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Developing a Nations or Creating a Myth Essay

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Updated: Sep 3rd, 2021

News reports suggest that economic giants from third world Asia namely China and India are expected to grow at the rate of 9.7 and 6.5 percent respectively. Though the difference between the two is quite high but both the nations are one of the fastest growing economies in the world. The GDP growth rate of these nations is much higher than that of any developed nation. It’s not just the growth rate but also the sheer size of the economies of these nations that has made them an indispensable part of the world economy. China has now become the factory of the world with large multinational companies infusing lots of money in establishing manufacturing units and India is now one of the major destinations for back office jobs and is the leading service sector economy. Its not just these two nations have shown higher growth but many other developing nations which includes almost the whole of South East Asia and a few parts of Latin America. The globalization has started giving results. The process which has got its roots right from the beginning of 20th century with the beginning of economic cooperation between Europe and the United States has now become synonymous with the word development no only in western world but also in Far East Asian Countries (The World Bank Group, 2000).

But still this globalization has yet to make this world a better place to live. Though as mentioned above India and China, the two most developing nations of Asia are actually among the two poor nations also. The standard of living in China is one fifth to that of a developed country and in India is even worse with standard of living being one tenth of the same variable. The difference between the rich and the poor have widen with every passing year rich becoming more rich while the poor are diving towards more destitution. So the concern related to the globalization process is the growth which is visible is actually more of mathematical in nature than the real cumulative growth. It might be taking place at the cost those who are less privileged (Kumar, 2007).

The purpose of this paper is to analyze the effects on developing nations which are said to the most benefited one when one of the components of globalization, i.e., foreign direct investment (FDI). The paper gives brief explanation of globalization and its different phases and theoretical aspects of some of its components. While presenting theoretical arguments, the main focus of the paper is an exploration of different aspects of FDI while keeping in view of its impact on the growth of economy in terms of growth in GDP. The paper looks in detail towards the contribution of FDI in the growth of developing nations and the role played by multinational firms in the fire-sale purchases. It has examined World Bank Development Indicators Website and this statistical investigation has been made to look into the above mentioned impact of FDI on GDP (The World Bank Group, 2000).

The outcome of the paper has concentrated around the conclusion that the component of globalization which promotes ‘Direct investment’ as is termed as Foreign Direct Investment has actually brought no change in most of the developing nations and in some cases it has even brought negative changes (Loungani & Razin, 2001). The outcome of the statistical analysis and the study of associated cases have found to have very little or no and the most surprising the negative effect in a few economies under investigation (Kumar, 2007).

In addition to the above mentioned conclusions, the benefits of the FDI have appeared to decline with more integration of market. Thus while studying the impact of FDI on countries, the other factors like domestic regulatory and market structures and the extent up to which the market has been liberalized are equally responsible and require to be considered and are equally necessary for the success and benefits of the FDI (Gallaghar & Zarsky, 2006).

Globalization, Trade Flows and Foreign Direct Investment

The developing countries have shown substantial progress if the economy is looked upon with trade perspective. The last decade of 20th century shown great results with share of trade rising i.e., the sum of import and export as percentage of GDP rising from 34.6 percent in 1990 to 51.6 percent in 2000. If compared with the results of developed countries where the share of trade in GDP showed marginal improvement from 32 percent to 37.1 percent in the same period, the level of trade as well as its growth in developing nations has shown better results. The most remarkable aspect of this trade is that even the least developed countries have seen very high growth rate in the total percentage of GDP, this trade flow occupies. The percentage of trade in GDP has increased from 26.7 percent to 41.3 percent in the above considered period of ten years (Loungani & Razin, 2001).

The Foreign Direct Investment in developing countries in the period of above mentioned ten years has also seen upward trend with this FDI occupying 3.5 percent of total GDP in 2000 but here this is much lesser if the same is compared to that of developed nations. In developed countries the FDI was found to be around ten percent of GDP in the year 2000. The FDI normally come under two categories. The first one is the investment in greenfield projects thereby building new capacity while the second one is the investment to acquire assets of local firms. The acquisition formed FDI causes “mergers and acquisitions” (M&A) phenomenon with private domestic companies being acquired by foreign investors or the government offloading its stake in state owned enterprises to foreign investors. From sector perspective, different transactions have been generated in different countries depending on things like appropriate conditions and opportunity. Some regions saw heavy investment in infrastructural sector like water and roads as well as public utilities like power sector and telecommunications with most of the investment being done for establishing Power Producing units with firms being termed as Independent Power Producers. Sectors like manufacturing, oil extraction and mineral mining have also seen substantial FDI input. So in short this FDI can be defined as a financial investment in a domestic firm by a foreign investor with the purpose of owing a significant equity stake in that firm. The sell of equities is one of the many forms of FDI. In other ways FDI can be happen in form of debt to finance the operations of the receiving firm either as a loan or as corporate bonds (Panelver, 2002).

The transnational corporations (TNCs) or the multi national companies (MNCs) are the major contributors to FDI transactions. An estimate which has been made in the year 1990 suggested that the world’s largest 100 TNCs mostly from United States, Japan and EU own around $2 trillion in foreign assets and providing employment to over 6 million people. So this FDI is not just a capital flow or financial investment in securities and bonds rather creation of multinational firms with production facilities spread all across the globe either through fresh establishment or through merger and acquisitions. This has now become the every heart of globalization of the reformed economy of the world under the guidance of World Trade Organization. So the FDI is a form of international cooperation either between the nations or between the firm and the nation or between two firms involving sharing of equity stake with all possibility of control over decision making powers as well as that of ownership being handed over to the investing foreign companies (Gallaghar & Zarsky, 2006).

FDI and Fire-Sale: the crisis of East Asia

The crisis of late 1990s in East Asia showed a very different business approach of MNCs and the realities of globalization. The argument based on the theory of Hirst and Thompson which states that excessive integration of the capital markets enhances the international mobility of capital there by diverging the domestic savings and investment (2003). The above mentioned global financial integration of system would break the relation between financial system and domestic investment. The fundamental relation as well as constraint that the local investment would need domestic savings gets lost and the finally the national economies would lose their capability to regulate domestic investment and the very way of determining the amount of domestic investment. The adjustment of interest rate including the convergence of savings and investment would get defined by international factors adding irrelevancy between domestic savings and domestic investment. The South East Asian crisis in late 1990s is the most relevant example of the above mentioned unabated globalization. The nations’ financial condition got crippled with excessive outflow of the capital. The net result of this crisis was the occurrence of fire-sale and conditional FDI. The companies were found to be putting great amount of money through FDI channel in Korea and other South East Asian countries. But this time the company went into large scale buying of local firms. These local firms were found to be facing financial crisis causing great fall in the total value of the firm with equities available at throw away prices. The Foreign Institutional Investors and investors in government’s securities taking their money out of the country but the same financial crisis created an investment opportunity for MNCs. A number of companies changed hands with a number of MNCs from US and Europe buying controlling stakes in different South Asian firms. This sort of FDI investment pattern is more of crisis driven rather than opportunity driven. Even the governments were found to shell out its stake in PSUs to foreign investors to get over the ongoing financial crisis. The fall in the value of currency and big debts diminishes the market cap of the domestic firms and then they are for sale on a platter at a throw away price to foreign players. The sudden fall in the value of the assets attracts the investors to buy those sick firms with a belief that once the crisis gets over these firms under the new management will turn out to be a golden goose (Aguiar & Gopinath, 2004).

The sale of firms into foreign hands during the time of crisis can be termed as a case of Fire-Sale FDI. But the question is that what exactly promotes this deflation in the value of the asset of domestic firms. Here the culprit is the financial intermediaries. These institutional investors enjoying implicit government guarantees over their liabilities go on unregulated investment. Excessive lending by these institutions often causes high inflation in the value of assets. The overpricing indicates sound financial condition of not only the borrowers but also of lenders because of their excessive lending. But in case of economic burst, the assets lose its value which later translates into lenders withdrawing money out of market. This panicked withdrawal by institutional investors causes further depreciation in the value of the asset (Krugman, 1998).

Now when role of FDI is looked upon; the foreign players are handed over the control of beleaguered domestic firms. The logic behind this transfer of control is that the firms’ productivity will get a boost under new management. But again the question is how a particular firm can be assumed of higher asset value under foreign control and at the same time are expected to bring higher return both in terms of productivity and profitability. The foreign investors with their strong financial condition are better placed to buy out a domestic firm than other domestic firms in an economic crisis. So the phases of overpricing and then panic stricken under pricing in case of financial or economic crisis and better record of foreign players both in terms of financial condition and efficiency causes rise in the cases of fire-sale. Sometimes the crisis is also overshot with both industry and government over assuming the negative impact and this as a whole makes way for more Fire-sale FDI (Krugman, 1998).

Development through FDI: a reality or just a Mirage?

If we look into what every major financial organization like the IMF; the World Bank; and any of the OECD states, the most common thing is that all of them have suggested that this FDI is very much similar to a doctor’s prescription which is for the improvement of ailing industrial sectors. The FDI has been termed as a vital fuel which can take the engine of growth of a nation to super fast zone. With this theme each and every global organizations have stated that the degree to which a developing country can get benefited with FDI is a very lucidly documented fact. This miracle drug not only powers the growth of the nation but simultaneously improve environmental and social condition in the receiver country. The transfer of cleaner technology and better management as well as socially responsible corporate policies helps in improving environmental and social conditions by enormous amount (Gallaghar & Zarsky, 2006).

But the things in reality are very much far from what has been documented by different sources mentioned above. Even a paper by one of the writers of OECD has mentioned that the so called social and environmental benefits that are expected to come through FDI may have differing results (2002). Its not that the result is always going to be positive; it might cause no or in worst case negative effect. But the apprehensions related to development issue are equally worrying; whatever that has been documented by great economists and many others might not give the result as suggested (Gallaghar & Zarsky, 2006).

Conclusion

The evidences and a number of cases after getting studied have clearly led to the conclusion that FDI has nothing like any miraculous property. The real wheel for the growth is often the policies and will power of the political establishment of the country involved. It’s not the FDI but the way the countries handle it while maintaining the interest of domestic industry which makes an impact on the economic health of the nation. The poorest and least developed nations have the scarcity of everything a civilized society possesses. The economy requires proper infrastructure for road transport and electricity to have a sustainable economic growth. The poor countries severely lack in these sectors and these are the most primary sector over there to invest. So the FDI should be done in this field rather than manufacturing and other sectors because the local market is very weak because very less purchasing power of the people. So for a poor nation, FDI should begin from infrastructural sector and then stretch to other sectors. Any other type of FDI might be profitable for the firm but for the country it’s not going to make any sustainable growth. So it is clear FDI is not a solution to the woes of poor nations.

References

Aguiar, M. & Gopinath, G. (2004) Fire-Sale FDI and Liquidity Crisis, The Review of Economics & Statistics, Vol. 87, No. 3, Pages 439-452

Gallagher, K. V., Zarsky, L. (2006). Rethinking Foreign Investment for Development, Boston University and Businesses for Social Responsibility, USA

Hirst, P. & Thompson, G. (2003) The Limits to Economic Globalization, , The Global Transformations Reader, Polity, Cambridge, 2003, p. 342.

Krugman, P (1998). Firesale FDI, Working Paper, Massachusetts Institute of Technology.

Kokko, Ari (1994). Technology, Market Characteristics, and Spillovers, Journal of Development Economics, Vol. 43, pp. 279-293.

Kokko, A. and M. Blomstrom (1995). Policies to Encourage Inflows of Technology Through Foreign Multinationals, World Development, Vol. 23, No. 3, pp. 459-68.

Kumar, A. (2007). Does Foreign Direct Investment Help Emerging Economies? Insights from the Federal Reserve Bank of Dallas, vol. 2, no. 1

Lipsey, R. E. (2002). Home and Host country effects of FDI, Working Paper 9293, National Bureau of Economic Research, Massachusetts Avenue Cambridge, MA

Lim, Ewe-Ghee (2001). Determinants of and the Relation between Foreign Direct Investment and Growth: A Summary of the Recent Literature, Working Paper 01/75, IMF.

Loungani, P & Razin, A. (2001). How beneficial is foreign direct investment for developing countries? Finance & development

Mabey, N. & Richard, M. (1999). Foreign Direct Investment and the Environment, From Pollution Havens to Sustainable Development, WWF-UK Report

Malampally, P. & Karl, P. S. (1999). Foreign Direct Investment in Developing Countries, Finance and Development 36 (1)

OECD (2002). Foreign Direct Investment for Development, Maximizing Benefits, Minimizing Costs, Paris: OECD

Penalver, M. (2002). Globalization, FDI and Growth: A Regional and Country Perspective, United Nations Department of Economic and Social Affairs

Shahid, Y. (2001). Globalization and the Challenge for Developing Countries, World Bank, DECRG

Singh, A (2005). FDI, Globalization and economic development: towards reforming national and international rules of the game. ESRC Centre for Business Research, University of Cambridge

Sinn, H. W. & Weichenreider, A. J. (1997). Foreign direct investment, political Resentment and the Privatization process in Eastern Europe, Economic policy

The World Bank Group (2000), Assessing Globalization, Economic Policy Group and Development Economics Group

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