Understanding The Term Foreign Direct Investments Finance Essay - Free Essay Example

The paper helps the reader to understand the meaning of the term Foreign Direct Investments (FDI). Countries investing beyond domestic frontiers are called as source countries, countries receiving foreign investments are called as host countries. This article explains factors affecting FDI movements between countries. Brief mention about circumstances that are detrimental to FDI inflows or outflows are also explained. Two developing economies; India and China are compared and evaluated on FDI attractiveness on the bases of factors discussed as influential to FDI growth in an economy. INTRODUCTION Understanding FDI: FDI refers to capital movements between countries; it can be capital inflows or outflows. Capital inflow occurs when country experiences investments by foreign individuals, group of individuals, corporations, and group of related enterprises, government agencies, social organizations or combination of the investors mentioned above and vice versa for capital outflows. Capital refers to: Monetary investments by foreign companies/individuals. Equity stake in a particular company or set of companies in an industry Transfer of technical know-how, personnel and assets between countries. FDI (capital inflows) can occur through the following methods: Opening up subsidiaries in host countries. Through joint ventures with investors or enterprise located in host countries. Through mergers or acquisition of unrelated or related enterprise located in host countries. Attempts to explain inward FDI flows to host countries include both micro and macro explanations. Micro ex planations focus on individual firms and the motives for expansion into foreign markets through wholly owned subsidiaries and joint ventures (rather than through licensing or exporting). For example, Aharonis (1966) pioneering study of direct investments by US firms abroad looked in detail at the company-specific characteristics of that kind of investment. A number of additional studies have followed that micro-level analysis (Caves, 1974; Grubaugh, 1987). The macro approach focuses on country level variables (e.g., exchange rate changes or interest rate differentials) to explain national FDI flows. These studies generally examine country-level factors that determine the country of destination of FDI, i.e., they explain why direct investors choose one country over another (Green and Cunningham, 1975; Culem, 1988; United Nations Centre on Transnational Corporations, 1992; Lipsey, 1999). Both macro and micro explanations are relevant; the two perspectives complement each other and further our understanding of FDI. In fact, Dunnings (1980, 1997) eclectic theory of FDI combines the two approaches, focusing on firm-specific advantages (e.g., a brand name or proprietary technology) that firms may possess relative to their rivals, benefits from internalizing the market for these advantages within the hierarchy of the firm when it expands abroad, and location advantages that attract FDI to one country vs. Another. As distinguished from these approaches, our analysis takes a macro-level view but it focuses on the macro attributes of the countries of origin of the FDI, rather than the countries of destination. We look at only one target country, Mexico, and explore the factors that explain why companies from different home countries have chosen to invest there. A review of the literature conducted in 1981 revealed that to that point, no comprehensive macro model had been developed to explain FDI inflows and/or outflows (Arpan et al., 1981). Even so, by that time, several substantial studies of the multiple causes of FDI had appeared in the literature (e.g., Aharoni, 1966; Green and Cunningham, 1975; Kobrin, 1976; US Department of Commerce, 1976; Root and Ahmed, 1979). During the 1980s, a number of studies explored multidimensional attributes of FDI flows, usually looking at the characteristics of the host countries (e.g., Fagre and Wells, 1982; Nigh, 1985; Lecraw, 1985; Schneider and Frey, 1985). An excellent review of this literature appears in United Nations Centre on Transnational Corporations (1992). Moving along a different dimension, researchers such as Ajami and Barniv (1984), Tallman (1988), and Grosse and Trevino (1996) began to focus on home-country determinants of FDI into target countries. All of these researchers who looked at country-of-origin effects have studied the US as the target country. Ajami and Barniv (1984) studied a variety of different economic factors that might affect FDI flows into the US. They found existing tra de between home countries and the US to be positively correlated with FDI inflows to the US. This supported their hypothesis that exports generally precede FDI because FDI involves much more commitment by the firm than exports. They also found differences in interest rates or capital market disequilibrium to be significantly correlated with FDI; this confirmed their hypothesis that there is a cost advantage for firms in a home country where interest rates (cost of borrowing) are lower than in a target (potential location of FDI) nation. Tallman (1988) developed a model with political and economic variables explaining variation in FDI inflows to the US. He found that home-country level of economic development is positively correlated with FDI inflows to the US. Further, he found that political risk is positively correlated with FDI into the US. The positive correlation between political risk and FDI supported his hypothesis that firms from relatively unstable home countries seek t o escape risk by expanding into a country with a more stable political environment the US. Grosse and Trevino (1996) developed another multidimensional (political, geographic and cultural distance, and economic) model of FDI. They test the model using data on inward FDI to the US by country of origin over a 12-year period. They find significant results for the model as a whole which included economic variables: (1) existing bilateral trade, (2) size of home-country market, (3) per capita income, (4) relative cost of borrowing, (5) relative rate of return, (6) exchange rate; a political variable: country-of-origin political risk; a geographic variable: geographic proximity; and a cultural variable: cultural proximity. For the individual variables, they found that existing bilateral trade, home-country size (GDP), exchange rate, cultural distance, geographic distance, and political risk were all significantly associated with FDI flows into the US. The multidimensional approach is a ppealing because it cuts across disciplines: it views FDI in light of economic, sociological, political, historical, and managerial perspectives. In general, the economic perspective focuses on market characteristics and efficiency-gaining motives for FDI. For example, if labour costs in foreign countries are lower than in the home country, there is disequilibrium and firms may invest abroad to take advantage of the cost savings. Socio-political arguments focus on the effects of the macro business environment on firm operations. For example, the degree of market orientation of the government, infra structure and legal environment will affect firms decisions to expand internationally. Geographic arguments, in general, focus on transportation and communication costs involved in managing and controlling dispersed international operations. For example, Germany and Switzerland are physically (geographically) close together; therefore, the costs of inter-nation investments are lower relat ive to another pair of countries that is further apart geographically (e.g., Germany and Brazil). ii. Issue arising as a result of establishing a presence abroad. Each year, hundreds of established and growing companies consider international expansion as a marketing and growth strategy. When developing a strategic plan to launch an international mergers and acquisition (MA) program, financial executives and their advisors must always consider the potential barriers and adjustments that might need to be made to maximize share holder value in a given transaction or in the execution of the given international market penetration strategy as discusses below. The Obstacles are In determining our ability to offer products and services abroad, consider the following: Language barriers Although it may seem simple enough at the outset to evaluate the features of a given product, service, or opportunity into the local language, marketing the services and/or the product may present unforeseen difficulties if the concept itself does not translate well. The target countrys standards for humor, accepted puns or jargon, or even subtle gestures may not be the same as your domestic countrys norms or idioms and may need to be adjusted accordingly. Marketing barriers. These types of barriers most frequently go to the deepest cultural levels. For example, whereas many overseas markets have developed a taste for fast food burgers and hot dogs, differences in culture may dictate that the speed aspect is less important. Many cultures demand the leisure to be able to relax on the premises after eating a meal rather than taking a meal to go. These cultural norms can, in turn, be affected by factors such as the cost and availability of retail space. Direct and subtle messages in advertising campaigns may need to be modified, the appeal of using a particular celebrity in a campaign may vary, and the channels for promotion may also need to be modified to meet the educational patterns and needs of the local consumer. Even marketing methodologies may need to be modified. In certain cultures, coupons are widely accepted and used by people who are both rich and poor (such as in the United States) but in other cultures, coupons are not widely used or accepted . In some cultures, even the use of comparative advertising, which is now commonplace in the United States, could be viewed as offensive or destructive. Legal barriers. Tax laws, customs laws, import restrictions, corporate organization, and agency/liability laws must all be researched by the company and its counsel. Domestic legislation needs to be examined as well for issues arising under labour law, immigration law, customs law, tax law, agency law, and other producer/ distributor liability provisions. Governmental Barriers The foreign government may or may not be a barrier for the foreign investment or expansion of a company. A given countrys past history of expropriation, government restrictions, and limitations on currency repatriation may all prove to be decisive factors in determining whether the cost of market penetration is worth the benefits to be potentially derived. Export regulatory requirements Any company which think of doing business or acquiring businesses either in a large scale or even a small transaction should always consider the implications and requirements of a body of the country. The regulations are define as the export controls (Andrew 2007). For instance when we consider a developed country like U.S it is incumbent and companies that sell, ship or transfer electronic goods determine controls or restrictions apply or selling. Hereby I conclude that when a company looking forward for the investing in a foreign country should always think of the pros and cons. There are various trade compliance services available for hire in order to help the exporters. Compliance guidelines and the specific requirements are available on web as well as there are number of agencies available in order to give the relevant information on the foreign direct investment.