Group Assignment-2

Submitted by: AKASH JOSHI VAIBHAV GARG

What is Foreign Direct Investment (FDI)?



A source of capital and investment involving foreign control of production A source of exploitation? A channel of technology transfer and industrial development?

What is FDI ?


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 10% or more of the ordinary shares or voting power of an incorporated firm or its equivalent for an unincorporated firm.

Types of FDI



direct investment in new facilities or the expansion of existing facilities. Greenfield investments are the primary target of a host nation s promotional efforts because they create new production capacity and jobs, transfer technology and know-how, and can lead to linkages to the global marketplace. downside of Greenfield investment is that profits from production do not feed back into the local economy, but instead to the multinational's home economy. This is in contrast to local industries whose profits flow back into the domestic economy to promote growth.

Greenfield

investment:

Types of FDI Continued



Mergers and Acquisition

transfers of existing assets from local firms to foreign firms takes place; the primary type of FDI.  Cross-border mergers occur when the assets and operation of firms from different countries are combined to establish a new legal entity.


Types of FDI Continued



Horizontal Foreign Direct Investment: investment in the same industry abroad as a firm operates in at home. Vertical Foreign Direct Investment: Takes two forms:


1) backward vertical FDI: where an industry abroad provides inputs for a firm's domestic production process 2) forward vertical FDI: in which an industry abroad sells the outputs of a firm's domestic production

Types of FDI based on the motives of the investing firm



Resource Seeking: Investments which seek to acquire factors of production that are more efficient than those obtainable in the home economy of the firm. In some cases, these resources may not be available in the home economy at all (e.g. cheap labor and natural resources). This typifies FDI into developing countries, for example seeking natural resources in the Middle East and Africa, or cheap labor in Southeast Asia and Eastern Europe. Market Seeking: Investments which aim at either penetrating new markets or maintaining existing ones.

Efficiency Seeking: Investments which firms hope will increase their efficiency by exploiting the benefits of economies of scale and scope, and also those of common ownership. It is suggested that this type of FDI comes after either resource or market seeking investments have been realized, with the expectation that it further increases the profitability of the firm. Typically, this type of FDI is mostly widely practiced between developed economies; especially those within closely integrated markets (e.g. the EU).

Global Trends
 

..

Concentrated in the USA, Japan and Western Europe FDI of developed countries in 1998:
 

Inflows: USD 460 billion Outflows: USD 595 billion China Brazil Mexico Singapore Indonesia

Top five host countries:

    

had 55% of FDI inflows to developing countries in 1998

Attractiveness as FDI Destination

            

Strong and stable government Pro-active government policies Investor-friendly and transparent decision making process Sound diversified industrial infrastructure Comfortable power situation Abundant skilled manpower Harmonious industrial relations Quality work culture Peaceful life Incentive packages Cosmopolitan composition Fluent English Chennai ranked second-best by BT Gallup Survey of Best Cities to do Business (Dec. 2001)

Dollar Flows to Asia

160000 140000 120000 100000 2001 2002 80000 2003 60000 2004 40000 2005 20000 0 Asia

Dollar Flows to Asia

40000 35000 30000 25000 20000 15000 10000 5000 0 China Hong Kong India S Korea Taiwan 2001 2002 2003 2004 2005

Dollar Flows Growth Rate

90 80 70 60 50 40 30 20 10 0 -10 China Hong Kong India S Korea Taiwan

Growth %

FDI Inflow
6 5 4 3 2 1 0 2003-04 2004-05 2005-06 India

Add here

..

FDI: Benefits to the Host Country



Resource Transfer Effects

 

Capital
 MNE

invests capital in foreign markets

Technology
 Research

supports that MNEs do transfer technology when they invest in a foreign country

Management
 When

MNEs invest and manage in a foreign country, they often transfer management skills to the host country s workforce

Employment Effects  MNEs, by investing in foreign countries, can create employment opportunities for the local workforce  Acquisition vs. Greenfield Investment Balance of Payment Effects  Balance of Payment: A country s balanceof-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. We look at the beneficial effects next

Effect on Competition


Efficient functioning of markets require adequate level of competition between producers

Inflow of payments from export of goods and services



To the extent that the goods/services produced by the FDI are exported to another country, there is a positive effect on the host country s B-of-P

FDI: Benefits to Host Country s Balance of Payment



Initial Capital Inflow



When a company invests in a foreign country, it brings capital into that country To the extent that the goods/services produced by the FDI substitute for imported goods/services, there is a positive effect on B-of-P

Substitute for Imports



FDI: Costs to Host Countries



Adverse Effects on Competition



MNEs may have too much power and kill off competition After initial inflow of capital, subsequent outflow of capital from the earnings of the FDI FDI may import inputs from abroad Key decisions that affect the host country s economy may be made by a foreign parent that has no real commitment to the host country

Adverse Effects on Balance of Payments



National Sovereignty and Autonomy



FDI: Benefits to Home Country



Benefits
 

Stream of income from foreign earnings FDI may import intermediate goods or inputs for production from the home country, creating jobs MNEs may learn skills from exposure to foreign countries

FDI: Costs to Home Country



Costs  Balance of payment:

 Initial

capital outflow (but often set off by future stream of foreign earnings)  Current account suffers if FDI is to serve home market from low-cost production location  Current account suffers if FDI is a substitute for direct export


Employment effects:
 FDI

a substitute for domestic production (e.g., Etch-A-Sketch)

Government Policy Instruments and FDI: Host Country Policies



Encouraging Inward FDI

   

Tax concessions Low-interest loans Grants Subsidies

Restricting Inward FDI



Ownership restraints
 Exclusion
 

from certain industries  Why do so?

To protect national interest (defense, etc) To facilitate resource-transfer

Performance requirements
 Local

content, exports, technology transfer, and local participation in top management

Dollar Flows Growth Rate

90 80 70 60 50 40 30 20 10 0 -10 China Hong Kong India S Korea Taiwan

Growth %

FDI Inflow
6 5 4 3 2 1 0 2003-04 2004-05 2005-06 India

Advantages of FDI in India

  

Domestic Investment Advantages FDI encourages domestic providing:

  

investment

by

New markets Demand for inputs New technology

  

Labor is mobile and often moves from multinational firms to domestic firms Increased competition makes markets more efficient Investments in new sectors simulates the growth of new industry and new products

Employment Generation and Labor Skills  Foreign firms generate hundreds or thousands of jobs  They generate employment in suppliers


  

Technology Advantages Foreign firms bring new technology

  

Increased productivity of labor and capital Improved product standardization Reduced error rates Upgrades overall stock of capital More efficient in raising and using financial resources Unrestricted access to parent company's technology Access to tacit knowledge

Foreign firms invest in new technology

   

  

 

Export Competitiveness Advantages Dominant technologies brought in by foreign companies makes products suitable for export Foreign technology increases production, reduces error rates and improves quality Foreign firms have strong distribution and marketing facilities Foreign firms have brand names that help exports

Disadvantages of FDI in India

Domestic Investment
 

Disadvantages FDI crowds out domestic investment by:

  

Being a monopolistic competitor Raises demand for money Raises interest rates Advertising power Ability to dominate the market Predatory pricing to prevent entry

Foreign firms have more:

  

Financial inflows raise the exchange rates, making exports unattractive

 

Technology Disadvantages Technology brought may be inappropriate The technology may be too capitalintensive Pollution-intensive technologies may be exported from countries where they are banned Sometimes, external transactions allow foreign technology to be acquired more cheaply, especially if the technology is mature

 

Environment Disadvantages Foreign firms operating in regions where rules are non-existent or not enforced have greatly exceeded emissions and effluent levels allowed in their home countries Foreign firms have exercised significant political influence to prevent the imposition of rules regarding the environment

Some of the major pitfalls .



FDI flows have simply enabled transnational giants like Coke and Pepsi to set up monopolies in highly profitable sectors where Indian business concerns were already meeting the requirements of the market. Coke and Pepsi, with their monopolistic stranglehold on the bottling and distribution chain have wiped out niche producers; consumers have less choice than they did before, and must pay more. Neither have these companies brought in any valuable new technology.

Contd


..

Highly controversial Enron Power project The Emerging Telecom Scandal FDI has come in the form of speculative investments in India's stock market

Conclusion
   

Foreign firms do generate technological development in the host country Crowding out is not a major problem Host countries should enforce environmental regulations This will not make foreign firms leave the country, as the cost of conforming to regulations is much lower than the difference in cost of labor Benefits in increased:
  

Competition Efficiency Innovation