There are lots of studies discussing the definition and nature of FDI. In his study, Hill (2008) defines FDI as:
“Foreign direct investment (FDI) occurs when a firm invests directly in facilities to produce and/or market a product in a foreign country.”
This idea is supported by Griffin and Pustay (2001), FDI are investment made for the aim of actively managing assets and property or firms located in host countries. Licensing, franchising and exporting and the specialized strategies enable companies internationalizing its business without investing in foreign facilities and factories-which is, there are no company ownerships. Nonetheless, many companies prioritize to go into international markets through the companies’ ownership of assets in host nations. That is why FDI is chosen.
Hill (2007) contends that FDI could hold the form of an acquisition of or a merger with an existing local organization or a Greenfield venture in a new facility. The data propose the greater part of cross-border venture is in the shape of acquisitions and mergers rather than Greenfield investment. This is supported by Calderón et al (2002), “Investment taking the form of acquisition of existing assets (M&A) grew much more rapidly than investment in mainly new assets (‘Greenfield’ FDI), particularly in countries undertaking extensive privatization of Public enterprise.”
Hill (2008) also state that, between 1998 and 2003, the estimation of United Nations point out some 40 to 80 percent of all FDI inflows was in the form of acquisitions and mergers. In 2001, for instance, of all FDI inflow, acquisitions and mergers accumulate for some 78%. Nevertheless, the flow of FDI into developing countries varies markedly with those into developed countries. Regarding the case of developing countries, cross-border mergers and acquisitions account for only one third of FDI. The poorer figure of acquisitions and mergers might merely reflect the fact that there are less target companies to acquire in developing countries. This is followed up by Griffin and Pustay (2005), FDI mostly take place between the developed nations. For illustration, at the end of June 1999 the Australia’s stock of FDI account for A$172.1 billion whilst the outward Australian investment account for A$90.5 billion.
Foreign direct investment is increasingly shifting away from extractive industries and manufacturing toward services (Manafnezhad, 2005). To be specific, Hill (2008) exemplified that 47% of outward FDI stock was in service industries in 1990; this percentage has increased sharply to 67% by 2003.
In his book, Hill (2008) suggested that there are four factors which drive the shift to services. Firstly, a lot of services cannot be traded globally. They necessitate to be produced in the countries where they are utilized. Secondly, whilst FDI stay more restricted in services, both developing and developed countries have obtained some steps to open up their service industries. In fact, some developing nations can have liberalized their service industries beginning at a higher level of restrictiveness at an even speedier rate than developed nations over the past decade. While comprehensive data of FDI’s restriction in services do not exist, it is probable to represent some subtraction from reservation lists in diverse international agreement which deal with investment. Thirdly, the boom of internet based global telecommunication networks has enable some service venture to reposition some of their value creation activities to various countries to take advantage of favorable factor costs. Lastly, in many countries the shift reflects the common move away from manufacturing and toward service industries. Services dominated 52% of GDP in developing countries and 72% in developed countries by the early 2000s.
FDI also creates some benefits and costs to the home countries. There are some criticisms which state that the benefits of FDI to home countries far outweigh the costs and any restrictions would be opposing to the country interests. Other criticize that FDI should be restricted since it is not always in the home country’s national interest.
As stated by Hill (2008), there are two sources which a home country gets beneficial from FDI. Firstly, the inward flow of foreign earnings benefits the capital account of the home country’s balance of payment. The data from 1980 to 2004 revealed that the FDI flows have account for 2% to 4% of global fixed capital formation. In US and Europe, there are 14% and 20% of manufacturing jobs accounted by FDI which are the key sources of world outward FDI though the FDI has shifted to build up the economics since 1980s (Chang 2008). In his study, Kokko (2006) asserts that economic growth and inward FDI show a positive relationship in developing nations in spite of some arguments regarding the financial development of the country.
Secondly, benefits arise when the home country MNE comprehended noteworthy skills from its exposure to foreign countries which could be transferred back to the home country. Through the exposure to foreign countries, the MNE could learn about superior management techniques and superior product and process technology.
The most important concern central is around the balance of payment and the employment effects of outward FDI. The balance of payment of the home country may suffer in three ways. First, FDI to foreign countries requires initial capital outflow which creates a burden to the capital account of the balance of payment. Chang (2008) promotes that the form of FDI in each situation is not easily defined. Since the form of FDI is ambiguous, it is likely that the outflow of FDI means damage to the home country. The benefits that a home country can rely on are the inflow of capital earned from future return of these FDI project. This effect though is often more than offset by the subsequence inflow of foreign earnings.
Second, if the intention of the foreign investment is to assist the home country from a low cost production location, then the balance of payments’ current account suffers. Third, the balance of payments’ current account suffers if the FDI is a substitute for direct exports.
Regarding the employment effects, the most critical matter arises since FDI is perceived as a substitute for domestic production. An observable consequence of such FDI is the decline of employment from home country. According to Braconier and Ekholm (2005) if the home country’s labor market is already strict, with not much unemployment, then the matter might not be great. Nevertheless, unemployment is the problem that home country is encountering, the apprehension about jobs export might arise. Hill (2008) illustrates that the US labor leaders raised an opposition frequently to the free trade pact between Canada, US and Mexico is that the US is going to lose thousands of jobs since US firms invest in Mexico in order to take advantage of low-priced labor and then export back to the United States.
FDI contributes a huge benefit to a host country’s economy by the amount of capital float to the companies, technology and management resources that might not be available or being in a low condition hence, thanks to those elements, the host economy growth rate will be increased.
When it comes to the demand of capital, MNE’s branches are easier to access to financial resources by leaning on large scale of business and especially financial strength of the mother company while it is a tough road to search for a quick and rich funds that available in the host country Hill (2008). Griffin and Pustay (2001) suggested that FDI should be encouraged to enable capital to flow where it is most worthy. Besides, due to the reputation and credibility, large MNEs might not struggle with obstacles when they want to gain capital loan from the markets as the host country firms usually fall for.
As stated by Hill (2008) the economic development and industrialization can be highly stimulated from the supporting of technology. There are two forms of technology which can be incorporated in a production process (e.g., the chain of making cookie, from mixing powder, shaping and packing) or can be incorporated in a products (e.g., in Led plasma TV). However, it is the fact that many countries, especially developing countries are not able to have enough required skills, search and development resources to improve their products and use up the advantage of technology in producing commodity and life. Therefore, those countries generally rely on developed countries with advanced industrialization for technology to stimulate economic growth rate, and obviously it can be provided through FDI. Wild et al (2008) agree with Hill and concludes that it is the reason why host countries have a high incentive to support technology importation. There is only one difference in their ideas which Wild et al (2008) comprehend that presently some of the developing countries are trying to develop and acquire their own technological expertise. Wild et al (2008) also exemplified that Singapore has been successful in accessing and developing their own technological expertise in harbor industry. It is believed that, Investors not only bring technology to the host country but also upgrading existing technology or in better way, they invent the new one.
Another benefit that brought by FDI is management skills. As the requirement of MNE’s, the ability of controlling and running business in foreign countries is highly required, thus managements are trained with latest management techniques can offer the improvement of working styles in the companies in the host country (Wild et al, 2008). Beside, the benefit might arise when local personnel are trained to take important positions such as management, financial or technical field in order to help establishing indigenous firms. Additionally, similar benefit might arise when advance skills of superior managements are stimulated local suppliers, distributors and competitors to improve their own management skills. Hill (2008) and Braconier et al (2001) add one more thing that some local people may eventually leave the company after they are trained in modern management techniques that resulted in the opening up of many more employment opportunities.
An additional effect of FDI that strongly believed as a helpful method for host country in dealing with high unemployment rate is it provides plenty of job opportunities for local workers that might be not created there. Hill (2008) proposes that there are two way that FDI effects on employment both in direct and indirect. When a MNE comes to establish even an acquired or a Greenfield operator, a huge number of workers are employed to work for the firm, it dedicates the direct effect of FDI on employment. Nonetheless, Jenkins (2003) criticizes that when FDI involves the acquisition of local firms rather than Greenfield investment, there is no rise in employment; employment is even probable to fall if the foreign owner subsequently rationalizes the firms .The indirect effects arise when jobs are created in many other fields of business in order to supply for the investment field. Besides, because of the increasing in spending of the MNE’s Employees it also increases jobs for particular local range that nearby the foreign firm. For instance, when Toyota made a decision to establish a new auto plant in France in 1997, estimation indicates that the plant would create 2,000 direct jobs and possibly another 2,000 jobs in support industries. However, Cynics (cite) argues that “not all the new jobs created by FDI represent net additions in employment”. The situation popularly happens when a MNE enters to run business in the host country, it creates thousands of jobs but on the other hand, due to huge advantages as were mentioned above about capital, technology and management skills this foreign company may take over the market share and therefore interval firms’ business will go down, lead to the significant downsizing in employment. As a consequence of this substitution effects, Cynics claimed that the number of job opportunities created by FDI might not be as a MNE promised at the beginning.
In other case, when a MNE decide to open business as an acquired operator in the host country, a certain action that definitely takes into account is to restructure the firm in order to improve its operating efficiency. Therefore, a huge number of employees will lose job or be replaced due to inappropriate ability and lack working skills. However, it is just the initial begin of the whole process of reforming. Once when the adjustment period is over, MNE foreign company intend to grow faster and as a result it also employs much more workers and perhaps even more than the domestic operators do as it is believed.
One of the significant benefits that FDI brings to the host country is to lift up the level of competition between firms. As the market share is shrunk for higher number of firms enter to the same business, they are forced to improve product quality, appearance as well as decrease the price to attract more customers. For example, FDI by large Western discount stores, consisting of Tesco, Wal-Mart, Carrefour and Costco appears to have encouraged local Korean discounters like E-Mart to advance the efficiency of their own operations (Hill 2008).
As for Economic growth of the national economy, FDI blows a fresh wind of doing business that contributes to the increase of growth rate in the host country. More advance technology usually comes with FDI that upgrade the quality of product with lower price due to higher level of competition. According to Griffin and Pustay (2001) “the long-term result may include increased productivity growth, product process innovations, and greater economic growth”.
Besides number of advantages that FDI brings to the host countries, it is to still concern about the adverse effects on competition. The national economy might be affected badly because of large MNEs. Thanks for rich capital funding from parent company as well as modern technology, MNE’s enterprise have more advantages to dominate the domestic market than its rivals do. As a consequence, market share easily fall into foreign firms and they are becoming monopoly in a very short time. Another important effect that MNE uses to gain market share is first form an acquire operator and then merge other firms in the same industry, the effect might be to lessen the competition in that market, build up monopoly power for the foreign firms, reduce consumer choice and increase prices. According to Symeonidis (2003), by doing this method, MNEs easily gain a huge number of customers that the local companies already had with certain reputation.
Numerous investor countries now have government backed assurance programs to protect major forms of foreign investment threat. Macmillan (2002) contends that a few emerging countries have putted in place a consistent policy as well as liberalized their outward FDI framework. The kinds of risks insurable throughout those programs comprise nationalization, war losses and the lack of ability to transfer earnings back home. Those programs are specifically helpful in supporting firms to carry out investment in countries where politics are unstable. Additionally, many advanced countries also have particular bank or funds that create government loans to firms desiring to invest in developing countries. Lots of countries have eradicated double taxation of foreign income as an incentive to support domestic firms to embark on FDI. Lastly, and possibly the most important, many investor countries have utilized their political influence to convince host countries to diminish their restrictions on inbound FDI. As an illustration, Japan diminished lots of its formal restriction on inward FDI responding to direct US pressure in the 1980s.
Virtually all investor countries have implemented some control over outward FDI. One general policy has been to limit capital outpouring out of apprehension for the balance of payment of a country (Hill, 2008). This is shared by Macmillan (2002) who contends that most emerging market governments inhibit outward FDI and, in any event, in this area there are no clear policies. Britain, for example, had exchange control regulations that bounded the capital amount which a firm can pull out of the country. Even though the focal purpose of these policies was to advance the British balance of payment, a significant secondary purpose was to make it more difficult to carry out FDI by British firms.
Besides, countries have irregularly manipulated tax rules to attempt to support their firms to invest at home. These policies’ objectives are to create jobs at home rather than in other countries.
Lastly, some countries sometimes restrict national firms from investing in particular countries due to political reason. Such prohibition could be informal or formal. For instance, US’s formal rules restricted firms from investing in some countries like Iran and Cuba, where political ideology and actions are judged to be opposing to American interest (Hill, 2008).
Foreign firms are increasingly common to be offered incentives to invest in their countries by the government. These incentives take many types, but the most general are low interest loan, tax concessions, and subsidies or grants (Hill, 2008). However, in their study, Wild et al (2008) divided these incentives into two categories namely financial incentives and infrastructure improvements. Financial incentives comprise of low tax rate and low interest loans. They argue that the shortcoming of these financial incentives is they could enable multinationals to build up bidding wars among locations that are vying for the investment. Because of the issues associated with the financial incentives, several governments are getting an alternative method to attracting the investment. Lasting benefits for societies surrounding the investment location can result from constructing local infrastructure improvements-“better seaports suitable for containerized shipping, improved roads, and increased telecommunication systems”.
Host countries also use a wide range of controls to inhibit incoming FDI. Again, there are two most common types-Ownership restrictions and performance demands.
Government could enforce ownership restriction that INHIBITS nondomestic firms from investing in particular industries, or from having possession of certain forms of business (Hill, 2008). Wild et al (2008) add that another ownership restriction is a condition that nondomestic investors retain less than a 50% share in local firms when they carry out FDI. They also dispute that government are eradicating such prohibitions because firms today usually could select another location that has no such prohibition in place. One example is when General Motor was choosing as if to invest in an aging automobile in Jakarta, Indonesia, the government of Indonesia abandoned its ownership restrictions of an eventual forced sale to Indonesians. The act of Indonesia was undoubtedly prompted by the fact that Vietnam and China were also encouraging GM for its financial investment.
The literature review actually offers and illustrates several idea, rationales, benefits and costs of FDI. It also includes some insightful example of the real world on FDI. Nevertheless, its benefits and implications are far outweighing the costs.
Braconier. H and Ekholm. K 2001, “Foreign direct investment in central and Eastern Europe: employment effects in the EU, The research institute of Industrial Economics (IUI), Stockholm, viewed 7th January 2011, http://www.snee.org/filer/papers/122.pdf.
Calderón, C & Loayza, N & Servén, L 2002, “Greenfield FDI vs. mergers and acquisitions: Does the distinction matter?” Central bank of Chile working paper, Agosto, viewed 7th 2010, http://www.bcentral.cl/eng/studies/working-papers/pdf/dtbc173.pdf.
Chang. C 2008, “Can a home country benefit from FDI? A theoretical analysis” School of economics and Finance, Victoria University of Wellington, viewed 7th January 2011, http://www.economics.unimelb.edu.au/seminars/app/UploadedDocs/Doc707.pdf.
Cynics, S 2007, “Home and host country effects of FDI”, National Bureau of economic research, working paper no. 9293, pp. 393-413
Griffin, W.R & Pustay, W.M 2001, ‘Foreign direct investment’, International business: A managerial perspective, 2nd edn, Pearson Education Ltd., Australia, pp.366-385
Hill, W.L.C 2007, ‘Drivers of globalization’, International business: Competing in the global marketplace’, 6th edn, McGraw-Hill Irwin, New York, p. 10
Hill, W.L.C 2008, ‘The benefits of FDI to host countries’, Global business today, 5th edn, McGraw-Hill/Irwin, USA, pp.359-396
Jenkins. Rhys 2003, “Globalization, FDI and employment in Vietnam”, University of East Anglia, United Kingdom, viewed 7th January 2011, http://www.unctad.org/en/docs/iteiit20061a5_en.pdf.
Kokko, A 2006, “The home country effects of FDI in developed economies” European institute of Japanses Studies, Stockholm school of economics, working paper No. 225, viewed 5th January 2011, http://swopec.hhs.se/eijswp/papers/eijswp0225.pdf.
Macmillan. P 2002, “Foreign direct investment from emerging markets: The challenges ahead”, New York, viewed 8th January 2011, http://www.vcc.columbia.edu/pubs/documents/FDIfromEMs-FM-13August09.pdf.
Manafnezhad, P 2005, “Foreign direct investment and steady shift to services (trade-offs and challenges)”, Statistic center of Iran, viewed 7th 2011, http://www.iaos2006conf.ca/pdf/Manafnezad.pdf.
Symeonidis, G 2003, “The effect of competition”, Cartel policy and the evolution of strategy and structure in British industry, The MIT Press, viewed 7th January 2011, http://mitpress.mit.edu/catalog/item/default.asp?tid=8696&ttype=2.
Wild, J & Wild, K & Han, J 2008, “Government policy instruments and FDI, International business: The challenges of globalization, 4th edn, Prentice Hall, pp. 218-220