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This essay discusses the impacts of foreign direct investment on host economies using various examples and case studies.
Foreign Direct Investment
Foreign Direct Investment refers to the direct or indirect ownership of a company or an incorporated business enterprise or assets in a host country by foreign residents with the aim of generating wealth it is a major catalyst to development .This essay seeks to discuss and evaluate the impact of these investments on host economies.
The United States of America, Japan, The United Kingdom and Germany are among the largest foreign investors in the United States of America. Foreign Direct Investment have had an impact on the economy by creating employment opportunities to Americans, in 1990 foreign companies employed a total of 2 million manufacturing workers altogether, representing 11 percent of all American factory workers. Moreover these foreign companies for instance tend to offer higher wages to their employees. This translates to higher labor productivity in the foreign owned companies and their employees have a higher purchasing power and standard of living and boost the American economy (Sumiye, O. pg 9-14).
Foreign owned multinationals play a big role in boosting exports from the United States, subsidiaries of foreign owned companies in 2006 contributed about 19 percent of all exports. The multinationals use their network and knowledge of foreign markets to sell American products. Much of the foreign investment in America is in the service industry this has greatly enhanced America's competitive edge in this industry (Jackson,J,K).
Case Study: Brazil
Foreign Direct Investment through outsourcing has promoted development where the multinationals pass on valuable technology to the countries where their subsidiaries are located. In Brazil for example, engines manufactured by General Motors subsidiary in that country were perfect substitutes for those manufactured in America. The foreign investors offered better wages than other employers. Foreign investments positively affect productivity in that the subsidiaries production levels were higher than those of companies that did not have foreign investors (Hanson, G, H).
Foreign Direct Investments also act as a major source of external finance in less developed countries as it played an important role in jump-starting economic growth by pumping in much needed capital, the transfer of technology and employment creation. They also help to open up the markets of the host nations, these investors are usually attracted by the enactment of sound economic policies developed by the host country which helps in boosting overall development. The foreign companies encourage export activity in the host country by acting as a bridge of knowledge of the markets overseas(Lipsey, R, E. & Sjoholm, R).
Case Study: India
In order for developing countries to attract significant volumes of foreign direct investment, they have tried to create a business friendly environment to promote investments. This has led to an improvement in the overall economic management of these countries because foreign direct inflow volumes are greater in countries that are better managed due to productivity and safety issues. In India for example, the government after 1991 formulated special incentives for investors such as power tariff incentives, free interest government loans and preferential land allocation.
Foreign Direct Investments provide key factors of production such as capital which is also valuable foreign exchange, competent managerial skills and willingness to bear risk to the Indian economy. It raises productivity in the country thus helping in poverty reduction which was a huge problem in India, resulting in income growth. These investments may however impact on domestic companies that might be involved in the same business and if the multinational company is dominant it might result in the domestic company closing shop. To benefit fully from foreign investment the host country must achieve some level of economic infrastructural development.
Impact of FDI on Growth
In the 1960's and 70's India's economy suffered as a result of adhering to protectionist policies. Market liberalization in the early 90's led to robust levels of economic growth. This growth however may present foreign companies with an avenue to earn excessive profits under distortions in trade and financial markets (Agrawal, P).
Through the multinational companies foreign investors play a crucial role in technological transfer especially to developing countries such as India. Foreign companies greatly enhance knowledge and skills of professionals in the host country through training or experience as a result of working for the multinationals. The increase in foreign investment in India led to an upgrade in technology The development of human resources is instrumental in the diffusion of technology to India Employees that have worked for multinational corporations may thereafter move on to work for other domestic companies taking with them the valuable skills, knowhow and experience they must have gathered while working for these companies. The Indian economy was also opened up to global managerial practices.
The entrance of multinationals to an economy triggers competition in the host nation's economy. Domestic companies up their game to raise productivity and improve the quality of their products in order for them to effectively compete with products from multinationals that are mostly high end; consequently consumers are the greatest beneficiaries of this (Sarkar, S)
There are however negative effects of foreign direct investment on the economy of the host nation for example the repatriation of royalties, profits and dividends are paid to the mother company usually in a foreign country. This results in a reduction in the balance of payments in the host nation. It might also lead to the transfer of inappropriate technology which may lead to higher production costs in the long run. Domestic companies may also be unable to compete with multinationals due to inadequate resources(Blomstrom, M, Globerman, S & Kokko,A).
Case Study: Vietnam
In 1987 Vietnam implemented its Foreign Investment Law which led to an increase in foreign direct inflows into the country .In this policy, market forces played a central role in Vietnam's economy. The investment climate in the country greatly improved as a result. Foreign Direct Investment has increased over time from 342 million US dollars in 1988 to about 21.3 billion dollars in 2007(Hoang, P,T).
Spill Over Effects
The foreign companies initially focused on the mining and oil industries due to Vietnam's wealth in natural resources. In the late 1990's foreign direct investments accounted for about 25% of total tax revenues and 13% of Vietnam's Gross Domestic Product . The increase in investments was reflected in several aspects of the economy, for example there was a marked increase in the Growth Domestic Product, employment and international trade. The country also enjoyed relatively high rates of economic growth; about 7% annually. The gap between local and foreign multinationals in that the multinationals are more technologically advanced and have a larger capital base, forces domestic companies to restructure their operations if they want to remain competitive and maintain market share.
Characteristics of Foreign Direct Investment and Poverty in Vietnam
The market oriented reforms resulted in high rates of economic growth; much to the benefit of the poor. The number of people living below the poverty line significantly reduced. Foreign companies were attracted by among others Vietnam's big market of about 70 million people, good quality human resource and a young labor force. The multinationals employed about 1% of the total population of Vietnam. Foreign Direct Investments grew virtually from nothing in 1987 to 8.6 billion dollars in 1996 making the country rank second in the world in terms of foreign direct inflows.
Concluding Remarks and Suggestions for Future Research
There are many aspects from which local Vietnamese companies can learn from the existence of foreign multinationals. Cases of Spillovers may be negative or positive or negative depending on the region, company or industry (Hoang, P, T).
Case Study: Costa Rica
In 1997 Intel, an American multinational decided to invest in a microprocessor plant in Costa Rica, Intel wanted to take advantage of the cheap labor available in Costa Rica that was highly educated. In order to create a favorable business environment in the country, the Costa Rican government formulated a free zone scheme that offered tax exemptions to companies that satisfied certain conditions under this scheme. Costa Rica political environment was relatively stable and also had low levels of corruption in government. The Costa Rican economy felt an impact as a result of Intel's investment through the employment of about 3500 Costa Rican workers directly and many more indirectly, through their suppliers of inputs(Foreign Direct Investment Policies).
After the investment
Intel's initial investment in Costa Rica which was valued at over 300 million US dollars at the time represented about 2.1 percent of Costa Rica's gross domestic product; this was a substantial investment by any standard. Intel also offered higher wages to their employees who were paid 3.36 US dollars per hour compared to 2.21 dollars elsewhere in the country; this was 50 percent higher than the average wage in the Costa Rican manufacturing sector, thus their employees had a higher purchasing power. The productivity of the economy generally increased workplace standards and improved the country's business culture; technological transfer also took place through the training of employees (Moran, H. T, Graham ,M E& Blomstrom, M).
Intel Costa Rica as a Free Zone Investor
The Intel Costa Rica Campus was too large to be located in the already existing Free Zone Park, this necessitated a revision of the law to include premises found outside the Free Zone Park. Intel Costa Rica received investment incentives as a Free Zone Investor which included total import tax exemption on capital goods, raw materials and components. The company also benefited from an eight year tax holiday and 50% on the next four years; 100% exemption on excise taxes, export taxes, taxes on local sales and taxes levied on repatriated profits. Customs clearance was fully expedited and was done on site in the case of Intel Costa Rica.
The "Signaling Effect"
Intel had extensively conducted due diligence in its search for an investment destination before choosing Costa Rica as an investment destination, their choice made headlines around the corporate world. This greatly marketed Costa Rica as a favorable investment destination for foreign multinationals especially in the technology sector. Intel's investment in Costa Rica had an overall positive effect on the economy in that it triggered an immediate improvement if infrastructure and in that process enabled the country to come up with a strategy to attract more foreign investors. Many more multinationals in the technology sector and other sectors began to view Costa Rica as a potential investment destination (World Bank).
Foreign Direct Investment plays an important role in the development of the host country through creation of employment, technological diffusion but most importantly it goes a long way in encouraging transparency in governments. It also acts as a catalyst for accelerated infrastructural development as this is an area where potential investors consider before investing. It may however have negative effect in that local companies that are unable to compete may be forced to close shop.