Trade is the mother of money. Why block it?

Foreign Direct Investments and Trade Blocs Blocking Free

and Fair World Trade


This one I did as an assignment for college. Unlike many others, this required some comprehensive research.

Introduction:

The growth of international production is driven by economic and technological

forces. It is also driven by the ongoing liberalization of Foreign Direct Investment

(FDI) and trade policies. In this context, globalization offers an unprecedented

opportunity for developing countries to achieve faster economic growth through

trade and investment. But these Foreign Direct Investments and Trade Blocs

are not helping all the countries grow at the same pace. Many fail to look at the

disadvantages of the same.

Discriminatory trade policy is the defining characteristic of a trade bloc. The different

types of trade blocs or PTAs (Preferential Trade Agreements) can be broadly

distinguished in three categories:

1)a free trade agreement (FTA) where trade barriers among member

countries are removed, but where each member remains responsible for the

determination of its trade policy vis-à-vis non-member countries;

2) a customs union (CU), with liberalised intra-bloc trade, as well as the adoption

of a external tariff structure and trade barriers towards outsiders common to

all members of the CU

3) a common market, which entails a CU with deeper integration between

its members (such as free movements of goods, services and factors of

production, common economic policies, etc.).

Foreign Direct Investment, or FDI, is a type of investment that involves the injection

of foreign funds into an enterprise that operates in a different country of origin from

the investor.

Foreign direct investment (FDI) is an integral part of an open and effective

international economic system and a major catalyst to development. Yet, the

benefits of FDI do not accrue automatically and evenly across countries, sectors and

local communities. National policies and the international investment architecture

matter for attracting FDI to a larger number of developing countries and for reaping

the full benefits of FDI for development. The challenges primarily address host

countries, which need to establish a transparent, broad and effective enabling policy

environment for investment and to build the human and institutional capacities to

implement them.

Although differences in labour costs may sometimes help influence firms’ decisions

to locate abroad, this is far from being the whole story. As the FDI data showed, the

majority of FDI still goes to the advanced countries, in particular the United States

where wages are high relative to those in developing countries.

Host governments sometimes worry that the subsidiaries of MNCs operating in their

country may have greater economic power than indigenous competitors because

they may be part of a larger international organization. This is sometime the case in

Less Developed Countries where MNCs have monopolized the market and raised

prices above those that would prevail in competitive markets, with harmful effects on

economic welfare of the host nations.

FDI can also have an adverse affect on the host country’s balance-of-payments

position is twofold. First, capital flight—the subsequent outflow of income as a

foreign subsidiary repatriates its profit to its parent company. Such outflows show

up as a debit on the current account of the balance of payments. A second concern

arises when a foreign subsidiary imports a substantial number of its inputs from

abroad, which also results in a debit on the current account of the host country’s

balance of payments.

Criticism levied at the operations of MNCs in developing countries was that FDI

could lead to loss of economic independence for the host country.

Based on the objective of import-substitution industrialization (in terms of formation

of Trade Blocs), the rationale was that developing countries could reap the benefit

from economies of scale by opening up their trade preferentially among themselves,

hence reducing the cost of their individual import substitution strategy.

Joining a trade bloc increases the size of the market that a firm can sell to.

Increasing market size will also diminish the market power of individual firms.

By opening up markets, domestic firms will face greater competition. Monopoly

power will fade as a result, and domestic firms will have an incentive to increase

productivity through implementing newer technology or better management. In

situations where partner countries are dissimilar in capital endowments, there may

also exist possibilities for investment. Capital will find the highest return. In general

this is where capital is scarce.

Findings:

MNCs have also encouraged less developed counties to concentrate their

production on raw materials to the detriment of food security. Thus cash crops

production becomes a dominant mode of production there. These productions

received primary attention from MNCs by way of incentives for production that

by far surpassed that of its counterpart—food crop. This practice has led to the

marginalization of women—the main producers of food in such countries.

The determining factor for a particular firm to establish production facilities abroad

or make a Foreign Direct Investment abroad is the prospect of earning higher profit

which induces firms to invest abroad, primarily because of lower labour costs.

Conclusion:

While the empirical evidence of FDI’s effects on host-country foreign trade differs

significantly across countries and economic sectors, a consensus is nevertheless

emerging that the FDI-trade linkage must be seen in a broader context than the

direct impact of investment on imports and exports. The main trade-related benefit of

FDI for developing countries lies in its long-term contribution to integrating the host

economy more closely into the world economy in a process likely to include higher

imports as well as exports. In other words, trade and investment are increasingly

recognised as mutually reinforcing channels for cross-border activities. However,

host-country authorities need to consider the short and medium-term impacts of FDI

on foreign trade as well, particularly when faced with current-account pressures,

and they sometimes have to face the question of whether some of the foreign-

owned enterprises’ transactions with their mother companies could diminish foreign

reserves.

It was argued that the liberalization has led to a substantial increase in intra-industry

trade, but much of the intra industry being horizontal in nature; it did not have a

significant effect on FDI. On the other hand, the trade associated with cross-border

vertical integration had a favourable effect on FDI. Trade liberalization has had a

favourable effect on FDI inflows in Indian manufacturing industries. Lower tariffs

and consequently higher cross border trade has attracted higher FDI into industries.

Foreign equity is attracted into dynamic firms which have higher imports and exports

and relatively new assets. Regions having greater involvement in international trade

are able to attract greater amount of FDI.

Reference List:

Journals:

Websites:

Bliss, C. J. (1994). Economic Theory and Policy for Trading Blocks.
Manchester: Manchester University Press

Paul R. Krugman, Maurice Obstfeld (2008) International Economics:
Theory and Policy

ibid.informindia.co.in
globalization.icaap.org
unctad.org
businessworld.in

-HITA GUPTA