According to investopedia.com, foreign direct investment (FDI) is an investment made by a company or entity based in one country, into a company or entity based in another country. The term FDI can also be defined as the flow of capital between countries. Foreign direct investments substantially from indirect investments such as portfolio flows, where overseas institutions invest in equities listed on a nation's stock exchange. The entities that invest directly in a company would however often exude a significant degree of control and influence over the beneficiary. Countries that have open economies characterised by skilled workforces with promising positive growth attract large amounts of foreign direct investments than closed highly regulated economies.
Developing countries often remain poor or are often termed as vulnerable to poverty despite their multiple efforts to develop. A fundamental catalyst to this state is the lack of enough national savings to finance their investments. This leaves them with the option of depending upon foreign capital to finance their investments.
In the past, such countries took loans from commercial banks this trait, however, in the 80's led to depletion of resources in the commercial banks to finance loans to several countries. The failure of the countries to pay back in time led to debt crises in countries hence the review of investment policies. Reviewing policies led to the evolution of foreign direct investment a more stable alternative to capital devoid of debt risks. Policies were put I place to attract foreign investors.
One of the economic problems in developing countries is that lack enough national savings to finance their investments. They are in constant need of foreign capital in forms of both direct and indirect investments. Initially, they took loans from international commercial banks. But in the 1980s the drying-up of commercial bank lending, because of debt crises, forced many countries to reform their investment policies so as to attract more stable forms of foreign capital, and FDI appeared to be one of the easiest way to get foreign capital without undertaking any risks linked to the debt. Thus, it became an attractive alternative to bank loans as a source of capital inflows.
Foreign direct investment has several advantages first it leads to Economic Development Stimulation. This happens because it boosts economic development in a country by several ways. It increases the cash flow of foreign exchange within a country making. With an improved economy means that as an investor one is able to get profit as there is a stronger currency, higher bargaining power hence good cash flow.
Likewise, foreign direct investment opens up a market to easy International Trade. Trade tariffs of individual states often make importation quite a task as many regulations have to be adhered to. For industries that need their presence in international markets so as to adequately meet their sales and trade goals, FDI presents them a chance to have easily influence in the market
An increase of per capita income is one of the greatest desires of all developing nations. This often translates to an improved living standard. FDI, therefore, presents a state with increased employment and economic Boost. This is often the case as FDI creates new jobs in a country. As investors trickle into a country's economy, they establish firms that require personnel to manage. Therefore, as it is economically viable in most cases to utilise the locally available manpower, residents of the host country are thus the beneficiaries of the employment opportunities. This leads to an increase in income hence the people have a higher purchasing power that translates to an economic-boost.
Human capital resource in a fundamental ingredient to a productive economy. FDI leads to the development of Human Capital Resources. The investment in a country by several players in different sectors of the economy often translates to the development of competences amongst the labour pool to perform several tasks. It is however not a direct effect of FDI as it takes the time to materialise. It is developed though training and sharing experiences amongst players in the economy. This is however not a tangible resource that can be quantified instead it is more of a resource that is on loan. This factor leads to a country developing and maintaining ownership of its resource base. This leads to increased innovations within the country across all sectors.
As parent enterprise seeking to invest in foreign direct investment to get expertise, technology and new products, it is possible to tax incentives that will give insight on the type of venture to invest in as one would have studied the market well. Likewise, the investment leads to transfer of resources regarding knowledge, technology among others that contribute to accessing new skill and technology.
Foreign direct investment leads to reduced disparities between revenues and costs. In so saying, countries can stabilise production costs and allow the product to be sold easily. With all factors kept constant, the result of FDI always leads to increased productivity in the host country. This translates to increased income.
There is nothing that is entirely good and has no negativity in it. Foreign Direct Investment is also mired with negative effects. First, it hinders domestic investment in two aspects. Investors may invest more in host countries than in their home countries hence loss of revenue. On the contrary, the citizen in the host country may face stiff completion hence inability to invest locally.
Foreign investment is faced with high risks especially in the political changes in the host countries. Variables may be introduced at any time to counter their success in the areas of operation. Thus, much caution is needed in the choice of country to invest in or, proxies may be used to survive such hurdles.
From the political effects, we have multiplier effects of expropriation that arise. This presents a scenario whereby a state assumes full control of your property and assets. This leads to crippled firm operations.
Foreign investments also disrupt exchange rates of countries. This may lead to reduced exchange rates of one country in the stocks trade while a reaction is an experienced in the counterpart state when their exchange rates are higher. Closely related to this is the increase in the costs of operation. What might have been cheap to export to a country now has a higher cost. This raises the startup and operations cost of establishing a business.
As above observed, increased costs of starting up may be experienced in some sectors. FDI may also lead to a situation whereby an investment may be economically non-viable either through overexploitation. Therefore, foreign investment startups are not only expensive but end up being a very risky affair.
Foreign exchange rates and direct investments might have adverse impacts on the investing country. Defamation of the rules may lead o sanctions to the home state. This will result in the inability of the home state to pursue investments in foreign markets thus crippling development.
Host countries, however, fear that they may be victim to modern-day colonialism. This is because they have their economies run by the foreign investors and they may, therefore, fall victim at the mercy of the foreign companies. Many irregularities may be performed to the host country but they will tolerate them since if the investors leave, there will be negative economic implications.
In the UK, according to the government website, FDI stock has increased six-fold since 1990 to US$ 1,199 billion by the end of 2011. This has seen several companies from Hong Kong, India, Singapore and China invest in the UK as external investors.
Determinants of FDIMany factors determine foreign direct investment. They include market size, openness, host country sector performance, transportation costs, infrastructure, tax rates, labour market flexibility, institutions and industrial/regional policy. The below sections seek to describe UK's performance in these determinants.
Cash flow is an important aspect to consider in the location of a firm. Top of the investor's mind when locating a suitable site is the market size. One would often tend to look for a place to larger potential demand notwithstanding the low cost of production. With more major markets, goods and services are utilised at faster rates . Hence a higher cash flow is experienced.
Artige and Nicolini (2005) state that market size as measured by GDP or GDP per capita seems to be the most robust FDI determinant in econometric studies. This is the main determinant of horizontal FDI. It is irrelevant for vertical FDI. Jordaan (2004) mentions that FDI will move to countries with larger and expanding markets and greater purchasing power, where firms can potentially receive a higher return on their capital and by implication receive higher profit from their investments. Charkrabarti (2001) views market size using the market-size hypothesis that supports the concept that a greater market is needed for efficient utilisation of resources and exploitation of economies of scale: as the market size grows to some critical value, FDI will start to increase after that with its further expansion. In ODI (1997), econometric studies comparing a cross-section of countries point to an unshakable correlation between FDI and the size of the market, which is a proxy for the size...
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