Foreign Direct Investments: Impact on the Growth of Domestic Companies
Foreign direct investments are opportunities for an individual or corporation to engage in business-related activities in a foreign country by conducting business operations or acquiring business assets in the foreign country by acquiring full ownership of the asset or controlling interest in a foreign company. Foreign direct investments are frequently associated with open economies and have existed since the dawn of civilization. The impact of foreign investments has brought about both negative and positive effects to a country, and the sector that is most affected by the foreign direct investments is the domestic companies, thereby, this essay takes a look at conflicting opinion by economists and philosophers on the impact of foreign direct investments to the growth of domestic companies. Empirical studies conducted on the role played by the foreign domestic investments in regards to the growth of domestic companies provide conflicting information, especially about developing countries.
Economists' Argument: Hinderance of Domestic Companies' Growth
Economists such as De Backer and Sleuwaegen favor the argument that foreign direct investments hinder the growth of domestic companies. They argue that the entry of foreign firms into the domestic market brings about crowding effects in the economy of host country which is brought about by some factors. The foreign firms, upon entry into the market, tend to compete with domestic firms for the market of the products produced, therefore, due to the appeal that is created by this firms. The growing domestic firms are unable to sell the goods produced leading to losses and increasing cost of their production, therefore, the firm's growth is inhibited, thereby, thrown out of the market. Another reason that leads to crowding effect is the financial manpower that is often associated with foreign direct investments. Foreign firms that have access to enormous financial resources tend to bully the domestic firms due to their ability to invest lump sum amount of money to the businesses giving the competitive edge against the domestic forms. The firm's ability to produce quality goods owing to the financial power leads to increased customer loyalty in the domestic market. Therefore, the market for domestic companies reduces and, as a result, is thrown out of business (Caves 96).
The foreign firms that move into a country as a result of foreign direct investments bring about panic to the domestic companies due to fear of losing the market to them since they possess the financial power to out muscle them in the market. As a result, employees tend to fear for their job security, thereby, unable to perform at the highest level leading to poor performance in the market and eventually decline in the growth of domestic companies (Chan 123).
Foreign direct investments lead to negative wage spillers which occur when the foreign firms offer high salaries and huge remunerations to domestic workers causing the domestic firms to lose employees to the foreign firms. The response of the domestic companies which force them to artificially increase the wages of their workers leads to increased cost of production in a bid to hold on to their workers, thus, leading to losses, as well as the decline in competition, a factor which directly inhibits the growth of domestic firms. Studies done by Gorg and Greenaway indicated negative spillovers arising from the segmented markets which foreign firms quickly gain an advantage over. The entry of foreign firms to a domestic market, as a result of foreign direct investment, may also account for a decline in growth of domestic companies.
The technological advantage brought about by the foreign firms often brings efficiency in production on the part of the foreign companies while also lowering the cost of production. The two factors are crucial in sustaining the existence of firms in any economy and, therefore, provide a competitive edge for the foreign companies rendering domestic companies minimal chances of competing for the market of their products. The loss of market, consequently, inevitably brings about the decline of local firms.
The encouragement of foreign direct investments is at times associated with many financial signatories, especially in instances where the government of the host nation requires significant financial investments to boost the economy in situations where it is not performing. In such circumstances, the government may experience a compromise in sovereignty, especially if loans provided to the government have obligations attached. Due to the strict rules attached, especially during payments, the domestic government carries out unfavorable businesses practices which include the charging of high taxes to domestic firms to raise the huge interests associated with the loans. Therefore, the increased taxes increase the cost of production effectively rendering the domestic companies out of business.
Foreign direct investments, especially in instances whereby the government of the host nation encourages them, may, in turn, lead to the decline of the domestic companies. The national governments which encourage the FDIs by creating enabling businesses environments through tax holidays and subsidies to fasten the economic growth of a country tend to affect the existence of domestic companies negatively. The incentives directed to the foreign firms give a competitive advantage by lowering the cost of production of the foreign firms, hence, offer cheaper goods to the market, a situation which domestic companies are unable to match leading to declining, therefore, inhibiting their growth.
In situations where the country involved is a developing country, the impact of FDIs on the domestic companies may prove to be hazardous due to the availability of abundant resources which provide an opportunity for huge returns on investments. However, foreign firms due to the financial and technological advantage tend to dominate the capital market which is associated with huge returns while the domestic companies are left to engage the labor market which is characterized by low returns as compared to the capital market. The investment in capital markets tends to give the foreign firms competitive dominance and can grow while the domestic firms with little returns in the labor market are unable to match them, thereby, leading to inhibited growth.
The entry of foreign firms into the economy as a result of FDIs has a big impact on the exchange rate between countries. The effect imposed on the foreign exchange may be brought by choice of the foreign firms to invest their profits back to their mother countries, a situation which negatively affects the value of the domestic currency which lowers the value of the domestic currency against the foreign currency. The result of the devaluation of the currency is the increase in domestic products compared to foreign, therefore, the volume of exports is automatically reduced, hence, foreign firms in the business experience difficulties which lead to the closure of their business.
The encouragement of foreign direct investments, especially by developing economies to spark economic growth in their economies, is a threat to the future operations of domestic firms owing to the over-exploitation of resources by the foreign firms. According to the dependency school of thought, the long-term effects of FDIs to the economy of a country are catastrophic to the economic growth of the country due to the overexploitation of resources of the host nation. The exploitation of resources is coupled by the investments of profits acquired to their respective country, thereby, rendering the host country resource-crippled in the long run. The shortage of resource or extinction spells doom for the domestic firms who face resource shortage exploited by the foreign firms, hence, inhibiting their growth.
Another effect of foreign direct investments that negatively affects the growth of domestic companies is the transfer of resources on lease periods or the acquisition of resources during their investment period. The acquit ion of these resources which is often used by developing countries to lure foreign firms denies domestic companies access to the use of the resources, therefore, unable them to compete with their foreign counterparts due to limited resource access as a result of the foreign companies gain monopoly over provision of goods and services involved in any dominate the market, a situation which puts domestic companies out of business inhibiting their future growth.
Opposing Arguments: Positive Impact of Foreign Direct Investments
However, other new liberal economists, such as Barry Julian Eichengreen and Richard E. Caves, argue against the notion that foreign direct investments hinder the growth of domestic companies and encourage domestic markets to open up to foreign markets to work freely. In their defense, they argue that foreign companies or investments associated with FDIs offer essential opportunities that spur the growth of domestic companies. Foreign direct investments inject competition into the economy, thereby, raising the competition level in the country they are hosted. Competition causes the domestic companies to increase their productivity, increases the quality of their products, and allows for innovation of new products due to better market research and lowering their general prices. The factors mentioned, therefore, increase the attraction of the products to the market, as well act as a motivation factor leading to the growth of the domestic companies.
Foreign direct investments also positively affect domestic companies, therefore, leading to their growth and development, especially in instances of merges. The merging of foreign firms with domestic companies brings about better governance and management practices all achieved through the imposition of internal reporting systems, principles of formation and closure, and imposition of their own company policies. The result of the new business practices is seen through increased production, huge returns on investments, growth of domestic firms through expansion of branches, and creation of better business environments encouraged through the corporate transparent policies introduced by the foreign firms which eliminate corruption and poor businesses practices.
The encouragement of foreign direct investments to country is often associated with the provision of resources, such as technology, capital technology, entrepreneurial skills, access markets, and managerial skills factors, which are essential towards economic industrialization and creation of jobs leading to the alleviation of poverty. The rise in per capita income is essential to the domestic companies due to the creation and expansion of the market of goods and services for the domestic companies which get ready market as a result of increased expenditure for the citizens for the goods produced by the domestic firms (Smarzynsk 23). The increase in market leads to increased profits, as well as expansion of the business, leading to growth of the domestic market.
Domestic companies benefit highly from the existence of foreign firms as a result of foreign direct investments in terms of taxes reduction by the government when trying to fasten the growth of the economy. The use of tax cut to attract foreign firms is often employed by the government so as to attract investors, as a result, the government is pressured to level the playing field, thereby, extending a similar gesture to the domestic sector. The reduction in tax, as well as provision of tax holidays positively, affects impacts on the returns of the companies due to reduced cost of operation, hence, the domestic enterprises can realize more profits, thus, promoting their growth. There are also significant spillover effects associated with foreign direct investments with one of the key effects is the introduction of new technology introduced to the host country. The introduction of new technology which is often done through training, provision of technological assistance by the foreign expatriates, as well as sharing of information in the field of management and business operation techniques, is of particular importance to the domestic companies. The new technology introduced boosts the domestic firm's performance as cheaper ways of production are invented, as well as increase in research on gaps to be exploited, and product innovation are laid emphasis on leading to the growth of domestic companies.
The incorporation of foreign direct investments also results in other bilateral relations between the countries involved, therefore, opening doors for the interaction of the economies through the exploitation of foreign markets. The opening of foreign markets allows the domestic firms to get involved in the multinational supply chains and, as a result, increase their market base to enable exportation of their products and services, thus, stimulating economies of scale. Positive spillovers in the labor market through vertical linkages achieved through the movement of employees to foreign markets, thereby, enable them to acquire skills and expertise which are in turn incorporated into the domestic firms. Hence, the exchange of employees through the vertical linkages provides a platform for discussion of ideas and experiences positively impacting the growth of domestic companies.
The development of supplier-customer linkages between the domestic firms and the foreign firms is also an important factor brought about by foreign direct investments due to the vast sharing of knowledge experienced by the foreign institutions. This knowledge diffusion that is directed to the domestic firms is achieved through the setup of higher quality products and service bars, better management, and organizational skills which are associated with technical assistance to the domestic firms. Therefore, leading adaptation of the practices which, in turn, increase the productivity of the domestic firms positively affects the growth of domestic companies.
The foreign firms may further provide the domestic firms with the knowledge required to penetrate the overseas market in instances of export-oriented foreign direct investments (Chan 67). The new knowledge acquired from the experiences of the foreign firms' wealth in the international market positively influences the domestic firms' involvement in the export market, therefore, leading to engagement of business transactions which are researched, as a result, boosting their growth and development through exploitation of trade channels and markets that have been approved by the international firms.
The presence of foreign firms through foreign direct investments may bring about demonstration effects to the host country. The effects which arise as a result of demand for more competent and skills workers in the labor market may pressure the government involved to invest more in education for the labor market to compete at the levels laid down by their foreign counterparts. The rise in education levels which lead to production of a skillful labor force positively affects the domestic firms which benefit from the qualified labor force leading to increased efficiency brought about by creation of a pool of knowledgeable workforce at the disposal of domestic companies, a factor that increases the quality and quantity of production of goods and services leading to ultimate growth of domestic companies.
Another positive impact of foreign direct investments to domestic firms is the provision of capital accumulation to the economy. The provision of capital affects the economy in two ways: first is through the investments in technology while the other is through direct investments to the economy, the latter is where domestic companies benefit from as they can acquire capital for the running of businesses and also the expansion of the activities (Chan 13). The new found capital which is provided to the domestic firms through loans and grants helps to expand the scope of business, therefore, enabling the firm to produce more, while at the same time, investment is risky, but high return venture, thereby, leads to their growth.
Foreign direct investments may also positively affect the transactions of domestic firms involved in international trade with the domestic firms affected by the changes that occur in the relations between exchange rates of countries. In situations whereby the foreign firms boost the domestic currency through investments into the host economy, the domestic currency increases in value, therefore, increasing the value of the exports in monetary value, hence, the domestic firms involved in trade with other foreign countries experience favorable and positive incentives to engage in exportations promoting their growth.
There are also indirect benefits that spur the growth of domestic companies, especially in areas related to economic growth. The impact in the sector which is experienced through investments which bring about economic growth through the development of infrastructure, employment increases, and improvement in the business environment is of great benefit to the domestic companies. The domestic companies benefit from the better operation conditions due to the improvement of infrastructure, the expansion of the market for their goods which is achieved through the employment increased level. (Fischer 45).
In conclusion, the arguments portrayed by both sides in economic thought provide convincing information to warrant the support of the notion that foreign direct investments inhibit the growth of domestic companies, as well as oppose the concept that FDIS do not inhibit the growth of domestic companies. Accordingly, foreign direct investment is a good move for any economy owing to the benefits that they offer both to the economy and the domestic companies themselves but should be done with protection from the government for the domestic companies to prevent their downfall.
Works Cited
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