The Economic and Social Impacts to India and Its Citizens from Inward Foreign Direct Investment



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2.3: FDI within the global economy


The advantages and disadvantages that foreign corporations bring to host countries are context specific depending upon several factors including the specific company, the industry, the regulatory environment of the host country (Farnsworth, 2004; Moran and Oldenski, 2013), as well as the motivations behind the investment (OECD, 2008; Rao and Dhar, 2011b; Forsgren, 2013). This last factor highlights the importance of understanding the specifics of FDI. Most discussions of FDI fail to fully define it. However, in order to understand the full implications of FDI to developing countries in particular, it is important to elaborate more fully on what exactly constitutes FDI as well as examine the different types of FDI. Companies and investors have several options available to them in regards to how they want to enter foreign markets. How a company enters or accesses a foreign market is often determined by the type of FDI. Different types of FDI are associated with varying degrees of advantages and disadvantages to host countries though all types of FDI can bring drawbacks. This section will first provide a comprehensive definition of FDI and explore the complexities and inconsistencies of the definition. It will proceed to further deconstruct four main types of FDI relevant to this thesis.

2.3.1: Defining FDI


The OECD is an international organisation consisting of 34 member countries, many of which are developed European countries, who aim ‘to promote policies that will improve the economic and social well-being of people around the world’(OECD, 2015). The organisation establishes definitions, guidelines and standards for global economic and financial instruments. In the 1980’s the OECD recognised the need to correct the traditional reporting models that could no longer keep up with the increasing complexity of cross border investments as well as TNCs’ complex financial manoeuvres of capital into and through offshore tax jurisdictions (OECD, 2008). Therefore, in 1983 the OECD constructed the ‘Benchmark Definition of Foreign Direct Investment’ (Benchmark Definition) which provided a “comprehensive set of rules to improve the statistical measures of foreign direct investment” (2008, p.14). The stated purpose of the Benchmark definition is to provide clear guidance for individual member countries compiling investment statistics2 (OECD, 2008). However, as will be explored here, the complexity of international investments continue to defy clear cut categorisation (Rao and Dhar, 2011a, 2011b; Chang, 2007, 2014; Kalemli-Ozcan and Villegas-Sanchez, 2013).

The OECD (2008, p.1) defines FDI as the following:

Direct investment is a category of cross-border investment made by a resident in one economy (the direct investor) with the objective of establishing a lasting interest3 in an enterprise (the direct investment enterprise) that is resident in an economy other than that of the direct investor. The motivation of the direct investor is a strategic long-term relationship with the direct investment enterprise to ensure a significant degree of influence by the direct investor in the management of the direct investment enterprise. The “lasting interest” is evidenced when the direct investor owns at least 10% of the voting power of the direct investment enterprise.

From the outset, the primary characteristics outlined in the Benchmark’s definition underscore the motivation of the investor as ‘lasting’ and having a significant managerial role in the direction of the enterprise. It is argued that this motivation will spur the investor to bring or create a collection of resources to the investment enterprise such as technology, knowledge, managerial know how, and increased production capabilities (OECD, 2008; Dunning, 2002, 2008; Rao and Dhar, 2011b; Moran and Oldenski, 2013). However, the qualitative characteristics of direct investment such as ‘lasting interest’ and ‘managerial role’ are quantified by a strict numerical guideline of 10 per cent ownership of the investment enterprise.4 Researchers often argue that 10 per cent ownership is arbitrary and does not denote significant influence of managerial direction or ‘lasting interest’5 (Chudnovsky and Lopez, 1999; Rao and Dhar, 2011a, 2011b; Chang, 2007, 2014). Lasting or long-term interest is not defined in terms of the amount of time an investor must keep the investment. How quickly FDI can be ‘liquidised’ and repatriated or taken out of the host country depends on the country’s capital markets and the rules that are in place to regulate and monitor capital flight (Chang, 2007, 2014).

The aforementioned characteristics are used to differentiate FDI from the other main form of international investment, portfolio investment (PI). PI refers to the purchase of stocks, corporate bonds, and other financial instruments in an investment outside the investor’s home country. PI investments are ‘indirect’ or ‘hands off’ and do not involve a managerial interest to direct the day-to-day operations of the enterprise (OECD, 2008; Kirabaeva and Razin, 2013). PI investments are short term in nature and often speculative (Kirabaeva and Razin, 2013; Chang, 2007, 2014; Rao and Dhar, 2011b). FDI, on the other hand, is associated with being a more stable form of investment in comparison to PI as well as capable of bringing more resources to the investing enterprise (OECD, 2008). Thus, the motivation behind the investment is different between the two as the OECD (2008, p.2) explicate:

The motivation to significantly influence or control an enterprise is the underlying factor that differentiates direct investment from cross-border portfolio investments. For the latter, the investor’s focus is mostly on earnings resulting from the acquisition and sales of shares and other securities without expecting to control or influence the management of the assets underlying these investments. Direct investment relationships, by their very nature, may lead to long-term and steady financing and technological transfers with the objective of maximising production and the earnings of the MNE [multinational enterprise] over time. Portfolio investors do not have as an objective any long-term relationship.

Given that FDI is associated with stability and spillovers, it is often preferred over PI as a source of development funding (OECD, 2008; Chang, 2007, 2014; Rao and Dhar, 2011b). However, the distinction between PI and FDI has become more blurred with new types of global investments that have risen in popularity, in particular, in the mid-2000s (UNCTAD, 2006). These new types of investments include private equities, venture capital, and hedge funds, and are made by collective investment institutions which are often banks and insurance companies (UNCTAD, 2006; Kirabaeva and Razin, 2013). Statistically, these types of investments purchase 10 per cent ownership of the enterprise but may not have lasting or managerial interest (Rao and Dhar, 2011a, 2011b, Chang, 2007, 2014; UNCTAD, 2006; OECD, 2008). However, the OECD states that because the investment exceeds the 10 per cent investment threshold, it should be counted as FDI, “even if a majority of such investments are short term and are closer in nature to portfolio investments (UNCTAD, 2006, p.16). Chudnovsky and Lopez (1999, p. 5) have argued that this blurring between FDI and PI has cast further doubt on the argument that FDI is a stable form of investment6.

The blurring of the distinction between FDI and PI has direct relevance for developing countries trying to incorporate FDI policies into strategic development initiatives. UNCTAD (2014, p.17) in its latest World Investment Report (WIR) explained that private equities are relatively active in emerging markets, in particular, in Asia. Figure 3 is taken from the WIR and depicts the presence of private equites in developing countries, in particular, within cross border mergers and acquisitions (UNCTAD, 2014, p.19). The graph illustrates the speculative nature of the investment and its increasing presence in developing countries as of late.



Figure 3: FDI by private equity funds, by major host region, 1995-2013

Rao and Dhar (2011b) as well as Chandrasekhar and Ghosh (2007) contend that it is crucial for policy makers to better understand the qualitative nature of the FDI coming into the host country in order to construct policies that are effective in capturing advantages and mitigating risks for the economy and its citizens. As will be explored in the upcoming empirical chapter (section 6.5.), India is attracting significant levels of FDI in the form of private equities, hedge funds and venture capital and sectors such as construction that have attracted such investment in bulk have experienced erratic growth patterns (Chandrasekhar and Ghosh, 2007; Rao and Dhar, 2011b). These types of FDI, it is argued, are less likely to bring resources that India needs such as increased decent employment opportunities, technology spillovers or managerial know-how (Chandrasekhar and Ghosh, 2007; Rao and Dhar, 2011b).

The OECD has, in part, addressed some of these complexities by implementing a new methodology for calculating FDI statistics which was implemented in late 2014 (OECD, 2014). The OECD (2014, p.5) describes the need for changes:

This new methodology will provide better measures of where international investment comes from, where it is going, and most importantly, where it is creating jobs and value-added. It does this by distinguishing between ‘real FDI’ as opposed to various financial flows that are currently counted as FDI but which don’t add to the ‘real economy.’



The important point here is that not all FDI is equally valuable and the OECD recognises this with the new methodology. Figure 4 illustrates the extent to which certain types of FDI that do not add to the real economy can bolster investment flows. Using the new FDI methodology, the graph depicts the flows with and without investments made through Special Purpose Entities (SPEs) for four countries: Austria, Hungary, Luxembourg and the Netherlands. SPEs are investments that are made through holding companies without generating economic activity or employment (OECD, 2014).


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