Positive Impact Of Fdi In Developing Countries example essay topic

FDI Defined FDI refers to the investment made by a foreign individual or company in productive capacity of another country for example, the purchase or construction of a factory. FDI also refers to the purchase of a controlling interest in existing operations and businesses (known as mergers and acquisitions). Multinational firms seeking to tap natural resources, access lucrative or emerging markets, and keep production costs down by accessing low-wage labour pools in developing countries are FDI investors. Foreign direct investment (FDI) is the movement of capital across national frontiers in a manner that grants the investor control over the acquired asset. Thus it is distinct from portfolio investment which may cross borders, but does not offer such control. Firms which source FDI are known as 'multinational enterprises' (Mines).

In this case control is defined as owning 10% or greater of the ordinary shares of an incorporated firm, having 10% or more of the voting power for an unincorporated firm or development of a greenfield branch plant that is a permanent establishment of the originating firm. Types of FDI: Greenfield investment: 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. Greenfield investments are the principal mode of investing in developing countries. Mergers and Acquisitions: occur when a transfer of existing assets from local firms to foreign firms takes place. 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 of assets and operations is transferred from a local to a foreign company, with the local company becoming an affiliate of the foreign company. Mergers and acquisitions are the principal mode of investing in developed countries. The pros and cons of FDI as a source of development Attraction of FDI is becoming increasingly important for developing countries. However this is often based on the implicit assumption that greater inflows of FDI will bring certain benefits to the country's economy. FDI, like ODA or any other flow of capital, is simply that, a source of capital. However the impact of FDI is dependant on what form it takes.

This includes the type of FDI, sector, scale, duration and location of business and secondary effects. A refocusing of perspective, from merely enhancing the availability of FDI, to the better application of FDI for sustainable objectives is crucial to push the debate forward. Various international fora and discussion have outlined a range of positive and negative aspects of FDI as a source of development for developing countries, some of which are discussed below. 1. Stimulation of national economy FDI is thought to bring certain benefits to national economies. It can contribute to Gross Domestic Product (GDP), Gross Fixed Capital Formation (total investment in a host economy) and balance of payments.

There have been empirical studies indicating a positive link between higher GDP and FDI inflows (OECD a. ), however the link does not hold for all regions, e.g. over the last ten years FDI has increased in Central Europe whilst GDP has dropped. FDI can also contribute toward debt servicing repayments, stimulate export markets and produce foreign exchange revenue. Subsidiaries of Trans-National Corporations (TNCs), which bring the vast portion of FDI, are estimated to produce around a third of total global exports. However, levels of FDI do not necessarily give any indication of the domestic gain (UNCTAD 1999). Corporate strategies e.g. protective tariffs and transfer pricing can reduce the level of corporate tax received by host governments. Also, importation of intermediate goods, management fees, royalties, profit repatriation, capital flight and interest repayments on loans can limit the economic gain to host economy.

Therefore the impact of FDI will largely depend on the conditions of the host economy, e.g. the level of domestic investment / savings, the mode of entry (merger & acquisitions or Greenfield (new) investments) and the sector involved, as well as a country's ability to regulate foreign investment (UNCTAD 1999). 2. Stability of FDI FDI inflows can be less affected by change in national exchange rates as compared to other private sources (portfolio investments or loans). This is partly because currency devaluation means a drop in the relative cost of production and assets (capital, goods and services) for foreign companies and thereby increases the relative attraction of a "host" country.

FDI can stimulate product diversification through investments into new businesses, so reducing market reliance on a limited number of sectors / products (UNCTAD 1999). However, if international flows of trade and investment fall globally and for lengthy periods, then stability is less certain. New inflows of FDI are especially affected by these global trends, because it is harder for a foreign company to de-invest or reverse from foreign affiliates as compared to portfolio investment. Companies are therefore more likely to be careful to ensure they will accrue benefits before making any new investments. Examples of regional stability are mixed, whilst FDI growth continued in some Asian countries e.g. Korea and Thailand, during the 1996/97 crisis, it fell in others e.g. Indonesia. During Latin America's financial crisis in the 80's many Latin American countries experienced a sharp fall in FDI (UNG A 1999), suggesting that investment sensitivity varies according to a country's particular circumstances.

3. Social development FDI, where it generates and expands businesses, can help stimulate employment, raise wages and replace declining market sectors. However, the benefits may only be felt by small portion of the population, e.g. where employment and training is given to more educated, typically wealthy elites or there is an urban emphasis, wage differentials (or dual economies) between income groups will be exacerbated (OECD a). Cultural and social impacts may occur with investment directed at non-traditional goods. For example, if financial resources are diverted away from food and subsistence production towards more sophisticated products and encouraging a culture of consumerism can also have negative environmental impacts. Within local economies, small scale and rural businesses of FDI host countries there is less capacity to attract foreign investment and bank credit / loans, and as a result certain domestic businesses may either be forced out of business or to use more informal sources of finance (ECOSOC 2000).

4. Infrastructure development and technology transfer Parent companies can support their foreign subsidiaries by ensuring adequate human resources and infrastructure are in place. In particular "Greenfield" investments into new business sectors can stimulate new infrastructure development and technologies to host economies. These developments can also result in social and environmental benefits, but only where they "spill over" into host communities and businesses (ECOSOC 2000).

Investment in research & development (R&D) from parent companies can stimulate innovation in production and processing techniques in the host country. However, this assumes that in-house investment (in R&D, production, management, personnel training) will result in improvements. Foreign technology / organisational techniques may actually be inappropriate to local needs, capital intensive and have a negative affect on local competitors, especially smaller business who are less able to make equivalent adaptions. Similarly external changes in suppliers, customers and other competing firms are not necessarily an improvement on the original domestic-based approaches (UNCTAD 1999).

5. "Crowding in" or "Crowding out"?" Crowding in" occurs where FDI companies can stimulate growth in up / down stream domestic businesses within the national economies. Whilst "Crowding out" is a scenario where parent companies dominate local markets, stifling local competition and entrepreneurship. One reason for crowding out is "policy chilling" or "regulatory arbitrage" where government regulations, such as labour and environmental standards, are kept artificially low to attract foreign investors, this is because lower standards can reduce the short term operative costs for businesses in that country. Exclusive production concessions and preferential treatment to TNCs by host governments can both restrict other foreign investors and encourage oligopolistic (quasi-monopoly) market structure (ECOSOC 2000, UNCTAD 1999). Empirical data for these scenarios is variable, but crowding out is thought to be more common in specific sectors.

For example, in industries where demand or supply for a product or service is highly price elastic (market sensitive) and capital intensive. Hence regulation brings additional costs of compliance and is therefore much more likely to influence a company's decision to invest in that country (OECD b). 6. Scale and pace of investment It may be difficult for some governments, particularly low income countries, to regulate and absorb rapid and large FDI inflows, with regard to regulating the negative impacts of large-scale production growth on social and environment factors (WWF 1999).

Also a high proportion of FDI inflows in developing economies are commonly aimed at primary sectors, such as petroleum, mining, agriculture, paper-production, chemicals and utilities. Primary sectors are typically capital and resource intensive, with a greater threshold in economies of scale and therefore slower to produce positive economic "spill over" effects (OECD a). Thus, in the short term, low income economies will have less capacity to mitigate environmental damages or take protective measures, imposing greater remediation costs in the long term, as well as potentially irreversible environmental losses (WWF 1999, OECD b). How can FDI be better applied to Sustainable Development? 1.

Accessibility and stability of FDI If FDI is to take a greater role in building developing country economies, further assessment of the factors which influence and are influenced by FDI flows is necessary. Foreign companies are thought to be attracted to recipient countries for a whole range of factors, e.g. political stability, market potential & accessibility, repatriation of profits, infrastructure, ease of currency conversion. Privatisation and deregulation of markets are seen as central means to attract FDI, however this can leave the poorest or most indebted countries open to destabilizing market speculation (ECOSOC 2000). National legislation can support better investment security for local markets, fair competition and corporate responsibility through defining equitable, secure, non-discriminatory, transparent investment practices (WSSD 1995, Habitat II 1996). Whilst there is concern that increased regulation could deter new foreign investors, there is evidence, such as in Eastern Europe, that tighter regulation of corporate, environmental and labour standards has not affected FDI growth (ECOSOC 2000).

Where low income and developing economies are successful in attracting FDI, they require considerable support to ensure that they can adapt to rapid and large inflows of FDI, and that these flows positively benefit domestic economic stability (WSSD 1995). This means developing strategies which encourage greater and longer term domestic investment and saving, as well as higher returns on investment capital. The development of an international multilateral rule-based trading and investment system has been advocated widely. However, whilst the abandoned Multilateral Agreement on Investment would have provided greater rights for companies and investors, it gave limited support for the social, economic and environmental concerns of host countries.

Furthermore, regulation of investment is only as effective as a country's ability to enforce it. The cost of implementation may be prohibitive for many countries, hence bilateral and multilateral support, along side multi-stakeholder participation, is vital for the formulation of such agreements (ECOSOC 2000, Habitat II 1996). 2. Socially Responsible Investment Ethical and socially responsible FDI can be encouraged through national, bilateral and international investment guidelines and regulation e.g. consumer rights, information provision, commercial probity, labour standards and corporate culture (UNCTAD 1999). Several institutions have developed or are currently working on responsible practice.

The ILO has 180 conventions referring to social responsibility and it also has more specific "Tripartite Declaration of Principles" (1977), concerning TNCs and social policy 2. UNCTAD has developed a "Code of Restrictive Business Practices". Eradication of poverty and reduction of gender inequality, where women make up nearly 70% of the world's poorest, should be prioritized. Whilst governments may seek FDI for labour intensive sectors, those sectors which require greater skills are likely to require investment in domestic training and education. Access to FDI for poorer communities and small to medium enterprises can be promoted by fostering credit / loans and capacity building programmes to improve their bargaining power (WCW 1995, WSSD 1995). Intellectual property right agreements between host countries and foreign investors can also be strengthened to ensure domestic technology transfer and skills development are better incorporated (UNCTAD 1999).

3. Environmental protection Greater efforts need to be made to assess the linkages between environmental impacts and FDI, although it may be difficult to isolate FDI impacts from other activities. Authorities and businesses can apply Environmental Management Systems (EMS) to assess the potential impacts of FDI ventures, e.g. ISO 4001 which details techniques such as Life-Cycle-Analysis, Environmental Impact Assessments (EIA) and Environmental Audits. These all require investment in inspection, monitoring, regulation and enforcement to ensure effective implementation.

The resources required to effectively adopt these approaches are often lacking in many developing countries, suggesting a vital need for targeted international assistance (UNCTAD 1999). Greater environmental commitment can also bring long term corporate gains e.g. greater efficiency and better quality of practice (OECD b). Parent governments and businesses play a pivotal role in ensuring that the environmentally sustainable technology filter out into host countries (UNCTAD 1999). In Agenda 21, WTO, GATT and TRIPS agreements governments are asked to take all practical steps to promote, facilitate and finance, as appropriate the transfer, diffusion, and access to environmental technology and know-how 3. Looking at specific sectors, tourism has been identified as a key source of FDI.

At CSD 7 member states were urged to develop policies which encourage tourism, attract FDI but also adopt environmentally appropriate practices (ECOSOC 1999). "Corporate environmentalism" has potential for considerable enhancement internationally. For example, in the energy sector, parent companies can support subsidiary use of renewable energy. This practice can provide a competitive advantage for businesses, especially where consumer / shareholder awareness of negative environmental impacts is strong (UNCTAD 1999). Examples of Key Institutional Roles and Responsibilities Relevant international institutions include: International Finance Corporation and Multilateral Investment Guarantee Agency (World Bank), Industrial Development Organisation (UNIDO), WTO, UNCTAD, Financial Stability Forum (11 national authorities, (G 7), World Bank, IMF, OECD, International Regulatory / Supervisory groupings, Committees of Central Bank Experts), UN CSD's ad-how open-ended technical working group on trade, finance and investment. All these institutions need greater cooperation, coordination and more openly accountable processes to look at how international flows of FDI flows can be better directed toward the specific goals of sustainable development.

Collectively, they need to ensure that finance, trade and investment strategies are mutually reinforcing toward sustainable ends. Critical areas which need to be addressed include: o Assessment of the linkages between finance and trade flows, ODA and private investment flows, as well as domestic finance o how to redress the imbalance between rich investing nations and poor recipients e.g. through independent arbitration of investment agreement so how institutions can prioritize socially and environmentally responsible FDI, whilst stimulating domestic economie so how and who will support developing countries to maximis e the benefits of FDI (employment, income generation, technology transfer, debt servicing, economic stability) whilst minimizing the negative elements (monopolistic TNCs, transfer pricing, social / cultural intrusion, environmental degradation) o Increasing support (funds, human resources) for monitoring the impacts and progress of macroeconomic policies which are aimed at enhancing the positive impact of FDI in developing countries (NCS 2000). In relation to monitoring FDI, there is also a need to further develop and apply sustainability indicators to better assess the impacts of FDI for different regions and sectors Examples of Indicators for FDI and Sustainability The question that remains to be answered is whether FDI can be better targeted toward the advancement of developing and heavily indebted countries, whilst ensuring the global security of coming generations. The General Assembly Special Session "Financing for Development" (FfD) in 2001 will consider how to mobilize domestic resources, international private financial flows, international financial cooperation, trade, debt, new financial mechanisms and governance, in the context of increasing globalization 4. During CSD 8 many of the elements of the FfD process were set as priority areas for future activities. The CSD called for international cooperation over capital flight and profit repatriation, integration of environmental priorities into public policy and programmes, as well as the use of economic instruments and incentives to support long term private investment.

The FfD meeting is therefore a crucial opportunity to take a closer look at institutional processes and the linkages between FDI, trade and financial mechanisms, so that all of these can be better targeted toward meeting sustainable development targets. The tenth CSD in 2002 is likely to provide a good opportunity to review the outcomes of these discussions and their implications. In this way the Earth Summit, later the same year, will serve as a platform for specific and coordinated international, regional and local programmes and initiatives geared toward making FDI a positive driver for a more sustainable future. Comparison between Indian and Chinese economy India's continued backwardness compared with its neighbor across the Himalayas has become a national obsession. The world's two most populous countries, China and India were close economic rivals just two decades ago, each struggling to bring progress to vast numbers of impoverished peasants. But now China, by quickly converting much of its economy to an unfettered and even rapacious version of capitalism, has surged far ahead.

The average Chinese citizen now earns $890 a year, compared with $460 for the typical Indian, according to the World Bank. Only slightly more numerous than Indians these days, Chinese citizens now buy one-third more cars and light trucks each year, 3 times as many television sets and 12 times as many air conditioners. China has high-speed freeways, modern airports and highly efficient ports that are helping it dominate a growing number of manufacturing industries. India's potholed roads, aging airports and clogged ports make exports difficult. China attracted as much foreign investment last month as India did all of last year. Like China, India has a growing middle class - it is just not growing as quickly, perhaps in part because India's expansion started in 1991, 13 years after China's.

The Chinese economy has been expanding by 8 to 10 percent a year for the last two decades, while India's has been growing at a still healthy 6 percent only for the last decade. India's population is growing twice as fast as China's, moreover, so income growth per person has been slower in India. Both countries are encumbered by many government-owned enterprises with low productivity - for India, most notably, its monopoly on distribution of electricity. The Indian economy has a few genuine bright spots. Pockets of high-tech prosperity have popped up in two southern cities, Bangalore and Hyderabad. These have benefited from India's willingness to allow free trade and minimal regulation for new industries, often involving computer software, telephone service centers for financial institutions and other service industries that do not involve moving goods on India's poor roads.

India vis-'a-vis China on account of FDI inflows India has outpaced the UK, Germany and Japan to emerge the third most attractive FDI destination among global investors in 2004, according to a recent study by ATKearney. While China and the US continued to occupy top two slots respectively, India - positioned sixth last year - rose to third spot primarily on the strength of an educated workforce, management talent and favorable regulatory environment, Paul A Laudicina, MD of ATKearney's global business policy council, said. While China leads the pack mainly on account of being a large captive market with huge growth potential, ability of Indian workforce has made it an attractive FDI destination. 'Going back to 1998, India was at 5th position and dropped to seventh the following year. From there, India has bounced back to third position; it's best till date,' Laudicina said.

Calculated on a scale of 0-3, the ATKearney index places China at 2.02, followed by the US and India at 1.4 and 1.39, respectively. China attracted $53.5 billion FDI in 2003, while foreign investment in the US plunged to $30 billion. In comparison, actual FDI inflows to India stand at $4.67 billion in its 2003-04 fiscal. For global investors, India and China are mirror images of each other, said Laudicina. 'While India was ranked high in having an educated workforce, management talent and favourable regulatory environments, China figured poorly on these counts.

China is more attractive as a market with good infrastructure and low labor costs. India scored low on these points. ' Bureaucracy was the single biggest concern in India, followed by political stability, infrastructure, and geopolitical climate (particularly India's relations with Pakistan). Clearly, China is "beating" India when it comes to attracting FDI, but it's important to remember that FDI is not a zero-sum game: A dollar invested in China is not necessarily a dollar being pulled out of India's pocket.

The catch here is that although the pressure is not going to be felt in the Indian economy as of now but it may loose their attractiveness to China for future inflows with due course of time. Why are the Chinese ahead? For a modern economy to succeed, a whole population must be educated. The Chinese have developed their human capital more effectively through a nationalized education system. In 1999, 98% of Chinese children have completed 5 years of primary education as against 53% of Indian children. India did not have universal education and educational standards diverge much more sharply than in China.

In some states like Kerala participation in primary schools is 90%. In some states it is less than 30%. Overall in 2001, India's illiteracy rate was 42%, against China's 14%. India had many first-rate universities at independence. Except for a few top universities such as the Indian Institutes of Technology and Indian Institutes of Management that still rank with the best, it could not maintain the high standards of its many other universities. Political pressures made for quotas for admission based on caste or connections with MPs.

China has repaired the damage the Cultural Revolution inflicted on their universities. Admission to Chinese universities is based on the entrance examination. China has built much better physical infrastructure. China has 30,000 km of expressway, ten times as much as India, and six times as many mobile and fixed-line telephones per 1,000 persons. To catch up, India would have to invest massively in its roads, airports, seaports, telecommunications and power networks.

The current Indian government has recognised this in its budget. It must implement the projects expeditiously. Real Estate in India The buzz around real estate development is FDI-centric. There are seminars, symposiums and discussions on Foreign Direct Investment (FDI) in real estate, ever since the government opened this field for 100% FDI. But nobody is telling us as to how the out-dated laws and regulations gripping this sector will be removed. How the out-dated land laws, Urban Ceiling Act (in Maharashtra), cumbersome, time consuming and corruption ridden, procedures for passing building plans, will be simplified.

It is noteworthy here, that because of the above mentioned hurdles, the leading developers from Mumbai and elsewhere, have gone to Dubai and are developing real estate there. They are developing projects worth Rs. 200 to Rs. 500 crores in Dubai. This means that there is enough money, expertise in construction, and development management abilities in India. So why we are screaming about FDI?

Instead, the government must first reform the existing laws and regulations, which if not scrapped, will never allow FDI in real estate to succeed. In Comparison with China The example of China is before us, where over 19 billion dollars have been invested in real estate development through FDI route, only because of the reforms in real estate sector and the laws regulating it. China is spending $200 billion "annually" on infrastructure development, whereas India is only proposing $150 billion investment in the next decade for the infrastructure development. This stark comparison tells us where we stand today. So, if the government is really serious about attracting sizable FDI in real estate, it must amend its approach and scrap, without delay, the outdated and corruption-centric laws and regulations. China bagged 11.6% of real estate FDI projects in OCT Consulting's sample of 587 projects worldwide in the three years to December 2004, with Asia as a whole attracting more than 21% of projects.

Recommendations - our wish list Amendments to FDI guidelines to in townships, housing, built-up infrastructure and construction projects, implementation of uniform VAT across States, abolition of Service Tax on the construction industry, especially the housing sector and drastic reduction stamp duty are some of the major recommendations by the Federation of Indian Chambers of Commerce and Industry to foster unfettered growth of the real estate sector. FDI should be permitted in companies which are otherwise engaged in real estate development companies and own properties, some of which may be developed, partly developed and / or undeveloped. This would assist in providing the necessary finance to the companies which face shortage of finance for funding their projects. Service tax in relation to construction of residential complexes having more than 12 houses have been proposed to be introduced as a new service.

However, no rationale has been provided for exclusion of services in relation to construction of residential bungalows, which may not form part of 'residential complexes'. Therefore this new change introduced in this budget should be reverted back. The opening up of FDI for the Retail sector will be a great boon for the Construction Industry. The symbiotic relationship between retail and the real estate sector can be explored in a number of formats, some of which are: o Builders and developers can construct the property and then hand it over to the retailers. o There is also the possibility of exploring joint venture collaborations. In this format the builder shall be responsible for identifying and acquiring land, constructing the building and further be responsible for the maintenance and the upkeep of the premises. The retailer in this format shall then be responsible to bring in the brands in the building.

This format provides the construction industry an extended scope of getting into retail in a joint venture format. This shall not be limited to the FDI scenario but can work well in the Indian retail industry scenario as well. This type of model lets the core business, which is construction, development and maintenance, get a value addition from another industry segment. Relaxing the existing 100 acres norm for the FDI inflow into real estate sector would help speed up construction works in the economy. It is difficult to get 100 acres in the urban areas, to enable foreign firms to build on plots starting from 25 acres against the current stipulation of 100 acres (applicable only in integrated townships).