Foreign Direct Investment in Economics

Explore the concept of foreign direct investment, its types, advantages, disadvantages, and its impact on economies like India and China. Understand the Minsky moment theory and its relevance in the global economy.

ECONOMICS
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FOREIGN DIRECT INVESTMENT
In general terms, foreign direct investment can be defined as investment done by a company or
an individual of one country in the business interests of another country. It can be in any form
such as establishing business or acquiring assets in another country, either full ownership or
control up to a certain percent can be there (Roberts, 2015). The concept of foreign direct
investment provides high growth prospects for the investors. It is not just an investment in
capital, it may involve management and technological skills as well.
The different types of foreign direct investments are as follows:
 Inward, outward and net foreign direct investment
 Real estate investment
 Portfolio investment
In this assignment, the major focus will be on inward foreign direct investment. When in a local
economy, either a foreign or external entity invests or purchases the goods, and then it can be
termed as an inward foreign direct investment. Foreign investors include:
 Multinational companies
 State-owned enterprises
 Sovereign wealth funds
 Private equity companies
 Private investment funds including pension funds
 Other private investors
India, being the fastest growing economy of today, many foreign investors are seeking for
investing their money and expecting high growths in the economy. India is considered as the
most politically stable and secure country (ICAI, 2017). Other factors which are taken into
consideration before investing in a foreign country can possibly be infrastructure, exchange
rate, cost and skills of labour, available talent, real estate etc.
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Below is the figure showing foreign direct investment inflow, globally and by a group of
economies from 2005 to 2016 and projections for 2017-2018 are also shown.
[Source: http://unctad.org/en/PublicationsLibrary/wir2017_en.pdf]
There can be several motivating factors and drivers which encourage foreign direct investment
in the developing economies, some of the possible factors are:
 Companies may go for foreign direct investment to seek the natural resources available
in the foreign market.
 Market-seeking can also be a relevant factor for the companies to invest in foreign
markets for their growths.
 For seeking efficiency, for instance, the companies of US are setting up manufacturing
units in India to take advantage of cheap labour.
 Many companies or individuals invest in foreign markets to spread their risks.
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INWARD FOREIGN DIRECT INVESTMENT
By the terms inward and investments, it can be explained that money is brought into a region
from an external source, may be to carry out certain functions or to purchase the capital goods.
Foreign direct investment became an on-going rise in the recent years and became necessary
for globalisation. The reports of UNCTAD (united nation’s conference on trade and
development) states that the inflow of foreign direct investment is decreased by 2% to
$1.75trillion in 2016 resulting in low economic growth and higher policy risks (Blonigen and
Piger, 2014).
[Source: http://unctad.org/en/PublicationsLibrary/wir2017_en.pdf]
In the developed economies, the inflows are increased and a significant growth can be seen in
the previous year. The rate of inward FDI rose by 5% to $1 trillion. The share of developed
economies in the inflow of global FDI grew to 59%. In the transition economies, the inflow of
FDI is almost doubled to $68 billion, after two years of continuous decline. The rate of outflow
of foreign direct investment from developed countries declined by 11% to $1 trillion. The policy
measures which are introduced in 2016 were majorly aimed at the promotion of investment
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and liberalisation. In the whole policy of FDI, only 21% part was of restrictions and regulations
upon trade, rest 79% of the policy was in support for liberalisation and promotion.
The economic growth rate is likely to increase globally to 2.9% in the coming year. Developed
countries are expected to grow more because of the liberalisation of foreign direct investment
policy. The developing and emerging economies are also likely to show growth in their
economies in 2017, main china as it a natural resource exporting country. Growth is seen in
these countries as the commodity prices are likely to increase in the near future, especially
crude oil and related products.
[Source: http://unctad.org/en/PublicationsLibrary/wir2017_en.pdf]
Foreign direct investment is considered as an important source of finance for the developing
economies. In the year 2016, the global inflow of FDI decreased by 2% to $1746 billion, and the
flows towards developed economies rose further even after remarkable growth in the previous
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years. The main reason for the increase of inflows in developed countries is the equity
investment, 74% of the FDI inflows are due to equity investment in the developed economies
(Savouidakis, 2015). On the other hand in the developing economies because of the low
commodity prices and slow economic growth, the inflows of investment reduced by 14% to
$646 billion. Out of the top 10 growing economies of the world, 6 of them were developing and
transition economies. The USA is the largest receiver of foreign direct investment with $391
billion followed by the United Kingdom with $254 billion and China with $134 billion.
[Source: http://unctad.org/en/PublicationsLibrary/wir2017_en.pdf]
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ADVANTAGES AND DISADVANTAGES OF INWARD FOREIGN DIRECT INVESTMENT
ADVANTAGES
Foreign direct investment is very relevant for all the economies of the world for their growth,
especially for developing economies and the countries with emerging markets. These countries
need the funding of investors and also expertise to increase their international boundaries
(Bishop, 2016). India, being a developing country attracts more foreign investment compared to
any other country in the global economy. Some of the pros of inward FDI are as follows:
 It provides access to the external sources of finance and also gives an inflow of foreign
currency which can be helpful in maintaining foreign exchange reserves.
 The standards of services and products are highly improved by increasing competition.
 The human capital can be upgraded and employment is created in the economy.
 The access to external markets will become easier because of networks of the
multinational companies.
 The infrastructure or physical capital of the economy can be improved.
 The formation of fixed capital is boosted and new technology is introduced into the
economy.
 The business behaviour and quality of governance are upgraded because of the transfer
of management practices.
 The productivity level is boosted and tax revenue can also be generated.
 The local business can perceive it as an opportunity and can merge with big
multinational companies.
DISADVANTAGES
In spite of having so many positive points of the inward foreign direct investment, it has some
disadvantages for the host countries. It can raise concern over the following issues:
 The level of local production can be displaced.
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 The dependency on foreign technology is increased, which can be harmful to the growth
of the economy.
 If the investment is done in existing facilities, then the problem of job generation may
occur.
 Local workers may be exploited by the foreign employers.
 The problem of disinvestment may be seen in the economy after a specific time.
 Chaos is created due to the existence of dual economies in the host country.
 Due to fierce competition, the prices of local products have to be lowered and thus local
companies will face losses.
 As the consumers move towards the multinational companies, local companies start
losing their loyal customers and subsequently business relations.
In India, the economy is seen attractive in terms of foreign direct investment and the investors
seem to be interested because of the huge size of its market and many other factors such as
policies of economy are rational, the domestic banks and financial institutions are improving
continuously, the manufacturing and outsourcing hub of India is remarkably good (Lee, et al.
2016).
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CHINA AND MINSKY MOMENT
When there is a major collapse in the value of assets suddenly, being the part of credit cycle or
the business cycle, then that situation can be termed as Minsk moment. When there is an
unsustainable growth in the market or speculation of the market is seen and it lasts for very
long, then the market will eventually fall into crisis. The longer the speculation persists; the
worst will be the downfall of the market.
In the global economy, China is considered as the largest manufacturing economy and largest
exporter of goods to the whole world. In 2016, it was declared as a second largest trading
country in the world and plays a very crucial role in international trade. The gross domestic
product of any country is the best possible way to measure its economy (Qi Juniper, et al.
2015). The GDP of China is 11.2 trillion USD as in 2016 and the annual growth rate of its GDP is
6.7%. Its per capita income in 2016 was 8123.18 USD with a population of approximately 1.4
billion, 50% of them live in cities. The market status of China can be presented as it is having a
very high annual growth rate as compared to other developed and developing countries. As the
economy of China works with more and more developed countries, it has easier access to
cheap labour and low production costs. China is highly investing in the infrastructure and its
level of savings is also increasing day by day.
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Above shown is the real GDP growth of the strongest economies of the world and projections
are also done for the coming years.
In the recent years, there is a growth in debt of China's government and many financial
complexities are seen because of many reasons and that can be:
 When the financial crisis was occurring around the globe, for sustaining the growth the
China's government took debt.
 Because of the state-owned enterprises, the debt of non-financial company rose from
100% of GDP to 170% of GDP from 2008 to 2016.
 Rapidly increasing investment in infrastructure and housing.
 The financial products in the economy are getting complex and the sector of non-bank
financing is growing instead of finance banking sector.
The top five banks of China in terms of total assets are as follows:
 Industrial and commercial bank of China with total assets of 3473.09 billion USD
 China construction bank corporation with total assets of 3016.45 billion USD
 Agricultural bank of China with total assets of 2815.92 billion USD
 Mitsubishi UFJ financial group with total assets of 2626.29 billion USD
 Bank of China with total assets of 2611.43 billion USD
The regulators of the financial system of China are divided by the activities that they oversee;
mainly the banks are regulated by China banking regulation commission. The financial markets
and securities market are regulated by China securities regulation commission (Liang, 2016).
The government of China has many sources of finance internally as well as externally such as
revenue from taxes, loans from world banks etc. below is the chart showing how the financial
system of China is regulated.
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[Source: https://www.brookings.edu/wp-content/uploads/2016/06/chinese-financial-system-
elliott-yan.pdf]
The levels of debt in China are posing a stability risk to the economy, as it is already warned by
the international monetary fund about the rising levels of debt. In order to meet the targets of
growing economy, the government of China took a huge amount of debt and to repay the
interest amount of that debt, it borrowed some more loans. The international monetary fund
also stated that the credit efficiency of the government of China had decreased in the last
decade and now it needs even more amount of money to maintain the same level of growth.
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THE FINANCIAL INSTABILITY THEORY OF HYMAN MINSKY
Hyman Philip Minksy is the professor of economics and an American economist. He researched
and attempted to provide the reasons for financial crisis even in the strongest economies of the
world. He explained in the theory that because of the business cycle or trade cycle in the
economy, the financial crisis has to occur at some point in time in the economy ( Minsky, 2016).
He also said that if the prosperity continues for a very long time in terms of growth of the
economy, then the government should be prepared for the next financial crisis.
In October 2017, the chairman of people's bank of China, Zhou Xiaochuan, warned China about
a Minsky moment, it can be the result of the excessive amount of debt and speculative
investments in the share market of the economy. From 2017, the economic growth and
expansion of China is slowed down and came to seven percent from ten percent. To maintain
the strong and sustainable growth in the economy, investments are increasingly done and thus
increasing the level of debt. China is having the highest rate of savings in the world, comprising
46% of its total GDP. It highly relies on investment and credit, it imbalances the economy and
its growth.
There are many reasons for chances of occurring Minsky moment in the economy of China, as
its levels of debt reached dangerously high levels. The speculative investment has grown too
much and its end result will be bad, as stated by Hyman Minsky that if an economy is doing
exceptionally well since a long period of time then a downfall has to be faced due to
fluctuations in the cycle (Fazzari and Papadimitriou, 2015). As in the last twenty to thirty years,
the economy of China is facing only growth and is still growing and because of this reason, all
the prospective investors from across the globe are investing in China through foreign direct
investment and seeking higher returns. As a result, there is more and more money and
investment done in the economy. Even if any slight fall in the economy is seen, the investors
withdraw their money from the market resulting in facing great downfall in the economy. Also,
the rise in prices of assets in the economy including shares and real estate is seen resulting in
low demand and blockage of liquid money thus increasing the risk for Minsky moment.
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Below is the graph showing the total loans of China and the annual percentage change between
2016 and 2017.
[Source: https://www.advisorperspectives.com/commentaries/2017/10/24/chinas-central-
bank-chief-warns-of-minsky-moment]
WHY MIGHT THE MINSKY MODEL NOT FIT CHINA?
Even though the chairman of people's bank of China claimed and warned the economy about
the Minsky moment, the government of China claims that the Minsky moment will not occur in
the economy as they were already prepared for such kind of situations.
China may not have typical Minsky moment, the main reason for the occurrence of Minsky
moment is the pressure of deleveraging in the economy. Deleveraging is reducing the levels of
debt in the economy resulting in a reduction in prices of assets and also cascading effect in the
breakdown of payments. The main threats for Chinese economy are those investors who can
easily withdraw and invest their money from one market to another, also the banks who are
undercapitalised, overvaluation of exchange rates and lower level of international reserves
(Cai, 2014). The amount of inward foreign investment in China is very low, also it is not easily
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and rapidly movable by the investors. It has ample of resources, both national and international
which can meet the needs of the economy at the time of crisis and keep the economy stable
and growing.
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REFERENCES
 Roberts, C., 2015. Foreign direct investment. AusIMM Bulletin, (Oct 2015), p.80.
 ICAI, P.B.O.W.O., 2017. Foreign direct investment. Women, 1(4th).
 Blonigen, B.A. and Piger, J., 2014. Determinants of foreign direct investment. Canadian
Journal of Economics/Revue canadienne d'économique, 47(3), pp.775-812.
 Savouidakis, K., 2015. Foreign direct investment.
 Bishop, G., 2016. A Rule of Reason for Inward FDI: Integrating Canadian Foreign
Investment Review and Competition Policy.
 Lee, I.H.I., Hong, E. and Makino, S., 2016. Location decisions of inward FDI in sub-
national regions of a host country: Service versus manufacturing industries. Asia Pacific
Journal of Management, 33(2), pp.343-370.
 Qi, C., Juniper, J. and Zhang, J.X., 2015. " Minsky Moment" and financial fragility: The
case of China. The Journal of Developing Areas, 49(6), pp.279-291.
 Liang, Y., 2016. Inside Shadow Banking in China: Credit Driven Growth vs. Financial
Stability. Journal of Economic Issues, 50(2), pp.461-470.
 Minsky, H., 2016. Stabilizing an unstable economy (Chapters 1-2). Economic Policy, 2.
 Fazzari, S.M. and Papadimitriou, D.B., 2015. Financial conditions and macroeconomic
performance: Essays in honor of Hyman P. Minsky. Routledge.
 Cai, P., 2014. There will be no Minsky moment for China. Business Spectator, Mar 25.
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