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Foreign Direct Investment (FDI) is a broadly used term. The essential element in the definition of FDI is the movement of capital whether public or private, from one country to another. This can happen through several channels. The concept of FDI is not a new phenomenon.
It dates back to early civilizations where conquering nations brought their resources to make it possible to exploit the opportunities created through conquest. The focus of this paper is to evaluate the trends in FDI since 1990, and to unearth the factors driving the changes in FDI.
In order to do this, it is imperative to take a brief look at the basis for FDI and the applications of FDI both from the view of a host country, and from the view of foreign direct investors.
It is also necessary to explore the evolution of FDI since 1990 in order to pick out important trends in relation to the dominance of developed countries, versus the current changes driven by emerging economies.
The need for FDI may arise from several situations. In the first case, a potential FDI destination assesses its local business opportunities in relation to its strategic advantages. The destination then compares this to its overall internal capacity to take advantage of these opportunities.
It then creates conditions that can help it to bridge the gap with the use of foreign capital. Countries that deliberately try to attract FDI usually are in the process of solving domestic problems such as high unemployment, or lack of local capacity to take advantage of locally available opportunities.
For instance, countries endowed with minerals such as Nigeria called upon multinationals to come and mine its oil because it lacked local capacity to do it. Such countries usually prepare profit sharing agreements and other incentives such as tax breaks and profit repatriation to make the venture worthwhile for both parties.
The second case is when a specific business entity discovers that there are certain opportunities available in a given investment destination. The business entity then seeks to develop the opportunity in order to attain specified business advantages.
In this case, the company that identifies the opportunities takes the initiative to invest in the country that promises certain business advantages to it. A case in point is the operations of the Coca-Cola Company.
This company realized that it is cheaper and more profitable to open bottling plants in host countries, rather than to produce the final products centrally in America for export.
The company then went from country to country establishing local bottling companies under its brand name in order to derive the benefits of operating within local environments.
The Uses of FDI
The uses of FDI include job creation in the investment destination, and for the citizens of the country that hosts the parent company. It also includes achievement of economic targets for a host country. The businesses that provide FDI benefit from increased profits, and attainment of strategic objectives.
For a long time, governments have known that one of the best ways of decreasing unemployment locally is by encouraging foreign investors to come and operate locally. When an investor comes into a country, it is necessary for the investor to employ local staff because of the high cost of maintaining low cadre expatriates.
The business immediately opens up several jobs for locals. In time, locals rise to higher levels of management.
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In addition to the direct jobs provided by an FDI venture, the government extracts income from the business by direct revenue from profit sharing agreements, direct taxes on profits earned, employee income taxes, and the taxes derived from other businesses established to support the primary FDI initiative.
In the case of China, the country is using FDI as a means of creating jobs for its own citizens. China is becoming an important donor to African countries. Its lending terms however usually include concessions by the local government for China to provide labor for the project.
This ensures that when the Chinese government lends money to a country, Chinese citizens get employment in the same project. This way, the country creates employment for its vast population.
At a macroeconomic level, the volume of FDI that a country receives can be the engine behind economic growth for that state. It is clear that a country such as China has become a leading FDI destination, contributing substantially to its recent economic development.
China proves that a government can choose to open up its markets and industries to FDI to achieve the needed economic growth.
For the specific business that invests in another country, FDI provides it with an opportunity to increase its competitive advantages in all the regions that it operates. A good case in point is service-oriented companies such as audit firms, law firms and logistics firms.
When these companies operate as transnational companies, they are able to serve multinational companies in their regions of interest. This gives them an immense competitive advantage over companies in the same field that do not have an international profile.
Evolution of FDI Since 1990
In 1990, the world was recovering from major shifts in geopolitics. The USSR had crumbled, and so had the Berlin wall. In the same period, the internet began its march towards global acceptance in earnest.
The geopolitical realignments, technological developments, and the rise of America as the dominant power in the world led to a drastic change in global economics. Many developing countries were beginning to feel the effects of structural adjustment programs pushed forward by the Breton Woods institutions.
The push towards democratic rule was taking place in earnest all over the world. This wave carried South Africa to independence with the same strength that it carried the breakaway soviet nations to autonomy.
Between 1990 and 2012, the world underwent four major phases in the growth of FDI. In the decade after 1990, global FDI increased strongly from 200 billion dollars to about 1.4 trillion.
The EU was the main beneficiary of FDI in the last four years of the twentieth century. In the year 2000, a four-year slump in FDI coincided with the bursting of the dot com bubble. The cause of the bubble was what the Federal Reserve chair termed “irrational exuberance”.
Investors overestimated the capacity of the internet economy to absorb their capital. Once it was clear that the sector was not going to produce projected returns, investors panicked, leading to capital flight. Many young dot come companies collapsed, leading to massive losses.
There was another period of strong growth in FDR between 2004 and 2007. During this period, the main beneficiaries of FDR were the EU, and the US. However, the inflows to other areas of the world increased consistently in the same period.
The overall global value of FDR peaked at an all time high of nearly 2 trillion dollars. In 2009, the global financial crisis took center stage as the bubble in the subprime mortgage market in the US burst. This led to a global recessions whose effects are still felt to date.
FDR dropped to about 1.3 trillion before starting to rise again. The pattern as at 2010 is the rest of the world economies, apart from the US, and the EU received more FDI inflows in comparative terms. Brazil, India, China, and Russia (BRICS) account for an increasing amount of FDI inflows.
The Dominance of Advanced Countries in FDI Inflows
The dominance of the developed countries in the absorption of FDI started on a very strong note in 1990. The US and the EU accounted for more than fifty percent of all FDI inflows. In the next decade and a half, there was a steady rise and fall in the volume of FDI depending on the FDI inflows to these countries.
Whenever the value of FDI rose in America and the EU, the worldwide trend showed a strong correlation to this occurrence. FDI inflows to the EU were historically volatile. In fact, the inflows seem to vary according to the global trends. This shows that trends in the global economy affects the EU the most.
The US mirrors these trends too but it displays greater resilience to global trends compared to the EU. The rest of the world seems to have benefited from the reductions of FDI to the EU. The value of the FDI inflows to the rest of the world increased steadily throughout the two decades under review, as the EU inflows fluctuated.
The Changes in the Current Disposition of FDI
In the last five years, the levels of global FDI to the rest of the world compared very favorably to the levels of FDI to the EU. In fact, the levels to rest of the world almost matched the combined inflows to the EU and the US. The BRICS were also making an important dent in the levels of FDI.
The country worth noting in a twenty first century setting is China. FDI in China was statistically irrelevant in 1990. Currently, China’s FDI inflows compare on equal terms with the inflows to all other developed countries apart from the US and the EU.
Factors Driving the Changes in the FDI
Several factors explain the twin phenomenon of the dominance of developed economies in FDI, and the recent changes in the role of FDI in the emerging markets.
Three of the factors explaining the dominance of developed economies include the presence of greater competitive advantages in these countries, ease of access to certain factors of production, and the potential to maximize returns because of access to markets with a high purchasing power.
Montgomery & Porter (1990) stated that countries have the capacity to develop new competitive advantages quite apart from their natural resources. This explains the reason why FDI inflows favor developed countries.
Over the years, the US and the EU invested in robust education systems leading to the creation of some of the most talented human resource pools available anywhere on earth. These countries also invested in industries that make some of the highest quality products on earth.
Apart from these, the countries seek to remain ahead in the innovation curve in manufacturing, IT, and in the services sector. Any investor feels confident that by taking their capital to these countries, they will reap a good reward because of strong microeconomic fundamentals.
In addition to these competitive advantages, the US and the EU also have strong macro economic performance partly because of clear regulatory frameworks, and predictable political climates.
All these factors serve to attract FDI to these countries. In the early nineties, there was a lot of commotion in other areas of the world. America and the EU looked liked the safest places to invest in the global economy.
A second factor that made the US and the EU attractive to foreign direct investors in most of the period under review was that these countries held a lot of promise in terms of the potential returns compared to the inherent risks.
The American economy seems to have a robust quality that makes it rebound after suffering from serious shocks such as the dot com bubble of early 2000, and the real estate crash of 2009. Similarly, the EU seems to attract FDI because of the vast economic potential of the EU market.
Investors find the EU attractive. However, the fluctuation in the FDI inflows to the EU shows that the EU is vulnerable to global economic shocks. While the EU attracts the highest amount of FDI, it also suffers the most when the global FDI levels fall.
The third factor that makes the EU and the US attractive to international investors is the ease of access to highly skilled labor and the presence of legacy systems that support production. FDI in the US and the EU usually goes to hi-tech industries, and the financial markets.
The presence of locations such as the Silicon Valley, a well-known technological innovation hub, illustrates the attractiveness of these countries. Areas such as the Silicon Valley are home to some of the most innovative people on earth. An investor will naturally seek to tap into the business potential of these locations.
In the same vein, the political stability of the US and most of the EU has made it possible for these countries to develop strong business systems and robust economic infrastructure that support innovation and production.
Since these countries have not had any wars fought on their own soil since the Second World War, the infrastructure is in good condition. These legacy systems are giving the EU and the US a strong footing in the competition for FDI.
The political stability has made it possible for the countries to develop some of the best-known global brands such as Google, and Coca-Cola. The success of these companies comes from the robustness of the underlying infrastructure.
The strong influence of the emerging markets in the competition for FDI in the last decade is the result of certain realizations by foreign investors. The turning point for FDI was somewhere between the dotcom bubble and the nine-eleven terror attacks.
The impact of these two events was an erosion of the confidence of foreign investors in the security of their investments in the US and in the EU. The message these two events sent to the investors were that the US and the EU were also susceptible to economic and security threats.
It is interesting to note that at the same time, China seemed ready to take off as in investment destination. The semi-liberalized China was looking for FDI and it was willing to allow more latitude to foreign investors than it did previously.
Russia, India, and Brazil were also busy working hard to make their countries attractive to foreign investors. Therefore, as the US and the EU dealt with the problem of terror and internal economic shocks, investors looked all over the world for opportunities to hedge their investments.
This explains the increasing interest in other parts of the world as FDI destinations.
The second reason why FDI patterns seem to be changing in favor of other parts of the world is that many countries have realized that the global economy is integrating.
This is one of the forces flattening the world. In other words, globalization is making the playing field level for all players because it is giving factors of production transnational power in complete disregard to the traditional geopolitical barriers.
The Increase in FDI in the emerging economies is also arising from some of the unique competitive advantages of these economies. China and India are destinations know for their low cost of skilled labor. This brings down the cost of production for mass manufacturers who find the cost of labor prohibitive in the US and the EU.
These countries compare favorably with the West in relation to the quality of products they can produce. Foreign investors therefore are willing to overlook some of the difficulties of operating in these countries because of the potential for higher returns.
In conclusion, the emerging economies are competing with the developed economies using their own competitive advantages.
While China may not beat the US when it comes to the production quality of innovations such as the iPhone, China can readily reproduce a cheaper knock off Smartphone that can offer the same advantages at a fraction of the cost of an original iPhone.
Chinese manufacturers can therefore serve a market looking for the benefits of the iPhone, but lacks the purchasing power. To an investor, profit is profit. If investing in China proves more profitable, a reasonable investor will put his money in China.
The goal of this paper was to evaluate the trends in FDI since 1990, by unearthing the factors driving changes in FDI since 1990. This necessitated a review of the need for FDI by both source and receiving countries.
The main findings in this review were that FDI leads to profits for the investors, and helps the investment destination to meet some of its economic needs such as creation of jobs, availing of the capacity to exploit natural resources and income from taxes and from operational profits.
The main drivers influencing the flow of FDI in the two decades since 1990 include existence of unique competitive advantages such as presence of highly skilled labor on one end, and cheap labor on the other end.
It also includes the capacity of developed counties to leverage their legacy systems to outperform developing countries. Emerging economies also attract FDI by providing investors with attractive terms, and developing alternative markets for products modeled after more expensive high quality versions of the same product.
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