Tashkent financial institute department of finance from "finance"

Foreign investments and their pros and cons

Foreign investment involves capital flows from one country to another, granting the foreign investors extensive ownership stakes in domestic companies and assets. Foreign investment denotes that foreigners have an active role in management as a part of their investment or an equity stake large enough to enable the foreign investor to influence business strategy. A modern trend leans toward globalization, where multinational firms have investments in a variety of countries.

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  Foreign investment refers to the investment in domestic companies and assets of another country by a foreign investor.
  
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  Large multinational corporations will seek new opportunities for economic growth by opening branches and expanding their investments in other countries.
  
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  Foreign direct investments include long-term physical investments made by a company in a foreign country, such as opening plants or purchasing buildings.
  
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  Foreign indirect investment involves corporations, financial institutions, and private investors that purchase shares in foreign companies that trade on a foreign stock exchange.
  
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  Commercial loans are another type of foreign investment and involve bank loans issued by domestic banks to businesses in foreign countries or the governments of those countries.
  

Foreign investment is largely seen as a catalyst for economic growth in the future. Foreign investments can be made by individuals, but are most often endeavors pursued by companies and corporations with substantial assets looking to expand their reach.

As globalization increases, more and more companies have branches in countries around the world. For some multinational corporations, opening new manufacturing and production plants in a different country is attractive because of the opportunities for cheaper production and labor costs.Additionally, these large corporations frequently look to do business with those countries where they will pay the least amount of taxes. They may do this by relocating their home office or parts of their business to a country that is a tax haven or has favorable tax laws aimed at attracting foreign investors.

Foreign investments can be classified in one of two ways: direct and indirect. Foreign direct investments (FDIs) are the physical investments and purchases made by a company in a foreign country, typically by opening plants and buying buildings, machines, factories, and other equipment in the foreign country. These types of investments find a far greater deal of favor, as they are generally considered long-term investments and help bolster the foreign country’s economy.

Foreign indirect investments involve corporations, financial institutions, and private investors buying stakes or positions in foreign companies that trade on a foreign stock exchange. In general, this form of foreign investment is less favorable, as the domestic company can easily sell off their investment very quickly, sometimes within days of the purchase. This type of investment is also sometimes referred to as a foreign portfolio investment (FPI). Indirect investments include not only equity instruments such as stocks, but also debt instruments such as bonds.

There are two additional types of foreign investments to be considered: commercial loans and official flows. Commercial loans are typically in the form of bank loans that are issued by a domestic bank to businesses in foreign countries or the governments of those countries. Official flows is a general term that refers to different forms of developmental assistance that developed or developing nations are given by a domestic country.Commercial loans, up until the 1980s, were the largest source of foreign investment throughout developing countries and emerging markets. Following this period, commercial loan investments plateaued, and direct investments and portfolio investments increased significantly around the globe.

A different kind of foreign investor is the multilateral development bank (MDB), which is an international financial institution that invests in developing countries in an effort to encourage economic stability. Unlike commercial lenders who have an investment objective to maximize profit, MDBs use their foreign investments to fund projects that support a country's economic and social development.The investments—which typically take the form of low- or no-interest loans with favorable terms—might fund the building of an infrastructure project or provide the country with the capital needed to create new industries and jobs. Examples of multilateral development banks include the World Bank and the Inter-American Development Bank (IDB).

In other words, foreign investment is when a domestic investor decides to purchase ownership of an asset in a foreign country. It involves cash flows moving from one country to another to execute the transaction. If the ownership stake is large enough, the foreign investor may be able to influence the entity’s business strategy.

Foreign investments are often made by larger financial institutions hoping to diversify their portfolio or expand operations for one of their current companies internationally. It is often considered a move for scaling purposes or a catalyst to spur in economic growth.

For example, some companies may expand their offices worldwide to reach global talent and connections. Examples would include Goldman Sachs, J.P. Morgan, Morgan Stanley, and other large corporations. In other cases, some companies may open facilities or operations to capitalize on cheaper labor or production costs offered in specific countries.For textile companies in particular, such as retail production, many factories are located in China and Bangladesh despite sales being focused on North America – such as H&M or Zara – because material and labor are significantly cheaper there; thus, outsourcing would result in higher profitability. In other cases, some large corporations will prefer to conduct business in countries that have lower tax rates.In 2019, global foreign direct investment was $1.54 trillion, according to the United Nations Conference on Trade and Development.3 That's a 3% increase over 2018 levels, but it's still far below 2016's level of foreign direct investment, which nearly hit $2 trillion.The decline in FDI was partially due to President Donald Trump's tax cut, signed into law on Dec. 22, 2017. The tax cut opened the door for companies to repatriate the trillions of dollars they held in foreign cash stockpiles for a one-time tax rate of 15.5% on cash and 8% on equipment.In the first six months of 2018, as Trump's tax bill took effect, more earnings were repatriated than in 2015, 2016, and 2017 combined.Trade agreements are a powerful way for countries to encourage more FDI. A great example of this is the North Atlantic Free Trade Agreement, the world's largest free trade agreement. It increased FDI between the United States, Canada, and Mexico to $731 billion in 2015.That was just one of NAFTA's advantages.

In the following lines I will illustrate pros and cons of FDI and their role in the development of our country. Here are the positive sides of the usage of investments:

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  Diversifies investor portfolios: Individual investors have the potential toachieve greater portfolio efficiency (return per unit of risk), as FDI diversifies their holdings outside of a specific country, industry, or political system. Generally, a broader base of investments will dampen overall portfolio volatility and provide for stronger long-term returns.
  
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  Provides technology to developing countries: Recipient businesses receive "best practices" management, accounting, or legal guidance from their investors. They can incorporate the latest technology, operational practices, and financing tools. By adopting these practices, they enhance their employees' lifestyles. That raises the standard of living for more people in the recipient country. FDI rewards the best companies in any country. It reduces the influence of local governments over them.
  
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  Provides financing to developing countries: Recipient countries see their standard of living rise. As the recipient company benefits from the investment, it can pay higher taxes. Unfortunately, some nations offset this benefit by offering tax incentives to attract FDI.
  
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  Promotes stable, long-term lending: Another advantage of FDI is that it offsets the volatility created by "hot money." That's when short-term lenders and currency traders create an asset bubble. They invest lots of money all at once, then sell their investments just as fast. That can create a boom-bust cycle that ruins economies and ends political regimes. Foreign direct investment takes longer to set up and has a more permanent footprint in a country.
  

³ Picture 1: Foreign Direct investment: pros and cons

However, as there is always some objections against any idea, we have numerous drawbacks of attracting foreign investments into domestic market:

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  Not suitable for strategically important industries: Countries should not allow foreign ownership of companies in strategically important industries. That could lower the comparative advantage of the nation, according to an IMF report.
  
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  Investors have less moral attachment: Foreign investors might strip the business of its value without adding any. They could sell unprofitable portions of the company to local, less sophisticated investors.
  
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  Unethical access to local markets: They can use the company's collateral to get low-cost, local loans. Instead of reinvesting it, they lend the funds back to the parent company.
  

In this paragraph I will illustrate clear examples and causes why FDI is really useful for our country. It can also affecteconomic development stimulation.Foreign direct investment can stimulate the target country’s economic development, creating a more conducive environment for you as the investor and benefits for the local industry. For example, investments into construction field in Uzbekistan are creating more and more job opportunities for both local graduates and unemployed people, cities are getting more populated and modernized because of the newly-built skyscrapers, up-to-date hotels, touristic landscapes, humanly-made lakes and futuristic business centers creating environment for the business and international trade.

⁴ Chart:1

As I have mentioned before, construction of business centers is pacing up the international trade.Commonly, a country has its own import tariff, and this is one of the reasons why trading with it is quite difficult. Also, there are industries that usually require their presence in the international markets to ensure their sales and goals will be completely met. With FDI, all these will be made easier.

To be more detailed, employment and economic boost also will be more enhanced as a result of engaging FDI into domestic economy. Foreign direct investment creates new jobs, as investors build new companies in the target country, create new opportunities. This leads to an increase in income and more buying power to the people, which in turn leads to an economic boost.It allows for more domestic development. As corporations focus their resources toward international development, a service gap invariably develops in the domestic economy where that corporation is. Another big advantage brought about by FDI is the development of human capital resources, which is also often understated as it is not immediately apparent. Human capital is the competence and knowledge of those able to perform labor, more known to us as the workforce. The attributes gained by training and sharing experience would increase the education and overall human capital of a country. Its resource is not a tangible asset that is owned by companies, but instead something that is on loan. With this in mind, a country with FDI can benefit greatly by developing its human resources while maintaining ownership. Furthermore, parent enterprises would also provide foreign direct investment to get additional expertise, technology and products. As the foreign investor, you can receive tax incentives that will be highly useful in your selected field of business. Foreign direct investment will allow resource transfer and other exchanges of knowledge, where various countries are given access to new technologies and skills. Foreign direct investment can reduce the disparity between revenues and costs. With such, countries will be able to make sure that production costs will be the same and can be sold easily. The facilities and equipment provided by foreign investors can increase a workforce’s productivity in the target country. Another big advantage of foreign direct investment is the increase of the target country’s income. With more jobs and higher wages, the national income normally increases. As a result, economic growth is spurred. Take note that larger corporations would usually offer higher salary levels than what you would normally find in the target country, which can lead to increment in income.

As it focuses its resources elsewhere other than the investor’s home country, foreign direct investment can sometimes hinder domestic investment. 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. Foreign direct investments can occasionally affect exchange rates to the advantage of one country and the detriment of another. If you invest in some foreign countries, you might notice that it is more expensive than when you export goods. So, it is very imperative to prepare sufficient money to set up your operations. 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. Remember that political changes can also lead to expropriation, which is a scenario where the government will have control over your property and assets. The rules that govern foreign exchange rates and direct investments might negatively have an impact on the investing country. Investment may be banned in some foreign markets, which means that it is impossible to pursue an inviting opportunity. Many third-world countries, or at least those with history of colonialism, worry that foreign direct investment would result in some kind of modern-day economic colonialism, which exposes host countries and leave them vulnerable to foreign companies’ exploitations. Investment of a foreign company in the American market can provide new technologies, capital, products, organizational technologies, management skills and potential cooperation and business opportunities for local businesses. For example, Volkswagen, a European automotive manufacturing company, is building a plant in Tennessee. Its investment needs local small businesses as suppliers -- from the construction sector during building, from suppliers of equipment and accessories in the automotive industry and from other businesses, such as cleaning services and plumbers.A foreign investment by an American company has positive effects at home. As it concentrates part of its operations abroad, the American company may not expand its activities in the local market at the same time, so it leaves more business opportunities and more potential customers for the small businesses that remain. A domestic business that invests overseas may bring new technologies to its home market or may need new business operations with small businesses to complement its activities abroad.