host countries and leaving them and their resources vulnerable to the exploitation of the foreign company.
Concerns have been expressed about interference by MNCs in the political and economic affairs of the host countries (Nye, 1974). The concern here is that the host country’s national interests will suffer if an MNC makes decisions on the basis of its own global objectives. MNCs bring about change not only by introducing new business practices in host countries (Business Week, 1986), but also through the new and different products and services they offer. This causes cultural change that may lead to conflict among members of a society.
Another issue that can bring about a negative impact to the host developing country is the issue of technology transfer by MNCs (Asheghian and Ebrahimi, 1990). There are two concerns in this area. The first is that the technology transferred by MNCs is ‘inappropriate’ for the conditions existing in the developing countries. That is, it does not take into account the host country’s factors of production. For example, it is argued that technology transferred to the developing countries does not take into account that these countries have high unemployment. As a result, labor-saving technology might not be appropriate in these countries. The second concern is related to the monopolistic position of the MNCs doing business in the developing countries (Vernon, 1971). The reasoning here is that MNCs’ monopolistic power over the technology they transfer to a developing country makes that country dependent on future flows of technology. As a result, the MNCs can dictate terms that are favorable to them.
Furthermore, FDI may harm the development of local entrepreneurship by deterring potential local investors from entering activities with a strong foreign presence, crowding them out where they exist (UNCTAD, 2003). FDI may lead to the direct or indirect crowding out of local capabilities, an erosion of the tax base or labor and environmental standards (Oman, 2000).
THE CONSEQUENCES OF ECONOMIC IMPACT BY FDI
While there may be attempts to restrict or resist FDI by developing countries, its positive economic impact is undeniable. In terms of the economic impact of FDI to the host developing country’s recent research by Farell (2004) revealed that FDI is indeed good for the economic health of developing countries, regardless of the policy regime, industry, or time period studied. In thirteen out of fourteen case studies, FDI increased productivity and output in the sector, increasing national income while lowering prices and improving quality and selection for consumers. Despite criticisms of the impact of FDI on emerging countries’ economies, their research showed that foreign companies paid higher wages and were more likely to comply with local labor laws than domestic companies.
The McKinsey Global Institute study revealed that FDI resulted in improved sector productivity, output, employment, and standards of living in the host countries, with few negative consequences (Farell, 2004). This type of export-oriented FDI posed little threat to locally owned businesses, which instead often benefit as foreign companies look for local distributors and suppliers. Furthermore, these local companies and businesses can also benefit by copying and building on what the foreign players are doing, as demonstrated by the domestic Chinese consumer electronics and high tech industries.
The impact on domestic living standards is one further positive result of FDI (Farell, 2004). In most of the emerging countries studied, the institute saw lower prices and better selection after foreign companies arrived, mainly because they have a tendency to improve the efficiency and productivity of the sector by bringing new capital, technology, and management skills and forcing less efficient domestic companies to either improve their operations or leave. While incumbent companies stand to lose, consumers benefit. Often, lower prices then led to an increase in demand and industry growth.
SUMMARY AND CONCLUSION
We can summarize that there is an influence of foreign direct investment (FDI) on economic growth in Asian countries. The Hausman (1978) test studied the effect of FDI on economic growth, and the effect of gross domestic product (GDP) on FDI. The results of FDI effect on growth show that FDI has significant and positive effect on economic growth in Asian countries.
Regarding these facts, we come to the conclusion that it is needed for Asian countries to attract the FDI to improve growth and welfare of their country. However, the effect of GDP on FDI shows that factors such as human capital, trade, economic infrastructure and capital have positive effect on attracting FDI. Hence, the Asian countries are able to increase their FDI and therefore, the growth of their country by underlining these factors.
Among other effective factors on economic growth, we could mention economic infrastructure, human capital, decrease of technology gap and capital formation which maximize the growth. However, the population growth, the increase of technology gap, and inflation brings to the decrease of economic growth. The Asian countries should commit their most attention to economic infrastructure and capital formation, because it directly maximizes GDP and affects it indirectly through attracting FDI.
For India, FDI is a strategic component of investment for its sustained economic growth and development through creation of jobs, expansion of existing manufacturing industries, short and long term project in the field of healthcare, education, research and development (R & D), etc. Government should make the FDI policy such a way where FDI inflows can be utilized as tools of improving domestic production, savings and exports through the fair distribution among states by giving much freedom to states, so they can attract FDI inflows at their own level.
While for Pakistan, the government need to create the investment policy which aims to give incentives for investment. Besides transfer of money, FDI also a transfer of new technology as well as managerial and entrepreneurial skill which is helpful for growth an economic development in country. Therefore, it is important of peaceful environment in the country to attract FDI in the country. The study show that FDI has significant and positive impact on employment creation in Pakistan so government has to think carefully to provide friendly environment for investment in industrial sector, agriculture sector, and energy sector in the country.
However, there might be FDI spillover effects in other forms. For example, quality improvement and export growth might result due to FDI presence. Moreover, there might be wider impacts of the whole economy, such as improvement in the infrastructure, the quality of the labour force, and the R & D activities of domestic firms, which would have long term good effects. For the specific case in China and in evolution economies in general, the regulatory environment might also improve in response to the presence of FDI.
Among benefits of FDI is Multinational Corporation (MNC) can be agents of both development and underdevelopment of the host country depending on what types of investment and what the profits from the investments are used for. The belief is that in the long run, the growth of the economies would lead to a higher level of income and therefore higher purchasing power of the citizens and consequently market expansion for the MNCs. Finally, there will be a win-win situation for both MNC and host country.
Among the Association of Southeast Asian Nations (ASEAN) countries, Singapore has a much higher performance in foreign direct investment in real estate (FDIRE) compared to other ASEAN countries on the basis of magnitude of growth, elasticity, and time effect. While Malaysian FDIRE have a neutral unpredictability volume, neutral stability in FDIRE by source countries with more number but small magnitudes of positive cash over valuations (COVs), also moderate time effect by source countries and most elastic to ASEAN countries. Nevertheless, FDIRE in Malaysia seems has long-term co-integration with FDI and demonstrates the positive trend in 2010.
Somewhat, these outcomes do not show the level of countries attractiveness among ASEAN countries for FDIRE. To determine the attractiveness of a certain country in FDIRE, there are several factors that should be analyzed. ASEAN countries have to compete with each other in offering the best environments for foreign investors, including various specific factors that influence investment decisions such as real estate investment opportunities, socio-cultural and technological advantages, political stability and favorable macro economy of host country.
The existence of FDI technology spillover in most ASEAN countries has played a significant role in contributing economic development in host countries. When combined with human capital in host countries, FDI technology spillover effects can be maximized. As a result, countries other than Brunei and Singapore, they should reinforce investment in education, attract highly skilled talents and thus complete the accumulation of human capital, all of which are very significant to economic growth.
Borensztein has proposed the ‘human capital threshold’ hypothesis and has been supported by actual data in most ASEAN countries. The affiliation of FDI with human capital in host countries can more effectively boost the economic growth only if the host country must exceed the ‘threshold’ of human capital, otherwise the entrance of FDI is more likely to just utilize the local cheap labour force, spoil the market share of domestic firms and thus prevent economic development.
FDI from China to Cambodia, Laos, Philippines, Singapore, Thailand and Vietnam has positive technology spillover benefits. As a result, there is absolutely a lack of factual basis for the Western media to criticize China’s FDI as ‘new colonialism’, which is threatening the long-term interests of ASEAN. Moreover, the education threshold of China’s FDI to ASEAN is lower; therefore the FDI has a positive effect to solve the problem of unemployment in countries with lower education level such as Myanmar, Indonesia and Laos.
Hence, we may conclude that developing countries may be able to attract FDI by concentrating on either maximizing their market size or following more flexible trade government. In addition, adding the skilled labour and building financial institutions with moderate and stable inflation may also enable them to attract FDI to enhance economic growth.
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