FDI

Page 1

Foreign Direct Investment: Catalyst for Economic Success

Anne Wilks Humanities Pat Holder

Constructing a stable thriving economy for a developing nation is comparable to fighting an uphill battle; the top seems obtainable but is always difficult to reach. In today’s modern world, Foreign Direct Investments1 have made the goal of economic success more accessible and maintainable on multiple levels. Once the FDI has been attracted it ultimately provides the means for raising the standard of living, through participating in the international market place which promotes the well being of the citizens. Globalization has been the catalyst for relationships between nations and the creation of an efficient global market. Through globalization FDI has been able to increase capital flow to countries with emerging economies from eighteen percent to thirty-six percent in fifteen years.2 Although FDI can initially have some negative consequences in capital-scarce economies, once they’re integrated into the global market, FDI generates economic interdependence thus, creating a vested interest in foreign growth therefore creating stability. Foreign enterprises have contributed to the creation of an efficient world market and responsible for establishing international relationships. FDI has the potential to generate: jobs, raise productivity, transfer skills and technology, and contribute to the long-term economic growth of the world’s developing countries. Primarily FDI allows for nations to increase their capital flow by encouraging relationships that will profit both parties involved; this can be done on an individual, corporate, or national level. When an investor needs a specific resource and another party can provide that service for a lower price, then an initial relationship is developed. For example, when the year 2000 rolled

1

Herein FDI Anil Kumar. "Economic Letter-Insights From the Federal Reserve Bank of Dallas." Federal Reserve Bank of Dallas. Jan. 2007. 29 Dec. 2007 <http://www.dallasfed.org/research/eclett/2007/el0701.html>. 2

around the fear of the Y2K bug infecting and crashing computers was world wide; thus United States3 began searching for an effective and low cost solution. India had been preparing for an opportunity such as this; their government had been pouring money into education since the 1970’s and were producing a large amount of qualified engineers. At this time there where very few jobs available for engineers in India; many were forced to seek employment in other countries. India jumped at the chance to get their foot in the door of the global market and this was the opportunity they had been waiting for. The Indian engineers were hired to fix the software resulting in the U.S. paying about onefifth the cost of having the same job done at home. After the Y2K bug scare was over, India and the U.S. never forgot each other and has built a still lasting relationship.4 This has happened over and over again, where the demand is the catalyst to an international relationship, making this cause and effect happen on a global scale. Once a country has caught an investor’s attention the next step is to captivate the investor in order to keep them coming back for more. In order for investors to consider foreign options for FDI, developing nations must have a stable government and some insurance that the return will be profitable. Initially many issues are taken into account when looking at investing in a nation, especially the policies that their government has in place. Important policies to consider are namely tariffs, foreign ownership, and monetary policy; all of which are significant deciding factors. Tariffs in layman terms are taxes on imported and exported goods that distort the normal forces of supply and demand. Low or no tariffs means the larger the return that will be made, which is the goal. Tax rates on investment returns are another

3 4

Herein U.S. Friedman, Thomas L. The World is Flat. 3rd ed. New York: Picador, 2005.

strategic part of the puzzle. In the end profitable economic activity must allow the investor to take their money home. Tax policies must be structured by the government to allow this to happen. Foreign ownership is deciding how much of your company that you can sell to foreign investors; and is an aspect that must be reevaluated continually by companies or government. An example of foreign ownership limit is the U.S. airline business allowing only twenty-five percent of the company to be foreign. The reason that an U.S. airline company can only sell twenty-five percent is because commodities such as airplanes can be used for various reasons in times of crisis, such as war, transporting groups of people in danger, and other political disputes. If a foreign investor does not agree politically by only owning twenty-five percent they will not have enough say to overrule the decision made. This is more of a precautionary made by individual companies and governments to ensure that they will still have the final say in the direction that the company decides to move in. Lastly, monetary policy is key factor that is affecting FDI. A foreign investor must have confidence in the stable value of a country’s currency. The central bank of a country trying to attract foreign investments must maintain a relatively stable currency by following polices that control inflation. Take a country like China where they are develop the majority of the goods produced in the world, they are able to do so for various reasons. One being that their currency is fixed and doesn’t float; meaning that the exchange rate for the Yuan doesn’t fluctuate depending on the supply and demand. Fixed rates unlike floating rates are controlled by the government which decides the official exchange rate. To keep a rate fixed the central bank has a high level of reserves,

used to release or absorb extra funds into or out of the market.5 By the government controlling the Yuan they are allowing for investors to pay less for the manufactured goods, making more people purchase their products. This means that people will continue to invest into China because their prices are so affordable. Many countries are arguing that it is not fair for China to peg their currency rate, that it gives them an unfair advantage; sanctions are being applied in order to discourage such activities, although negotiations are still in the process. When governments that encourage FDI are in power it allows for stable economies to grow and for more opportunities to come forth. Governments that run efficiently and continues to work with investors there is less possibility of the investment going sour. If the country is to shift power, whether that is presidents, a shift in the actual government structure, or even a change in heart about FDI, can jeopardize the investment all together. Issues that could put the investment at risk are, new tax laws, different views on how FDI should be handled, new policies and regulations, etc. Many times in this situation there is nothing really the investor can do, unless they are protected by international law. International laws are very hard to negotiate because once there is an investment made in a country that investor must abide by those nations laws. Once the government is changed the contract could very well be altered as well and the investor would have no say or way to challenge it. For example, in Mexico recently there has been an increase of foreign investment in casinos but the government changed a law on taxes. Essentially the Mexican government drew in foreign investors to the gaming industry by making their policies seem very reasonable. But the government just passed

5

Reem Heakal. "Floating and Fixed Rates." Investopedia. 30 Dec. 2007 <http://www.investopedia.com/articles/03/020603.asp>.

a law stating that twenty percent of the gross income would go directly to the government. Usually the tax will be on the net income allowing for more profit to be made. Investors now are losing their investments and are pulling out with a loss and Mexico has discouraged any other foreign investors to come and invest. Once incorporated into the international global market, countries can continue to expand through their connections economically and can eventually begin to support themselves. When stable countries invest in developing nations they are essentially the only source of income for government. Wealthy investors are venture capitalist, in the sense that they are risking their money in hope of making a decent return on the investment. Most emerging markets cannot always ensure that the investor will receive a profit from a transaction because of the nation’s lack of stability or for unforeseen events that might possibly occur. But if the investor does make a significant return it creates a relationship between the two nations that will hopefully maintain and strengthen. Nation’s governments, depending on how they decide to spend the money, can make a substantial change for their citizens. When a nation’s economy does well the standard of living for the people is bound to eventually rise; which in turn will create greater job opportunities allowing for movement up the economic ladder of success. Foreign affiliates of some sixty-four thousand transnational corporations has generated about fifty-three million jobs alone; that shows the extent of what FDI can do.6 Countries with high standards of living continue to flourish and are now the countries that are using FDI to grow even more.

6

“United Nations Conference on Trade and Development.” UNCTAD. 2007. 29 Dec. 2007 <http://www.unctad.org/Templates/Webflyer.asp?docID=9439&intItemID=2068〈=1>.

Economically stable nations continue to grow through FDI as well because their people have access to goods for a cheaper price and the more that people can afford raises the standard of living. When individuals of a nation move up in the business world the nation can succeed as a whole. On the flip side, when a developing nation has a low valued currency more countries are drawn in to invest into it because the prices are low in comparison to those in their own country. In the case of China, by keeping the Yuan from floating, it allows investors to make a greater return from the goods they are producing or buying there. Importing and exporting goods is helping both sides turn a profit not only in the actual products; but it is also creating job opportunities and encourages a more educated work force. When a certain skill level or is in demand the country that can first produce individuals with those skills can cease opportunity in the global marketplace. Governments that invest in their education system will ultimately help create opportunity for economic growth. But there are other needs of a country for the government to invest in, such as military, well being of the citizens, and even the basic infrastructures such as, sanitation, water systems, agriculture, etc. It depends on what the government deems the priority on the list. 7 Although FDI allows nations to jump start the development of their economy, it comes with some potential drawbacks; such as weakening codes for labor, health, and the environment, can lead to an over throw of the government, and the imposition of western culture. Weakening codes for labor is an effective way to cut costs and one of the more commonly used methods. When manufacturing products in factors companies are usually solely looking at how to make the most profit. A successful way to maximize 7

Ibid.

labor from the workers is having them live close to factories; companies build housing, usually of poor quality to house their workers. By determining where the workforce lives this helps the employers easily mange how many hours the workers put into the factories. Another way to save money includes under compensating employees for their efforts and paying less then initially offered. Predominantly in South-East Asia factor workers are promised wages and then once they move to the factory housing are given a significantly lower wage. There are no contracts in the beginning stages and so there is nothing legally that the individual can do to fight it. Hiring children is another way to cut costs; companies can pay children less to work in factories. In today’s society it is harder to employee children due to child labor laws, but children are still being hired. The weakening in health codes means that companies can spend less money in the up keep of their factory or housing. Reduced environment codes allow for improper disposal of waste and more cost efficient, not necessary the green way, to reach resources. When countries or entrepreneurs are looking to invest, they want to make sure that the government will be stable enough to ensure that the transaction will be completed. In some instances, for a country to even be considered, other parties will take action to over throw the government to allow for the new system to be set in place, one that the investors will favor more. Military coupes are not uncommon in order to allow for FDI to come to a nation. Coupes don not always necessarily work out and the initial government will be reinstated. Coupes also usually make the country unstable during the transitioning stages making it worse for the citizens. Lastly western culture being imposed on traditional countries has been a recent issue on the rise. Western culture is based on capitalism and that allows for a disregarded

traditions. People in western culture are looking towards how to make the most possible money and usually that leaves out time for past customary routines. India for example is having a hard time accepting the western culture that has come with the boom of their economy. Younger generations are becoming more independent are embracing the idea of the capitalistic society that has been created. Valentine’s Day is seen as a western holiday and many traditionalists do not approve of this “Hallmark� holiday. It has become a day that contributes to the card, candy, flower industries and a day to show affection toward another, which is not appropriate in their society. They believe what happens in the bedroom should stay in the bedroom and that is a private matter between two people.8 Foreign direct investments have the potential to deliver enormous benefits to developing nations. Besides helping bridge the gap between saving and investing in capital-scarce economies, capital flow often brings with it modern technology and encourages development of a the nation as a whole. FDI has been effective in promoting growth and productively in countries that have the resources to make it, but never had the opportunity. FDI creates opportunities for developing nations to create a thriving and stable economy, allowing our world to grow as well.9

8 9

Freidman Kumar

Turn static files into dynamic content formats.

Create a flipbook
Issuu converts static files into: digital portfolios, online yearbooks, online catalogs, digital photo albums and more. Sign up and create your flipbook.