What is Foreign Direct Investment (FDI)? Moffet et al. explain it is the purchase of physical assets, such as a plant and equipment, in a foreign country, to be managed by the parent corporation. There are typically two ways a firm can go about implementing FDI. The first option can be through Greenfield investments and the second option is through merger and acquisition activity. The first type of investment is simply establishing a production or service facility starting from scratch from a green field. The latter describes how companies can opt to enter into a merger by combining their business entities under common ownership or opt to acquire a firm to gain access to a foreign market it wishes to invest in.
Of course with any kind of investment there are the pros and cons. For the country gaining FDI increased tax revenues will help contribute to their GDP. Employment and wages will increase and declining markets will be replaced. Human and technology transfer will occur with an improvement in infrastructure. For the firm investing the access to a new market offers the potential of new customers and greater profits thus maximising shareholder’s wealth.
On the negative side the domestic government may lose control in its efforts to attract FDI. MNEs are notably wealthier and more powerful than many countries. Take Proctor and Gamble for example, they state on their website that their market capitalization is greater than the GDP of many countries. They go on to say that with this stature comes both responsibility and opportunity. The opportunity is being able to influence governmental decisions. Another problem is that the benefits of FDI may only be felt by a small proportion of the nation. Especially if the FDI is in primary activities such as oil as there are little spill over effects. For the businesses investing there is the major risk of failure, thus losing the money invested. Market volatility, political issues and uncertainty help to reduce the success rates of FDI.
The good
FDI can be extremely successful when done right and I can’t write a blog on FDI without mentioning the case of Botswana and De Beers. De Beers is a family of companies that dominate the diamond mining, diamond trading and industrial diamond manufacturing sectors. In the 1970s they decided to invest in Botswana. The success was so great that over a period from 1970 to 2000 Botswana was the fastest growing economy in the world.
The bad
The ugly
FDI can offer its advantages and when it comes good it’s great but there are also substantial risks. Therefore, companies play it safe by investing primarily in developed countries where there is less risk of kidnap!
Despite added risks associated with FDI in poorer countries particularly in Africa, do you think it is important that companies consider investing in these areas in order to help reduce the huge gap between them and more developed nations? Will such investment become inevitable once higher wages are demanded from workers in countries currently producing much of the world's goods such as China?
ReplyDeleteI do think it is important companies invest in less developed countries such as Africa. Unfortunately most African nations are unstable and therefore to invest in such countries poses a high risk. Shareholders want a high return on their investments but may see investing in unstable countries as just too risky. The potential failure is too much of a cost. Companies may move their operations to countries where cheap labour can be sourced. However, although China's wages have been rising most countries have decided to stay put. China has the appropriate infrastructure for the companies operating there. If companies were to move to places with cheaper labour they would have to invest heavily to achieve an infrastructure in order to take advantage of the cheaper labour.
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