Foreign Direct Investment and Financial Liberalisation

Introduction

To begin with, it should be stated that the paper is aimed at arguing on the matters of Foreign Direct Investment principles and rules, taking into consideration the issues of market liberalization and restructuring. Foreign Direct Investment can be said to be the concept in which a company from a foreign nation makes a physical investment in another. This may involve establishing an enterprise such as building a factory.

Foreign domestic investment basically involves establishment of an enterprise by a foreign investor in a certain nation. Simply put, FDI infers to any form of investment interest that is earned by any particular enterprise outside the traditional territory. Foreign direct investment mainly consists of a Multinational corporation operating from a host nation and doing business in other countries. An FDI establishment usually consists of an international business in a parent nation that has foreign affiliates in a number of countries. Control over a foreign affiliate investment is a requirement for an FDI to pass as one.

According to the International Monetary Fund, control means the ownership of at least 10% of ordinary shares or voting power of the foreign affiliates. An ownership of less than this percentage means that the investment is referred to as portfolio investment (IMF, 2006). At the same time any firm would likely qualify to be classified and the FDI if it possesses a certain level of power to vote within the setup of the business enterprise or subsidiary that exists in a foreign country.

FDI or foreign direct investment as is commonly referred to can variably be used as a tool to measure the ownership of such productive assets as factories, land mines and so by a foreigner. The measure can also be extended to measure the scope of globalization in economic terms.

For the FDI to thrive there should be a mutual relationship between the subsidiary abroad and the parent company at home. This relationship in turn gives rise to multinational corporations. In comparison with the other research papers, this one regards financial liberalization and structural reforms as the key reasons for foreign direct investment, while the other authors prefer regarding deeper reasons and tools for successful foreign direct investment.

Objectives

What are the main determinants of Foreign Direct Investment? Foreign Direct Investment is mainly determined by the economical and commercial atmosphere of the recipient country. However, there are other determinants as well and they include such things as the stability of the country, the labor system of the country and the market environment in the country.

Structural reforms are very instrumental in the Foreign Direct Investment inflows in all countries in the world. However, the countries that are found in the Eastern European and the Latin American Countries have been very much helped by the introduction and implementation of structural reforms in their countries. This can be attributed to the fact that structural reforms are very instrumental in ensuring that the country is always attractive to the foreign investors. This is because structural reforms help a country in ensuring that the economical climate of the country is attractive to foreign investors as well as the country being stable in such things as the economy, prices, and trade and labor systems.

One of the countries that have benefited through this approach is Brazil which made introduced and implemented structural reforms and now is one of the richest countries in the world and is one of the rapidly growing economies in the world. Another country that has benefited is Norway which has continued to be a very successful country and this can be attributed to the fact that it also introduced and implemented structural reforms which have helped it very much in ensuring that the economy has grown rapidly over time.

Motivation

The motivation of this speech is that structural reforms have a direct impact on the foreign direct investment. This can be attributed to the fact that the countries that have introduced and implemented structural reforms have been noted to efficiently utilize the inflows from the foreign direct investment to stabilize their economies and also enhance the rapid growth of their economies. One of the most important things to note is that structural reforms are very instrumental in ensuring that a country’s economy is attractive to the foreign investors who will ensure that the country achieves a significant economical growth. Structural reforms ensure that a country has a stable economical climate as well as well organized labor systems in the country.

Structural reforms have a very positive effect on the growth of a country and this is because the country finds it easy to adopt some new policies which when implemented boosts the growth of the economy. Structural reforms also are beneficial to a country because it enhances the productivity of the country hence ensuring that the country is a competitive entity in the global market. This is because structural reforms ensure that the country is focused on producing quality products hence ensuring that it is very competitive in the international market.

Structural reforms also ensure that the country have higher employment rates hence the need for the country to ensure that many industries are employing the citizens to full capacity. From this point of view, it is necessary to mention that Different economic factors encourage inward FDIs. These include interest loans, tax breaks, grants, subsidies, and the removal of restrictions and limitations. Factors detrimental to the growth of FDIs include necessities of differential performance and limitations related with ownership patterns.

Thus, Campo’s consideration on the matters of market liberalization is regarded to be overlooked. This can be attributed to the fact that the country also implemented policies, which ensure that the industries in the market are competitive in the international market hence ensuring higher returns and the capability of employing more people. As for the reasons of regarding the financial liberalization as the prerequisite for simplified FDI, it should be stated that Some FDI procedures entail the transfer of strategic benefits.

FDI activities may be carried out to provide the sufficient level of optimization of available capabilities and economies of scale. From this point of view the FDI and the process of liberalization should be regarded as the efficiency seeking tool. It is generally the additional motivation factor, which Campo does not regard deeply.

However, a very important aspect of the structural reforms has been overlooked in many studies. When implemented positively, structural reforms will also ensure that the country is having a very encouraging capital flow. This is merely by the fact that foreign investors when they are investing in the country, there is an increased flow of capital within the country. This aspect is one of the motivating factors of the study of structural reforms and how they help a country in ensuring that there is a high level of capital flow in the country.

The fact that this study has not been fully researched into can be attributed to axiomatic reasons. This is because structural reforms can differ in outlook and different structural reforms may different effects on a given economy. This can be evidenced by the fact that structural reforms in the Eastern European countries and the Latin American countries have been very successful in ensuring that the countries are very attractive to the foreign investors hence ensuring that the foreign direct investment inflow is very beneficial to the countries’ economies. However, other countries have not been able to implement the positive structural reforms which can be attributed to the situation the countries are in.

Many of the third world countries have had different results and they have not been very instrumental in ensuring that the countries are benefiting economically. This has been highlighted as one of the problems which hinder the development of the third world countries. However, this case has not been felt by the second world countries which have also continued to be economical giants because the reforms have been very well articulated and sometimes they have been held a joint by countries of a given region.

Determinants of Foreign Direct Investment

Foreign direct investment has various determinants and they can be categorized by two broad categories which are classical determinants and structural reforms. Classical determinants include such aspects as the infrastructure in a given country, the size of the market, economical or macro stability, the institutions as well as the natural resources a country is endowed with. Structural reforms focus on such aspects as the financial liberalization, the privatization in the country and liberalization of trade.

The calculation of the foreign direct investment is done using two approaches which are FDI in relation to the GDP of a given country and FDI in relation to the per capita of a given country.

Financial Liberalization

Financial liberalization also referred to as economic liberalization is whereby a government relaxes its control over economic and financial activities in a given country. The concept encourages wider and greater participation by the private sector and in the same respect it reduces the government involvement and control of the economical activities in a country. Many of the developed countries in the world have been using this economical approach to ensure that there is increased mobility of the capital within the country and that the country will still remain as a world leader in economical terms.

Financial liberalization also ensures that there is increased effectiveness and efficiency in the market and in return the private sector is afforded such incentives as reduce tax rates, flexibility in the labor market, and reduced restriction to both domestic and foreign investment. Some experts have linked the concept of financial liberalization to the concept of neo-liberalism (Alfaro, 2004).

Originally, the Financial liberalization is often regarded as a controversial issue as there is little empirical evidence for its positive effects on economic growth.

In the developing countries, there is a difference in the way financial liberalization is viewed. Whereas the developed countries view economic liberalization as opening the markets to the investors, the developing countries view this as opening the market to foreign investors from the developed countries. This has been meted with some criticism because the developed countries have been deemed to be benefiting at the cost of the developing countries.

Most of the developed countries are found in the European Continent and North American Continent whereas the weakest regions are Africa, Asia and Latin America. Many countries from the weak regions especially those in Asia and Africa have been exploited by multinationals from the developed countries and hence the reason for the criticism (Sullivan, 2003).

Taking into consideration Campo’s point of view, there is strong necessity to regard financial liberalization from the perspective of forced investments. Thus, these investment processes generally had the tendency to increase in the circumstances of below-market return. Originally, this tendency causes the negative effect on the financial institutions, and makes essential obstacles for making new profits.

However, economic liberalization has been very beneficial to some countries like Brazil, China and India. These countries have been recording the fastest growing economies in the world and this can be attributed to the fact that they have fully liberalized their economies and they have been giving incentives to the foreign investors which encourage more investment in the country. This can only be achieved if the government is willing to protect the domestic investors from unfair competition from the foreign investors as well as ensuring that the domestic investors are also given incentives to ensure that they can compete on a fair level with the foreign investors (Singh, 2005).

Structural Reforms and Foreign Direct Investment

There are various structural reforms that the emerging economies can make to ensure that they attract and benefit foreign investments. Financial reforms fare very importantly for emerging economies although the investors from foreign countries are not always financially constrained. Structural reforms are one of the best signals that attract the foreign investors and this can be rooted to the fact that they create benefits for the foreign investors and this is through their manipulation of the major parameters that influences a foreign firm to invest in a country. The most notable parameter is the reform of the domestic economic activities (Singh, 2005).

The development of a country financially has been noted by many experts to be the most crucial element of economic development. This concept has been rooted to the fact that the countries which have well developed financial markets have also the best capabilities of utilizing the foreign direct investment present in that country in a more efficient way.

There is a potential for the foreign direct investment in a country to general benefits but if their financial markets are not fully developed, then the potential is lost of taking advantage of the foreign direct investment. The recipient country has a role to play so as to ensure that the country benefits from the foreign direct investment that is present in the country. This can only be achieved by the government of the recipient country ensuring that there are reforms that seek to maximize the country’s benefits from the foreign direct investment (Alfaro, 2004).

The central financial activity subject, which is engaged in performing the FDI processes is the central bank. Originally, it stands for providing liquidity support for the financial system of any State. This support is performed by offering credits to the shareholders of financial institutions and to firms, and relieving firms that had acquired foreign debt. Moreover, the opportunity of giving credits may be opened for the foreign financial structures, which choose the FDI for expanding their financial activity. Nevertheless, as researchers often state, the FDI activity is possible only

The most important thing to note is that financial reforms help greatly in ensuring that the country is attractive to the foreign investors. Foreign investment inflows can only be enhanced by the country addressing some structural reforms especially in the financial markets and their development. Countries in Eastern Europe and Latin America have started gaining from the FDI and this can be rooted to the fact that the countries have adopted the right reforms especially during their transitions.

Another reason can be attributed to the fact that these countries from these regions have more stable macroeconomic environment and this cannot be said to be true to other countries especially in Africa and Asia. It is important to note that the foreign investors are attracted to the countries that have stable macro economical environment and also have higher levels of economic development. There are also other things that investors put into consideration and they include such things as the environment, infrastructure and in better trading conditions, the financial reforms will have a very positive impact on the economy of the recipient country (Sullivan, 2003).

Financial Reforms

There are three indexes that are used to measure the financial development and the depth of the financial development. FD1 is used to measure the overall financial development death and FD2 is used to measure the efficiency of the financial intermediaries such as banks. FD3 is used to measure the stock market’s financial development. These measurements make up three variables.

The ratios of the gross domestic product’s liabilities which are liquid and which are based on the liquid liabilities which are accrued to the financial institutions in a country also use the three variables. This is done by looking at the demand and the interest of the currency and the interest bearing liabilities of the financial and non-financial institutions of the country. It is also important to look at the ratio of the private sector’s credit to gross domestic products. Another important thing to consider is the commercial banks’ assets and the total sum of the commercial banks as well as the central bank’s assets.

Privatization

Another important aspect of the structural reforms is the aspect of privatization which has benefited many countries in improving their economical development and also ensuring that the country is rapidly developing. This can be attributed to the fact that privatization is a very instrumental way of ensuring that the country is exercising financial liberalization. This is because privatization ensures that the government control is limited to all financial activities in the country.

When measuring the rate of privatization two measures are usually used. These measures include the government proceeds from privatization and the government revenue from privatization but there is need to exclude the revenue held by a foreign buyer.

Foreign Investment in New Markets

During the late 1980s, there was massive collapse of the socialist systems and also the import-substitution systems and with this collapse, there was opened a number of opportunities for investing. Some of the best regions that were offering foreign investment opportunities are those that are located at the Eastern Europe and Latin America and this can be attributed to the fact that these countries had been industrialized to some extent although the labor in those markets was not fully developed.

It is important to note that foreign direct investment helped these countries very much in the development of their economical technology and this is why they are some of the leading economies as far as growth is concerned. Foreign direct investment also played a very important role in ensuring that these economies were very competitive in the international market and this can be attributed to the various technological advancements that the foreign direct investment introduced in these countries (Prasad, 2003).

However, these are the only countries with emerging economies that have been able to positively utilize the inflows of the foreign direct investment. Other countries in some of the poorest regions of the world have not been able to take the advantage that the foreign direct investment has been affording other emerging economies. However, the problem can be viewed in two ways; the foreign investors in these regions have the agenda of exploiting the economies of the third world countries and the other approach is that the third world country as not quick to introduce the structural reforms that can ensure that the countries benefit maximally from foreign direct investors (Singh,2005).

On the other hand, investing into economies of Third World countries makes them dependent on the investor’s finances, and discourages countries from independent financial development. Thus, a country has an opportunity to become a raw material appendix with the economy, conquered by foreign capitals.

On the part that the foreign investors have been exploiting the economies of the third world countries can be expressed by the fact that the multinationals in the world’s poorest countries benefit from the fact that there is cheap labor and the government has given the multinationals tax incentives and yet the multinationals sell their finished products at very high costs in the country. This means that the situation is only benefiting the foreign investors and in the extreme opposite worsening the economy of the recipient country (Campos, 2008).

There is also the fact that the third world countries have not undertaken the best structural reforms to ensure that they benefit maximally from the foreign direct investment. This can be attributed to the fact that the countries have been subjected to bad leadership or the fact that the developed countries have introduced policies which hinder the countries from ever making a progress. This can only be changed through the government coming up with new policies which will ensure that the countries are not victimized by the developing countries or the multinationals. However, the government must ensure that it introduces policies which are attractive to the foreign investors as well they ensure that the countries benefit from the inflow of the foreign direct investment (Kaminsky, 2000).

Main Findings

The research found that structural reforms attracted foreign direct investments in any country but especially in the regions of Eastern European and Latin America. Financial liberalization in these two regions and also privatization were deemed to be more important than the other determinants of attracting foreign direct investment. The link between the financial direct investment and the financial sector reforms are mainly in the areas that include the supervision, stock market development and the credit ceiling which should be lessened for ensuring that the country is attractive to the foreign direct investment.

The paradox of financial reforms can be said that it only matters to the firms which are not in any way constrained financially because they offer better speculation of the future trends of the financial status of the country.

From the econometric point of view it should be stated that the issues of FDI are regarded as the essential factors for changing and modifying the economic system of a country. Originally, the financial coefficients stay comparatively the same, as the main issue associated with spatial confidence is included in the matters of probability values. Thus, one’s assurance in the results should amplify. The spatial autoregressive variable (LAMBDA) is statistically essential for both spatial error models, moreover, it will be useful for further indicating the improvement over ordinary least squares.

The data, which is represented in the paper is detailed enough, thus, all the required analyses may be performed with comparatively high precision, nevertheless, the complexity of the issue prevents from capturing the very essence of the regarded matters. Especially this is related with the matters of the impact of financial liberalization on the processes of FDI in the perspective of financial independence of the country, whose economy is invested.

Conclusion

This paper come to the conclusion that foreign direct investment has been very instrumental in ensuring that the Eastern European Countries and the Latin America Countries have benefited and this means that their economies are some of the fastest growing economies in the world. This can be attributed to the factor that foreign direct investments have introduced various technologies that have been very instrumental in ensuring that the economies have developed very rapidly.

On the other hand some of the developing countries have not been helped by the foreign direct investment and this can be attributed to the fact that these countries have not been implementing structural reforms. One of the most important things to note is that the structural reforms are very important for foreign direct investment in the recipient countries.

Resources

Alfaro, L., A. Chanda, S. Kalemli-Ozcan, and S. Sayek, 2004, “FDI and Economic Growth: the Role of Local Financial Markets,” Journal of International Economics 64: 89–112.

Campos, N. F. and Y. Kinoshita, 2008, “Foreign Direct Investment and Structural Reforms: Evidence from Eastern Europe and Latin America,” IMF Working Paper No. 08/26.

Kaminsky G. and C. Reinhart C, 2000, “On Crises, Contagion, and Confusion,” Journal of International Economics, Volume 51, Number 1, pp. 145-168(24).

Prasad, E., K. Rogoff, S. Wei, and M.A. Kose, 2003, Effects of Financial Globalization on Developing Countries: Some Empirical Evidence, IMF Occasional Paper No. 220 (Washington: International Monetary Fund).

Singh, A., A. Belaisch, C. Collyns, P. Masi, R. Krieger, G. Meredith, and R. Rennhack, 2005, Stabilization and Reform in Latin America: A Macroeconomic Perspective on the Experience Since the Early 1990s, IMF Occasional Paper 238.

Sullivan, A; Steven M. S. 2003. Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 551.

International Monetary Fund (IMF), 2006. Balance of Payments Manual, fifth edition (Washington, DC).