Foreign Direct Investment

The Indian Experience

Leena Ajit Kaushal

• Publisher: Business Expert Press
• Year: 2019
• Print ISBN: 9781949443493
• eBook ISBN: 9781949443509
• Topic: Economics
• Subtopic: Business General
• Index: Economics

This research based book offers insight to the changing perspectives regarding FDI from traditional theory to new theory, from local to global link, and from opportunity to responsibility.

Readers will understand the various factors, determinants, and theories that underpin the presence of firms in the global economy. The author illustrates, by way of case studies, specific implications of FDI policy and practice on issues like ecology and environment, technology transfer, labor market, and relevance of further liberalization policies in FDI in the context of Indian economy.

The coverage for such an important theme is too vast to cover in a single volume; therefore, this volume restricts its analysis to a select few themes in hopes that this endeavor will trigger an ongoing debate on myriad aspects and concerns of FDI on countries like India.

CHAPTER 1

Theories of International Trade and Foreign Direct Investment

Cross-national business activities are best explained with the help of international economics, international finance, and global business literature. However, over the last couple of decades, there have been significant advances in international trade, foreign direct investment (FDI) theories exploring rampant globalization and cross-border investment activities. International trade theories generally concentrate on reasons for trade flow between at least two nations. They also refer to the nature and extent of gains or losses to an economy besides addressing the effects of trade policies on an economy. Most theories of international trade like classical, neo-classical and product life cycle theory discuss the reasons for trade flow between nations (Morgan and Katsikeas 1997).

FDI theory, on the contrary, attempts to address the limitations of international trade theories. FDI attained a critical position in the global economy after the Second World War. Theoretical studies on FDI facilitates a better understanding of economic mechanism and behavior of economic agents, both at the micro and macro level encouraging cross border investments. FDI theories could be broadly classified under macroeconomic and microeconomic perspectives (Gray 1981; Petrohilos 1983; Denisia 2010; Lipsey 2004). Macroeconomic FDI theories highlight country-specific factors and align well with trade and international economics. Macro-level factors that impact the host country’s ability to attract FDI include market size, GDP, growth rate, infrastructure, ­natural resources, institutional factors such as political stability, socio-­economic factors, and so on, of the country, amongst others.

Microeconomic FDI theories being firm-specific relate to ownership and internalization benefits and incline toward industrial economics and market imperfections. These theories examine FDI motivations from the investor’s viewpoint and connect with firm-level or industry-level perspective in decision making. FDI theories are reasonably complex to explain and apply. The chapter attempts to summaries different FDI theories, however; there is no generally accepted theory, and every new approach is adding certain new elements with criticism or improvement on the earlier one.

Definitions of Foreign Direct Investment

IMF defines FDI as a category of international investment where the ­resident entity in one economy being the direct investor obtains a lasting interest in an enterprise resident in another economy known as direct investment enterprise.¹ The term “lasting interest” highlights the existence of a long-term relationship between the direct investor and the enterprise apart from the significant degree of influence in the management of the enterprise.

India Definition

FDI is characterized by a lasting interest which signifies the existence of a long term relationship and a significant degree of influence. In general, more than 10 percent ownership of the ordinary shares or voting power signifies this relationship. It includes both initial and subsequent transactions. According to the definition, FDI entails any foreign investment exceeding 10 percent limit through eligible instruments in an Indian listed company. However, all the existing foreign investments made under the FDI Route will be treated as FDI even if they are below the threshold limit.² FDI also entails initial investments below 10 percent threshold which are later raised to 10 percent or beyond within one year from the date of the first purchase. The onus of rising to this level lies solely on the company, and if it does not touch 10 percent mark, then the investment shall be treated as portfolio investment. Nevertheless, if an existing FDI falls to a level below 10 percent, it will still be treated as FDI without an obligation to restore it to 10 percentage or more, as the original investment was an FDI. Foreign Investment in an unlisted company, irrespective of the threshold limit is considered as FDI. However, an investor can either hold the investments under the FPI route or the FDI route, but not both.³

International Finance Corporation (IFC)

According to the IMF and OECD definitions, direct investment reflects the aim of obtaining a lasting interest by the direct investor of one economy through direct investment in an enterprise located in another economy. The “lasting interest” entails the existence of a long-term relationship between the two and a significant degree of influence on the management of the enterprise. Direct investment involves both the initial and subsequent capital transactions between investor and enterprise which could either be incorporated or unincorporated. Capital transactions which do not account for any settlement, like an interchange of shares among affiliated companies, are also recorded in the Balance of Payments and the IIP.

Direct investor and direct investment enterprise, as defined by the IMF and the OECD may be an individual, an incorporated or unincorporated private or public enterprise, a government, a group of related individuals, or a group of related incorporated and/or unincorporated enterprises which have a direct investment enterprise, operating in a country other than the state of residence of the direct investor. A direct investment enterprise is an incorporated or unincorporated enterprise in which a foreign investor owns 10 percent or more of the ordinary shares or voting power of an incorporated enterprise or the equivalent of an unincorporated enterprise. Direct investment enterprises may be subsidiaries, associates or branches. A subsidiary is an incorporated enterprise in which the foreign investor controls directly or indirectly (through another subsidiary) more than 50 percentage of the shareholders’ voting power. An associate is an enterprise where the direct investor and its subsidiaries control between 10 and 50 percent of the voting shares. A branch is a wholly or jointly owned unincorporated enterprise.⁴

Organization for Economic Cooperation and Development (OECD) 2008

The Benchmark Definition of FDI sets the world standard for direct investment statistics. It mainly focuses on the FDI statistics around direct investment positions and related direct investment financial and income transactions (flows).

The OECD Benchmark definition of FDI serves several objectives. It provides a single point of reference for compilers and users of FDI statistics. Apart from this it also gives clear guidance to individual nations in a compilation of direct investment statistics to develop or change their statistical systems. It provides international standards for FDI considering the effects of globalization. The international standard also provides the basis for economic analysis, especially for international comparisons and for identifying national deviations from the norm that impact on the comparison. The definition also guides practical users of direct investment statistics in studying the relationship of FDI to other measures of globalization. It governs in methodologically measuring differences between national statistics that are required for both cross-country and industry analysis of FDI.⁵

Several economic studies have recognized inter-dependence and complementary relationship between trade and FDI. Approximately 50 percent of world intra-firm trade takes place between affiliates of multinational enterprises. According to WTO members, FDI being a vital generator of business also need formal rules like the one developed for trade.⁶ A significant proportion of world FDI operations are already addressed in the WTO system of rules, for instance, the provision of services through commercial presence, as provided for in mode 3 of the GATS, is a form of FDI.⁷ According to UNCTAD, FDI in services sectors accounts for approximately half of world FDI stocks. Most of the existing Bilateral Investment Treaties (BITs) aiming to protect existing and future investment between the parties have “asset-based” definition and broad ­coverage of both FDI and portfolio. The OECD Code of liberalization of capital movements, on the other hand, adopts a “transaction-based” definition of capital movements. It lists all forms of transactions covered by the code to liberalize the capital movements instead of protection of the assets. FDI is the form of investment that establishes lasting economic relations by effectively influencing the management. According to the Canada-US Free Trade Agreement of 1988, the “enterprise-based” definition of investment deals with the acquisition of a business enterprise where the investor gets the controlling rights over the business.

International Trade Theories

International trade theories aim to explain international trade. Trade is the notion of exchanging goods and services between two people or ­entities however International trade is a step further where the trade occurs between entities located in different countries. Trade takes place on the pretext of profit making. Prima facie this may appear quite ­simple; nonetheless, there is a great deal of theory, policy, and business strategy involved in international trade. There is a brief description of a few ­significant international trade theories that form the very basis of trade relations between different nations.

Theory of Absolute Advantage

Scottish economist Adam Smith in his 1776 work, “An Inquiry into the Nature and Causes of the Wealth of Nations” illustrated absolute advantage as a certain country’s inherent capability to produce more of a commodity than its global competitors. Absolute advantage refers to the capacity of any economic agent to produce a larger quantity of a product than its competitors. Smith also used the concept of absolute advantage to explain gains from free trade in the international market. He argued that the absolute advantages enjoyed by countries in different commodities would facilitate free international trade through exports and imports. Adam Smith did not develop long-run growth theory but referred to the importance and effects of increasing labor productivity as well as saving which helps in deducing the conclusions on growth. Smith referred to technical progress as a means to raises aggregate output but profoundly emphasized on the potential of the division of labor for improving labor productivity.

Classical Theory of International Trade

English political economist David Ricardo in his book “Principles of Political Economy and Taxation” developed a Classical theory of comparative advantage is also known as the classical theory of international trade. It explains why countries engage in international trade even when one country’s workers are more efficient at producing every single good than workers in other countries. The theory adequately describes the scenario where a country produces goods and services in which it has advantages. However, after fulfilling domestic consum...

Table of contents

• cover
• halftitle
• title
• copyright
• dedi
• Abstract
• contents
• epilo
• preface
• 01_Chapter 1
• 02_Chapter 2
• 03_Chapter 3
• 04_Chapter 4
• 05_Chapter 5
• 06_Chapter 6
• 07_Chapter 7
• 08_Bios
• 09_Index
• 10_Adpage
• backcover