LECTURE 7

Contemporary Issues
in Global Economics
WIUT
Date: October 23, 2017

Presenter: Murodullo Bazarov

Todays Topic
Globalization: winners and losers
Poverty and Global Inequality
International Trade Issues
Economic Integration
International Labor Migration
Climate Change
Foreign Direct Investment
Global Value Chains
Global Financial Crisis
Rise of State Capitalism: China, Russia and Brazil
Lecture outline
International flow of financial resources: types,
reviews
Welfare effects of International capital transfers
Issues related to FDI
International flow of financial resources
International flow of financial resources is trans-boundary (international)
movement of financial capital in the form of obligations, money for trade,
and investments in other countries by legal entities.
Forms of international flow of capital are:
1. Development assistance:
1. Foreign aids
2. Non-concessional loans
3. Etc.
2. Loans
3. Remittances
4. Investments:
1. Portfolio investment
2. Foreign direct investment
Foreign aids / development assistance
Foreign aid is a voluntary, and non-commercial (and often
non-concessional) financial, technical assistance to one
(usually developing) county by other (usually developed)
country (countries).
E.g. include:
1. Grants
2. Non-concessional (low rate) loans
3. Technical assistances
4. Humanitarian aid
5. Etc.
Loans / credits
Loans are the commercial transactions whereby the
financial institutions of one country provide capital
resources to businesses (companies) of another country.
Remittances
A remittance is a transfer of money by a foreign worker to
an individual in his or her home country.
Money sent home by migrants competes with
international aid and FDI as one of the largest financial
inflows to developing countries: workers' remittances are
a significant part of international capital flows, especially
with regard to labor-exporting countries
Portfolio investment
Portfolio investments are investments in the form of purchase
of portfolio of securities, including transactions in equities
(securities), such as common stock, and debt securities, such
as bonds, obligations, etc.
It is a PASSIVE form of investment (those who lend / provide
money do not get involved in the business of the company who
borrows money).
E.g.:
1. USA based investment firm purchases the bonds of a
Malaysian company in KL stock exchange
2. Japanese investment firm purchases the obligations of a
Korean company in Seoul stock exchange
Portfolio investment
Motives:
Higher returns in other (usually developing) countries
To diversify risks:
Portfolio theory tells us that by investing in securities
with yields that are inversely related over time, a
higher yield can be obtained for the same level of risk
Varying resource endowment of different countries
(Heckscher-Ohlin model) create different prices of
capital in different countries (capital price is higher in
countries with low capital-labor ratio)
Foreign direct investment
A foreign direct investment (FDI) is an investment in the
form of a controlling ownership in a business in one
country by an entity based in another country.
E.g.
1. Peugeot is planning to open a car manufacturing plant
in Uzbekistan.
2. Coca-Cola owns large network of plants manufacturing
drinks across the world
3. McDonalds is planning to invest to Uzbekistan
Foreign direct investment
1. Real investments in tangible assets such as factories,
capital goods, land, and inventories where both capital
and management are involved. It is usually undertaken
by multinational corporations
2. By definition, FDI reflects a long term investment as it
involves a stake of 10% or more in a host country
enterprises, together with managerial control.
FDI and portfolio investment compared
BASIS FOR COMPARISON FDI PORTFOLIO
INVESTMENT

Role of investor Active Passive

(participation in
management )

Degree of control High Relatively low

Term (period of lending / Permanent or long term Short term

investment)

Investment form: Money / physical assets Money

Results in: Transfer of funds / technology Capital flow

/ other resources
Foreign Direct Investment
Foreign direct investment
MOTIVES:
FDI over exporting
High transportation costs, trade barriers
FDI over licensing or franchising
Need to retain strategic control
Need to protect technological know-how
Capabilities not suitable for licensing/franchising
Follow few main competitors
Immediate strategic responses
Capital transfers: welfare effect
ICT: welfare effects
Multinational Corporations (MNCs) and FDI

FDI is associated mainly with MNCs. Why?

Source of most of FDI is MNCs
Why to invest in the form of FDI? Why not portfolio
investment?
a) Motives are the same as in Portfolio investment (capital is
cheaper in developed countries, and other resources are
cheaper in developing nations / countries). Hence, return
on capital is higher in developing countries.
b) On top of it, MNCs possess (have) unique knowledge,
skills that can be profitably used in developing countries.
Foreign direct investment
Modes of Entry
1. Greenfield: investment from scratch as no local entity for
sale
2. Merger and Acquisition: 100% acquisition or joint-venture
Types of expansion
1. Horizontal same products produced abroad and
domestically
2. Vertical either to produce inputs or to approach closer to
end users
3. Diversification
FDI: issues and opposing views
The radical view: inbound FDI harmful;
Are imperialist dominators
Exploit host to the advantage of home country
Extract profits from host country; give nothing back
Keep LDCs backward and dependent for investment,
technology and jobs
The free market view: FDI should be encouraged
Adam Smith, Ricardo, et al: international production should
be distributed per national comparative advantage
An MNC increases the world economy efficiency
Adds to local economys comparative advantages
FDI: issues and opposing views
Benefits to host country:
Growth through increasing the capital stock and through
increasing the rate of technological change
Resource -transfer
Employment
Balance-of-payment (BOP)
Import substitution
Source of export increase
Costs to the host country:
Adverse effects on the BOP
Capital inflow followed by capital outflow + profits
Production input importation
Threat to national sovereignty and autonomy
Loss of economic independence
FDI: issues and opposing views
Other benefits:
Employee training usually comes with FDI contributing to
increase level of human capital
Technological spillovers (employees move from TNCs to
domestic firms)
Domestic firms observe the practice of MNCs
Tax revenue to host government collecting from corporate tax
FDI is believed to be more productive than domestic investment
FDI: issues and opposing views
PROBLEMS CREATED BY MNC / FDIS:
MNCs dominate the host countries economies
Driving out domestic entrepreneurs
Resource transfer
Creating technological dependence
Transfer R&D funds to home country
Transfer profits and natural resources to home country
Lack of training of local labour
Current account may worsen due to importation of capital goods
and intermediate goods
Overexploitation of natural resources
Use of highly capital intensive technologies in appropriate for
labour-abundant developing nations
Minimizing the tax payments by using transfer pricing mechanisms
FDI: issues and opposing views
It is interesting to mention that most of empirical studies that show
negative impact from FDI argue that FDI could generate positive
spillovers when:
FDI is entered in the form of joint venture
FDI is promoted in parallel with free trade policy
FDI is required to comply to local content policy
The technological gap between home and host country is not too
large
The host country has a certain degree of human capital
absorptive capacity
Courtesy of UoW
FDI: issues and opposing views
Problems for the home country:
Tax payment reduction
Job loss for home country
 Thank you!
And any questions?
References
1. Salvatore, D. (2013), International Economics: Trade and Finance, 11th ed.,
Singapore: Wiley, pp. 353-367
2. Krugman, P.R., Obstfeld M., Melitz, M.J. (2014), International Economics:
Theory and Policy, 10th edition, USA: pp. 222-230
3. http://www.globalization101.org/category/issues-in-depth/investment
4. http://www.scoop.it/t/insights-into-the-global-economy