Factor Mobility and Foreign Direct Investment

1. Factor Mobility and Foreign Direct Investment  Jashim Uddin Senior Lecturer, East West University, Bangladesh

2. Nature of contemporary factor movements Capital: Interest rate variations result in differences in expected return which in turn emphasize capital transfer Short term capital transfer for FDI as wire transfer is relatively low cost Foreign aid and loans Donation to NGOs Labor: Labor mobility require high transportation cost and legal documentation Immigration outside require adaptation with foreign language and missing ones support groups Permanent (migrated) and temporary (assignment of MNE managers, wage earners) human movements occur Payment differential to labor force is the dominant factor to result labor force mobility

3. Effects of factor movements Inflow of human skill may result in reduction of particular imports Capital inflow can turn labor intensive economy to capital intensive economy Loss of productive human resource generates a reciprocal flow of remittance Reverse factor movements like human capital and financial capital create substantial impact on a country’s economic development

4. Relationship of trade and factor mobility • Substitution: Labor and capital will tend to move away from countries in which it is abundant to those in which it is scarce. • Complementarity: Factor mobility through direct investment often stimulate trade because of • The need for components • the parent’s ability to sell complementary products • The need for equipment for subsidiaries Foreign direct investment and control In FDI control must accompany the investment. Ownership of at least 10 or 25 percent of voting rights in a foreign enterprise makes the investment direct. Control largely depends on government control of the host country. Contd..

5. Governmental concern: Host countries national interests will suffer somewhat if an MNE make decisions from its global or national objectives. Decisions related to one countries economy come from another country. • Investor Concern: Control is important for investors as they are willing to do the best for their global operations rather than best for a specific country. MNEs intends to handle its vital resources (capital, patents, trademarks, and management know-how) by wholly owned subsidiaries. More the control in FDI more the rate of technological transfers and lesser the operating cost, because: • The parent and subsidiary usually share a common corporate culture • The company can use its own managers, who understand its objectives and the nature of difficult to teach processes that it wishes to transfer • The company can avoid protracted negotiations with other company • The company can avoid problems of enforcing an agreement

6. Motivations for FDI as an alternative or supplement to trade • Sales expansion objectives: Expansion of sales is a basic reason for accepting the risk of foreign operations. Sales expansion motive affected by the following factors. • Transportation: Companies cost of transportation added with production cost but some products are impractical to ship over long distances or incur substantial cost increment. • Lack of domestic capacity: Excess capacity at home emphasizes on export. When demand condition outside pushed up and lose consistency with domestic capacity and transportation cost, require new investment to start foreign capacity. • Scale economies and product alterations: Products, those require high fixed cost, little alterations or standardization, can achieve scale economies when production volume is very large. Substantial alterations for different foreign markets will provide less scale economies. Such products permit small plants to serve national markets rather than int’l to reduce transportation cost. Contd…

7. It means additional investment to locate facilities abroad and to compensate loss of scale economies through shift in production to less cost location. • Trade restrictions: Though substantial reduction on import tariff has happened, still there are many restrictions. Such restrictions make import costlier and local production cheaper. • Country-of-origin effects: Goods produced in own country can have positive effects because of nationalism. A specific country-of-origin can express greater dependence from consumers, like- Frech perfumes. Consumers have a logical fear that service and replacement parts for imported products will be difficult to obtain. The rise in JIT manufacturing permits suppliers to stay near to deliver quickly. • Changes in comparative costs: Changes in production cost, basically due to rising income level, force companies to shift production location to achieve global scale economy and price advantage.

8. Resource acquisition objective: Gaining resources outside means ensuring resources for future sales. Certain factors favor FDI as a way to gain resources. • Vertical integration: Advantages of vertical integration may accrue to company through either market oriented or supply oriented investment in other countries. Companies also gain certain economics through vertical integration. Because supply and or markets are more assured, companies may able to carry smaller inventories and spend less on promotions. They do not have to incur costs of negotiating and enforcing contracts with other companies. • Rationalized production: Some companies produce different components or different potions of their product line in different parts of the world to take advantage of low labor costs, capital, and raw materials. A company can also produce each complete product in different country to achieve scale economics. This sort of rationalization also provide benefit when exchange rate fluctuates. • Access to knowledge: Setting up foreign offices enables a company to gain knowledge that is not available in home country. FDI opening up the ability to watch an economy more closely.

9. Risk minimization objectives: Companies can reduce risk by operating internationally, as it diversify sales base. In addition to diversify sales base and customer base, there are some other risk minimizing objectives. • Following customers: When a major customer make FDI the supplier have no alternative than following the customer. By which the supplier can retain the business, can prevent other competitors to be the supplier in foreign locations, can overcome the problem of export restrictions. • Preventing competitors’ advantage: Competitors entry to foreign markets lead a company to make the similar move to prevent the chance of competitors’ gaining advantage in the foreign markets. • Political objectives: FDI made by a country through its companies also have political intentions. • Gain supplies of strategic resources like oil needs FDI to have more control on prices. • Develop positive image to a country by making FDI, which have future political intensions.

10. Resources and methods for making FDI • Assets employed: FDI is a cross border capital movement that occurs when anticipated return (premium for risk factor and cost of transfer) is higher in overseas than at home. Always capital movements are not the only means of asset transfer, it also can occur by transferring managers, cost control systems, process technology in production. Payment for export sometimes kept in foreign offices to invest there by which cost of transfer can be minimized. • Buy-versus-build decision: FDI can occur either by acquiring an existing operation or construct new facilities. • Reasons for buying: Privatization program of other countries put many facilities in the market for sale. MNEs can take the advantage of such purchase. In a country where unemployment rate is low, searching new employees is a difficult job. Buying an existing company which gives not only labor and management but also existing organizational structure. Through the acquisition goodwill and brand identification can be retained. It is most important when building new brand is very costly and risky. Local capital supplies can be more familiar with ongoing operations. Contd…

11. Acquisition reduces cost and risk also saves time, company also can avoid start up problems and get immediate cash flows rather than tying up funds during construction. • Reasons for building: Acquisitions offers advantages but a potential investor not necessarily able to realize them. Positive indications for building foreign facilities are in the following: • No desired company available for acquisition or government restriction to acquisition as it reduces competition and a weapon for foreign dominance. • Acquisition will lead to carry over problems, like-labor relations, poor brand image, or inefficient facilities. • Different management style may conflict with each other. • Local financing may be easy when setting new plants and facilities that may create new jobs.

12. Direct investment patterns • Location of Ownership: Industrialized countries account for a little over 90% of all investment outflows. • Location of investment: The major recipient of FDI are developed countries, which received 79% of the world’s total in 2001. The interest for investing in developed countries mainly result from the following: • The markets are larger in developed countries • Lowest perceived risk for political and economic stability • Least discrimination toward foreign companies through OECD