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

Figure 4: FDI inflows with and without SPEs for Austria, Hungary, Luxembourg and the Netherlands

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Figure 4: FDI inflows with and without SPEs for Austria, Hungary, Luxembourg and the Netherlands

Source: OECD, FDI in Figures, April 2014, p.5.

This new methodology, the OECD (2014) argues, will provide governments and other stakeholders a better measurement for understanding the economic and social effects of FDI and TNCs7.

Although the new measurement techniques by the OECD are an improvement over previous methodologies, the adequacy of FDI statistics remains deficient (Stephan and Pfaffmann, 2001). Stephan and Pfaffmann (2001) examine the most important sources for national and international FDI data and conclude that official statistics suffer from several inadequacies. The authors contend that international comparisons are particularly hindered by the degree of nonconformity of FDI definitions amongst individual countries. Although the OECD and IMF provide benchmark definitions, countries do not apply these consistently. Furthermore, there are deviations in the design of national reporting systems as well as accounting practices (Stephan and Pfaffmann, 2001). It is also important to note the connection between power and knowledge (Foucault, 1980) and the possibility that bias may be introduced into statistical calculations to affect the outcomes being studied (Stuckler et al, 2009). Stuckler et al (2009) examine the statistics produced by international financial institutions (IFIs), in particular the European Bank for Reconstruction and Development (EBRD), in their assessment of various countries’ transition from socialism to capitalism. The authors reveal that the ERBD calculations were biased in the direction of positive growth for countries that followed neoliberal policies. Other researchers such as Banerjee et al (2006) and Kurtz and Schrank (2007) similarly investigate bias in IFIs’ statistical methods and come to similar conclusions. Given the inconsistencies in the definition of FDI, the variation in how it is calculated in and between countries and the statistical bias that can be produced in calculations and presentations; it should be noted that while FDI data is helpful in understanding investment flows it is a social construction of national and global financial institutions with inherent bias and pitfalls in adequacy and reliability.

Having discussed the characteristics of FDI, the proceeding section will further deconstruct FDI into four main types and discuss the characteristics, risks and benefits.

2.3.2: Types, benefits and risks of FDI

As discussed above, there are different types of FDI with various risks and/or advantages associated with each type. There are four main types of FDI that are most relevant to this thesis: greenfield, joint ventures, mergers and acquisitions and round tripping investments. The first type of FDI is greenfield investment. Greenfield investment involves setting up a new production facility or subsidiary from the ground up (OECD, 2008; Harms and Meon, 2013). Greenfield investments are argued to have the greatest potential to produce positive externalities or spillovers into a host country as employees will be hired and construction activities for the enterprise will take place (UNCTAD, 2006; OECD, 2008; Harms and Meon, 2013).

Joint ventures are a second type of investment and involve a partnering alliance between two firms on a temporary basis for the duration of a specific task (Nunnenkamp and Andres, 2014). For a joint venture, a separate corporate entity is formed for the project that will cease to exist once the venture is complete (Nunnenkamp and Andres, 2014). Joint ventures are often thought of as working collaborations.

Mergers and acquisitions (M&A) are a third type of FDI and occur when foreign investors fully acquire, partially acquire or merge together with an existing enterprise in the host country (UNCTAD, 2006). Thus, the foreign company is buying into an existing company located in the host country. M&A are commonly referred to as brownfield investment (as opposed to ‘greenfield’ investment) (Chang, 2007, 2014; Rao and Dhar, 2011b). M&A do not add any new production facilities and most likely do not immediately augment (or reduce) the amount of capital invested at the time of acquisition (UNCTAD, 2006; Harms and Meon, 2013). In time, whether the foreign investor wishes to increase the purchased company’s production capabilities or add anything to the enterprise is entirely up to the motivation behind the investment. UNCTAD (2006, p. 17) illustrates the uncertainty of spillovers from M&A in the upcoming passage:

FDI is a package of assets, including not only capital for investment but potentially also technology, organizational and managerial practices and market access. Greenfield FDI can provide this, while the potential impact of cross-border M&A on these aspects of host-country development is less known.

However, in some cases, M&A are made with an unambiguous motivation to either not improve productive capabilities and simply carry on as normal or actively break the company down and sell off its assets; a tactic referred to as ‘asset stripping’ (Chang, 2007, 2014). Furthermore, M&A have been criticized as a strategic tactic employed by TNCs to monopolize markets by essentially buying out the competition. Singh (2002, p.17) observes the following regarding the problematic and monopolistic nature of M&A:

Instead of launching ‘greenfield’ projects which create new opportunities for employment and competition, TNCs prefer the easy route of M&A to consolidate economic clout. In reality, M&A add little to productive capacity but are simply the transfer of ownership and control with no change in the actual asset base. The major problem with M&A is the promotion of monopolistic tendencies which, in turn, curb competition and widen the scope for price manipulations.

Round tripping is a fourth type of investment and occurs when domestic investors channel money abroad and subsequently redirect the investment back into the domestic economy as a direct investment (OECD, 2008; Fung et al, 2011). Round tripping is domestic investment that is disguised as FDI through a ‘routing economy’ that is often a country with very low or no tax rates (Rao and Dhar, 2011b). Domestic investors use round tripping to acquire the better tax rates and other incentives that are often provided to foreign investors (Hanlon et al, 2013). Round tripping has wide-ranging implications for governments and citizens (Fung et al, 2011). Not only does it dramatically inflate reported FDI flows but it is a major form of tax evasion (Hanlon et al, 2013; Fung et al, 2011). Research conducted by Hanlon et al (2013) concluded that round tripping in the US led to a loss of $8 billion to $27 billion in tax revenue in 2008 alone. As will be explored in the next chapter, business tax revenue supports and funds the states’ social welfare programs. Thus, there are real impacts to citizens of host countries that experience high levels of round tripping investments.

In sum, there are different ways FDI can be utilised to access foreign markets. These different types of FDI bring various disadvantages and benefits to host economies and can impact the citizens of host countries in different and various ways. Of course there are different types of companies as well, for example resource seeking firms or market seeking firms and these too bring different types possible disadvantages. Different types of firms will be explored in the next chapter. As discussed above both FDI and TNCs are argued to have the capability to promote spillovers and encourage the development of assets and resources that developing countries need. The proceeding section outlines the possible impact, both positive and negative, associated with possible spillovers from FDI.

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