The world is a global village means if we want anything in today’s 21st century, we can access it with the help of money and technology, quick accessibility makes the world interdependent on each other for needs or requirements, but have you ever wondered how your favorite cell phone company, for example, Apple can change their production base from the US to your country too but bow the question is how is it possible? And the answer FDI means foreign direct investment from that country in your country.
What is FDI?
A Foreign Direct Investment is an investment made by a foreign company or an individual in a foreign country keeping business interests in mind.
For example, US multinational company Apple started a factory in INDIA to produce smartphones and laptops. Then it is counted as FDI. With the help of FDI, investors establish foreign business operates or acquires foreign business assets i.e.
Establishing ownership or controlling interest in a foreign country.They not only brings money with them but also brings down skillful workforce, give employment to the destined country ,knowledge ,technology which will help the developing country to develop alongside with developed country and keep in pace with them.
Where did FDI is made?
Foreign direct investment are commonly made in open economies that have more skilled workforce and keeping economic growth in mind .FDI brings more money to the destination country as well as more skills, technology, and knowledge, etc.
When did in India FDI get started?
In 1991 Indian economic crisis was a result of poor economy policies and the resulting trade deficits. In order to mitigate the ongoing economic crisis the the then Prime Minister P. V. Narasimha Rao appointed Manmohan singh as the finance minister of India. After that Indian economy opened its doors to Privatization ,liberalization and Globalization .Later is called as LPG model of Indian economy.
The program of economic policy reform in 1991 has yielded amazing results, improving the life style of Indians. In that year itself GDP rose up to $266 billion in 1991 to $3 trillion in 2019 (1100%).While PPP rose from $1 trillion to $12 trillion in 2019(1100%).
FDI is an important monetary source in the field of Indians’ economic development .Today india globally ranked as the number 1 in the Greenfield FDI ranked and a part of top 100-club on ease of doing business.
factors that affects foreign direct investments are:
- Skills and Wage costs of labor:
- Currency Stability:
- Labour Skills:
- Transport and Infrastructure:
- Size of economy/potential growth:
- Tax rates:
- Access to free trade areas:
- Exchange Rates:
- Commodities:
- Political Stability:
Skills and Wage costs of labor:
The multinational company that invests abroad is to outsource –intensive production to countries with low wages. If wages in the developed country are $10 per hour but in regions in the Indian subcontinent the cost is $! Per an hour. In this way, costs can be reduced by outsourcing production. That is why many European and American firms have invested in clothing factories in the Indian subcontinent.
It is also found that FDI leading to higher wages, higher productivity, and increased wage inequality, mostly due to an increase in the skill premium. This is why there is a difference between the rate of wages of skilled and unskilled workers.
Wage rates don’t affect FDI, countries with high wages still able to attract higher investment tech giants. For example, Singapore is among the most costlier countries to live in but countries like the US, Germany, France, Britain still invest in Singapore. Because of its infrastructure and business-friendly ecosystem where a business can grow rapidly.
On the other hand, companies may be reluctant to invest in Africa regions because low wages are out weighted by other drawbacks, such as sub-Saharan regions are land-locked countries where infrastructure and transport links are not so good.
Currency Stability:
If the host country has a weak exchange rate the country can attract more FDI because it will be cheaper for the multinational companies to purchase assets. Companies are often attracted to invest in the same exchange rates and with volatility exchange rates invested companies are discouraged to invest in.
Labour Skills:
Some industries require high skilled labours for example electronics, IT, AI, Pharmaceuticals, Investment banking, Electronics etc. So multinational companies prefer to invest in those sectors of countries with a little investment they can get high-quality labour productivity with low wages.
For example in India English is the official language and most people speak good English, so India has attracted significant investment in call centers because the highest percentage of people speak English and with low wages, they can make the most out of it.
India also has a conducive environment to attract FDI in the fields of service sector which attracted the highest FDI equity in 2021 followed by computer software and hardware, telecommunications, and trading sector because people in India in these sectors are highly skilled with wages.
On the other hand, Singapore is one of the most expensive cities in the world to live in and worldwide known as the financial hub of Asia. It’s a place with great expatriates, investors, and entrepreneurs with highly skilled workers.
It is a great place for financial trade, excellent infrastructure, and has a stable progressive legal and regulatory framework those are the reasons that make it appealing to attract a high flow of FDI to this amazing country to invest in.
Transport and Infrastructure:
When it comes to Transport and Infrastructure the desirability of investment increases when a country has a high quality of infrastructures like roads railways ports and aviation infrastructure. A country may have low wages but if it is landlocked then how the goods imported to the world market.
Singapore and hong-kong are both examples of countries that have taken a competitive advantage from their geographic location in terms of trade facilitation. Countries with access to sea and port had an advantage over the land-locked countries, which will have high charges on ship goods.
Size of economy/potential growth:
FDI sometimes attracted by the size of the population. the economic condition of the host country and the scope of the economic growth of the involved country because selling goods directly to the host country is quite easy sometimes. For example European country with a large population base. Auto mobile Companies like Fiat in Italy, Volkswagen in Germany,easten part of Europe like Poland, the fashion capital of the world France for its luxury items companies invest and build factories to sell the growing consumer class.
Small countries with less population are at a disadvantage because it is not worth investing in a small population. Now china and india will be a target for foreign investment as these countries are the newly emerging market the could demand the goods and services of the multinational company.
Tax rates:
Multinational corporations don’t like to pay their fair share of taxes. They will do everything in their power to exploit loopholes and minimize their tax liability. Major multinationals such as Amazon, Apple, Google, and Microsoft have the interest to invest in countries with low fair tax rates or negligible and a business-friendly environment.
Countries like Irelan, Luxemburg, and the cayman islands-destinations where tax rates are low or negligible in fact it has been controversial because google and Microsoft have funnel all their profits through Ireland, despite having operations all over Europe.
Access to free trade areas:
It is a significant factor for firms investing in a place where there is less tariff barrier, harmonization of business rules and regulation and free movement of people. For example major firms invests in Europe dut to its access to EU single market which is all time a free trade area.
After Brexit, UK is less attractive in terms of FDI due to outside of the single market. Now with the creation of the African continental free trade agreement (Af CFA) Africa now becomes a single market for trade. With this African rise their hope for larger FDI and to have a growing economic condition.
Exchange Rates:
A weak exchange rate in the host country like most of the African countries can attract more FDI because it will cost cheap for the multinational countries to purchase assets. In Vietnam, its currency is flexible to attract investors.
In EU expect Denmark all the European countries have EURO as their currency so it s quite easy for the investors to deal with a fixed currency rate, therefore it attracts a large sum of FDI. However, volatility in exchange rates could discourage exchange rates.
Commodities:
One of the major reasons for the FDI is existence of secure supply of commodities. It has been the reason for growing FDI in African and China.
Political Stability:
The politically stable country has a high chance of influencing the investors for inward FDI in the developed country while in the politically uncertain countries foreign investors are hesitant to invest due to sudden policy reversals. so in politically stable economies are the ideal type for foreign investors to invest in.
For example, the Russian economic crisis combined with economic sanctions is a major factor to discourages foreign investors to invest in the country. That is why most of the communist countries in Europe joined hands with the European Union.EU is a single market with more political and economic stability, which attracts foreign investors.
Conclusion:
There are different factors that determine foreign direct investment and it is difficult to segregate individual factors. There are many variables such as type of industry, macro-economic stability, more skill full people, their culture and heritage, health and educational infrastructure and language plays a pivotal role in order to attract the FDI.
Low-wage costs tend to be more important as they are labor-intensive industries to work in. It is also depending on the source of FDI for example American firms may give preference to more political openness or may value countries where English spoken is more.
I am a girl who’s passionate about charts and numbers in economics and enjoy converting them to simple lines so that any layman can understand them easily.