FDI: A dynamic growth engine for emerging economies
Saturday, 11 August 2007
Md. Salim Uddin FCA, FCMA, MBA
THE major change in international business activity in the post-world war II era involved the shift away from an emphasis on trade as international business in favour of direct foreign investment, joint ventures and a multiple of other types of operations conducted by multinational firms. In accounting for this expansion, one must examine many factors related to the firm and its internal operations, the nature of the economic framework in which it operates, changes in communications and transportation technology over time as well as shifting raw materials, markets, technology and firm considerations affecting the particular good or service. As firms expand, many forces can lead to growing international involvement, such as the need for raw materials or access to larger markets.
From the product life cycle model, it is evident that firms become involved abroad in stages, first by exporting products, followed later by direct investment in production facility in other markets, and finally by moving labour -- intensive operations to lower -- cost producing areas. In this way international business can link together geographically distant producers and consumers and often establishing a relationship of identification as well as interdependence between them. However, the interdependence of national economies throughout the world is in any analysis not a new phenomenon. What is significant is the shift in the nature of economic interdependence and the pattern and trend in international trade.
In this context, the Multinational Enterprises (MNEs) are considered as the single most important agent of economic globalisation as their role in international trade and investment is possibly overwhelming. Much of the changing shape of the global economic systems sculptured by the multinational enterprises through their decisions to invest in particular geographical locations. It is also moulded by the resulting flows of materials, components and finished products as well as of technological and organisational expertise between geographically dispersed operations.
Therefore, the multinational enterprises (MNEs) play a pivotal role in linking rich and poor economies and in transmitting capital, knowledge, ideas, and value systems across borders. Their interaction with institutions, organisations and individuals is generating positive and negative spillovers for various groups of stakeholders in both home and host countries. In consequence, they are focal points in the popular debate on the merits and dangers of globalisation, especially when it comes to developing and emerging economies. In this regard, the solid understanding of the role of MNEs in emerging economies like Bangladesh is vital both for policy makers and for MNEs themselves. Policy makers are influencing the regulatory regime under which both MNEs and local business partners operate. They are interested in understanding how Foreign Direct Investment (FDI) influences economic development and national welfare.
The expectation that FDI will benefit the local economy has motivated many governments to offer attractive packages to entice investors. The rationale is that the social benefits of inward FDI would exceed the private benefits of FDI and investors would take into account only the latter when deciding over investment locations. The policy debate need evidence on how and to what extent, FDI influences economic development of a country. In many research studies and surveys FDI has been found to be a growth engine for the socio-economic development of emerging economies.
FDI as a dynamic growth engine has multidimensional qualitative and quantitative favourable impact on the socio-economic development of any country like Bangladesh.
It plays an important and growing role in global business. It can provide a firm with new markets and marketing channels, cheaper production facilities, access to new technology, products, skills and financing. For a host country or the foreign firm which receives the investment, FDI can provide a source of new technologies, capital, processes, products, organisational technologies and management skills, and as such it can provide a strong impetus to economic development.
In its classic definition, FDI is defined as a company from one country making a physical investment in other country in the form of building a factory and the like. The direct investment in buildings, machinery and equipment is in contrast with making a portfolio investment, which is considered an indirect investment. In other words, Foreign Direct Investment (FDI) is defined as a long-term investment by a foreign direct investor in an enterprise resident in an economy other than that in which the foreign direct investor is based. The FDI relationship consists of a parent enterprise and a foreign affiliate which together form a Trans National corporation (TNC). In order to qualify as FDI the investment must afford the parent enterprise control over its foreign affiliate. The UN defines control in this case as owing 10% or more of the ordinary shares or voting power of an incorporated firm or its equivalent for an unincorporated firm.
In recent years, given rapid growth and change in global investment patterns, the definition has been broadened to include the acquisition of lasting management interests in a company or enterprise outside the investing firm's, construction of a facility, or investment in a joint venture or strategic alliance with a local firm with attendant input of technology, licensing of intellectual property.
In the past decade, FDI has come to play a major role in the internationalisation of business. Reacting to changes in technology, growing liberalisation of the national regulatory framework governing investment in enterprise, and changes in capital markets profound changes have occurred in the size, scope and methods of FDI. New information technology systems, decline in global communication costs have made management of foreign investments far easier than in the past. In such a context, foreign direct investment can take many forms, depending on the type of investors, the investor's investment objective and the degree of risk the investor is willing to assume.
Greenfield investment: It takes the form of direct investment in new facilities or the expansion of existing facilities. Greenfield investments are the primary target of a host nation's promotional efforts because they create new production capacity and jobs, transfer technology and know-how, and can lead to linkages to the global marketplace. However, it often does this by crowding out local industry; multinationals are able to produce goods more cheaply (because of advanced technology and efficient processes) and uses up resources (labour, intermediate goods, etc.). Another downside of Greenfield investment is that the profits from production do not feedback into the local economy, but instead to the multinational's home economy. This is in contrast to local industries whose profits flow back into the domestic economy to promote growth.
Mergers and Acquisitions: In this case a transfers of existing assets from local firms to foreign firms takes place. This is another primary type of FDI. Cross-border mergers occur when the assets and operation of firms from different countries are combined to establish a new legal entity. Cross-border acquisitions occur when the control company becoming an affiliate of the foreign company. Unlike greenfield investment, acquisitions provide no long term benefits to the local economy -even the most deals the owners of the local firm are paid in stock from the acquiring firm, meaning that the money from the sale could never reach the local economy. Nevertheless, mergers and acquisitions are a significant form of FDI and until around 1997, accounted for nearly 90% of the FDI flow into the United States.
Horizontal Foreign Direct Investment: It involves the act of investment in the same industry abroad as a firm operates in at home. It widens geographical expansion of a successful enterprise.
Vertical Foreign Direct Investment: It takes two forms: (a) Backward Vertical FDI where an industry abroad provides inputs for a firm's domestic production process. (b) Forward Vertical FDI in which an industry abroad sells the outputs of a firm's domestic production
Proponents of foreign investment point out that the exchange of investment flows benefits both the home country (the country from which the investment originates) and the host country (the destination of the investment). Opponents of FDI note that multinational conglomerates are able to wield great power over smaller and weaker economies and can drive out much local competition.
The truth lies somewhere in the middle. For small and medium sized companies, FDI represents an opportunity to become more actively involved in international business activities. In the past 15 years, the classic definition of FDI as noted above has changed considerably. This notion of a change in the classic definition, however, must be understood in the proper context. Very clearly, over 2/3 of direct foreign investment is still made in the form of fixtures, machinery, equipment and buildings. Moreover, larger multinational corporations and conglomerates still make the overwhelming percentage of FDI. But, with the advent of the Internet, the increasing role of technology, loosening of direct investment restrictions in many markets and decreasing communication costs mean that newer, non-traditional forms of investment will play an important role in the future. Many governments, especially in industrialised and developed nations, pay very close attention to foreign direct investment because the investment inflows into and out of their economies can and does have a significant impact. In this regard, the different types of FDI flows seem to depend on the motives of the investors. Major motives behind the investment from the perspective of the
THE major change in international business activity in the post-world war II era involved the shift away from an emphasis on trade as international business in favour of direct foreign investment, joint ventures and a multiple of other types of operations conducted by multinational firms. In accounting for this expansion, one must examine many factors related to the firm and its internal operations, the nature of the economic framework in which it operates, changes in communications and transportation technology over time as well as shifting raw materials, markets, technology and firm considerations affecting the particular good or service. As firms expand, many forces can lead to growing international involvement, such as the need for raw materials or access to larger markets.
From the product life cycle model, it is evident that firms become involved abroad in stages, first by exporting products, followed later by direct investment in production facility in other markets, and finally by moving labour -- intensive operations to lower -- cost producing areas. In this way international business can link together geographically distant producers and consumers and often establishing a relationship of identification as well as interdependence between them. However, the interdependence of national economies throughout the world is in any analysis not a new phenomenon. What is significant is the shift in the nature of economic interdependence and the pattern and trend in international trade.
In this context, the Multinational Enterprises (MNEs) are considered as the single most important agent of economic globalisation as their role in international trade and investment is possibly overwhelming. Much of the changing shape of the global economic systems sculptured by the multinational enterprises through their decisions to invest in particular geographical locations. It is also moulded by the resulting flows of materials, components and finished products as well as of technological and organisational expertise between geographically dispersed operations.
Therefore, the multinational enterprises (MNEs) play a pivotal role in linking rich and poor economies and in transmitting capital, knowledge, ideas, and value systems across borders. Their interaction with institutions, organisations and individuals is generating positive and negative spillovers for various groups of stakeholders in both home and host countries. In consequence, they are focal points in the popular debate on the merits and dangers of globalisation, especially when it comes to developing and emerging economies. In this regard, the solid understanding of the role of MNEs in emerging economies like Bangladesh is vital both for policy makers and for MNEs themselves. Policy makers are influencing the regulatory regime under which both MNEs and local business partners operate. They are interested in understanding how Foreign Direct Investment (FDI) influences economic development and national welfare.
The expectation that FDI will benefit the local economy has motivated many governments to offer attractive packages to entice investors. The rationale is that the social benefits of inward FDI would exceed the private benefits of FDI and investors would take into account only the latter when deciding over investment locations. The policy debate need evidence on how and to what extent, FDI influences economic development of a country. In many research studies and surveys FDI has been found to be a growth engine for the socio-economic development of emerging economies.
FDI as a dynamic growth engine has multidimensional qualitative and quantitative favourable impact on the socio-economic development of any country like Bangladesh.
It plays an important and growing role in global business. It can provide a firm with new markets and marketing channels, cheaper production facilities, access to new technology, products, skills and financing. For a host country or the foreign firm which receives the investment, FDI can provide a source of new technologies, capital, processes, products, organisational technologies and management skills, and as such it can provide a strong impetus to economic development.
In its classic definition, FDI is defined as a company from one country making a physical investment in other country in the form of building a factory and the like. The direct investment in buildings, machinery and equipment is in contrast with making a portfolio investment, which is considered an indirect investment. In other words, Foreign Direct Investment (FDI) is defined as a long-term investment by a foreign direct investor in an enterprise resident in an economy other than that in which the foreign direct investor is based. The FDI relationship consists of a parent enterprise and a foreign affiliate which together form a Trans National corporation (TNC). In order to qualify as FDI the investment must afford the parent enterprise control over its foreign affiliate. The UN defines control in this case as owing 10% or more of the ordinary shares or voting power of an incorporated firm or its equivalent for an unincorporated firm.
In recent years, given rapid growth and change in global investment patterns, the definition has been broadened to include the acquisition of lasting management interests in a company or enterprise outside the investing firm's, construction of a facility, or investment in a joint venture or strategic alliance with a local firm with attendant input of technology, licensing of intellectual property.
In the past decade, FDI has come to play a major role in the internationalisation of business. Reacting to changes in technology, growing liberalisation of the national regulatory framework governing investment in enterprise, and changes in capital markets profound changes have occurred in the size, scope and methods of FDI. New information technology systems, decline in global communication costs have made management of foreign investments far easier than in the past. In such a context, foreign direct investment can take many forms, depending on the type of investors, the investor's investment objective and the degree of risk the investor is willing to assume.
Greenfield investment: It takes the form of direct investment in new facilities or the expansion of existing facilities. Greenfield investments are the primary target of a host nation's promotional efforts because they create new production capacity and jobs, transfer technology and know-how, and can lead to linkages to the global marketplace. However, it often does this by crowding out local industry; multinationals are able to produce goods more cheaply (because of advanced technology and efficient processes) and uses up resources (labour, intermediate goods, etc.). Another downside of Greenfield investment is that the profits from production do not feedback into the local economy, but instead to the multinational's home economy. This is in contrast to local industries whose profits flow back into the domestic economy to promote growth.
Mergers and Acquisitions: In this case a transfers of existing assets from local firms to foreign firms takes place. This is another primary type of FDI. Cross-border mergers occur when the assets and operation of firms from different countries are combined to establish a new legal entity. Cross-border acquisitions occur when the control company becoming an affiliate of the foreign company. Unlike greenfield investment, acquisitions provide no long term benefits to the local economy -even the most deals the owners of the local firm are paid in stock from the acquiring firm, meaning that the money from the sale could never reach the local economy. Nevertheless, mergers and acquisitions are a significant form of FDI and until around 1997, accounted for nearly 90% of the FDI flow into the United States.
Horizontal Foreign Direct Investment: It involves the act of investment in the same industry abroad as a firm operates in at home. It widens geographical expansion of a successful enterprise.
Vertical Foreign Direct Investment: It takes two forms: (a) Backward Vertical FDI where an industry abroad provides inputs for a firm's domestic production process. (b) Forward Vertical FDI in which an industry abroad sells the outputs of a firm's domestic production
Proponents of foreign investment point out that the exchange of investment flows benefits both the home country (the country from which the investment originates) and the host country (the destination of the investment). Opponents of FDI note that multinational conglomerates are able to wield great power over smaller and weaker economies and can drive out much local competition.
The truth lies somewhere in the middle. For small and medium sized companies, FDI represents an opportunity to become more actively involved in international business activities. In the past 15 years, the classic definition of FDI as noted above has changed considerably. This notion of a change in the classic definition, however, must be understood in the proper context. Very clearly, over 2/3 of direct foreign investment is still made in the form of fixtures, machinery, equipment and buildings. Moreover, larger multinational corporations and conglomerates still make the overwhelming percentage of FDI. But, with the advent of the Internet, the increasing role of technology, loosening of direct investment restrictions in many markets and decreasing communication costs mean that newer, non-traditional forms of investment will play an important role in the future. Many governments, especially in industrialised and developed nations, pay very close attention to foreign direct investment because the investment inflows into and out of their economies can and does have a significant impact. In this regard, the different types of FDI flows seem to depend on the motives of the investors. Major motives behind the investment from the perspective of the