Over the last two decades, Foreign Direct Investment (FDI) has grown tremendously even above trade flows. A number of organisations, particularly multinational companies, have embarked on FDI as a means of extending the manufacture of their products in countries abroad. (Markusen and Venables, 1999; Graham et al, 2004). For instance, according to statistics, between 1987 and 1993, the United Kingdom attracted an approximate figure of £27.2 billion of net inward foreign direct investment. Further estimates show that manufacturing firms in the UK employ over 78,000 people; this accounts for over a quarter of the net output sales of UK manufacturing companies. (Driffield and Munday, 1998). The objective of this paper is to examine the reasons why a firm may wish to engage in foreign direct investment and explain the differences between FDI in developed and developing countries. To achieve this, the paper will begin by providing some definitions of the term FDI. According to Bashier and Talal (2007); Padma and Savant (1999), “FDI is an investment made by multinational business enterprises in foreign countries to control assets and manage production activities in those countries”. On the other hand, Graham et al (2004) define FDI as the process whereby a company in one country makes a physical investment to build a factory in another country. Krugman (1995) considers FDI to be a diversification strategy in which multinational companies purchase assets which are usually associated with the manufacturing and distributing facilities in another country. (Graham Krugman, 1995).
- Determinants of FDI
A number of reasons exist to explain why firms engage in FDI. Lim (2008: p. 40) contends that multinational firms engage in FDI in order to seek a share of the market, additional resources, production and market efficiency and strategy asset capacity. These reasons were supported by the United Nations Conference on Trade and development (UNCTAD) who rather refer to them as economic determinants. They purport that companies are continuously and increasingly seeking to develop their portfolio by leveraging their FDI. They engage in FDI in order to expand their customer base by serving newer markets, to access technological and natural resources, as well as to map out their values chains efficiently throughout the globe. (UNCTAD, 2002). Shapiro (1989) and Hill (2006) suggest four major reasons why firms engage in FDI. They contend that cost reduction, economies of scale, knowledge seeking and maintaining one’s customer base are the four main reasons why a firm would engage in FDI. By cost reduction Shapiro (1989) suggests that in order for a firm to survive in its home country, it might need to invest abroad to benefit from lower costs of production and to keep up with the pace of competition especially when its immediate competitor has gained access to a similar lower costs of production abroad. (Shapiro, 1989, pp 408) By this, he contends that firms in competitive industries whose main consideration is to keep cost low, would continuously search for lower cost production sites and production technologies worldwide. Secondly, Shapiro (1989) suggests that the effect of economies of scale is a motivating factor that propels firms to engage in FDI. He suggest that a firm, particularly one which invests heavily in research and development for the manufacture of its products, as well as capital intensive firms, may need to engage in FDI because they need a larger customer base than that their domestic base so that they can recapture their investment in the knowledge applied from research and development, and also in order to spread their overheads over a larger sales quantity. (Shapiro, 1989 pp 408). Simply put, Shapiro means that firms who operate in industries whose fixed costs are higher relative to variable costs would engage in FDI in order to achieve volume sales so as to break even and stay in production. Thirdly, knowledge seeking is one other major reason. Hill, (2006) contend that a firm would invest directly abroad so as to gain the knowledge and experience relevant for its business which would subsequently prove useful elsewhere. This is particularly important for firms in industries with rapid product innovations and technical breakthroughs, such that they can continuously track the developments and performance of overseas competitors and face them off appropriately. Lastly, a firm will decide to invest directly abroad because of its need to follow its multinational customer abroad in order to guarantee the latter of a continued supply of their products. Therefore, some firms engage in FDI in order to keep their customers and ensure supply efficiently. For instance, failure to do so might lead to such a multinational customer seeking a local supplier which will mean the firm will lose out on its supply contract with its multinational company. In addition, a trade barrier may hamper the supply of products which will, in turn, affect the production of goods for the multinational company, and hence strain the relationship between the two parties. (Shapiro, 1989, pp 410; Hill, 2006)
- FDI in Developed and Developing Countries
A company may wish to invest in a developing or developed country for several reasons. Both areas have attributes and demerits which an investor considers worthwhile before engaging in an FDI. A firm will be attracted to invest in a developed country in order to benefit from the infrastructure and technological base present in a developed country. Firms based in developed countries normally have the access to different methods of financing; they also have personnel who hold distinct skills. Moreover, they have the facility for continuous research and development which enhances development through training and implementation of findings from the research. More importantly, a firm in the developed country has the presence of management skills which has become a more important factor in recent years for companies wishing to invest abroad. Despite the attributes, firms in developed countries have very expensive labour comparatively. On the other hand, a company may wish to invest in a developing country in order to take advantage of the cheap labour mainly present in those areas, and favourable tax policies, despite drawbacks such as possible political instability. For instance Volvo and General Motors are examples of companies which have outsourced their car assembly plants to China. However, the drawback for FDI in the developing country is the huge expenditure to be spent on training personnel in these countries to be able to meet the production demands of the firm. This is often a turn off for a firm wishing to invest in a developing country but it is an advantage for the developing country who will benefit from the development of the human capital. (Lagouni et al, 2001)
From the above discussion, it is fair to conclude that it is beneficial for a firm to engage in FDI in general, because the advantages inherent in both developed and developing countries outweigh the disadvantages therein. In addition, the rationale for FDI activities resound with reasonable success in the overall production capacity of the company, its market share, its customer base and the sales volume.
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