Globalization has imposed huge challenges on businesses, but customers as well. From one perspective, businesses face a huge competition with the people, companies, and nations integrating with each other at a rapid rate. On the other hand, customers are heart of any business; they are crucial element for companies striving to succeed.
However, one of the important globalization impacts on customers is wide variety of goods and services and companies need to develop strong relationship with their customers and well designed product offerings in order to gain competitive advantage over the rivals. It is not rare case that more and more companies, especially those experienced ones, are looking to expand their business operations globally by variety of entry strategies they may employ in order to gain access to targeted market. One of the strategies is foreign direct investment (FDI) disposing with the numerous advantages but disadvantages too. It is necessary for any company looking to engage into FDI to understand the concept of FDI as well as its benefits and drawbacks since the positive and negative consequences can be visible not only on their performance, but also on the overall performance and economic growth of the host country.
Typically, developing countries are the most targeted once since they have a lot to offer, and the access to these markets is quite easier due to the not heavily imposed regulations. Does the increase in FDI inflows can have extremely positive impact on poverty reduction as one of the major issues arising in these countries, remains to be answered in the research paper. Keywords: FDI, advantages, disadvantages, impact, poverty, reduction 4 1. INTRODUCTION “Globalization is a process of interaction and integration among people, companies, and governments of different nations.
It is a process driven by international trade and investment and aided by information technology” (Parker, 2005). The trend of globalization has imposed huge benefits, but at the same time tremendous challenges on businesses, customers, and countries as well. Companies, especially experienced multinational enterprises (MNCs) are looking for new business operations abroad consistently. They can choose from a variety of entry strategies to gain access to the new markets abroad and benefit from such movement.
When company faces saturation in domestic country, it is not rare case that it develops facilitates in foreign countries for the purpose of entering and keeping the new market. This way will help and gives the opportunity to corporate with new market in which goods and services can be sold and recognized as new and unique. Developing foreign markets means that multinationals will attract higher level of population who are potential buyers.
Multinational status also removes geographical boundaries which will in the end increase the corporation’s growth. Aiming to lower costs and increase a present at a global level, a corporation may look for this status. This status can be relevant for any company that holds offices, factories, or factories in process in more different nations. Usually, as we have mentioned at the very beginning, these companies have centralized headquarters to control and direct their global management initiatives.
For instance, multinationals originating from America frequently set up production or assembly offices in developing countries where land and labor are significantly cheaper than it is in the United States. A company is likely to gain multinational status with an incentive to raise market share, lower costs of production through the purchase of cheap labor force, elude trade barriers and reduce its tax liability (Railey, 2015). From a wide choice of entry strategies, large and successful multinational enterprises very often use foreign direct investment as their own strategy. Most of them consider FDI as the most appropriate and the most beneficial way of entry for them generating high level of profitability as well as attaining high level of managerial and technological expertise. Further in the research paper, the concept of FDI will be explained, major advantages and disadvantages will be elaborated in detail. Additionally, the research paper will provide a clear insight into the nature of developing countries, why companies usually choose to expand their business operations in developing countries, and the impact of FDI on poverty reduction in developing countries will be revised.
5 2. PROBLEM STATEMENT 2.1 Research Aim The aim of the research paper is to define foreign direct investment as an increasing trend that multinational corporations follow, to elaborate in detail potential benefits and drawbacks of FDI, as well as to figure out the impact of FDI on poverty reduction or alleviation from the perspective of developing countries.
2.2 Research Question What are the main advantages and disadvantages of FDI and do the FDI inflows have an impact on poverty reduction in developing countries? 3. LITERATURE REVIEW 3.1 INTRODUCTION 3.1.1 Foreign Direct Investment (FDI) Foreign direct investment (FDI) is an investment made by a company or individual in a country other than the home country. This can be achieved either by setting up business operations abroad or purchasing business assets in a targeted country in a form of ownership or controlling interest in a foreign firm.
Precisely, FDI can be made by establishing subsidiary or associate company in a host country, acquiring an interest in controlling of a foreign firm, and by merging or joint venture with a foreign firm. The crucial characteristic of FDI is that it implies investment with either effective control of, or considerable impact over, the decision making of foreign business. The mentioned type of investment is typically pursued in open economies, excluding or barely operating in economies with rigid regulations (Investopedia, 2018). 3.1.2 Why Developing Countries? The reason why FDI is taking more and more place in developing countries can be explained by numerous factors that multinational corporations find favorable when making the investment. First of all, developing countries dispose with variety of natural resources.
At this point, the top recipients in Africa are Angola, Equatorial Guinea, and Sudan. All of these countries are attractive to MNCs since they can take advantage of the richness of their natural resources at low-costs. Furthermore, some developing countries such as Brazil, China, and India represent huge growing markets.
Lower costs of labor represent an important aspect for MNCs when making their investment decisions. Therefore, developing countries appear to be perfect for meeting low-cost labor expectations. Last but not least, poor government regulations are definitely one of the main factors that satisfy the development of FDI in developing countries. MNCs find tax concessions extremely favorable for their operations (Jocelyn, 2011). 6 3.
1.3 Advantages of FDI As a matter of principle, FDI offers tremendous and important benefits that can be perceived from two distinct perspectives that are contingent on the way the investment makes a success. The first perspective is related to the all benefits associated with MNSs themselves while the second perspective indicates all advantages assigned to foreign countries. The main advantages associated with the multinational enterprises are: access to markets, access to resources, and lowering cost of production. Access to markets assumes favorable conditions for entrance into the foreign market. For instance, certain countries and their government may impose restrictions on access to their home market in order to protect their own companies and industries. Further, access to resources in important for companies since they can gain significant natural resources (i.
e. precious metals) and FDI is considered to be an effective way for the purpose of achieving this objective. The last, but not least benefit for MNCs is provision of lower costs of production if the labor market/labor force is cheaper, and if the regulations in the foreign market are less rigid (Grimsley, 2010).
Advantages assigned to foreign countries are: capital inflows, and higher revenue indicating how FDI can be significant source of external capital for a developing country. This can help a country to cover savings gap and eventually can cause economic growth and development. For example, if there is a huge company in certain small state, the state will make use of local labor, equipment, and supplies which will ultimately lead to the new job opportunities in that country. In order to operate successfully, the company will have to employ local workforce that will make an improvement in employment level of the country.
Given the new job opportunities, the local workforce will be able to spend more due to the greater income levels. At the same time, local workers can improve their performance through education, training, and challenges that might confront them. With an objective to achieve enhancement in all aspects of the business, the same can be attained by using advanced technology that lead to better access to research and development, managerial and technological expertise (Grimsley, 2010).
One of the most significant preferences among all other advantages of FDI is the multiplier effect, the increase in a country’s money supply that results from banks being able to provide loans. The extent of the multiplier effect depends on the percentage of deposits that banks are obliged to hold as reserves. In its basic term, it refers to the money used to create even more money and is estimated by dividing total bank deposits by the reserve requirement. Any increase in aggregate demand will result in a proportionally larger increase in national income (Grimsley, 2010). Following this trend, tax revenues from profit of MNC’s are also one of the advantages.
Tax revenues are achieved from the products and activities of the company, taxes imposed on company employee income and purchases, etc. Developing governments can use this capital inflow and revenue from economic growth to build and advance its physical and economic infrastructure such as building roads, communication systems, and educational institutions (Grimsley, 2010). 7 3.1.
4 Disadvantages of FDI As there are many advantages of the Foreign Direct Investments there is also a negative side of it. These disadvantages are influencing economic, political and environmental aspects of a country. Some disadvantages that we mention can be seen as a main threat of a foreign direct investment. They are mostly having just one aim and that is to gain profit no matter how. With such investments can be made the cruelest exploitation of the workforce, what investors in their countries might not work.
Country will not have some profit of it such as paying taxes or some other revenue to the country and also there is an environmental damage which is most usually done to the developing countries with not such low of polluting and explicating resources (Jocelyn, 2011). In the beginning of foreign direct investment, reflection is positive because they hire unemployed workers, and the overall economy began to grow slightly. However, at this level, stop growth trends and with the passage of time their values begin to decline, because earnings do not harmonize with the growth of retail prices. Mostly when big companies came to the some country as a foreign direct investment they are using inexpensive and low skilled workers.
They are working for minimum wages and usually are not trained or educated. There are some situations when this is not a case but mostly they are using just this labor to satisfied needs of a new company. Interests foreign investors are always clear. Besides the basic interest to fertilize equity, always guide and two imperialist objectives – maximum exploitation of labor and other resources in order to enlargement profit (Jocelyn, 2011).
Another disadvantage to the country where foreign direct investment is coming is that at the beginning is that made profit in the importing capital is exported to the country of investor. Also investors tend to unfair competition destroy the local economy and achieve full domination of a market and systematically create a growing dependence on foreign capital. Underdeveloped countries are importers of capital and foreign investors are generally unequal partners. Whoa there baselines are very different, and significantly divergent interests. These countries are economically inferior and insufficiently strong to resist various demands and blackmail investors, which determines their submissive role, while foreign investors generally powerful, demanding and very aggressive. Capital importers are, in most cases, countries without a significant impact in international relations, with a lack of vision and development programs, with a weak economy and lack of domestic capital accumulation. They typically do not have long-term plans, but short-term interests, which are based on attracting investors to hire labor and at least partially launched economy.
In pursuit of change and ambition to improve the state of the economy and society in general, managements of these countries often make mistakes and indiscriminately introduced by investors (Jocelyn, 2011). The worst scenario is one in which a foreign company buys a home company with a view to turn it off or to gain a monopoly on the market. Similar outcomes can be seen in the pursuit of a few foreign companies, possibly in the same property, which want to enter the domestic market and provide an oligopolistic competition to be able to control the supply and price, cutting out so domestic enterprises from market race. The legal system should certainly protect the domestic economy from such denouement. There are cases where foreign direct 8 investment can reduce domestic employment. This happens when a foreign corporation takes away part of the market share of domestic enterprises and domestic enterprises were forced to lay off workers. This effect can be compensated by employing local residents carried out by a foreign company. However, in cases where a foreign company employs mostly highly educated workforce, and the host country does not have enough human capital for its needs for employment, it will turn the employment of foreigners at the expense of local residents and will thus cause a negative impact on local employment.
Sometimes foreign companies prefer foreign suppliers, with whom they have well-established relationships and therefore imported inputs, thus worsening the relationship of international trade in the balance of payments. The same effect has and the repatriation of profits by foreign companies achieves in the domestic country and return to his country. Political decision-makers should certainly legally restrict the repatriation of capital, which is the main cause of the slowdown of economic growth of the national economy. One of the big problems is certainly the transfer of profits from a branch in the parent company. This leads to the overflow reservoir host country abroad. Legal and other regulations of the state trying to prevent this phenomenon, but the transnational companies are available numerous mechanisms that easily circumvent legal restrictions (for example, transfer pricing).
Transfer of profits distorts the balance of payments, and initial positive effect resulting capital inflows are sometimes completely neutralized (Jocelyn, 2011). Government transition countries can often encourage foreign investment by introducing a variety of tax breaks and exemptions. Such policies may lead to reduced budget revenues and privileged position of foreign enterprises in the domestic market, which discourages the competitiveness of the domestic economy. Consequently, it can happen so-called dual economy, where foreign sector developed, modern techniques, manufactures products for the world market, and the domestic sector is more into traditional techniques produces products for the national market (Jocelyn, 2011). 3.
2 LITERATURE FINDINGS 3.2.1 Critical Overview: FDI’s Impact on Poverty Reduction After examining all the advantages and disadvantages of FDI in previous section, let us focus on its effect or impact on poverty reduction in developing countries.
The literature available provides a lot of articles made on this topic. Nevertheless, there is no much of research available to describe the direct link between FDI and poverty reduction. As it is mentioned earlier, FDI is considered to have an important impact on the economic development of a country by providing capital to encourage different aspects of economic development. Aaron (1999) has analyzed the methods by which FDI can help to reduce the level of poverty in developing countries. He also looked at the means by which policy makers in these countries can raise the contribution in terms of poverty alleviation. To investigate the relationship between FDI and poverty reduction, Aaron has observing this link from two different approaches. The first approach implies the connection of FDI and growth, and the second approach indicates the relationship between growth and poverty reduction.
The author has categorized the potential outcomes of FDI on the host economy as direct and indirect 9 outcomes and emphasized the distinction between the two in order to see the impact of FDI on social development and poverty alleviation. The elements of direct outcomes include the level of employment and income created by FDI. In addition, Aaron’s research suggests that FDI gives a rise of female participation in labor force which immediately generates higher income for households. However, the increased income is followed by lower wages compared to the male salaries for the similar jobs. Hung (2005) has explored the FDI effect on growth and poverty alleviation using the regression analysis and panel data covering ten years (1992-2002) across twelve provinces and cities in Vietnam. The same as Aaron did, Hung believed that the FDI has direct and indirect effects any by employing huge set of indicators, he analyzed this relationship. First of all, he has investigated whether there is positive impact of FDI inflows on economic growth of a particular province. Besides, Hung also wanted to see if there is a negative correlation existing between economic growth and the number of people living below the poverty line.
At the end, Hung’s results were reported as indicating that poverty reduction is a result of increase in FDI inflows, while there is also positive correlation between FDI and economic growth. Soumar? and Gohou (2009) have made the empirical research to scrutinize the FDI influence on growth and poverty alleviation by employing econometrics models on panel data across countries in Africa. Unlike most of the authors, they did not use gross data of indicators such as GDP and FDI, but rather they have chosen to apply ratios such as FDI net inflows over gross capital formation. In addition to GDP, the authors have examined Human Development Index (HDI) to get the more precise and detailed results. Eventually, their results have claimed that FDI reduces poverty to significant extent while at the same time increases welfare of the specific country. These results have assumed that the relationship between FDI and welfare has experienced considerable variations across African regions.
For instance, Central and Eastern parts of Africa are highly affected by FDI in terms of its welfare, while the Northern and Southern Africa are not affected by FDI to the high degree. 4. CONCLUSION To put in a nutshell, even though many people do think that foreign direct investments are one of the greatest benefits to the country, there are many disadvantages also. The globalization of the world economy has resulted in an increase in the importance of foreign direct investment.
Transition countries became increasingly open international operations, have liberalized their regimes and thus become attractive to foreign investors. Multinational companies can have many positive effects on growth and development of the host country, and they are primarily reflected in the possibilities of technology transfer, knowledge and skills, capital inflows and so on. However, each country should be assessed and possible risks of such entry, because foreign direct investments are not an automatic solution of all problems, the positive effect depends on the environment in the country the host, for example the absorption capacity of the host country (Jocelyn, 2011). 10 As a matter of fact, foreign direct investment can have direct and indirect effects on poverty alleviation. The indirect influence of FDI on poverty alleviation can be visible through economic growth, leading to the improvement of living standards.
Greater living standards are result of considerable increase in overall GDP of the targeted country, advancement of technology and productivity, but also as a result of favorable economic environment in terms of favorable exchange rates, interest rates, and trade freedom. On the other side, direct effect of FDI on poverty reduction is recognized through the economic growth, reduced number of people living below the poverty line, increased level of employment, greater demand for work force, etc. The nature of these effects relies on different conditions and numerous factors. Hence, the state that is willing to benefit as much as possible in terms of FDI inflows and ultimately poverty alleviation, has to create an environment which is going to be economically, politically, and legally appealing to this type of investment. (Ucal, 2014).