International Business Investment Opportunities: Trends and Theory of Foreign Direct Investment (FDI)

What is Foreign Direct Investment (FDI)

Wild and Han (2004) defined the FDI as the purchase of physical assets or a significant amount of the ownership (stock) of a company in another country to gain a measure of management control. Markets can be served by FDI and trade when a firm integrates their operations across borders by trading intermediate goods and services ( Econocmists Advisory Group Ltd ,1996) .

According to Alfaro and Charlton (2007) policy makers often consider foreign direct investment (FDI) as a source of important productivity externalities for the host countries. Additionally, FDI is one source of supplying capital and can be a source of valuable technology and to foster linkages with local firms.  However, despite the strong relation between economic growth and FDI, it is evident that some FDI projects are better than others (Alfaro and Charlton, .2007) while academics treat FDI as a homogenous capital flow (Alfaro and Charlton, 2007).

Economic development in host countries have been driven by FDI as it brings technology, capital, management know-how, jobs and access to new markets.  The benefit that FDI brings to host countries especially to developing countries can be underlined by Policy-makers (OECD-ILO, 2008).  Therefore, government have been set up different policies to attract inward FDI.  It can be argued that although the FDI and multinational enterprises (MNEs) are considered to be beneficial for local development, however, there are social concerns about their presence in host countries (OECD-ILO, 2008). For example, multinational enterprise (MNEs) have often been accused of taking unfair advantage of low wages and weak labour standards in developing countries where there is a weak union. MNEs also have been accused of violating human and labour rights in countries where governments fail to enforce such rights effectively.

According to Alfaro, and Charlton (2007) a complex measure implementation has been set up in Dublin to Beijing to accept or refuse FDI projects. As a result, the value of inward investment must be judged on its nature and quality rather than in quantitative measures or job numbers alone (IDA, 2008).

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FDI Motives and Locations

Corporate have many motives for expanding abroad including sourcing low cost factors, avoiding taxes, managerial rent-seeking, and behaving strategically by following competitors (Chung and Alcacer ,2000).

While others conduct foreign direct investment (FDI) when they possess unique capabilities to be sold to foreign firms (Chung and Alcacer, 2000).

If these companies are not able to do so, then the firm will expand abroad to gain the highest returns - the capabilities are “internalised”.  Recently, the major motive is that, firms expand abroad to search for new capabilities. This motive has been termed “asset seeking” and “reverse internalisation”( Chung and Alcacer, 2000).

National policies in the host country, however, try to find ways to attract some types of FDI and regulate other types.  This is resulted in FDI projects can differ greatly in terms of the national benefits to be derived from them (Alfaro and Charlton, 2007).  For example, the UNCTAD’s World Investment Report (2006) defined “quality FDI” as “the kind that would significantly increase employment, enhance skills and boost the competitiveness of local enterprises.”  

As a result of the inflow of managerial resources, the FDI makes a vital contribution to productivity growth of the host country.  However, the FDI has a negative impact on reduction in employment at domestic firms in response to competition from foreign multinational.  Empirical studies highlighted that foreign firms are more productive and profitable than domestic firms and can make a significant contribution to overall growth (Alfaro and Charlton, 2007).  For example, FDI in Ireland increased by 14% with a total of 130 new investments (Ireland’s Industrial Development Agency, (IDA), 2008) and this created 8,837 new jobs in 2008 (IDA, 2008).

The Importance of FDI for Developing Countries

There was a rise in FDI in 2007 reflected relatively high economic growths and strong economic performance in many parts of the world (United Nation, 2008)  As a result, this increases corporate profits and in turns provided funds to finance investment and reduced the impact of decreasing loans from the banks affected by the sub-prime credit crisis(United Nation, 2008).   Around $1,100 billion profit in 2007 which contributed to higher reinvested and about 30% of total FDI flows in 2007.  These profits was generated in developing countries rather than in developed countries (United Nation, 2008).

Reference

Alfaro, L. and Charlton, A. (2007) Growth and the quality of foreign direct investment: Is All FDI Equal

Chung, W. C. and Alcacer, J. (2000) Heterogeneous Investment Motives and Location Choice of Foreign Direct Investment in the United States (September, 2000). NYU Stern School Working Paper.

Economists Advisory Group Ltd (1996)The Single Market Review Series: Summary Impact on trade and investment.FOREIGN DIRECT INVESTMENT

Summary

IDA  Annual Report 2008. [online] Available at: http://www.idaireland .eu/news-media/press-releases/ida-annual-report-2008/ (Accessed: 20/ 4 /2011)

OECD-ILO (2008) Conference on corporate social responsibility: Employment and industrial relations: promoting Responsive Business Conduct in Globalising Economy

UNCTAD, 2006. World Investment Report: FDI from Development and Transition Economies: Implications for Development. United Nations, New York.

United Nation (2008) World investment Report: Transnational Corporations, and the Infrastructure Challenge. United Nation Conference on Trade and Development (UNCTAD)

Transfer Pricing and Off-shore Tax Haven Usage

Public service depends heavily on taxes but there is a contradiction in western legislation toward tax havens for more than a century that affects both rich and poor nations alike(Shah, (2009).   Individual and companies have to pay taxes.  However, by employing creative solicitors and accountants, some multinational companies and wealthiest people afford to escape paying taxes (Shah,(2009).  

Companies such as Enron, Newscorp, Elan, Exxon, Northern & Shell Group, Portland Investment, Microsoft, General Motors and others have used tax havens to reduce or eliminate their tax bills.   As a result, in the 2002 the UK government lost extra revenue of £85 billion.  If it was collected, it would have been funded schools, hospitals, pensions, public transport and social infrastructure.  

The UK government is unable to tackle this problem, claiming that there is insufficient fund to invest in public service (Mitchell et al. 2002).  However, the government could tax billions of pounds that escape in offshore tax havens by adopt a progressive taxation policies and tax the rich more.  As stated by the United Nations (1998)

 “The common denominator in money-laundering and a variety of financial crimes is the enabling machinery that has been created in the financial havens and offshore centres”.

Why would companies avoid paying taxes?  Tax avoidance is one way in which companies have been utilising to maximise shareholders funds.  Therefore, multinational companies are placed to exploit tax havens and hide the true profits.  For example, According to Mathiason (2007) Jersey has increasingly been used by Swiss bankers to help their clients avoid the withholding tax levied on Swiss corporate dividends.  Around $78bn of so-called Swiss fiduciary deposits were moved from their banks to Jersey.

Reference

Shah, A. (2009) Tax Avoidance. Available at: http://www.globalissues. org/article /54/tax-havens-undermining-democracy. (Accessed:13 April 2011

United Nations Office for Drug Control and Crime Prevention, (1998)

Financial Havens, Banking Secrecy and Money Laundering, Vienna, United Nations.

Mathiason, N. (2007) Jersey is $491bn tax haven: 4 November 2007  Availabel at: http://www.guardian.co.uk/business/2007/nov/04/4tory (Accessed:  15 April 2011)

Mitchell, A., Sikka, P., Christensen, J., Morris, P. and Filling, S. (2002)

No Accounting for Tax Havens:  Shedding light on darker practices Working for an Open and Democratic Society