CIRCUMSTANCES UNDER WHICH FDI CREATE A CONDITION FOR A VIRTUOUS CYCLE OF ECONOMIC DEVELOPMENT

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CIRCUMSTANCES UNDER WHICH FDI CREATE A CONDITION FOR A VIRTUOUS CYCLE OF ECONOMIC DEVELOPMENT

This paper delineates and discusses the circumstances that Foreign Domestic Investments creates conditions for a virtuous circle of economic development. To have an imperative explanation of the concept, it is prudent to define the unembellished concept Foreign Direct Investments. It refers to the process whereby the populace of a country acquires the full control and ownership of assets with the sole purpose of controlling production, distribution and other activities of a firm in another country. It is therefore that investment that is made to obtain the lasting interest in a business that operates in an economy as opposed to that of the investors voice of having direct influence in the management. According to the United Nations World Investment report, Foreign Direct Investment is defined as an investment that involves relationship and a reflection of control of the foreign direct investor in an enterprise in a foreign affiliate. Long term differentiates FDIs from the portfolio investments which are on a short term basis with insecurities turnover. It is no doubt that foreign direct investment acts as a catalyst for the economic transformation in a myriad of economies across the globe. One of the major benefits of foreign direct investment is that it provides finance for the acquisition of capital goods. It also facilitates the transfer of technology from relatively more advanced economies to less developed ones. It also results into the positive spillovers to the continental economy through various linkages with the local supplies, imitation, competition. However, it can also result into negative spillovers and therefore deteriorates growth in a country. This will make people fear from investing in the country given that it is possible of loosing. With the benefits stated, there has been an upsurge in the demand especially over the last two decades. Although the demand has increased, there has been a variation between and within

regions. Up to 1980, the Caribbean and Latin America were the largest recipients of the FDIs. The situation changed in late 1980s with the appetite being diverted to the Pacific and Asia countries. UNCTAD 2000) The two regions catered for the 85% of the FDIs injected to the developing countries. By 1998 Pacific received 46.3%, Latin America and the Caribbean 39% Central and Eastern Europe 10.2%, Africa 4.5% and Asia 2% of the total FDIs. A number of factors have influenced the distribution and the volume of FDIs especially in developing economies. Some of these factors includes; political stability, favorable government regulatory policies, low level of corruption, low administrative costs, presence of good business environment, skilled labor force, physical infrastructure, interest rate, productivity and the cost of labor. The below section of the paper will focus on some of the circumstances under which foreign Domestic Investments can lead to a vicious cycle of economic development. Some of these factors are as discussed below; Stability in the financial system The development of a stable financial system of the recipient country is a necessary precondition for any FDI so as to influence growth and development in a country. A financial system which is developed will be more beneficial to the economy as opposed to less developed one. When the financial system is developed then it will be easy technological fusion in the economy. FDIs require enhanced financial system since the composition of inflows of foreign resources which raises domestic savings requires proper systems and therefore easy match in the economy. Finances which are entailed in the injection can also include the purchases which are made by the foreign direct investors, new investment of the profits by the foreign investment enterprises from the parent firm; they may also borrow abroad on the account among other systems. It is no

doubt that the inflows of the FDIs are more focused to regions where there is stability in the financial systems. Research indicates that the FDIs are positively correlated with the nations kind of policy and the system they practice. There are a number of institutions in a country that ensures that the economy grows sustainably. The financial institutions that offer credit services are mainly privatized. Without these institutions the economy of any nation will not be in a position to grow at the required rate and with the laid down projections Therefore it is necessary to ensure that the financial systems and institutions are made stronger. The stability explains the reasons behind the inflow of the FDIs in the Latin countries from 1978 to 2003. In comparison to a country like China that has had very high number of FDIs with seldom benefits. Growth notwithstanding, Chinas poor financial system can be indicated to be responsible for the reduced benefits. China is the second largest recipient of FDIs in the world but little impact can be pointed from the injections. Poor financial system limits the realization and transmission of those benefits associated with the FDIs. Poor financial system is constituted by the banks credits. Therefore to have real benefits from the FRIs it is necessary to ensure that all the financial systems are put in place. Proper financial systems means that banks and other financial institutions can lend money to the public and therefore a number of businesses will be started. At the same time, there will also be accompanied by technology and therefore the time duration in the processing of funds will be minimized. This will lead to an increase in the real growth of the GDP and subsequent GNP. It will translate to an economic development. The second level of platform that FDIs will influence the economic development in a country is through the presence of infrastructural development. The benefits which are rendered by the FDIs are on a higher note associated with the reduction in the transportation costs and the market accessibility. Poor infrastructure usually leads to transaction costs with minimal access to the

market. Each and every country specializes in the production of different goods which it believes will be essential in ensuring that it competes well and trade with others. These goods must access market for easy trade. Without proper infrastructure, there will be poor market accessibility both at the local level and at the international/global front. This will discourage the FDIs from investing in a particular country. Any attempt to obtain efficiency can only be realized when infrastructure is extended through the consideration of the commercial principle and the shift if a liability to provide infrastructure through contract management or leases such as full privatization, builddown-operate and the build-operate-transfer. These methods will adopt good methods to facilitate the process of attracting the FDIs. (Admati & Pfleiderer 489) Quality of infrastructure also influences exports in a country and therefore influencing economic growth in a country. With proper infrastructure, the level of investors will improve given that they will be attracted to investing more in the country. An economic paper on the state of Pakistan indicated that there is a positive correlation between infrastructure and direct investments in the country in both short and long run. In Pakistan the data indicated that every percent upsurge in infrastructure development will lead to almost similar proportion increase in the FDI inflows by a value of 1.31%. Poor infrastructure relates to low economic development. This is similar to the correlation with the low level of the FDIs in the market. Therefore to increase the number of FDIs in the economy that will relates to economic development, it is proper that the proper level of infrastructure is put in place. This will increase the level of economic growth and consequent development in an economy as indicated by Pakistan. The third factor that influences the inflow of FDIs and subsequent development is the political stability of that particular region. A myriad of economies in transition especially those in Eastern Europe have seen an upsurge in the number of foreign direct investment during the

past decade.

Though the inflows observed in the region were a bit different due to their

uniqueness and dynamism. The economy of most of these countries increased as FDIs has a positive impact in the transition process of any country. There are also countries in the Eastern Europe region that recently joined the EU has had a low number of the FDIs due to unrests and instability in the governance system. Some of the political problems that have also faced these countries include; succession problems, intra and interstate wars, ethnic clashes, terrorism and problems with a single party system. Political instability has also been the reason behind the low number of FDIs investing in a number of African nations. A myriad of these countries have experienced ethnic clashes, religious conflicts, neo-colonization, and poor ethnic relations among other issues. It is frequently said that investing cannot be practiced in insecure regions which explains the reasons as to why these countries are poor. Investors are always interested in what they get in return and not necessary what the host nations gets. The host country benefits from the spillovers and therefore when there is instability in the political system then there will be no driving force for them to invest there. A politically stable state will mean that FDIs will go higher and therefore increase in economic growth. The growth will be a pre requisite for the economic development in a country. (Djankov AND Hoekman 55) The fourth circumstance through which FDIs will led to an upsurge in economic development is the cost of labor in the economy. Labor is very important to any level of economic growth and development in any economy. The labor cost is high then it means that it wills that the cost of doing business will be high. A reduction in the cost of doing business will be observed when the demand of labor is high and reasonable prices are being charged. When, the cost of labor is cheap in a country then FDIs will be higher as compared to when it is expensive. China and India with very cheap labor has had a high number of FDI inflows since

the cost of doing business will be reduced. Labor is part of the entire cost of production and therefore the quality which is provided should also be taken into consideration. To increase the number of FDIs in an economy, governments should ensure that the labor through the unions is charging reasonable prices which can be offered by the firms doing business in a country. Therefore labor influences a lot the level of FDIs. When it is high, level of FDIs will be low with a subsequent reduction in the economic development in a country. Size of the market is another factor that should be considered when discussing Foreign DIRECT Investments. A number of studies have been conducted in the past shows that there is a positive correlation between the FDIs and the size of the country. The rationale behind the argument is that the investments which are injected in the economy must justify the returns which will be gotten after the sales and the elimination of the costs. The firm must also constant the time duration it will take it to break even. This period will determine whether it will still continue with the operations or not. If the duration is longer the management might get shy continuing investing in the country as it will not be viable. It is the rationale behind many of the multi nationals will not be interested in investing in third world countries in Africa despite the resources they are endowed with. China and India have got very big physical and large population and therefore a large number of FDIs are directed into the economy. The size of the economy will mean that there is an extensive diversity and therefore technology is easier to be advanced. When a country has a high population then it will be justified An economic development will be easily propelled especially when there are so many investors coming to the economy and are convinced that they will get markets for the produced goods and services. (Lucas 93)

Openness of the host country is also another condition which can attract the investors into the economy. An economy that is investor friendly will likely experience a high number of investors, the government regulations must not restrict business start ups in the market. The condition should be friendly therefore investors should be in a position to set up business facilities in the economy. When a multinational makes any profit and dividends, they should be allowed to freely repatriate the same to there home countries. The Asian tigers were so friendly to most of the investors who took their businesses in their countries. Singapore for instance, has got superb systems that make it easier for the FDIs. A complexity and regulations will definitely is courage investors from injecting their fortune into the economy. Openness also relates to the appreciation of technology and flexibility in terms of culture change and adoption. China is currently offering a number of professionals with the English training. This is to make the communication with other countries across the globe easier. The movement of the As discussed, FDIs is no doubt promoting economic development and therefore when the country is opened then the output in a nation will be higher. (Admati & Pfleiderer 491) Every economy across the globe requires an injection to have a continued virtuous circle of economic development. It is a fact that Foreign direct Investment plays an important role kin most of the developing nations across the world. It should be clear that the injections are more beneficial to the underdeveloped and the developing economies. A characteristic of these countries is that they lack needed savings and income to fund most of the projects. They cannot therefore meet the visions required investments in a nation. The foreign direct investments will therefore bridge the gap between the available resources and resources which are required to achieve economic development.

Most of this government must therefore formulate required policies that are investment friendly. The conditions must be those that favor the situations of doing business in that particular country. The policies relative advantage should be focused on coming up with the methods if adopted then the number of investors will increase in an economy. The virtuous cycle of development will be possible in these countries even as the international investors will be making profits. Attraction of FDIs will mean stability in the political system, stability in the financial system, development of infrastructure among other variables. There will also be the creation of employment and therefore improving the living standards of the people from these countries. In a nut shell the circumstances which are regarded as basic for the successful operations of the FDIs should never be assumed in the economy. The developing or underdeveloped which are receiving low level of investors should work towards enacting policies that will improve the conditions/circumstances in the economy. This will lead to an upsurge in the economic growth and development in economy

References Admati, Anat. and Pfleiderer, Peter Forcing firms to talk: Financial disclosure and externalities, Review of Financial Studies, 13, 479-520. 2000 Print Djankov and B. Hoekman, (2000) Foreign investment and productivity growth in Czech enterprises, The World Bank Economic Review, Vol. 14, No. 1 (Washington, D.C.), pp. 49-64.2000 Print! Lucas, Robert E. Why doesnt capital flow from rich to poor countries? American Economic Review, 80, 92-6. 19990 Print!