Economic Concepts and International Finance
Foreign Direct Investment and Multinational Corporations
Foreign direct investment (FDI) involves long-term investments by private multinational corporations (MNCs) in countries overseas. There are two main types of FDI:
- Greenfield investment: MNCs build new plants or expand existing facilities in foreign countries.
- Mergers and acquisitions: MNCs merge with or acquire existing firms in foreign countries.
MNCs are attracted to developing countries because they may offer:
- Abundant natural resources
- Large or growing markets
- Lower labor costs
- Lax regulations
FDI can benefit developing countries by:
- Providing employment
- Improving education and training
- Increasing access to research and development (R&D), technology, and marketing expertise
- Stimulating industrialization
- Increasing employment, which can have a multiplier effect on the economy
- Generating tax revenue for governments
- Improving infrastructure
- Providing more choice and lower prices to consumers
- Improving the efficient allocation of world resources
However, FDI can also have negative effects, such as:
- Pollution and other environmental costs in countries with weak environmental regulations
- Exploitation of low-skilled workers with little training or education
- Excessive power and influence of MNCs
- Tax incentives that reduce government revenue
- Transfer pricing, where MNCs manipulate prices between different divisions to take advantage of tax loopholes
Current Account
: The CA is a measure of the flow of funds from trade of G, S and other income flows. It is usually sub-divided in 4 parts: 1) balance of trade in G: It is a measure of the trade of all tangibe goods, also known as visible trade. The balance is calculated by revenue from X – Expenditure on M of G. If revenue is greater than expenditure then there is surplus in BOT in G, if theres greater expenditure theres deficit in BOT in G. 2) BOT in S: it is a measure of the revenue receive from X of S – expenditure on M of S, over a period of time. Also known as invisible trade. Includes S such as tourism. 3) Income: it is a measure of net monetary movement of profit, interests and dividens moving into and out of the country over a period of time, due to financial investments abroad. Domestic firms may have set up branches in other countries and so profit being repatriated represents a positive item, while profits sent out of the country by foreing firms set up in teh country represents a negative item. Resident and institutions may have invested in foreign banks so interests received from this financial investments represnets a positive item while any payment of interest to foreign investors represents a negative item. Residents and instituions may have purchased shares in foreign companies so any dividends received represents a ppositive item and dividends paid to foreign share holder represents a negative item. 4) current transfer: its a measure of the net transfer of money which are payments made between countries but no exchange in G & S. Gov level includes things like foreign aid and growth while individual level inclueds foreign workers sending money to their families. In conclusion curerent account = BOT in G + BOT in S + net income flows + net transfer
Floating E.R: In floating E.R system the value of the currency is determined, in theory, just by demand and supply of the currency on the foreign exchange market. Theres no Gov intervention to influence the value of the currency, which is appreciated when it sises and depreciated when it decreases. Regarding demand side, foreign buyers will demand local currency if they wish to buy local X of G and S, travel to the country, invest in local frims, save their money in local banks, or make profits speculating on the value of the currency. Therefore demand will raise if theres an increase in demand for G & S due to: 1) Foreign ountries have higher inflation, so local G & S are cheaper than foreign, 2) an increase in foreign income allow those poeple to increase demand for local currency G&S, 3) A change in foreign preferences in favor of local products. Demand can also increase due to local invesement prospects improve, local interest rates increase (it is more attractive to save in local banks) or speculating of rising value of local currency. Regarding Suplly side, local currency will be supplied at foreign exchange market if they wish to buy foreign G&S, tavel abroad, invest in foreign firms, save in foregin banks, or make money speculating on foreign currencies. Therefore supply will raise if: theres an increase in foreign G&S due to: 1) higher inglation than abroad, 2) an increase in local income, 3) a change in local preferences in favor of foreign products. Supply can also increase due to foreign invesement prospects improve, foreign interest rates increase or speculation about foreign currencies value. An increase in the supply of local currency will shift supply curve rightwards, depreciating its value. An increase in the demand of local currency will shift demand curve rightwards, appreciating its value (diagram + equilibrium followed by appreciation followed by depreciation)
Increase in the quantity and quality of FOp is directly linked with economic growth and despite the fact that economic development is a far more complex concept, E.G will, if used properly, lead to E.D. NAtural FOP such as land are difficult to increase in quantity so improvement in quality (better planning( would be the best choice. Human capital can be increased by encouraging population gorwth or immigration levels, yet developed countries wont allow increase in population size so they will put emphasis in impoving quality of human capital (improved education). Physical capital are factory buildings, machinery, etc. Social capital are schools, roads, hospitals, etc. The quantity is affected by the level of savings, domestic and foreign investment and Gov intervention. Quality is improved with higher education, R&D, access to foregin technology, etc. Firms can either choose for caoital widening which is extra capital used with an increase amount of labor (productivity is the same), or capital deepening which is an increase in te amount of capital per worker (increases productivity) and involves improvements in technology. High levels of E.G leads to higher GDP per capita which should lead to improvements in S of L, yet it depends on how income is distributed. E.G leads to higher averages in economic indicators of welfare, but not always shared by the whole population. Increased GDP should increase Gov revenues from taxation and its in better position to provide essential services as education. On the other hand E.G can increase inequality specially through market-based policies and can create negative externalities for society and environment
managed E.R: At managed E.R system currency is allowed to float but with some Gov intervention. No currency can be completely free floating since there are time in which the currency will suffer extreme fluctuations which causes uncertainty for businesses and will affect trade. The most common system is where the central banks sets an upper and lower E.R value (which is not made public for fear of speculation) and currency is allowed to float inside the limits. If the E.R gets close to the limits, central banks will intervene. The reasons for intervention are; 1) to lower the E.R to increase employment. 2) to increase E.R to fight inflation. 3) to maintain a fixed E.R. 4) toa void large fluctuations in floating E.R system. 5) to achieve E.R stability to improe business confidence. 6) to improve a CA defficit. The methods for intervention are: 1) using reserves of foreign currencies to buy or sell foreing currency to increase the value of local currency, go may buy its own currency using reserves, increasing demand and so forcing E.R up To lower the value of local currency Gov will buy foreign currency using local, to increase supply. 2) changing interest rates, to increase the value, central banks will raise interest rates till they are higher than abroad, attracting foreign financial investment, increasing demand for the currency. To lower the value central banks will lower interest rates, so that when people invest abroad they will exchange local for foreign currency increasing supply
Financial account: The financial account measures the net changes in foreign ownership of domestic assets. If foreign ownership of domestic assets increase quicker than domestic ownerships of foreign financial assets, there is more money coming into the country than leaving so there is a financial account surplus. it has 3 components: 1) Direct investment: its a measure of the purchuse of long term assets where the aim is to gain a profits from foreign company. Inclueds buying property, purchasing a business or stocks. A positive return is expected, either making profits or increasing value over time. The buyer of the assets is taking risks. The main activity is in FDI. 2) Portfolio investment: its a measure or stock and bond purchase. Its not direct investment since its not a lasting interest in a company. Consists in the uying and selling of things like treasury bills and Gov bonds. the investor is putting the money forward hoping that interest will be paid and money repaid some time. It is borrowing and lending on the international market. 3) reserve assets: its the reserve assets of gold and foreign currencies which all countries hold accounts. reserve account will increase if theres surplus on all the ccounts. Net changes in the official reserve account balances the accounts. The problem is that there are too many individual transactions for the measurement to be exact and so BOP accounts wont balance. To solve this “‘net errors and omissions’ is added. It becomes more accurate as time goes by.
Foreign aid is any assitance given to a country that wouldnt have been provided through norma; market forces. The reasons for foreign aid are: To help people from natural disasters or wars, to help developing countries achieve E.D, to create or strengthen political or strategical relations, to fill the saving gap of developing countries (encourage investment), to promote E.D and welfare of developing economies. there are 2 types of foreign aid: 1) Humanitarian aid: To alleviate Short term suffering. It usually comes under the heading of grant aid, which is provided as a gift not to be repaid. 3 Forms of humanitarian aid: 1) Food aid: Provisionn of food or money to pay for food from donor countries, 2) Medical aid: provision of medical services as well as money to facilitate medical services from donor countries, 3) Emergency aid: provision of emergencies supplies (shelter, tents, clothing, lightning, etc). 2) Development aid: to alleviate poverty in the long run and improve welfare of individuals (specifically ODA) 5 types: 1) Long term loans: usually repayable over a period of 10-20 years, ‘soft loans’ because sometimes are repayable in local currency or mix, also at low interests. 2) tied aid: grants/loans given to a developing country on condition that funds are used to buy G&S from that country, 3) Project aid: money given to a specific project in a country often in form of grant aid, to improve infrastructure, 4) Technical assistance aid: to raise level of technology by bringing foreign technology and technicians that can instructs on its use and to raise quality of uman capital by the provision of training facilities and expert guidance or foreign scholarshops to study abroad, 5) commodity aid: grant aid given by countries to increase productivity in developing economies. Provides funds to purchase commodities. *foreign aid can be from Official Development Assistance (ODA) or unofficial, organized by non-governemtn organizations (NGO)