Why Foreign Direct Investment?

Foreign direct investment (FDI) is concerned with purchase of physical assets or ownership rights of a company in another country. It can take the form of a ‘greenfield investments’ which is a blank canvas approach to the market in that the company will have to invest heavily in infrastructure. In contrast managers could opt for international merger and acquisition activity which could be seen as the easier option in that an infrastructure base is already set up and ready to go. But why do companies choose to go down the route of FDI anyway? After all other options in international trade are available for example exporting.

Well in recent years changes to the global economy as a whole have facilitated the use of FDI. Factors such as increased economic trade and greater market integration have been a starting point and therefore countries have recognised the need to reduce barriers to global trade. Transnational companies (TNCs) have been the biggest beneficiaries of this trend of global integration.

In turn this has led to a much greater number of TNCs indulging in FDI. Governments have had a supporting role in this and have helped put policies in place to encourage FDI projects. Examples include bilateral trade agreements and double taxation treaties both of which are positive indicators of world trade.

However it needs to be considered whether FDI is being targeted at the correct markets? After all surely it’s the developing economies who would receive the most out of such projects? It seems however that the majority of FDI funds are being directed and received within developed economies. This is likely to be down to TNC corporations being weary of underdeveloped markets, infrastructure and stability to sustain successful strategies in these countries.

Reflecting back on last week’s blog regarding corporate tax, levels of taxation can also be a major influence on the location of FDI. After London, Belfast is the most attractive city in the UK for FDI, particularly in technology and financial services (BBC, 2010) – could this have anything to do with the lower rate of corporate tax of 12.5% in comparison to the 28% faced by companies based in London?

So how can countries in the emerging world attract FDI and more importantly is attracting FDI something they regard as important for future development? Factors which may be used to their advantage to attract FDI include natural resources which may not be found in other locations, cost of labour and taxation rates as highlighted by last week’s blog post.

FDI is often thought of as being extremely beneficial to the host country bringing in much needed capital to the economy, expertise and improvements to infrastructure, in turn improving the quality of living for the population. However are these benefits so great in reality? It has been argued potential costs can actually impact on the host country due to the presence of the TNCs. These mainly derive from the power of such companies may yield. This could have a negative impact on local competition due to the strength of their brand recognition. Also TNCs can have an impact on the decisions of the host country government due to them being reliant on the economic power of the TNC. Issues such as environmental, human rights and corruption will also have to be taken into consideration. After all, high profile companies such as Primark have been in the spotlight with regards to child labour (the guardian, 2008).

Examples of FDI occurring within the emerging economies are becoming more prominent though. North Korea for example has the potential to attract FDI funds due to its vast natural resources such as timber, coal and gold which China desires. The UN Conference on Trade and Development estimates that FDI in 2010 was $38million (£24m) most of which comes from China (BBC, 2012).

It is also clear that emerging economies are seeking to attract FDI.  The Shanghai Commission of Commerce yesterday released information yesterday regarding intentions of the region to attract around US$10 billion in foreign direct investment annually by 2015. The city will attract this FDI through “its mature market system, skilled workforce, efficient government and transparent laws to draw foreign investors instead of using preferential policies to lure them” (Easyday, 2012). Surly this shatters some of the misconceptions about FDI being damaging for emerging economies? It would seem they are in reality going out of their way to attract it as a means of development!