Cross Border Investment Using FDI Essay (Critical Writing)

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FDI is generally reckoned to mean the private capital flows from a parent investor organization to another organization located outside such parent investor organization’s national jurisdiction. These investments can come about in a variety of forms including vanilla equity, varied forms of options linked equity, and plain debt or convertible debt. These investments can also be in the form of ploughed back profits and contribution of knowledge, skills, and technology; with all the latter being either expressed in value terms or optioned in stakeholder stances. An investment is treated as FDI, as contrasted to the other popular concept of portfolio investment if the investment is sized sufficiently to lend the parent organization some degrees of control over the management of the enterprise, usually over 10% of the firm. (IFC, 1997) FDI, quite unlike portfolio investments, are made with a long time horizon in view and generally, they represent more stable ownership capital and are not hot flows in search of speculative gains in foreign markets. The main object behind making FDI is to serve domestic markets, exploit natural resources, or provide platforms to serve world markets through exports. The importance of FDI for capital accumulation well-acknowledged and FDIs are sought after by several foreign countries. The most apparent reason is the fact that FDIs add to foreign exchange reserves and participate directly in the process of economic development and growth. Since the 1990s, when globalization concepts caught on finally in the international trade terminology and riding on the unprecedented innovative growth in communications and information technology the FDIs have shown an increasing trend. In fact, he international capital flows have been largely comprised of flows of private capital. For instance, in 1990 44% of all international capital flows were private, by 1996 85% were private, and FDI was the largest single type of flow. (IFC, 1997) Foreign direct investment has even left behind growth in international trade in that the FDI grew at an average rate of 13 percent per year from 1980-97, whereas exports registered an annual growth rate of just about 7%. (Mallampally & Sauvant, 1999).

FDI is virtually a decision testing the entrepreneurial quotient of the investing organization. Particular in the case of venture capital all FDIs translate to the entrepreneurial view of the chief investor or promoter which, more often than not, is either a single individual or a group of individuals. In fact, probing the factors which stimulate entrepreneurial activity is equivalent to probing factors promoting FDIs.Though FDIs may be further counterweighted by corporation laws of the country invested in. As has been stated above the FDI turned an increasingly important element in global economic development and integration during the 1990s (UNCTAD, 2003). This significant development ran parallel, temporally, with the process of transition from socialism to capitalism and was also witness to the integration and assimilation of the Central and Eastern European (CEE)countries into the global economy riding the vehicles of international trade and capital flows. (Di Mauro,1999; Buch et al,2003). Nevertheless, data reveals that the actual FDI flows to transition economies have been rather modest; for instance, in 2002, FDI to CEE countries accounted for a mere 4.4% of world FDI, though it did have almost doubled from the 1999 low level of a bare 2% (UNCTAD, 2003).

As has been stated above taking an FDI decision keeping in mind the risks associated with a foreign country is an instance of high caliber entrepreneurial decision making. In the instant case, Eastern Europe is a transition economy, and relocating to Eastern Europe would require a critical and sagacious appraisal of all such factors from an entrepreneurial point of view. Joseph Schumpeter had an interesting definition of an entrepreneur as an individual who attempted to “… reform or revolutionize the pattern of production by exploiting an invention… or untried technical possibility for producing a new commodity or producing an old one in a new way… [This] requires aptitudes that are present in only a small fraction of the population…” (Schumpeter, 1934, p. 132). This definition of Schumpeter’s seems to suggest that in addition to a climate for the growth of entrepreneurship, the organizing and initiating of new enterprises and entrepreneurial activity depends substantially on the availability of prospective entrepreneurs, i.e., individuals possessing personality traits fortuitously or strategically combined with personal circumstances which enable commencement of the new private economic activity. This is also particularly important for an FDI organization seeking to invest. Potential for entrepreneurial activity had been initially proposed and applied primarily at the individual or micro level of analysis. Within this framework, entrepreneurial activity results from the interaction of the nascent or potential entrepreneur with his or her environment (Krueger and Brazeal 1994). Within an OLI framework, this entrepreneurial potential is part of intangibles overflow.

International trade is a way to achieve a higher standard of living and improving the per capita income and GDP growth for all trading nations. The post-1990 era has seen a rapid expansion of trade in the trading sections among all the trading nations. One of the important issues is the controlling of rapid growth in the trade deficit. Trade involves the exchange of goods or services for cash or on credit. There are several other activities, which facilitate trade, and these along with trades are known as commercial activities. Commerce includes all those activities, which are connected with trade and auxiliaries to trade such as transport, warehousing, insurance, and banking and finance.

Research has been done on the FDI of the EU and other European countries. The research topic is FDI (foreign direct investment) inflow in CEE (Central and Eastern Europe). Some organizational studies have been taken up to measure the impact of FDI in invested countries. These studies reveal that FDI into transition economies tends to promote growth, promote technical innovation, and accelerate enterprise restructuring in addition to providing capital account relief (EBRD, 2002). Some other studies have argued for the fact that FDI help hastens the transition process by promoting more effective corporate governance and by bringing about a radical enterprise restructuring, so critically required in any transition process (Djankov &Murrell, 2002). Similarly, Barrell & Pain (1999) elaborate that with evidence from transition economies that productivity, R & D expenditure, innovation, and company performance are higher in foreign-owned firms. A number of studies, investigating flows of FDI into transition economies empirically using aggregate inflow data have been made, e.g., Brenton et al. (1999), or enterprise surveys, e.g., Meyer (1998). Some other research efforts have focused on specific issues concerning transition and FDI decisions; for instance, Wheeler and Mody (1992) and Resmini (2001) probe the varying dimensions of the impact of institutional factors on FDI.

In the present instance, one can use the Dunning framework to come at the FDI decision on relocation of production facilities. Using elements of Dunning’s (1981) OLI framework (Ownership, Location, Internalisation) the research would discuss the various factors that have either encouraged or dampened foreign direct investment after 1990 in Central and Eastern Europe. Dunning(1981) posits that three conditions need to be met concurrently in order to initiate an FDI decision. The investing organization should derive both an ownership (O) advantage and an internalization (I) advantage, as the foreign market presents a clearly calculated and reckoned locational (L) advantage. Ownership advantages assume the shape of organization-specific assets which can be tangible-say, products or technologies; and intangible-say, patents, processes, or brands. In this manner, reaping the OLI advantages the investing organization is able to more than cover the incremental transaction costs involved in multinational operations due to either the cost or demand benefits brought about by the ownership advantage. Such FDI investing overseas entities also look out for an internalization advantage. This primarily comprises the benefits that accrue to the organization from harnessing and even exploiting the ownership advantage by making a conscious choice to produce in a foreign country under its own umbrella internally, rather than through the other modes of entry in such foreign market, say, by franchising or licensing the product or process globally. Apparently, the last set of advantages accruing under the locational advantages is absolutely pertinent in determining the exact foreign location where the organization finally chooses to manufacture its products. Such advantages may include those that are derived from cheaper factor prices, better access to customers, relaxed government regulations with respect to trade, favorable exchange rates, other capital flows, and felt and observed institutional and political stability. Once the balance sheet of the above factors is drawn the company can take up an assessment of the manner in which it will meet emerging liabilities and encash the assets in the concerned FDI.

Work Cited

International Finance Corporation.(1997). Foreign Direct Investment: Lessons from Experience. Washington, D.C.: International Finance Corporation and Foreign Investment Advisory Service.

Mallampally, Padma and Karl P. Sauvant. Foreign Direct Investment in Developing Countries. Finance and Development. 1999: 34-37.

United Nations Conference on Trade and Development (UNCTAD), 1999–2003. World Investment Report. UN, Geneva.

Schumpeter, J. A.(1934). The theory of economic development. Cambridge, MA: Harvard Press.

Krueger, N. F., & Brazeal, D. V. (1994). Entrepreneurial potential and potential entrepreneurs. Entrepreneurship Theory and Practice, 183, 91-104.

European Bank for Reconstruction and Development (EBRD), 1994–2002. Transition Report. EBRD, London.

Djankov, Simeon, Murrell, Peter, (2002). Enterprise restructuring in transition: a quantitative survey. Journal of Economic Literature 40, 739–792.

Barrell, Ray, Pain, Nigel,(1999). Domestic institutions, agglomerations and foreign direct investment in Europe.European Economic Review 43, 925–934.

Brenton, Paul, DiMauro, Francesca, Lücke, Matthias,(1999). Economic integration and FDI: An empirical analysis of foreign investment in the EU and in Central and Eastern Europe. Empirica 26, 95–121.

Meyer, Klaus E., (1998). Direct Investment in Economies in Transition. Edward Elgar, Aldershot.

Wheeler, David, Mody, Ashoka,(1992). Institutional investment location decisions, the case of US firms. Journal of International Economics 33, 57–76.

Resmini, Laura, (2001). The determinants of foreign direct investment into the CEECs: new evidence from sectoral patterns. Economics of Transition 8, 665–689.

Dunning, John.,(1981)” International Production and the Multinational Enterprise’. Allen & Unwin, London.

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