Globalization is a two-way process. Initially, countries allow the inward flow of FDI and restrict or prohibit outward FDI. Gradually countries implement more liberal policies, permitting both inward and outward FDI.
By Rahul Guhathakurta
Image Attribute: Car and machinery, Flickr Creative Commons, David Valenzuela
International business can be best understood as a continuum. Every country is involved at some stage or other international business and allied operations. According to the radical (closed economy) view, multi-national companies (MNCs) control technology and provide key management jobs to their home country national and they can never be forces of economic development. According to the free market view, foreign investment is essential to ensure production of goods in the most efficient locations, and so all the barriers to trade and investment have to be removed. No country has embraced either the radical view or the free market view in totality. Most countries have taken best-of-both-worlds approach. Countries try to maximize the benefits of foreign direct investment (FDI) and minimize its negative effects on the domestic industry and economy.
Some home country governments encourage outward FDI by:
1. Providing insurance covers to MNCs to protect them against risks of nationalization, war, etc.
2. Providing double taxation relief.
3. Persuading the host country to relax norms for inward FDI.
However, most home country governments, including those that have a free market economy (like the U.S. and the U.K.), impose some restraints on the outward FDI. Differential tax treatment for earnings from domestic operations is one of the ways in which they impose a restraint on outward FDI.
Host country governments offer tax incentives, attractive financing, and good infrastructure to attract FDI. However, many host countries also place restrictions in the shareholding pattern in the domestic subsidiary to ensure that resource transfer benefits are maximized for the host country like in the case of United Arab Emirates (U.A.E.)
Changes in Foreign Direct Investment (FDI)
As many economies have started opening up their doors for international trade and investment, the flow and stock of FDI have shown significant changes. The stock of FDI refers to the cumulative value of foreign investment, and the flow of FDI refers to the amounts invested across national borders each year. The dominance of U.S. companies as the source and destination of FDI has been shrinking. From dominating some 45 percent of world trade and investment, the U.S. now accounts for only 13 percent of world trade and investment. (Refer the map below)
Map Attribute: WTO 2014 Press Release - Merchandise exports and imports in current US dollars by region, 2013
Developing nations (such as India and China) that have liberalized their economies are gaining importance as sources and favorable destinations for FDI. The Japanese automobile industry in the U.S., the Korean electronic goods industries in India, the global business process outsourcing investments in India. are the examples of the change in the pattern of flow of FDI. Also, the investment opportunities in infrastructural development are very lucrative to attract the FDIs.
Benefits of FDI to Host Country:
Internation trade was assumed to be a zero-sum game. i.e., the gain of one country implies a loss for another. But Adam Smith and David Ricardo changed this perception and proved how international trade can be gainful to both the trading partners. Most countries today believe that both benefits and costs are associated with FDI-benefits in terms of transfer of technology and creation of employment and costs in terms of repatriation of profits and adverse balance of payments position if the host country subsidiary has to import most components from the home country.
Resource transfer effects
MNCs generally have access to funds that are not available with the host country firms. Raising capital in the host country has the benefit of retaining some part of the profits in the host country. The World Bank and International Monetary Fund (IMF) have emphasized the need for financial market reforms in recipient countries in order to realize the full benefits of capital flows. Improper banking can only lead to a crisis like the one in South Eas Asia in 1997.
As MNC helps to develop and improve the quality of manpower in the host country. Host countries usually insist that MNCs reserve some management jobs for the citizens of the host country. Substantial management benefits arise when the managers trained by MNCs subsequently establish their own organizations.
MNCs also help in the transfer of technology. Technology plays a vital role in the development and industrialization of an economy. The two forms of technology are:
1. Process technology - which means the manufacturing process e.g., building bridges.
2. Product technology - which means introduction of a product e.g. mobile phones.
Countries that do not have a strong research and development base depend on FDI for transfer of technology. Mobile phones, ATMs are some examples of the technology, developing countries have received. Many MNCs, including Motorola, Microsoft, and IBM, have invested huge amounts in development centers in China. But the host country does not actually gain access to technology during the setting up of a wholly-owned subsidiary since the basic technology is retained by the parent. Instead of an FDI, the host country can have a licensing arrangement with MNCs. MNCs do not like licensing because it could create a competitor. As a licensee (the host country) gets direct access to valuable technology, it could set up as an independent company. Japanese car makers, who initially had a licensing arrangement with U.S. car makers, improved on U.S. automobile technology and gained considerable market share.
Benefits of FDI to Home Countries:
Through FDI, the home country transfers production to locations where goods can be produced most efficiently. As a result, the home country gains a comparative advantage in the production of those goods. This is one of the reasons why non-core business processes are being increasingly outsourced across national borders. An example of such outsourcing is GE's call centers in India for the global operations of some GE businesses.
The capital account of the country improves during the inflow of foreign earnings. Especially if investments have been made in a country with an appreciating currency, inflow of funds will translate into more units of home currency. But when goods produced in a foreign subsidiary are imported into the home country, an adverse BoP position is created. And initial outflow of funds has an adverse effect on the capital account. This is one of the reasons for some countries to permit inflow FDI but restrict outflow FDI and repatriation of profits of MNCs. The export of components and equipment to foreign subsidiaries will create employment opportunities at home. Japanese automobile makers in various emerging economies import many components from their home countries. This creates a demand for those goods and employment opportunities in Japan. A reverse resource transfer effect occurs when knowledge of new markets, products, processes, and technologies are transferred back to home countries.
Conclusion:
Globalization is a two-way process. Initially, countries allow the inward flow of FDI and restrict or prohibit outward FDI. Gradually countries implement more liberal policies, permitting both inward and outward FDI. Through FDI, home countries benefit by gaining access to new markets and efficient business locations. This enables them to capture larger market share. The FDI recipient countries benefit through technology transfer, improved management capabilities, increased employment opportunities and faster economic growth and development. In a nutshell, the globalization is a much-required tool for countries to grow together by indulging into cross-border trade and commerce and simultaneously creating win-win opportunities for those who are involved.
About the Author:
Rahul Guhathakurta is the Founder of IndraStra Global. He tweets @rahulogy
