Last Updated 22 Jun 2020

Foreign Direct Investment

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Foreign direct investment occurs when a company undertakes a physical investment in form of building a factory or another company in another country thus the term foreign investment. It occurs when a foreigner establishes an enterprise in a country.

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. This forms an FDI relationship which is made up of the parent company and the foreign affiliated company and the combination leads to the formation of multinational corporations.

To qualify for foreign direct investment, the parent company must be in control over the foreign company. To make foreign direct investment more attractive, companies host companies usually give tax incentives to investing companies while more tax relief is given to companies which invest in marginalised areas in a country. However, the tax laws and regulations regarding FDI vary from one country to the other but better investment terms are offered in most poor and developing countries (Easson, 2004).

FDI is a major player in the global business especially due to the rapid globalization which has taken place in the recent past. It is a major avenue which provides firms with opportunities for market expansion, cheaper labour and production facilities, technology, finance, skills and even marketing channels. Despite the positive impacts that foreign direct investment has, it may lead to negative impact on the host country which may include over exploitation of natural resources as well as pollution. The debate on whether countries should encourage or discourage foreign direct investment thus arises.

Whether a country encourages or discourages FDI should be dependent on the nature of the investment and the circumstances or benefits versus disadvantages such an investment may lead to (Chen, 2000). Possible benefits of promoting foreign direct investment One of the major benefits that may accrue form promoting foreign direct investment is that a country may be in a position to exploit some of its natural resources which it could not have otherwise exploited due to financial or technological constraint.

Most of the countries are well endowed with natural resources which are under explored and under utilised which could be of higher economic value. Lack of adequate financing and/ or technological know-how and expertise may hinder a country from exploiting such resources. This is mostly the case in developing countries. On the other hand, most developed countries have the finances and are well endowed with better and efficient technology but they may not have such resources. To ensure such resources are exploited, a country may require foreign direct investors who have the necessary resources to carry out such tasks.

Where a country has the resource but lacks finances, skill and technology, the government should promote FDI. Such foreign direct investments are common in African countries for example in Sudan where China has invested in the oil industry. Without such investment, Sudan’s oil would be unexplored and less economical to the government of Sudan (Boocock, 2002). Another possible benefit of encouraging foreign direct investment in a country is that such a relationship opens up more international markets for the jointly produced products.

Encouraging foreign direct investment improves the relationship between the host country and the foreign country thus creating and widening the international markets for the products. Most of the products produced by FDIs are traded amongst the two countries and are more widely accepted as they are viewed as being local products in both countries. This in turn increases sales and profitability thus improving economic growth in both countries. As mentioned above, foreign direct investment may also involve a foreign company opening a branch in another country.

As such, the foreign country gains access to markets in the country where it invests. As such, countries should encourage foreign direct investment as they are bound to benefit from a widened market base (Graham, & Spaulding, n. d). The manufacturing industry is also a potential beneficiary of foreign direct investment. Foreign investors bring with them vast knowledge and technology that is vital in increasing production. Most of the developing countries lack efficient technologies to enable them produce goods more profitably. On the other hand, developed countries have the technology the developing countries require.

Encouraging foreign direct investment would lead to improved productivity. Apart from improving the productivity and efficient, foreign direct investment also brings together a pool of experts’ from the host country and the foreign country thus ensuring creativity and innovation. Also, the quality of goods is improved thus making them more competitive thus increasing their sales. The global market is very competitive and has regulations regarding product quality and other product standards. Promoting a foreign direct investment would enable countries meet such standards thus increasing imports (Hanson, 2001).

Promoting foreign direct investment in a country would also be beneficial especially to the small and also medium sized companies in that it would help them to be more involved in global business arena. FDI may involve a foreign company investing in a local company by buying interests. This may open doors for growth through such affiliations as well as better management practices. Countries should promote foreign direct investment if such investments are likely to enhance the growth of the country’s companies or industries (Fitzgerald, 2007).

The classic definition of FDI refers to the construction of physical or fixed fixtures by a foreign company in a country. Most of the FDI are based on this definition. Construction of industries or factories in a country leads to creation of employment opportunities thus improving the living standards of the citizens thus improving the overall economic standards of the country. Promoting foreign direct investment would thus lead to a decrease in unemployment levels and an improvement of the economy in a country.

Also, areas where factories or companies are developed or built tend to develop quickly thus encouraging overall growth of the whole country (Moran, Graham & Blomstrom, 2005). Foreign direct investment is worthy to be considered for global reasons since it helps in removing trade barriers which are imposed by foreign government. By engaging in foreign direct investment, a company is hedged from most of the foreign trade barriers which are imposed on other companies. Mergers and acquisitions are major contracts undertaken during foreign direct investment.

This ensures that a company is not treated like a foreign country thus ensuring that it does not pay the tariffs imposed on foreign government. A government should promote foreign direct investment especially where it wants its companies to go global (Moran, Graham & Blomstrom, 2005). Reasons why countries should restrict foreign direct investment One of the reasons why countries especially the developing countries should restrict foreign direct investment is due to the potential harm such investment may pose the natural resources in a country.

As noted earlier, most direct investment involves construction of industries or factories by foreign investors in a host country. The investing countries mostly look for resources which a country is unable to exploit due to constraints in its finances, skills and technology. The investing countries thus overexploit such natural resources which may be detrimental to the ecology of a nation. Also, most of the products from the investing countries are exported back to their own countries mostly as unfinished products citing inadequate technological or manpower resources.

The host country thus does not benefit from such products. When such commodities are exported back to the host country as finished goods, they are usually very costly and thus the investing country is the only beneficiary. Also, most of such investments are carried out in poor and developing countries which have no financial strength to challenge such practises. Over exploitation of natural resources is one reason which makes the foreign direct investment undesirable. Income from foreign direct investment is taken back to the investing countries and as such not beneficial to the host country (Hanson, 2001).

Another undesirable aspect of foreign direct investment is that most of the investing companies employ individuals from their own countries thus do not create employment opportunities for the local individuals especially in the top management posts. This has adverse effects to both the investing countries and the host countries. The investing countries are faced by brain drain in the labour sector thus lowering the productivity. This may also necessitate importation of professionals which may be very costly for the country. The host countries suffer from increase in unemployment especially for the professionals.

As such, all countries should discourage foreign direct investment due to these negative impacts they have on the labour sector (Chen, 2000). Before investing, an investor carefully assesses the investment opportunities and settles on the one which is bound to increase his or her profitability. Investments are thus carried out in areas which have available raw materials, market and cheaper labour. The investing company thus benefits from availability of cheap labour and also raw materials. This on the other hand is devastating for the host company and its citizens.

Most companies invest in foreign countries so as to reduce the costs associated with production in their own countries. Developing countries are most targeted for such investments. The investing companies end up making huge profits at the expense of the local citizens. Foreign direct investment is supposed to be beneficial to both the investing and the host companies but this is not always the case (Moosa, 2002). Foreign direct investment should also be discouraged due to its potential harmful effects on the environment. Different countries have different environmental regulations.

Countries with more stringent environmental rules and regulations are less desirable for investment. Companies in such countries are supposed to comply with such rules and this is usually very costly. To evade complying with such rules, such companies look for investment opportunities in areas where environmental rules are less stringent. Lack of universal laws and regulations to control environmental regulations makes FDI undesirable. Most of the companies which invest in other countries end up polluting the environment of that area thus altering the ecology of such places.

The developing countries are more targeted for such investments. Countries should restrict FDI if it poses environmental threat (Chen, 2000). Another reason as to why the countries should restrict foreign direct investment is due to the impact they usually have on local industries. Most of the companies which look for opportunities in foreign countries are often established companies and usually global companies. Allowing them to invest in a company leads to the killing of the upcoming industries.

Companies which invest in a country may lead to unfair competition with local upcoming industries. Mostly, the investing companies have superior and advanced up to date technology as well as expertise. Their products also tend to be of higher quality than those of the host country’s products. Such competition kills those upcoming companies. The government has a role to protect the infant industries in their countries and thus they should restrict foreign direct investment which threatens the survival of the infant industries (Bora, 2002).

While dealing with the issue of whether a country should or should not promote foreign direct investment, it should consider the following factors. A country need to consider the impact such an investment would have on its natural resources. While it is vital to exploit available natural resources for economic purposes, the country should consider the long term effects such exploitation may have on the ecology of the country. This is mostly so in the mining industry and agricultural sectors. Some undertakings may lead to devastating effects on the long term productivity of a country.

Careful assessment of the proposed company’s activities should be done before it is undertakings (Moran, Graham & Blomstrom, 2005). Environmental effects which may arise due to foreign direct investment should also be considered before a country undertakes campaigns to promote this form of investment. Some of the FDI projects are usually harmful to the environment and thus should be restricted. However, FDI projects especially in mining industries undertaken in developing countries have served to reduce pollution.

Due to lack of efficient technology and expertise, some developing countries used to use crude methods while mining which were causing air pollution. FDIs have helped reduce such pollution. Countries should prohibit any project which may lead to degradation of the environment (Hanson, 2001). The manufacturing industry should also be considered while deciding whether a country prohibits or promotes foreign direct investment. Some FDIs lead to improvement of manufacturing processes in the host country thus increased productivity especially where such investments are formed through mergers, acquisitions or partnership.

Such foreign direct investment are beneficial to the manufacturing industry thus should be promoted. However, investments leading to the stagnation or destruction of infant industries should be prohibited by the government of a country (Moran, Graham & Blomstrom, 2005). Conclusion The move towards globalizations has led to increased need for foreign direct investments in the world. Most companies from developed countries are looking for investment opportunities in developing countries in search of new markets, cheap labour and other resources.

Foreign direct investment is one of the strategies which countries and companies are using in order to ensure that they remain competitive in the global market. Most developing countries have benefited from the foreign direct investment from developed countries especially in the mining and agricultural sectors. While deciding whether to promote or prohibit foreign direct investment in a country, the government should weigh the advantages and the disadvantages of such investments. Some proposed foreign investment may be accepted while others may be denied or prohibited.

Careful analysis and research should be carried out before accepting any form of foreign direct investment in a country. Reference: Boocock, C. N. (2002): Environmental Impacts of Foreign Direct Investment in the Mining Sector in Sub-Saharan Africa. Retrieved on 11th March 2009 from, http://www. naturalresources. org/minerals/docs/oecd/global%20forum%20fdi%20&%20mining%202002/env%20impacts%20of%20fdi%20in%20the%20mining%20sector%20in%20sub-saharan%20africa. pdf. Bora, B. (2002): Foreign Direct Investment: Research Issues.

ISBN 0415238145, Published by Routledge Chen, J. (2000): Foreign Direct Investment. ISBN 0333800931, Published by St. Martin's Press Easson, A. J. (2004): Tax Incentives for Foreign Direct Investment. ISBN 9041122281, Published by Kluwer Law International Fitzgerald, V. (2007): Foreign Direct Investment and Emerging Markets. Retrieved on 11th March 2009 from, http://www. valpyfitzgerald. com/shows/LBS_lecture. ppt. Graham, J. P. ; Spaulding, R. B. (n. d): Understanding Foreign Direct Investment (FDI). Retrieved on 11th March 2009 from,

http://www. goingglobal. com/articles/understanding_foreign_direct_investment. hm. Hanson, G. H. (2001): Should Countries Promote Foreign Direct Investment? Retrieved on 11th March 2009 from, http://www. unctad. org/TEMPLATES/Download. asp? docid=11210=1;intItemID=1527. Moosa, I. A. (2002): Foreign direct investment: theory, evidence, and practice. ISBN 0333945905, Published by Palgrave Moran, T. H. , Graham, E. M. ; Blomstrom, M

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