Theories of Foreign Direct Investment (FDI): positive and negative impact of FDI

Prepared By: Jennifah Nordin Nur Afisha Yusuf UiTM Sarawak

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Presentation Outline
Definition of FDI Introduction to FDI Statistical Data of FDI in Malaysia
Theories of FDI Positive Impact of FDI Negative Impact of FDI
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Definition of FDI
Foreign direct investment (FDI), defined as investment made to acquire a lasting interest in or effective control over an enterprise operating outside of the economy of the investor (International Monetary Fund 1993 as cited in Juma;2012) As an investment by foreign corporation in any country (Bose; 2012)

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FDI in Malaysia
Budget 2013 announced that net inflows of FDI amounted to RM13.6 Billion

Malaysia was ranked the third largest recipient of FDI among the ASEAN countries, after Singapore and Indonesia (Investment performance 2011) Total investment approved in the Malaysia economy in year 2011 was RM148.6 Billion

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Statistics from MIDA-2013 & 2012

PROJECT APPROVED BY COUNTRY 2013 AND 2012 MIDA.pdf PROJECT APPROVED BY MAJOR INDUSTRY 2013 AND 2012 MIDA.pdf TOTAL PROJECT APPROVED BY STATE MIDA.pdf

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Why Countries seek FDI

Domestic capital is inadequate for purpose of economic growth; Foreign capital is usually essential, at least as a temporary measure, during the period when the capital market is in the process of development; Foreign capital usually brings it with other scarce productive factors like technical know how, business expertise and knowledge

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Theories of FDI
1. Modernization theories Theory suggest that FDI could promote economic growth in developing countries

While economic growth requires capital investment

Believe that transfer of technology through FDI in developing countries is important to develop the country

Also lead to managerial skill and marketing network

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Theories of FDI

2. Dependency Theory Dependence on FDI-lead to negative effect on growth and distribution of income Create industrial structure in which monopoly is predominant Economy controlled by foreigners would not develop organically but would rather grow in a disarticulated manner

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Theories of FDI
3. Product Life Cycle Theory Develop by Raymond Vernon Explain why US manufacturers shift from exporting to FDI Relevant to manufacturers initial entries into foreign market Manufacturers-gain monopolistic export advantage from product innovations

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Cont
Stage 1: New product stage, where the product continues to be concentrated in the United States Stage 2: Product becomes standardize in its growth Stage 3: Mature stage: cost competition among producers and start to look countries that can offer lower production cost (Shenkar, 2007)
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Theories of FDI
4. Monopolistic Advantage Theory Stephen H. Hymer found that FDI take place because powerful MNE choose industries/markets in which they have greater competitive advantage Suggests that the MNE posseses monopolistic advantage that enables it to operate subsidiaries abroad which is more profitable than local competing firms Monopolistic advantages drawn from two sources namely superior knowledge and economies of scale (Shenkar, 2007).
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Theories of FDI
5. Japanese FDI Theory Developed in 1970s by Terumoto Ozawa the theory relates with the FDI inflow and outflow of a country and its relation to economic growth

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Theories of FDI
1. 1st phase of economic growth The country is underdeveloped Labour costs are very low Become a target by foreign companies who seek to lower down their production cost At this stage, there is almost zero FDI outflow 2. 2nd phase of economic growth New FDI starts to flow inside the country due to growing internal markets and improve standard of living More FDI outflow happens due increase in labour cost
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Theories of FDI
3. 3rd Phase of economic growth Competitiveness of a country measured based on level of innovation FDI inflows and outflows are motivated by both market factors and technological factors

http://unctad.org/en/docs/iteiitv1n1a3_en.pdf
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Theories of FDI
6. Five Stage Theory - John Dunning Stage 1 Low incoming FDI, but foreign companies are beginning to discover the advantages of the country No outgoing FDI no specific advantages owned by the domestic firms

Five Stage Theory - John Dunning

Stage 2 Growing incoming FDI do the advantages of the country - especially the low labour costs The standards of living are rising which is drawing more foreign companies to the country Still low outgoing FDI Stage 3 Still strong incoming FDI, but their nature is changing due to the rising wages The outgoing FDI are taking off as domestic companies are getting stronger and develop their competitive advantages

Five Stage Theory - John Dunning

Stage 4 Strong outgoing FDI seeking advantages abroad (low labour costs) Stage 5 Investment decisions are based on the strategies of TNCs The flows of outgoing and incoming FDI come into equilibrium

http://aib.msu.edu/awards/19_1_88_1.pdf

Positive Impact of FDI

1. Human Capital Development What is Human Capital Development??? Define as the reserve economically productive human capabilities. Represent an issue of ability to do and individual capabilities Study-reveal that there is a strong relationship between FDI inflow and human capital development of a host country (Khalid Zaman, Iqtidar Ali Shah & Muhammad Mushtaq Khan; 2011) Foreigner engage in employee training (Zilinske;2010)
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Positive Impact of FDI

2. Employment opportunity Due to competition brought by FDI, its competitiveness increase and a country become more productive. Porter in his book title The competitive advantage of Nations highlighted this issue Increase in competitiveness lead to creation of employment (Arango;n.d) Swiss affiliates have created more than 430,000 jobs across the U.S. with 177,800 jobs in manufacturing and 21,100 in R&D. Of the 5.3 million jobs supported in the U.S.
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Job opportunities in Malaysia by sectors-2012

Overview approved project jan mac 2013 and 2012 MIDA.pdf

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Positive Impact of FDI

Philippines-the Department of Labor and Employment (DOLE) has announced that the number of unemployed people nationwide continues to decline, as foreign companies start renewing their investment interests and contracts in the country post-2008 economic recession. The results of the April 2012 Labor Force Survey (LFS) did indicate that the number of unemployed people in the country went down slightly from estimated 2.87 million to 2.8 million in the same period last year (Gokianluy; 2012)
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Example
Wal-Mart set to grow in China Tuesday, April 2, 2013 Wal-Mart (WMT.NYSE) says its growth in China is on target and it plans to invest US$80 million (RMB500 million) to upgrade existing stores in the market, The Wall Street Journal reported. The retail giant said it plans to remodel 50 of its nearly 400 stores in China, and open 30 new stores in the country in several second-tier cities. Wal-Mart will also look to boost investment in warehouses and logistics networks to reduce costs and increase food safety standards. Wal-Mart may add 18,000 jobs to its China payroll this year http://www.chinaeconomicreview.com/wal-mart-set-grow5/28/2013 22 china

Positive Impact of FDI

3. Transfer of Technology

Ramirez highlighted that FDI allows transfer of technology and specialized knowledge which in turn increase productivity (as cited in Arango;n.d)

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Positive Impact of FDI

Horizontal technological spillover (within industry)-refers to the effect the presence of MNCs has on domestic firms in the same sector
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Vertical technological spillover (inter industry) as a result of the interaction between domestic and foreign firms that are not in the same industry. (Aldaba; 2012)
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Positive Impact of FDI

4. FDI lead to increase in competition Improve the factors of production and accumulation of capital in the host country The entry of MNCs increase the supply in the host country market Thus forcing the local firms to reply to this competition as to maintain their market shares Due to this competition, it will lead to increase in productivity, lower prices and more efficient allocation of resources. http://www.fep.up.pt/investigacao/workingpa 25 pers/10.11.02_wp390.pdf

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Positive Impact of FDI

5. Reduce Poverty According to a poverty report provided by the World Bank (2003), the percentage of people living below the standard poverty line in Vietnam decreased rapidly from 58 percent in 1993 to 29 percent in 2002 (Hung; n.d)

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Negative Impact of FDI

1. Environment deterioration

Kirkulak, Qiu and Yin (2011) reveal in their study that China has an abundance of energy and the most common form of energy is coal

Most of the sulfur dioxide (SO2) released into air is from coal (coal is the most primary source to meets its national energy

Lead to atmosphere pollution called SO2

HOW government of China control pollution? By having environmental policy-mainly base on taxation
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Negative Impact of FDI

2. Cultural difference 1994-Wal-Mart expand their business to china Different perception of Chinese people about US companies (Bose;2012)

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Negative Impact of FDI

3. Decrease in expected profitability of investment project WHY?? Due to corruption-lead to investor will take into consideration level of corruption in a host country before making decision to invest Study conducted by Ali Al-Sadiq (2009) reveal that a one point increase in the corruption level leads to a reduction in per capita FDI inflows about 11 percent. Houston study indicate that corruption has a positive effect toward economic growth with a weak rule of law, and its has a negative effect in countries with sound institution (as cited in Ali Al Sadiq;2009) 29 5/28/2013

Negative Impact of FDI

4. High level of FDI has a negative Impact on R& D

High level of FDI volatility-lead to less innovationreduce R&D effort and reduce cost involve in R& D (Robert Lensink and Oliver Morrissey as cited in Changwatchai;2010).

Its happen in developing countries and Asean countries.

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The endthanks for listening

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