Cost Benefit Analysis of FDI

By Lijo M. Loyid

Foreign Direct Investment (FDI)• Foreign Direct Investment is an investment in

the form of a controlling ownership (10%or more) in a business in one country by an Business entity based in another country.

• Businesses that make foreign direct investments are often called multinational corporations (MNCs)or multinational enterprises (MNEs).

Greenfield & Brownfield

• A MNE may make a direct investment by creating a new foreign enterprise, which is called a greenfield investment, or by the acquisition of a foreign firm, either called an acquisition or brownfield investment.

Cost Benefit Analysis

• A cost-benefit analysis is a process by which business decisions are analysed. The benefits of a given situation or business-related action are summed, and then the costs associated with taking that action are subtracted.

• Prior to erecting a new plant or taking on a new project, prudent managers conduct a cost-benefit analysis as a means of evaluating all the potential costs and revenues that may be generated if the project is completed. The outcome of the analysis will determine whether the project is financially feasible or if another project should be pursued.

Cost and benefits of FDI can be classified as two•Cost and Benefits of the investing MNC

•Cost and Benefits of the Host Country

Benefits of Host Country• Improving the balance of payments - inward investment will

usually help a country's balance of payments situation. The investment itself will be a direct flow of capital into the country and the investment is also likely to result in import substitution and export promotion. Export promotion comes due to the multinational using their production facility as a basis for exporting, while import substitution means that products previously imported may now be bought domestically.

• Providing employment - FDI will usually result in employment benefits for the host country as most employees will be locally recruited. These benefits may be relatively greater given that governments will usually try to attract firms to areas where there is relatively high unemployment or a good labour supply.

Contd..• Source of tax revenue - profits of multinationals will

be subject to local taxes in most cases, which will provide a valuable source of revenue for the domestic government.

• Technology transfer - multinationals will bring with them technology and production methods that are probably new to the host country and a lot can therefore be learnt from these techniques. Workers will be trained to use the new technology and production techniques and domestic firms will see the benefits of the new technology. This process is known as technology transfer.

Contd..

• Building of economic and social infrastructure.• Strengthening of the government budget.

Stimulation of national economy• The presence of one multinational may

improve the reputation of the host country and other large corporations may follow suite and locate as well.

Costs of the Host Country • Cultural and political interference.• Unhealthy competition to Domestic players• Over utilization of local resources(both natural

and human resources)• Violation of human rights(child labor eg. the

case of NIKE in Vietnam, APPLE in China etc).• Threat to indigenous technology.• Threat to local products.

Benefits of Investing MNCs• Access to markets: FDI can be an effective way

for you to enter into a foreign market. Some countries may extremely limit foreign company access to their domestic markets. Acquiring or starting a business in the market is a means for you to gain access.

• Access to resources: FDI is also an effective way for you to acquire important natural resources, such as precious metals and fossil fuels. Oil companies, for example, often make tremendous FDIs to develop oil fields.

Contd..

• Reduces cost of production: FDI is a means for you to reduce your cost of production if the labor market is cheaper and the regulations are less restrictive in the target foreign market. For example, it's a well-known fact that the shoe and clothing industries have been able to drastically reduce their costs of production by moving operations to developing countries.

• Its also likely that Investors may get investment incentives, promotion, social amenities.

Costs to Investing MNCs

• Risk from Political Changes. Because political issues in other countries can instantly change, foreign direct investment is very risky. Plus, most of the risk factors that you are going to experience are extremely high.

• Hindrance to Domestic Investment. As it focuses its resources elsewhere other than the investor’s home country, foreign direct investment can sometimes hinder domestic investment

Contd..• Economic Non-Viability.

Considering that foreign direct investments may be capital-intensive from the point of view of the investor, it can sometimes be very risky or economically non-viable.

• Expropriation. Remember that political changes can also lead to expropriation, which is a scenario where the government will have control over your property and assets.

• Investment abroad takes away employment opportunities of the people in the Home country.

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