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Lectures 29-31: Foreign Direct Investment

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1 Lectures 29-31: Foreign Direct Investment
Determinants of FDI Evaluation of FDI Effects of FDI

2 Fall 2007 NU-FAST Zahid Siddique
What in it? Trade theories concentrate on why countries export & import and what? Don’t explain why firms make FDI instead of exporting domestic goods sell foreign firms the right to produce its goods, use its process or brand for licensing fee Often export and FDI are regarded substitutes by firms Important issues involve: factors influencing FDI decisions FDI and imperialism debate effects of FDI on both countries Fall NU-FAST Zahid Siddique

3 Fall 2007 NU-FAST Zahid Siddique
FDI Foreign direct investment (FDI) occurs when a firm invests directly in production facilities in a foreign country FDI implies control, else it is portfolio investment (PI) PI is investment in foreign financial instruments Govt. sets arbitrary ownership-minimums for reporting statistics and policy making (usually 10%-25%) Must differentiate b/w flow & stock of FDI Flow is amount of FDI undertaken over a given period of time outflow: flow of FDI out of a country inflow: flow of FDI into a country Stock is total accumulated value of foreign owned assets at some given point in time Fall NU-FAST Zahid Siddique

4 Acquisition Vs Establishment
FDI takes two major forms establishment of a wholly new operation in a foreign country (called Greenfield investment) acquiring/merging with existing firm in foreign country Normally, FDI happens in the form of acquisition b/c: it is easy to execute firms have valuable strategic assets; e.g. brand loyalty, consumer relationships, distributional channels less risky and costly to acquire them than to build efficiency may be improved by transferring capital, technology and management skills May take two dimensions Horizontal FDI: investment in same industry as at home Vertical FDI: investment in input-providing industry or output-selling industry for domestic production Fall NU-FAST Zahid Siddique

5 Horizontal FDI and internalization theory
Why firms go for FDI despite that: it is expansive and risky compared to exporting/licensing expensive b/c acquiring resources abroad needs resources risky b/c of cultural differences One reason is avoiding transportation cost However, economists don’t weigh it highly as it is out of their standard mantra of ‘market mechanism’ Justification of ‘Market imperfections’ is what they prefer to explain this phenomenon Imperfections arise due to Barriers against exports decrease the profitability of exporting relative to FDI Fall NU-FAST Zahid Siddique

6 Horizontal FDI and internalization theory
Barriers against sale of ‘know-how’ (expertise) technological, marketing & management ‘know-how’ build competitive advantage (or asset) for firms the larger the market-size, the larger the potential for profitability arising due to them One easy way to transfer this ‘know-how’ is licensing Rule: make FDI only if transfer of ‘know-how’ difficult Many difficulties according to economists licensing may means giving away your asset to your potential competitor (e.g. Pizza Next) licensing does not allow tight control over production process which may be required to benefit from input cost differences producing parts at different locations or may be for maintaining company’s strategies Fall NU-FAST Zahid Siddique

7 Horizontal FDI and internalization theory
some aspects can’t be transferred via licensing; e.g. marketing and management skills can’t be codified Some other reasons are also advanced to explain FDI Product life cycle already discussed in trade theory Location specific advantages Porter’s diamond roots Strategic behavior of firms Go through them yourself Fall NU-FAST Zahid Siddique

8 Horizontal FDI: the decision tree
Transportation costs and trade barriers Low Exports High Is know-how amenable to licensing? No FDI Sources of Market imperfections Yes Tight control over operation needed? Yes FDI No Can know-how be protected? No FDI Yes Licensing Fall NU-FAST Zahid Siddique

9 Fall 2007 NU-FAST Zahid Siddique
FDI—good or bad Making value-judgment presumes ‘some criterion’ Basis of ‘decision criterion’ changes policy guide Marxists Vs Social democratic critiques of markets Orthodox Vs revisionist evaluation of capitalism Evaluation on the desirability of FDI depends largely upon ideological underpinning of state officials Four broader perspectives Radicals: Marxists roots Liberals: Free market roots Pragmatic nationalists: social democratic roots Islamists: Revisionists and orthodox Let’s highlight their important features Fall NU-FAST Zahid Siddique

10 1) Radicals—left to globalization
Marxists and Liberals are arch rivals on the role of ‘private property’ in economic development Liberals: no development strategy can go without private property and, hence, it is ‘good’ policy: insulate private property Marxists: private property is the source of economic exploitation and, hence, is ‘evil’ policy: abolish private property Conduct of FDI makes firm ‘multi-national enterprise' (MNE) Since almost all MNE work on the principle of ‘private property’ FDI is seen as tool for the promotion and domination of this property form at global level—i.e. materializes imperialistic agenda of liberal capitalism Fall NU-FAST Zahid Siddique

11 1) Radicals—left to globalization
Marxists charge MNE for: exploiting host country cheap labor extracting profits to their home countries keeping control over technology to keep LDC dependent lobbying and corrupting political officials Extreme Radical opposes acceptance of FDI by host country as it leads to economic ‘domination’ and not of ‘development’ Nationalize if any MNE exist in the country This view dominated b/w 1940s-1980s has lost loyalty mainly after fall of USSR and partially due to poor economic performance of socialist economies Radicals offer merely instrumental critique of capitalism FDI is barrier to the realization of freedom and equality Have no alternative plan of life other than ‘modernity’ Fall NU-FAST Zahid Siddique

12 2) Liberals: agents of globalization
Base their argument on superiority of Smith’s free market order, and Ricardo’s comparative advantage for efficient allocation of resources To them, FDI is a means to this end at global level hence favor Globalization Countries face foreign pressure as they assume increasing subordination in globalization for deregulation—limiting state restrictions in business, and Privatization—shifting ownership from public to private agents Dichotomy: ‘capital is global’ but ‘countries want its hold nationally’ Solution: make your home land a ‘market place’ for capital This is what is meant by Globalization Fall NU-FAST Zahid Siddique

13 Globalization: pros and cons
Proponents of globalization take economic plea results in lower prices of goods and services stimulates economic growth raises incomes of consumers creates new job avenues Critics take a multi-dimensional approach job loss in industries attacked by foreign competition downward pressure on wages of unskilled labour environmental degradation cultural imperialism of global media and multinationals political hegemony of America Receive article from photo-state shop Emma Aisbett (2005), “why are critics so convinced that globalization is bad for the Poor?” Fall NU-FAST Zahid Siddique

14 From Globalization to Glocalization
An unintended result of globalization is glocalization—i.e. think globally but act locally Globalization: looking at similarities Glocalization: looking at differences Interaction among cultures revealed value of ‘differences’ Multiculturalism is presented as solution to this problem we should enjoy differences b/c we can’t rationally prove any conception of good and culture superior to others all ways of life be treated and given equally opportunities However, it is fallacious both in theory and practice multiculturalism presumes an over-riding rule which is ‘Human Rights framework’ subordinates all ways of life to capitalistic way of life Conflicting ways of life can’t flourish together Fall NU-FAST Zahid Siddique

15 3) Pragmatic nationalists
Pragmatism is an epistemology according to which: truth is relative what matters is the effects of an action—i.e. ‘truth’ is what works to achieve desired ends Pragmatic nationalists don’t take ideological position, rather evaluate benefits & costs of FDI maximize national benefits and minimize costs out of FDI going case by case Allow FDI only if benefits outweigh costs Block FDI that harms indigenous industry Court FDI that is in national interest Tax breaks Subsidies Fall NU-FAST Zahid Siddique

16 Fall 2007 NU-FAST Zahid Siddique
Summary Ideology Characteristics Host-Govt. Policy Radicals Marxist roots View MNEs instrument of imperialist agenda Prohibit FDI Nationalize foreign owned MNEs Liberals Neoclassical economic roots View MNEs instrument for efficient allocation of resources Allow free movement of FDI Make home country ‘market’ for global capital Pragmatic nationalists View FDI having both benefits and costs Resist FDI if costs outweigh benefits Bargain for greater national benefits Offer incentives Fall NU-FAST Zahid Siddique

17 Islamists: Revisionist fallacy Vs Orthodox legacy
Revisionists seek to Islamize all western discourses; whether economic, social or political disagree on number and extent of issues to be Islamized Fail to see historicity of western civilization; i.e. capitalism regard it universal and historically necessary phenomenon Since, to them, market is a natural and neutral order of life can’t oppose FDI, except on pragmatic grounds endorse ‘Muslim nationalism’—viewing Islam as a means for the progress and domination of Muslims or may take a ‘cultural plea’ against FDI Their fallacy is to ‘view Islam in context of capitalism’—i.e. Islam = capitalism or Socialism with some + & - not view Islam an independent civilization Can’t apprehend how the objectives of Shariah (مقا صد الشريعه ) are hampered by the domination of capitalism via MNEs Fall NU-FAST Zahid Siddique

18 Islamists: Revisionist fallacy Vs Orthodox legacy
Since orthodox equate capitalism with Jahilya and regard Islam an independent civilization FDI is seen as means for domination of capitalist Jahilya MNEs promote and sustain capitalistic way of life by universalizing ‘for-profit business enterprise’ and ‘utility hunting consumption attitude’ Domination of capitalism corrupts Islamic society at all levels In individual sphere: eliminate possibilities for flourishing of Islamic individuality—one characterized by زهد (self-denial) and فنا (self-annihilation) In social sphere: marginalize collectivities based on love, co-operation and religious ties In state sphere: instrumentalize state-powers for capital accumulation and desire-fulfillment agency trio makes organic-whole—can’t perpetuate in isolation Fall NU-FAST Zahid Siddique

19 Islamists: Revisionist fallacy Vs Orthodox legacy
Fall NU-FAST Zahid Siddique

20 Islamists: Revisionist fallacy Vs Orthodox legacy
Fall NU-FAST Zahid Siddique

21 Back to Science: ‘knowledge of buying and selling’
FDI has both positive as well as negative sides Benefits of FDI include: Transfer of Resources (capital, technology, skills) Employment effects more jobs created in case of Greenfield investment but jobs also lost due to shut down of home industry links more negative in case of acquisition b/c MNEs reduce work force to restructure operation Balance of Payment Effect to be discussed in next topic Growth effects ‘economic theory’ shows positive relation b/w FDI and growth Fall NU-FAST Zahid Siddique

22 Back to Science: ‘knowledge of buying and selling’
Cost-side comprises: Hampering of competition MNEs force domestic firms out of business by drawing resources from elsewhere to subsidize its production may also monopolize production by merging two firms together after acquiring them Loss of national sovereignty country losses economic independence as major economic decisions are left to foreigners who have no loyalty to host country Next Topic: BOP & Exchange Rates Fall NU-FAST Zahid Siddique

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