Globalisation is a reality that touches the lives of all people on this planet. Through it international trade has increased and made most people and countries wealthier, for some the level and standards of living has improved due to it. It is a process of growing interdependence between all people across the world, as trade, investments and governance link them together economically and socially, spurring market liberalisation.
Globalisation in the form of foreign direct investment accelerated in the late 1980s. FDI mainly consists of funds invested directly abroad from the headquarters of the multinational corporation, or as reinvested earnings of a foreign affiliate or as funds borrowed from the parent company.
When a company invests directly in a foreign country to produce or market a product, it is called foreign direct investment. It is a company controlled by ownership by a foreign company or foreign individual. It involves the establishment of production facilities abroad, building new facilities from ground up or purchase of existing business. Foreign direct investments have now taken a more significant place than exports in the global market. One of the most striking features of the international economic development in the last 10 – 15 years have been the very strong growth in foreign direct investments. The average yearly outflow of FDI have increased from about $25billion in 1975 to record $430 billion in 1998. Infact it has accelerated faster than the growth in world trade.
Traditionally, there were barriers to FDI in most countries; various measures made it more difficult for foreign firms than for domestic ones to engage in production, and for foreign multinationals there have been strict rules in many countries. There were also restrictions related to moving income across borders, problems with taxation, and so on. More recently, the policies have changed significantly where many countries emphasize the benefits of foreign investments.
As a consequence, most countries have reduced or removed the former barriers to FDI, which have influenced companies to engage in international business. Foreign direct investments is a means of expanding their sales, acquire resources or may be to minimise risks. In addition, the governments may own FDI or influence their home-based companies to establish FDI because of political motives. However companies can pursue operating modes other than FDI, such as exporting, importing from another country or joint ventures, and licensing etc., which have less risk than FDI. So why would a company operate in a high-risk environment less familiar than at home?
Companies have different motives for investing abroad. They may be because of general trade barriers, greater revenue, labour market imperfections, vertical integration or shareholder diversification.
Every country has certain trade restrictions. Tariffs and quotas restrict the free flow of goods, services and people. The government restricts imports making it difficult for companies to sell their products in a foreign country. So these companies must produce in the foreign countries if they have to sell their products there. For example, Hyundai is increasing its FDI in India because of Indian import restrictions on automobile parts. Often it is seen that governmental restrictions favour big companies as they can afford to invest huge amount of resources abroad making it difficult for smaller companies who can only afford exportation as a means of serving foreign markets.
Country of Origin Effects
Consumers of a country may prefer to buy goods of their own countries. The belief that goods produced in their own countries are better is very prevalent in many countries (perhaps because of nationalism). Sometimes they may also believe that products from a given country are superior, for example, automobiles from Germany, electronic goods from Japan or perfumes from France. So when they order a foreign made good, the fear is that it may not be delivered in time. For products like automobiles, importing of spare parts may be difficult. In all of these cases, companies may find advantage in placing FDI where their output will have the best acceptance.
If the production cost of a company includes freight, it becomes impossible for some goods to be transported as the cost increases. It is quite impractical. For example companies like Pepsi Co. US and Unilever British-Dutch prefer investing in a foreign country to exporting their products.
There are numerous motives for companies to invest in foreign countries. While numerous, there has been one prominent motive: companies conduct foreign direct investments when they posses unique capabilities. While such companies might sometimes prefer to sell these capabilities to foreign companies, market failures hinder the transfer of some capabilities to others. Therefore to obtain the highest returns from their capabilities, they expand abroad themselves.
This is another prominent motive that has emerged in the recent times. Some companies, instead of utilising their capabilities abroad, may expand abroad in search of new capabilities. In this case a company expands not because it has capabilities but since it seeks them. This is also termed as `reverse internalisation’.
An oligopoly is a market structure with a small number of firms. The key feature is that the number is so small that each firm bases its decisions on what its competitors are doing or are expected to do. It is different from prefect competition where there are many firms and no one firm can affect the market and hence there is no need to pay attention to competitor’s decisions. A firm might seek to invest abroad because its competitors are investing abroad. Alternatively, the firm may view foreign investment as a way to pre-empt its competitors’ moves into a foreign market.
* Greater Revenue
It is very rare that a company’s domestic competitor will also be there in every foreign market in which it is located. `Where there is less competition, the firm may be able to obtain a better price for its goods or services. For example, Goodrich had only one competitor in the Mexican market when it began producing V belts locally, whereas it had dozens of competitors in the United States. Increasingly, firms are obtaining greater revenue by simultaneously introducing products in foreign markets and their domestic markets as they move towards greater globalisation of their operations. This results in greater sales volume while lowering the cost of the goods sold.’
* Lower Cost Of Goods Sold
Government inducements for foreign investors create a pull factor. Many governmental units offer incentives such as tax breaks, infrastructure investments, and subsidized land and utility costs in an effort to attract foreign investors. Governments also serve as information providers, and try to match potential investors with specific locations or local firms. These can affect the cost of goods sold positively. For example, Greece offers investment grants upto 50 percent of the investments to new investors.
`This might be considered a supportive reason for opening up new markets overseas, because certainly the ability to communicate rapidly and less expensively with customers and subordinates by electronic mail and videoconferencing has given managers confidence in their ability to control foreign operations.’ With advancement in computer technology it is now possible to access databases and computer generated drawings from any part of the world. For example, in India there are numerous software companies and their clients all over United States. A few years ago, software teams were required to fly back and forth between the two countries. Now, at the end of the day, customers in the United States e-mail their problems to India, and while they are sleeping, the Indians work on the solutions and have them back at the United States before the Americans have had breakfast. For their work, Indian software engineers receive only 20 percent as much as do their American counterparts.
Some investments are motivated by the desire to minimize uncertainty by putting two firms under common control. This is most effectively seen by considering vertical FDI. A firm that acquires control of a supplier (for example, a computer manufacturer that buys a semiconductor maker) removes a great deal of uncertainty about the availability and price of supplies. Similarly, a firm that invests in a customer removes uncertainty about demand for its product. `Advantages of vertical integration may accrue to a company through either market oriented or supply oriented investments in other countries. Recently there have been more examples of supply oriented investments designed to obtain raw material from other countries. This is because of growing dependence on emerging economies for raw material supplies. Companies from industrial countries are more apt to have the resources necessary to invest in emerging economies than are companies from emerging economies to invest in industrial countries.’
Since intangible assets are difficult to package and sell to foreigners, multinational companies often enjoy a comparative advantage with FDI. For example, Coca-Cola has a very valuable asset in its closely guarded `secret formula’. To protect that proprietary information, Coca-Cola has chosen FDI over licensing.
Whenever a company is investing in a foreign land, it is attracting shareholders too. Shareholders from different parts of the world are an advantage to the company as it increases its funds and strengthens its reputation as a diverse company.
Sometimes governments give incentives to their companies for FDI to develop relations with other countries or to gain the supplies of strategic resources. Sometimes they do it to reduce security risks. For example, the Chinese National Petroleum Corporation, a Chinese government-owned company, has been investing in Kazakhstan, Peru, Sudan and Venezuela so that China will be less dependent on foreign companies for its oil supplies.
It is now a competitive requirement that companies invest all over the globe to access markets, technology, and talent. Foreign direct investment (FDI) data are a clear indicator of the trend toward globalization. The United States, the world’s largest economy, sees far greater FDI activity than the other major industrialized economies in sheer dollar terms. Foreign Direct Investments in the US has rapidly risen from $185 billion in 1985 to $630 billion in 1996.
While it has been a trend that developed economies with favourable political situations and an open economy, such as the United States, attract large foreign investors, the shift these days has been towards the developing economies. `From 1985 to 1990, the annual inflow of FDI into developing nations averaged $27.4 billion, or 17.4 percent of the total global flow. By 1997, the inflow into developing nations had risen to $149 billion, or 37 percent of the total.’ The emerging economies of South East Asia and China became one of the most important regions followed by Latin America for the inflows of FDI.
Since 1998, China consistently has ranked among the most attractive markets worldwide, along with Brazil, India and Mexico. `Starting from a tiny base, foreign investments surged to an annual average rate of $2.7 billion between 1985 and 1990 and then exploded to a record of $45.2 billion in 1997, making China the second biggest recipient of FDI inflows in the world after United States.’ This year too China continued its rise while the other large emerging markets declined in attractiveness. Investors are increasingly attracted to the Chinese market and are more optimistic about the Chinese economy. One of the most important reasons is the availability of low-cost but well educated skilled labour. The population of China being very high, there is a vast potential for investment by companies producing consumer goods. Also the production costs in China are comparatively lower than in other developing economies. For many companies china is a base for their products in other Asian countries.
Recognizing that FDI can contribute to economic development, all governments want to attract it. Indeed, the world market for such investment is highly competitive, and developing countries, in particular, seek such investment to accelerate their growing efforts. With liberal policy frameworks becoming a commonplace and losing some of their traditional power to attract FDI, governments are paying more attention to measures that actively facilitate it. Hence, to conclude we can say that in this fast growing economy the Foreign Direct Investments have a very important role to play so as to bring about a revolutionary effect in the global marketplace.