Factors favoring Foreign Direct Investment

By | May 2, 2014

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Foreign Direct Investment

1.1 i) What do you understand by Foreign Direct Investment?

Foreign Direct Investment, the term foreign investment, or foreign direct investment (FDI), refers to the ownership and active control of the productive assets of ongoing business concerns by an investor in a foreign country. It may include investments in manufacturing, mining, farming, assembly operations as well as other facilities and service industry. And it is believed that foreign direct investments are generally made for the long term and with the expectation of producing a project (Schaffer, Agusti & Earle 2009, p. 19).

In my own understanding, there are two major features depicting the behaviors of FDI:-

First of all, FDI is beneficial to both MNC as well as the target government and economic. It is known that the Foreign Direct Investment (FDI) in any country abroad is the net inflow of investment (capital or other), in order to acquire management control and profit sharing (10% or more voting stock) or the whole ownership of an accredited company operating in the country receiving investment. The foreign direct investment generally encompasses the transfer of technology and expertise, and participation in the joint venture and management (globaljurix.com 2009). Therefore, it is general and widely accepted that the MNC engaging in the FDI in other nations other than the home country has utilize the labor, material as well as other production inputs in generating their project and achieve the project maximization target; but on the other hand it also contribute to the local economic and social development by transfer of technology and expertise as well as other positive effects.

Secondly, on the other hand the FID is not necessarily 100% positive and constructive to the domestic industry development. If there is a large gap between the developments of the domestic industry compared to the development of the international industry represented by the large MNCs. In some perspective, domestic industry can actually lost some of its share of the domestic market to foreign companies, which illustrated that it remained at a competitive disadvantage. There can be no major development in terms of substantial domestic industry growth if the competitors are too big and strong. Therefore from the perspective of the local government, the FDI needs to be utilized but with monitoring and regulation to some extent.

1.2 ii) Comment on the factors favoring Foreign Direct Investment

1.2.1 Capital Availability

The first very factor favoring the FID is capital availability. In the early 2000s, China overtook the United States as the world’s largest recipient of foreign capital. FDI is comprised of capital that an outside investor is willing to place (and risk) within a local region. Conditions in the global capital markets and general economic environment play a role in determining the flow of FDI into China. A thriving global economy, capital markets and business environment create large swaths of investable capital, a portion of which is converted to FDI. Large amounts of capital actually contribute to the surge of FDI activities.

1.2.2 Political factors that motivate FDI

A category of factors favoring the FDI decisions are political. Although several political considerations have been alluded to above, this subsection restricts itself more to what may be called basic political attitude than to specific policy actions. And among the primary political factors that attract FDI are a stable government and laissez-faire attitude. Also, a secondary political factor is the effort of the states to attract FDI (jrap-journal.org 1990). This is also the actual case happening in China. From the beginning of the nineties and particularly from 2001, when China joined the WTO, until the present, the attitude to foreign investment in China has changed, among other matters, foreign investors are permitted to form companies that are 100% owned by foreign capital. Sales to the local market are permitted and foreign investment is also allowed in sectors other than industry and hi-tech, such as banking, insurance, financial services, etc. As a result of joining the WTO, China is expected to standardize specific benefits that were previously granted only to overseas investors or only to Chinese companies (worldwide-tax.com 2010). But obviously the government attitude does not itself powerful enough to attract desired quantity of FDI but it needs to work with the certain economic conditions. That is the reason why FDI adopted by many governments is not successful for all of them.

1.2.3 Openness to international trade and access to international markets

It is believed that economic reforms, open-door policies and other efforts to promote trade, through bilateral trade agreements and unilateral actions such as lowering of tariff barriers can attract export-oriented FDI. Other FDI motivators such as enjoying attractive and strategic geographic positions adjacent to potential important countries and providing access to regional and global markets (OECD 2002) will all relying on the government’s open policy to allow such advantages to be utilized appropriately. For example, to maintain steady growth of FDI is a must for China to implement the policy of reform and opening up. Since the mid and late 1980s, China has adopted various measures to stimulate FDI. Foreign investment has made significant contributions to China’s economic development. Foreign-invested enterprises contributed 35 percent of China’s industrial output value and more than 20 percent of the country’s tax revenue, and created 30 million job opportunities. This is not only an achievement of China’s reform and opening up, but also an important pivot for advancing reform and opening up. Hence, to maintain steady growth of FDI helps to consolidate the achievements of reform and opening up (china.org.cn 2012).

1.2.4 Low labor cost driven FDI

With the commonly found high salary level in the developed country, it is widely accepted that the high labor cost in the home country has become a major reason for the MNCs to approach FDI in the relatively less developed countries where low labor cost can be source. Such FDI activities are even more common in the labor intensified industries such as the textile industry. This also explains that why out flow FDI from China is usually targeting at the African countries and other Asian developing countries.

1.3 iii) Appraising Foreign Direct Investment involves financial and operational complexities not encountered in evaluating domestic projects. Discuss the main complexities.

1.3.1 Reduced advantage in ownership and control

Projects can exhibit multiple forms, as they face different contexts and may aim at several kinds of goals. Projects result from various forms of cooperation between companies such as strategic alliances, partnerships, joint-ventures, or consortiums with other organizations that support the collaborative strategic efforts of the members (Hamel, Doz, & Prahalad, 1989). Within these alliances and partnerships individual organisations pursue independent strategic aims, as well as shared goals. Often collisions of interests has to be resolved with political negotiations and trade-offs. As a result, project constellations remain fragile formations driven by contract liabilities and agreements where ownership and control do not bring directly competitive advantage.

1.3.2 Complexity in investment policymaking

According to the World Investment Report 2012, many countries continued to liberalize and promote foreign investment in various industries to stimulate growth in 2011. At the same time, new regulatory and restrictive measures continued to be introduced, including for industrial policy reasons. They became manifest primarily in the adjustment of entry policies for foreign investors; and in a more critical approach towards outward FDI. International investment policymaking is in flux. The annual number of new bilateral investment treaties (BITs) continues to decline, while regional investment policymaking is intensifying. Sustainable development is gaining prominence in international investment policymaking. Numerous ideas for reform of investor–State dispute settlement have emerged, but few have been put into action (unctad-docs.org 2012). And because of the shaping of the policy environment, such policymaking trend has actually increased the complexities faced by the MNCs in evaluating the FDI projects.

1.4 iv) Analyze the Rio Disney project (Disney theme park in Brazil) from the perspective as a foreign direct investment.

1.4.1 Case background

Three potential countries of interest for a Disney Theme Park would be Brazil, Chile, and Colombia. All are located in South America, a market in which there is no theme park yet. These three potential markets each have their own benefits and risks (essaysforstudent.com 2012).

1.4.2 FDI analysis on Rio Disney project

Disney theme park in Brazil is considered as a better choice other than in the other two candidate countries for a number of considerations. Brazil is the leading economy in Latin America which is made up completely by developing and emerging markets. About half the countries in the region are classified as lower middle income countries (for example: Peru, Bolivia, Colombia, Panama) and the other half is classified as upper middle income countries (Brazil, Mexico, Argentina, Chile). Brazil became an independent nation in 1822. It is the largest and most populous country in South America. It continues to pursue growth in both agriculture and industry. (wikinvest.com 2010). And therefore its major economy position and degree of development has made it a better choice among the candidates. Secondly,