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Merits and Demerits of Foreign Direct Investment

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METHODOLOGY: Qualitative and descriptive text. Also, the enumerated points for Merits and Demerits have been substantiated with relevant examples and/or data in the form of Case point.

OBJECTIVES: An attempt has been made to make this report country-specific; therefore, the merits and demerits; the advantages and disadvantages, as would be almost similar with all developing countries, have been co-related with India’s dynamics and some data has also been presented therein.

Mankiw (2004) stresses that international trade affects economic growth and can indeed to be regarded as a type of technology in that it converts non-specialized production into specialized production.

Ogutucu (2002) argues that the Foreign Direct Investment (FDI) is a major catalyst for the development and the integration of developing countries in the global economy.

ABSTRACT: Globalisation is leading to greater convergence between economies. The academics today are intrigued by questions such as whether the policies to promote Foreign Direct Investment (FDI) make economic sense and whether the benefits of FDI are sufficient to justify the kind of policy interventions seen in practice. Foreign Direct Investment has played an important role in the process of globalization during the past two decades. It has shrunk the markets and accelerated trade. Another debating point has been the case of FDI versus export promotion for sustainable growth of a country’s economy.

While domestic investments add to the capital stock in an economy, FDI plays a complementary role in overall capital formation and in filling the gap between domestic savings and investment.

At the macro-level, FDI is a non-debt-creating source of additional external finances. At the micro-level, FDI is expected to boost output, technology, skill levels, employment and linkages with other sectors and regions of the host economy.

Determinant of FDI: There is little doubt on the fact that when a large company considers going into diversified operation across the globe, the first thing that into their mind is the size of the market. It is always essential for attracting the foreign investors as it is the prime consideration prior to invest their money into foreign countries. The suitability and attractiveness of various destinations is the primary determinant for any FDI because capital formation is an important determinant of economic growth.

Many parent enterprises provide FDI because of the tax incentives that they get. While higher taxes deter foreign investment, a more educated work force and larger goods markets attract FDI. There is also some evidence that multinationals tend to agglomerate in a manner consistent with location-specific externalities.

During the last two decades, many emerging economies have dramatically reduced barriers to FDI, and countries at all levels of development have created a policy infrastructure to attract multinational firms. More than 160 governments have established investment promotion agencies (IPAs) to attract foreign direct investment, and more than 70% of these agencies report that they focus their resources on a small number of “target” industries that they deem to be of particular benefit. Merits/Advantages of Foreign Direct Investment

Policy makers and academics often maintain that foreign direct investment (FDI) can be a source of important productivity externalities for the host countries. In addition to supplying capital, FDI can be a source of valuable technology and know-how and foster linkages with local firms that can help to jumpstart an economy.

Helps in economic development of the country in which invested: FDI helps in the growth of a country by direct influx of capital. A typical characteristic of developing and underdeveloped economies is the fact that these economies do not have the needed level of savings and income in order to meet the required level of investment needed to sustain the growth of the economy. In such cases, foreign direct investment plays an important role of bridging the gap between the available resources or funds and the required resources of funds. Case in point: The Asia-Pacific region continued to attract the most FDI in 2012, increasing its global share to 31.7%. Consequently, Bangladesh, Indonesia and the Philippines recorded project growth of 66.7%, 11.3% and 7.6% respectively.

Helps in creating jobs and increases employment:
Case in point: The FDI projects in India increased by 20% in 2011 with 932 projects, which created an estimated 255,416 jobs. Technology transfer: Countries are able to learn newer forms of technologies and skills. Through FDI, technology transfer takes place for which countries vie. Moreover, introduction of latest equipment and technology fosters production with minimal error. Case in point: The automotive industry in India where state of the art manufacturing plants have been set up and world class vehicles are available for consumers. Domestic businesses get more competitive: To escape being ousted, domestic businesses gear up for competition and update themselves with international standards.

This opens export market for them and their performance metrics improve. Businesses benefit by receiving management, accounting or legal guidance in keeping with the best practices practiced by their lenders. They can also incorporate the latest technology, innovations in operational practices, and new financing tools that they might not otherwise be aware of. Case in point: Bajaj Auto which was two wheeler and three wheeler manufacturer changed its face by entering into the motor cycle market in 1986. It revamped itself, garnered to competition and went global. Improvement of infrastructure: Developing countries do not have infrastructure to support growth of domestic industries, in many cases. FDI and PPP either invest in infrastructure or governments develop the facilities to attract the FDI.

Case in point: Exclusive SEZ, roads, shipyards, communications networks and power get a focus in the host country. Improved transport network though a derived demand, Ministry of Railways is constructing a Dedicated Freight Corridor (DFC) covering about 2700 route km long two routes – the Eastern Corridor from Ludhiana in Punjab to Dankuni in West Bengal and the Western Corridor from Jawaharlal Nehru Port, in Mumbai, Maharashtra, to Tughlakabad, Delhi/Dadri along with the interlinking of two corridors at Khurja in Uttar Pradesh. Achieving global market integration: FDI creates a global consumer with standardized brands being available all through the world. It encourages more international travel and thus, a cultural fusion takes place with people enjoying music and cuisines of other cultures and countries.

More efficient global allocation of resources: The entire capital instead of getting invested in the local country gets invested across the globe because of emergence of transnationals. Consumer benefit: Consumers get better quality products, better incomes because of job opportunities and greater saving capability. Investment in new sectors stimulates growth of new industry and new products: The standard of living in the recipient country is also improved by higher tax revenue from the company that received the foreign direct investment. UNCTAD’s World Investment Report 2006 for instance describes “quality FDI” as “the kind that would significantly increase employment, enhance skills and boost the competitiveness of local enterprises. Increased demand for inputs: Since the available resources in developing and under-developed countries are not optimally used, with FDI converging, they are utilized, therefore, shifting the production possibility curve outward.

Related and supporting Industries prosper: When a multinational, such as Suzuki Motors, Hyundai, or Bombardier makes entry into a country, it sources parts from the host country because an FDI is always a long term trade. New markets: FDI helps enterprises enter markets and gain a foothold in countries that have several import tariffs in place, so reaching these countries through international trade is difficult. Disadvantages/demerits of Foreign Direct Investment (Host Country) Too much foreign ownership of companies can be a concern, especially in industries that are strategically important. Second, sophisticated foreign investors can use their skills to strip the company of its value without adding any. They can sell off unprofitable portions of the company to local, less sophisticated investors.

Or, they can borrow against the company’s collateral locally, and lend the funds back to the parent company. The past has given many examples of how foreign direct investment can also at times be detrimental to the economy of a country, some examples of which are highlighted below: Political Lobbying: In the past, there have been many instances in which MNCs have resorted to political lobbying in order to get certain policies and laws implemented in their favor. At times, these MNCs are so large that their revenues even exceeded the Gross Domestic Product (GDP) of some smaller nations and compel or threaten them to pass judgments and policies in their favor. Exploitation of Resources: Exploitation of natural resources of a host country is not a very uncommon phenomenon in the case of FDI. MNCs of other countries have been known to indiscriminately exploit the resources of host countries in order to get short run gains and profits and have even chosen to ignore the sustainability factors associated with the local communities and local habitat, very much like what happened in the 17th century colonialism.

Threaten Small Scale Industries: MNCs have large economic and pricing power due to their large sizes. With immense capital resources at hand, they can resort to prolific advertising, which gives them an instant edge over small local competitors. They can also use pricing strategies to not only capture the market but also prohibit new entrants. Since these companies are global players and their operations spread across countries, they have effective supply chains which enable them to have economies of scale which smaller players in the domestic market of the host country cannot compete with.

Consequently, MNCs have been known to push out smaller industries out of business. Technology: Although, the MNCs have access to new and cutting edge technology, they do not transfer the latest technology to the host country with a fear that their home country may lose its competitive advantage, hence the maximum potential of the host economy cannot be achieved as a result of old technology transferred. Moreover: FDI hinders domestic investment, demand for domestic investment decreases. Exchange rates increasing in one and reducing in the other.

CONCLUSION: While the large Multi National Corporations of the West are getting advantages of market expansion from FDI, the host countries are also utilizing it as a major mechanism and source for accelerating their domestic
economic growth. Since the initiation of economic reforms in 1979, China has become one of the world’s fastest-growing economies. From 1979 to 2005, China’s real GDP grew at an average annual rate of 9.6%. It is one the top FDI recipients in the world today. India received $129 million on 1990-1991 and FDI flow into India grew 17% in 2013 to $28 billion. India ranked 16th among the top 20 global economies receiving most FDI.

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