Foreign direct investment

Foreign direct investment (FDI) is defined as a long term investment by a foreign direct investor in an enterprise resident in an economy other than that in which the foreign direct investor is based. The FDI relationship, consists of a parent enterprise and a foreign affiliate which together form a Transnational Corporation (TNC). In order to qualify as FDI the investment must afford the parent enterprise control over its foreign affiliate. The UN defines control in this case as owning !" or more of the ordinary shares or voting power of an incorporated firm or its equivalent for an unincorporated firm. In the years after the #econd $orld $ar global FDI was dominated by the United #tates, as much of the world recovered from the destruction wrought by the conflict. The U.#. accounted for around three%quarters of new FDI &including reinvested profits' between ()* and (+!. #ince that time FDI has spread to become a truly global phenomenon, no longer the e,clusive preserve of -./D countries. FDI has grown in importance in the global economy with FDI stoc0s now constituting over 1!" of global 2D3. In the last few years, the emerging mar0et countries such as /hina and India have become the most favoured destinations for FDI and investor confidence in these countries has soared. 4s per the FDI /onfidence Inde, compiled by 4.T. 5earney for 1!!*, /hina and India hold the first and second position respectively, whereas United #tates has slipped to the third position. Types of FDI

Greenfield investment6 direct investment in new facilities or the e,pansion of e,isting facilities. 2reenfield investments are the primary target of a host nation7s promotional efforts because they create new production capacity and 8obs, transfer technology and 0now%how, and can lead to lin0ages to the global mar0etplace. 9owever, it often does this by crowding out local industry: multinationals are able to produce goods more cheaply &because of advanced technology and efficient processes' and uses up resources &labor, intermediate goods, etc'. 4nother downside of greenfield investment is that profits from production do not feed bac0 into the local economy, but instead to the multinational;s home economy. This is in contrast to local industries whose profits flow bac0 into the domestic economy to promote growth. Mergers and Acquisitions6 occur when a transfer of e,isting assets from local firms to foreign firms ta0es place, this is the primary type of FDI. /ross%border mergers occur when the assets and operation of firms from different countries are combined to establish a new legal entity. /ross%border acquisitions occur when the control of assets and operations is transferred from a local to a foreign company, with the local company becoming an affiliate of the foreign company. Unli0e greenfield investment, acquisitions provide no long term benefits to the local economy%% even in most deals the owners of the local firm are paid in stoc0 from the acquiring firm, meaning that the money from the sale could never reach

the local economy. Nevertheless, mergers and acquisitions are a significant form of FDI and until around ((<, accounted for nearly (!" of the FDI flow into the United #tates.

Horizontal Foreign Direct Investment6 is investment in the same industry abroad as a firm operates in at home. ertical Foreign Direct Investment6 Ta0es two forms6 ' bac0ward vertical FDI6 where an industry abroad provides inputs for a firm;s domestic production process 1' forward verticle FDI6 in which an industry abroad sells the outputs of a firm;s domestic production processes.

India ! "#est destination for FDI" I$DIA is the ;best destination; for foreign direct investment &FDI' and 8oint ventures, claims country;s /ommerce and Industry minister 5amal Nath. 4ddressing an audience of U# investors at the Focus India #how in /hicago recently he said that India had emerged as an across the board low cost base, attractive enough to multinationals to relocate in the country. =ore than one hundred of the Fortune *!! companies have a presence in India, as compared to only >> in /hina, he pointed out. ?eiterating that India promises high return on investments, Nath said that repatriation of profits was freely permitted, while according to a survey conducted by the Federation of Indian /hambers of /ommerce and Industry &FI//I' a few months ago, <! percent of foreign investors were ma0ing profits and another 1 percent were brea0ing even. These figures would have since improved further he said, adding that FDI policies in India were among the most liberal and attractive in emerging economies. 9e listed out the policy initiatives ta0en by the government in specific sectors such as telecom, ports, airports, railways, roads, energy and construction development with a view to improving competitiveness of the Indian economy. Further, lucrative investment opportunities were being offered to investors though ta, incentives and customs duty concessions for import of plant and machinery needed for the pro8ects. 4n #pecial .conomic @one &#.@' 4ct was also in place to facilitate this process. The minister also sought to dispel the impression that India was lagging behind in manufacturing. AThis is far from the truth. -f course, we are good in #ervices B Cusiness 3rocess -utsourcing, but that does not mean that we lag behind in manufacturing s0ills. In sectors li0e auto%components, chemicals, apparels, pharmaceuticals and 8ewellery we can match the best in the world. =ore than a doDen Indian companies are among the top five global producers in their product categories. It is to showcase our manufacturing that we have come to /hicagoE, he said adding that in FDI India was loo0ing for 2reenfield investment F investment that would create

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employment and bring in technology and not 8ust investment that would replace Indian capital. #pea0ing at an interactive meeting with the 4sia #ociety in New Gor0 Nath said that wooing foreign direct investment &FDI' was an integral part of the economic strategy of both the central and the state governments in India. A$hat is important is that India has an open system with social and political safety valves, and a regulatory environment that provides comfort, long%term stability and security to the foreign investorE, he added. In this conte,t he quoted the /hief =inister of $est Cengal Cuddhadeb Chattachar8ee, as saying in an interview to a business magaDine6 A$e must come face to face with realityH. $e have to attract more funds, more foreign fundsH.. foreigners could come here. They are not coming here for charity. They will earn profit and create 8ob opportunities. That is the mutual interestE. 4fter these words of the /hief =inister of $est Cengal, the Indian #tate with the longest surviving /ommunist 2overnment, Ayou can ma0e some estimate of the economic climate in India and our responsiveness to foreign investmentE, the minister added. The minister said that if he were to describe the Indian economy of today in 8ust three ob8ectives, he would put it as AIndia6 the Fastest%2rowing Free%=ar0et DemocracyE. 9e also too0 the opportunity to correct the misconception that India today was lagging behind in manufacturing s0ills while e,celling only in services and business process outsourcing. AIn sectors li0e auto% components, chemicals, apparels, pharmaceuticals and 8ewellery we can match the best in the world. $e have the s0ills, we have the positive environment and attitude. 4ll we want is investment and better technology. Today few other countries have embraced foreign technology and management best%practices with as much enthusiasm as has IndiaE, he added.

Foreign Direct Investment %& 'timulation of national economy FDI is thought to bring certain benefits to national economies. It can contribute to 2ross Domestic 3roduct &2D3', 2ross Fi,ed /apital Formation &total investment in a host economy' and balance of payments. There have been empirical studies indicating a positive lin0 between higher 2D3 and FDI inflows &-./D a.', however the lin0 does not hold for all regions, e.g. over the last ten years FDI has increased in /entral .urope whilst 2D3 has dropped. FDI can also contribute toward debt servicing repayments, stimulate e,port mar0ets and produce foreign e,change revenue. #ubsidiaries of Trans% National /orporations &TN/s', which bring the vast portion of FDI, are estimated to produce around a third of total global e,ports. 9owever, levels of FDI do not necessarily give any indication of the domestic gain &UN/T4D ((('. /orporate strategies e.g. protective tariffs and transfer pricing can reduce the level of corporate ta, received by host governments. 4lso, importation of intermediate goods, management fees, royalties, profit repatriation, capital flight and interest repayments on loans can limit the economic gain to host economy.

Therefore the impact of FDI will largely depend on the conditions of the host economy, e.g. the level of domestic investmentI savings, the mode of entry &merger B acquisitions or 2reenfield &new' investments' and the sector involved, as well as a country7s ability to regulate foreign investment &UN/T4D ((('. (& 'ta)ility of FDI FDI inflows can be less affected by change in national e,change rates as compared to other private sources &portfolio investments or loans'. This is partly because currency devaluation means a drop in the relative cost of production and assets &capital, goods and services' for foreign companies and thereby increases the relative attraction of a AhostE country. FDI can stimulate product diversification through investments into new businesses, so reducing mar0et reliance on a limited number of sectorsIproducts &UN/T4D ((('. 9owever, if international flows of trade and investment fall globally and for lengthy periods, then stability is less certain. New inflows of FDI are especially affected by these global trends, because it is harder for a foreign company to de%invest or reverse from foreign affiliates as compared to portfolio investment. /ompanies are therefore more li0ely to be careful to ensure they will accrue benefits before ma0ing any new investments. .,amples of regional stability are mi,ed, whilst FDI growth continued in some 4sian countries e.g. 5orea and Thailand, during the ((+I(< crisis, it fell in others e.g. Indonesia. During Jatin 4merica7s financial crisis in the K!7s many Jatin 4merican countries e,perienced a sharp fall in FDI &UN24 (((', suggesting that investment sensitivity varies according to a country7s particular circumstances. *& 'ocial development FDI, where it generates and e,pands businesses, can help stimulate employment, raise wages and replace declining mar0et sectors. 9owever, the benefits may only be felt by small portion of the population, e.g. where employment and training is given to more educated, typically wealthy elites or there is an urban emphasis, wage differentials &or dual economies' between income groups will be e,acerbated &-./D a'. /ultural and social impacts may occur with investment directed at non%traditional goods. For e,ample, if financial resources are diverted away from food and subsistence production towards more sophisticated products and encouraging a culture of consumerism can also have negative environmental impacts. $ithin local economies, small scale and rural businesses of FDI host countries there is less capacity to attract foreign investment and ban0 creditIloans, and as a result certain domestic businesses may either be forced out of business or to use more informal sources of finance &./-#-/ 1!!!'. +& Infrastructure development and tec,nology transfer 3arent companies can support their foreign subsidiaries by ensuring adequate human resources and infrastructures are in place. In particular A2reenfieldE investments into new business sectors can stimulate new infrastructure development and technologies to host economies. These developments can also result in social and environmental benefits, but only where they Aspill overE into host communities and businesses &./-#-/ 1!!!'. Investment in research B development &?BD' from parent companies can stimulate innovation in production and processing techniques in the host country. 9owever, this assumes that in%house investment &in ?BD, production, management, personnel training' will result in improvements. Foreign technologyIorganisational techniques may actually

be inappropriate to local needs, capital intensive and have a negative affect on local competitors, especially smaller business who are less able to ma0e equivalent adaptions. #imilarly e,ternal changes in suppliers, customers and other competing firms are not necessarily an improvement on the original domestic%based approaches &UN/T4D ((('. Towards .arth #ummit 1!!1 .conomic Criefing #eries No. -& ./ro0ding in1 or ./ro0ding out12 A/rowding inE occurs where FDI companies can stimulate growth in upIdown stream domestic businesses within the national economies. $hilst A/rowding outE is a scenario where parent companies dominate local mar0ets, stifling local competition and entrepreneurship. -ne reason for crowding out is Apolicy chillingE or Aregulatory arbitrageE where government regulations, such as labour and environmental standards, are 0ept artificially low to attract foreign investors, this is because lower standards can reduce the short term operative costs for businesses in that country. .,clusive production concessions and preferential treatment to TN/s by host governments can both restrict other foreign investors and encourage oligopolistic &quasi%monopoly' mar0et structure &./-#-/ 1!!!, UN/T4D ((('. .mpirical data for these scenarios is variable, but crowding out is thought to be more common in specific sectors. For e,ample, in industries where demand or supply for a product or service is highly price elastic &mar0et sensitive' and capital intensive. 9ence regulation brings additional costs of compliance and is therefore much more li0ely to influence a company7s decision to invest in that country &-./D b'. 3& 'cale and pace of investment It may be difficult for some governments, particularly low income countries, to regulate and absorb rapid and large FDI inflows, with regard to regulating the negative impacts of large%scale production growth on social and environment factors &$$F ((('. 4lso a high proportion of FDI inflows in developing economies are commonly aimed at primary sectors, such as petroleum, mining, agriculture, paper%production, chemicals and utilities. 3rimary sectors are typically capital and resource intensive, with a greater threshold in economies of scale and therefore slower to produce positive economic Aspill overE effects &-./D a'. Thus, in the short term, low income economies will have less capacity to mitigate environmental damages or ta0e protective measures, imposing greater remediation costs in the long term, as well as potentially irreversible environmental losses &$$F (((, -./D b'.