Current recession has placed doubts in the minds of economic experts who perceive deteriorating financial conditions as a major threat to internationalization and FDI in Europe. Such doubts may have been sparked by a 39 reduction in FDI inflows to Europe. Although these concerns seem valid but evidence dictate that Europe is an attractive economy for foreign investors and it is destined to rebound sharply once global economy begin to stabilize.
According to a major survey by United Nations, a quest for markets, resource and efficiency will continue to drive internationalization and FDI (United Nations 2007, p. 7). Moreover, prevailing long term trends, future economic outlook and availability of financial resources are conducive to FDI growth (p. 9). Europe remains highly attractive to foreign investor as companies with FDI makes high proportion of overall market, as compared to other world markets. Consequently, EU-15 countries are just behind North America with 66 percent of companies with FDI whereas EU-12 is fast catching up by nearing 50 mark (p.22).
I - Aims Objectives
The objective of this paper is to analyze the historical and current FDI trends in Europe, as it pertains to internationalization. This paper evaluates future prospects that should spur regional FDI growth while shedding light on probable factors that may be hindering such progress in European countries. It is also suggested that integration of EU-12 in European Union will offer more incentives to foreign investors to invest in a market that is saturated with highly stable West European economy as well as fast developing Central and East European block. Some of the major questions the paper will focus on answering are
How FDI will evolve in Europe after 2009
What is the impact of FDI on local economy
What are the risks to foreign investors
How can Europe attract more FDI
II - Methodology
The final research will constitute relevant literature related to the scope of internationalization and its effect on FDI in Europe. Primarily, the theory will be based on books, academic journals, official reports from professional organizations and reputable sources from internet. In order to gain better perspective, books or academic journals will be utilized for historical aspects while official white papers and internet will help in accumulating current facts. It is the intent of writer to include as much electronically accessible literature in public domain, as possible. Such a strategy should help readers to gain better insight by easily referring to a more extensive source of information.
III - Data Collection
Most of the data will be compiled from recent research by OECD, EuroStat, European Central Bank, IMF and UNCTAD. According to experts these organizations are major sources of reputable data for studies on internationalization and FDI (OECD 2008, p. 38). Moreover, the data use is merited due to an active role of these organizations in compiling such statistics and their presence in the heart of Europe, except IMF.
IV - Overview
Recent advancement in technology has significantly condensed international borders. In this regard, it will not be an overstatement to suggest that global trade boundaries have actually shrunk to such an extent that experts are already foreseeing a virtual trading environment without physical limitations. The coining of term internationalization is a direct result of such an ideology. It is a process by which companies engage in wide ranging business activities in another country. In order to conduct such activities, these foreign entities make physical investment, known as foreign direct investment. Since FDI is an integral part of internationalization, an effective FDI strategy greatly impacts the well being and development of societies.
Internationalization FDI
Since last few decades, internationalization is evident by a sudden increase in the value of trade as a percentage of World GDP from 42.1 in 1980 to 65.1 in 2007. During this time period, FDI has also jumped more than five folds reaching an unprecedented level of approximately 32 percent in 2006 from 6.5 percent in 1980. Although the path to prosperity may differ widely amongst individual States but foreign direct investment, in particular, is the most important factor in globalizing local economies (IMF 2008).
According to IMF, countries engaged in global business activities, are destined to enjoy higher rates of economic stability, financial growth and top standards of living.
The Case of Europe
European Union provides an excellent proof of integration with World economy. Therefore, it is pertinent to study internationalization and FDI in context of the developments taking place in Europe. Currently, EU is a conglomerate of 27 member States that have become united under a similar economic and political agenda. Combined, these States produce 30 share of the nominal gross world product (IMF 2009). Despite these figures, there exist wide ranging disparity in economic conditions of different regions, making EU a perfect candidate to study the impact of internationalization, in general, and FDI in particular.
Although EU has developed a single market by standardizing laws to promote free trade, economic disparities within EU remain a concern. According to EuroStat, PPP per capital in inner London is almost 14 times greater than that of the poor regions of Bulgaria (EuroStat 2007). These circumstances together with a motive to end inequality have promoted European Nations to open their economies to international trade. As a whole, EU is generating an estimated GDP of nearly 18.39 trillion making it the largest economy in the World. It is also the largest importer and largest exporter of goods and services as well as the biggest trading partner to emerging and developing economies including China (Peoples Daily Online, 2007).
FDI in Europe Current Situation
Regarding Europes quest to become a truly global economy, role of foreign direct investment cannot be ignored. FDI refers to one countrys participation in economic affairs of another country by methods such as management, technology transfer and joint venture, among others. FDI can also be measured by foreign ownership of factories, land and other tangible or intangible assets. Whereas ongoing recession has decreased global inflows of foreign direct investment by almost 39 from 1.7 trillion dollars in 2008 to only 1 trillion dollars in 2009 but it is bound to rebound, once the recession is over (UNCTAD 2010). These numbers were not very different for EU block. Europe was also hit hard by the current recession which saw FDI inflows reducing 27 percent to 373 billion dollars from a high of almost 518 billion dollars, a year earlier. Another noticeable factor was a significant reduction in cross border merger and acquisitions, MA. According to figures compiled by United Nations, cross border MA fell by almost 53 percent from previous year to mere 127 billion dollars by the end of 2009 (p.2).
As previously stated that FDI is depended on multiple factors therefore the impact of FDI in one broader geographical region may be diverse. Such a trend has been noticed in Germany and Italy where FDI inflows have actually increased by 40 and 75 percent, respectively. More interestingly, Belgium has reported a growth rate of 385 in MA last year which is an indication that FDI and MA is a significant but separate function in the internationalization. Despite these statistics, it is exciting to note that Europe has fared well than many contemporary economies such as USA and Japan where the decrease in numbers is most alarming.
In 2009, there were almost 27 mergers or acquisitions that were greater than 3 billion dollars in transaction. The largest of these constituted electronic services industry. Most prominent were the acquisition of Genentech Inc of United States by Roche Holdings AG of Switzerland accounting for almost 46,695 million dollars. Some other major deals included acquisition of Endesa SA of Spain by Enel SpA of Italy and Nuon NV of Netherlands by Vattenfall AB of Sweden (p.7, Annex 1). These MAs highlight the fact that modern Europe is driven by an international economy where Multinational companies not only engage in investments within Europe but outside of it.
Reasons for Decline
One of the primary reasons for such FDI slump in Europe is basically attributed to falling profits in countries who would normally invest in Europe. Multinational companies in these countries reinvested their earnings in local economies by re-channeling loans from foreign affiliate banks to their headquarters. Moreover, fallout in leveraged buyout transactions by private equity funds from many countries have also halted the MA process resulting in lesser FDI inflows (p. 3).
FDI as Economic Indicator
Such is the importance of these statistics that OECD forum, where governments of 30 democracies work together to address social, political and economic issue, decided to set a benchmark definition for FDI in order to help experts analyze policies. New definitions related to FDI and methods of its evaluation are explained in regular updates of OECD handbook. Several international organizations are in charge of compiling this complex data. These include five principal organizations namely, OECD, EuroStat, European Central Bank, IMF and UNCTAD. The data released by EuroStat and UNCTAD is deemed very consistent whereas analysts often resort to OECD handbooks to disseminate data from other sources (OECD 2008, p. 38). This data is used extensively by governments, NGOs, economists, writers and commentators to address the impact of internationalization and FDI on the well being of societies.
V - Literature Review
Regarding Europe, such data takes even more significance due to its central role in internationalization as well as its status as leading trade partner to USA, China and Japan. Such an impact is obvious in current literature. While there is an extensive collection of literature addressing positive outcomes of FDI, this report also looks at some negative aspects including the threat posed to local firms by multinationals and a potential ineffectiveness of bilateral investment agreement.
Problem with Multinationals
Historically, it was believed that the degree of internationalization and a firms performance has linear relationship but such concepts have been vehemently challenged in current economic environments (Gabler 2003). Analysts are starting to consider the objectives of multinational companies, MNC, which may be to become more competitive in their respective industries rather than exploring external opportunities, as previously thought. Therefore the main source of benefit of internationalization is not seen in exploiting external factors but induction and exhaustion of intra-firm comparative advantage (p. 67). In context of this German survey, one is forced to rethink the problems faced by national and small organizations that are in greater risk of loosing their competitive advantage by the induction of such MNC in their system whose primary motive is to exploit intra-firm competitiveness rather than aim for a broader vision. It can be argued that it is not only local organizations but local culture itself that is under threat. For example, two prominent writers, Anne-Wil Harzing and Arndt Sorge have suggested that multinational companies may be integrating their own cultural values in Europe. Studying the country of origin effect, their research suggest that multinational companies follow a set track of rules that is mainly developed in their home countries and steadily imposed on work environments. Considering the power of large multinationals, previous work from economists such as Goodherham, Whitley and Guillen also provide conclusive evidence that it the home culture instead of industry size or sector of operation that primarily decides the operational framework in another country (Harzig Sorge 2003). Such factors become even more controversial from evidence published in reputable literature suggesting that international performance of European countries is actually driven by a handful of high performance firms (Mayer Ottaviano 2007).
Regarding the emergence of International trade in West European countries, some commentators also proclaim that internationalization has contributed to job losses and economic insecurities in middle to low class workers (Duane Hanse 2003, p.220).
Bilateral Investment Treaties FDI
As a precursor to FDI, companies and host countries rely in bilateral investment treaties. These BIT are common place these days. Proliferation of these treaties is due to risky nature of international businesses. A firm, when planning to invest in a foreign country, is reluctant because of conditions such as property rights, government enforcement and corruption. In contrast, host governments are skeptic on the motives and staying power of these MNC. This mistrust is the real cause of BIT.
While, the objective of these treaties is to foster an environment of trust between MNC and host countries, opponents of such treaties also believe that foreign investors gain an unfair advantage in the negotiations which is counterproductive to the growth of local investment environment (Jennifer Ackerman 2004). They argue that MNC play a more dominant role in investment hungry economies as these foreign entities sometimes acquire exemption from local laws by demanding substantial subsidies an indemnity that local companies cannot receive. Objections of these analyst is not without merit because it suggests that foreign direct investments by gaining unfair advantages through bilateral investment treaties may be harmful to developing countries in East European block rather than Western Europe. Subsequently, such FDI may have little visible impact on the social-economic environment of developing countries. Further studies have indicated that there is a weak relationship between BIT and FDI because BIT may actually propel foreign entities to bypass law resulting in conflicts with local businesses (p. 34). In contrast, experts have also found a positive relationship in more risky environments where multinational companies may be able to do more good by ratifying rules in their favor.
FDI The Phenomenon Unfolding Itself
Whereas these implications may be a concern for local firms but writers also state that we may be seeing a global phenomenon of internationalization taking place where more efficient firms are taking place of less efficient organizations thus paving way for increase in productivity, wages and GDP (Mayer Ottaviano 2007, p. 1). If this trend continues to unfold, it is not illogical to conceive a future consisting of MNC relying on FDI as their primary source of maintaining competitive advantage. Such theories also paint a brighter picture for companies that are willing to explore international trade as a viable alternative to growth. The following paragraphs will relate how small firms and governments are tackling issues regarding FDI by taking proactive measures and turning their weaknesses into advantage.
What about Smaller Players
Apart from the fact that large MNC play a vital role in sustaining lifeline of international trade, the role of medium and small companies should not be ignored. In their study of Belgium firms, writers from three leading business institutions have theorized that it is the entrepreneur spirit of medium and small firm that propels them to succeed in an international environment. It can be deduced from their argument that internationalization is not restricted to large MNC but it is open to those small players who are willing to undertake risk. According to their work, international learning effort lies at the core of success in international markets (Clercq, Sapiens Crijns 2003). When firms get more comfortable with foreign environment, it acts as a catalyst to increase their appetite for international activity. Secondly, the more knowledge that this firm acquires, the more willing it is to utilize and expand that knowledge (p. 4-5). Despite the fact that their research does not provide evidence of results of FDI from medium and small companies, it helps answers controversy surrounding the conditions for success of these organizations.
Changing Roles of Governments
The role of national governments has increasingly becoming important in an internationalized economy. These governments have to deal with economic and technological changes which may be beyond their regulation sphere. A good example is growth of e-commerce which has given rise to such tribulations as copyright issues and piracy. As indicated earlier in this article, large mergers acquisitions are primarily taking place in electronic sector therefore national governments may find themselves limited to the whims of large corporations who are undertaking an increasingly influential role in determining how to do business. Such undertakings by companies of foreign origins require governments to design regulations which do not curtail the progress of domestic industries in response to international pressure.
Unison of Public Private Sectors in attracting FDI
European Union has tackled this issue by maintaining their steering potential of national institutions in the form of international institutions (Knill Lehmkuhl 2002). These international institutions help alleviate concerns from foreign entities by regulating on a global scale (p. 45). Another constructive idea of European countries is to allow their public institutions to aid private sectors which in turn nurture development among all sectors (p. 51). The unity of private and public sectors of European international institutions became apparent in 1998 on the issue of domain names when US government tried to politicize the issue. Because European governments did not want a system controlled by US interest, it fought hard to reinstate a more liberal policy by applying consistent two fold pressure from private and public institutions. US authorities cracked under this mounting pressure thus relegating responsibilities to ICANN which oversees global cyberspace regulations (p. 54). Such harmonization of Europes public and private sectors can act as a model for international governments on how private sector, recipient of foreign direct investment, and government may integrate to play a more productive role in reinforcing their agenda.
EURO
Study of foreign direct investment in Europe is never complete without the biggest ever economic experiment undertaken in modern era, the introduction of Euro. This combine endeavor by multiple countries has not only resulted in boosting foreign investment but also created new opportunities for new global strategies. On the occasion of EU 10th anniversary, research revealed that the aggregate impact of introducing Euro is in the range of 5.
It is theorized that Euro boosted trade inside the EuroZone since it lowered the price of relative goods coming from within Europe. According to EU report, the lowering of prices either came from reduction of bilateral trade between European countries or due to the increase in competition that reduced prices via pro competitive effect (p. 5). Nevertheless, it is now becoming clear that launch of Euro has a pro-FDI effect on European countries (EU Economic Paper 2008). This FDI effect was much larger in manufacturing than in services therefore it is assumed that when barriers to MA in service sector breaks down, it will have a strong ripple effect which will trigger a new wave of mergers and acquisitions in Europe. As Europe is still suffering from recession which has eroded FDI to 39, such a boost may help Europe come out of recession more quickly than its counterparts. Despite concerns, evidence suggests that Euro also fostered cross border MA activities by both large and small firms. Amid debate, authors have predicted that effects of Euro have largely been pro-FDI constituting 15 for in-to-in flows, 7.5 for out-to-in to 200 and 100, respectively for into in and out to in flows (p. 6).
FDI Transitional Europe
In his book, the impact of FDI on economic growth an analysis for the transition, Marco Neuhaus succinctly describes the positive impact of FDI on the transitional economies of Central and Eastern Europe. The impact of FDI was more profound due to the integration of these economies with Europe and a possibility of future reunion with EU. Economic integration was achieved by increasing trade inflows from other West European countries. As a result, the net inward stock of FDI in these transition economies increased almost eightfold between 1994 and 2002. In numerical figures, it comes out to 155 billion dollars which is 31.8 share of the GDP (Marco 2006). In a comparative analysis on the accumulation of capital stocks, the author proved that level of capital contribution was mainly attributed to in flows from outside countries. Similarly, rapid technological progress was also the direct consequences of FDI inflows (p. 18)
Analysts further argue that FDI became an increasingly important element in internationalization process when transition economies of Central and Eastern European block moved towards Socialism to Capitalism in 90s. As a result of this transition, Eastern Europe benefited from FDI that has since facilitated growth, promoted technical advancement and offered capital accumulation (Alan Saul 2004). During 1994 to 2000, the FDI flows had largely been concentrated in three countries, Czech Republic, Hungary and Poland but the trend is changing to include other countries. Bulgaria is a prime example of such a change which has received a staggering 385 growth in FDI compared to 39 decline in rest of Europe, during 2009.
The role of FDI in transitional economies of Europe is further enhanced by the interdependence of the governments which rely on FDI to cover account deficit, fiscal deficit and supplement capital formation (Krkoska 2001). Although it is true that FDI inflows in transitional economies is low as compared to developed European economies but such a progress should be measured by the percentage of GDP. When comparing inflows as percentage of GDP with other transitional economies, it is revealed that Central and East European block has fared well in terms of monetary benefits. At the top of this list are four East European countries including Azerbaijan, Slovakia, Czech Republic and Bulgaria, each posting more than 6 of GDP due to FDI (p. 3-4).
In Central Europe, a large part of the FDI is generated by the process of privatization. Despite this trend, there are a number of transition countries that have been able to successfully attract FDI without a significant privatization programme. Countries such as Czech Republic and Slovakia have promoted privatization to local investors by debt financing linked to foreign credit.
Europes Reliance on FDI
Beside recession, another major factor in current European FDI crisis is the reliance of European States in capital restructuring from FDI inflows. In Europe subsidiaries of MNE are relatively low (Kalotay Filippov 2009). As these entities are immune to the risk of FDI inflow, their scarcity resulted in amplifying the effect of recent crisis.
Still, a possible solution to Europes future FDI problem may lie in further diversification strategies. Experts argue that, effective and sustainable FDI policies require measures that avoid beggar-thy neighbor solutions. In the context of investment promotion, the challenges are to find new sectoral priorities (for example, replacing the automotive industry), and new measures (including a rethinking of the system of subsidies which in the current form has been to little avail in stopping job losses (p. 32).
It is understandable that FDI in Europe has declined but economic figures indicate that such decline is still respectable in comparison to figures in 2006 and 2007. The region attracted a growing volume of projects from 2003-2008 which has created more job opportunities. Furthermore, FDI projects are beginning to see an increase once more. In September 2009, there were 1,200 new projects initiated which is more than preceding months indicating a possible recovery. Current development strategies still depend on foreign investment but this trend is changing as Europe is shifting its focus on upgrading FDI to higher value added industries and functions.
According to a major survey by United Nations, a quest for markets, resource and efficiency will continue to drive internationalization and FDI (United Nations 2007, p. 7). Moreover, prevailing long term trends, future economic outlook and availability of financial resources are conducive to FDI growth (p. 9). Europe remains highly attractive to foreign investor as companies with FDI makes high proportion of overall market, as compared to other world markets. Consequently, EU-15 countries are just behind North America with 66 percent of companies with FDI whereas EU-12 is fast catching up by nearing 50 mark (p.22).
I - Aims Objectives
The objective of this paper is to analyze the historical and current FDI trends in Europe, as it pertains to internationalization. This paper evaluates future prospects that should spur regional FDI growth while shedding light on probable factors that may be hindering such progress in European countries. It is also suggested that integration of EU-12 in European Union will offer more incentives to foreign investors to invest in a market that is saturated with highly stable West European economy as well as fast developing Central and East European block. Some of the major questions the paper will focus on answering are
How FDI will evolve in Europe after 2009
What is the impact of FDI on local economy
What are the risks to foreign investors
How can Europe attract more FDI
II - Methodology
The final research will constitute relevant literature related to the scope of internationalization and its effect on FDI in Europe. Primarily, the theory will be based on books, academic journals, official reports from professional organizations and reputable sources from internet. In order to gain better perspective, books or academic journals will be utilized for historical aspects while official white papers and internet will help in accumulating current facts. It is the intent of writer to include as much electronically accessible literature in public domain, as possible. Such a strategy should help readers to gain better insight by easily referring to a more extensive source of information.
III - Data Collection
Most of the data will be compiled from recent research by OECD, EuroStat, European Central Bank, IMF and UNCTAD. According to experts these organizations are major sources of reputable data for studies on internationalization and FDI (OECD 2008, p. 38). Moreover, the data use is merited due to an active role of these organizations in compiling such statistics and their presence in the heart of Europe, except IMF.
IV - Overview
Recent advancement in technology has significantly condensed international borders. In this regard, it will not be an overstatement to suggest that global trade boundaries have actually shrunk to such an extent that experts are already foreseeing a virtual trading environment without physical limitations. The coining of term internationalization is a direct result of such an ideology. It is a process by which companies engage in wide ranging business activities in another country. In order to conduct such activities, these foreign entities make physical investment, known as foreign direct investment. Since FDI is an integral part of internationalization, an effective FDI strategy greatly impacts the well being and development of societies.
Internationalization FDI
Since last few decades, internationalization is evident by a sudden increase in the value of trade as a percentage of World GDP from 42.1 in 1980 to 65.1 in 2007. During this time period, FDI has also jumped more than five folds reaching an unprecedented level of approximately 32 percent in 2006 from 6.5 percent in 1980. Although the path to prosperity may differ widely amongst individual States but foreign direct investment, in particular, is the most important factor in globalizing local economies (IMF 2008).
According to IMF, countries engaged in global business activities, are destined to enjoy higher rates of economic stability, financial growth and top standards of living.
The Case of Europe
European Union provides an excellent proof of integration with World economy. Therefore, it is pertinent to study internationalization and FDI in context of the developments taking place in Europe. Currently, EU is a conglomerate of 27 member States that have become united under a similar economic and political agenda. Combined, these States produce 30 share of the nominal gross world product (IMF 2009). Despite these figures, there exist wide ranging disparity in economic conditions of different regions, making EU a perfect candidate to study the impact of internationalization, in general, and FDI in particular.
Although EU has developed a single market by standardizing laws to promote free trade, economic disparities within EU remain a concern. According to EuroStat, PPP per capital in inner London is almost 14 times greater than that of the poor regions of Bulgaria (EuroStat 2007). These circumstances together with a motive to end inequality have promoted European Nations to open their economies to international trade. As a whole, EU is generating an estimated GDP of nearly 18.39 trillion making it the largest economy in the World. It is also the largest importer and largest exporter of goods and services as well as the biggest trading partner to emerging and developing economies including China (Peoples Daily Online, 2007).
FDI in Europe Current Situation
Regarding Europes quest to become a truly global economy, role of foreign direct investment cannot be ignored. FDI refers to one countrys participation in economic affairs of another country by methods such as management, technology transfer and joint venture, among others. FDI can also be measured by foreign ownership of factories, land and other tangible or intangible assets. Whereas ongoing recession has decreased global inflows of foreign direct investment by almost 39 from 1.7 trillion dollars in 2008 to only 1 trillion dollars in 2009 but it is bound to rebound, once the recession is over (UNCTAD 2010). These numbers were not very different for EU block. Europe was also hit hard by the current recession which saw FDI inflows reducing 27 percent to 373 billion dollars from a high of almost 518 billion dollars, a year earlier. Another noticeable factor was a significant reduction in cross border merger and acquisitions, MA. According to figures compiled by United Nations, cross border MA fell by almost 53 percent from previous year to mere 127 billion dollars by the end of 2009 (p.2).
As previously stated that FDI is depended on multiple factors therefore the impact of FDI in one broader geographical region may be diverse. Such a trend has been noticed in Germany and Italy where FDI inflows have actually increased by 40 and 75 percent, respectively. More interestingly, Belgium has reported a growth rate of 385 in MA last year which is an indication that FDI and MA is a significant but separate function in the internationalization. Despite these statistics, it is exciting to note that Europe has fared well than many contemporary economies such as USA and Japan where the decrease in numbers is most alarming.
In 2009, there were almost 27 mergers or acquisitions that were greater than 3 billion dollars in transaction. The largest of these constituted electronic services industry. Most prominent were the acquisition of Genentech Inc of United States by Roche Holdings AG of Switzerland accounting for almost 46,695 million dollars. Some other major deals included acquisition of Endesa SA of Spain by Enel SpA of Italy and Nuon NV of Netherlands by Vattenfall AB of Sweden (p.7, Annex 1). These MAs highlight the fact that modern Europe is driven by an international economy where Multinational companies not only engage in investments within Europe but outside of it.
Reasons for Decline
One of the primary reasons for such FDI slump in Europe is basically attributed to falling profits in countries who would normally invest in Europe. Multinational companies in these countries reinvested their earnings in local economies by re-channeling loans from foreign affiliate banks to their headquarters. Moreover, fallout in leveraged buyout transactions by private equity funds from many countries have also halted the MA process resulting in lesser FDI inflows (p. 3).
FDI as Economic Indicator
Such is the importance of these statistics that OECD forum, where governments of 30 democracies work together to address social, political and economic issue, decided to set a benchmark definition for FDI in order to help experts analyze policies. New definitions related to FDI and methods of its evaluation are explained in regular updates of OECD handbook. Several international organizations are in charge of compiling this complex data. These include five principal organizations namely, OECD, EuroStat, European Central Bank, IMF and UNCTAD. The data released by EuroStat and UNCTAD is deemed very consistent whereas analysts often resort to OECD handbooks to disseminate data from other sources (OECD 2008, p. 38). This data is used extensively by governments, NGOs, economists, writers and commentators to address the impact of internationalization and FDI on the well being of societies.
V - Literature Review
Regarding Europe, such data takes even more significance due to its central role in internationalization as well as its status as leading trade partner to USA, China and Japan. Such an impact is obvious in current literature. While there is an extensive collection of literature addressing positive outcomes of FDI, this report also looks at some negative aspects including the threat posed to local firms by multinationals and a potential ineffectiveness of bilateral investment agreement.
Problem with Multinationals
Historically, it was believed that the degree of internationalization and a firms performance has linear relationship but such concepts have been vehemently challenged in current economic environments (Gabler 2003). Analysts are starting to consider the objectives of multinational companies, MNC, which may be to become more competitive in their respective industries rather than exploring external opportunities, as previously thought. Therefore the main source of benefit of internationalization is not seen in exploiting external factors but induction and exhaustion of intra-firm comparative advantage (p. 67). In context of this German survey, one is forced to rethink the problems faced by national and small organizations that are in greater risk of loosing their competitive advantage by the induction of such MNC in their system whose primary motive is to exploit intra-firm competitiveness rather than aim for a broader vision. It can be argued that it is not only local organizations but local culture itself that is under threat. For example, two prominent writers, Anne-Wil Harzing and Arndt Sorge have suggested that multinational companies may be integrating their own cultural values in Europe. Studying the country of origin effect, their research suggest that multinational companies follow a set track of rules that is mainly developed in their home countries and steadily imposed on work environments. Considering the power of large multinationals, previous work from economists such as Goodherham, Whitley and Guillen also provide conclusive evidence that it the home culture instead of industry size or sector of operation that primarily decides the operational framework in another country (Harzig Sorge 2003). Such factors become even more controversial from evidence published in reputable literature suggesting that international performance of European countries is actually driven by a handful of high performance firms (Mayer Ottaviano 2007).
Regarding the emergence of International trade in West European countries, some commentators also proclaim that internationalization has contributed to job losses and economic insecurities in middle to low class workers (Duane Hanse 2003, p.220).
Bilateral Investment Treaties FDI
As a precursor to FDI, companies and host countries rely in bilateral investment treaties. These BIT are common place these days. Proliferation of these treaties is due to risky nature of international businesses. A firm, when planning to invest in a foreign country, is reluctant because of conditions such as property rights, government enforcement and corruption. In contrast, host governments are skeptic on the motives and staying power of these MNC. This mistrust is the real cause of BIT.
While, the objective of these treaties is to foster an environment of trust between MNC and host countries, opponents of such treaties also believe that foreign investors gain an unfair advantage in the negotiations which is counterproductive to the growth of local investment environment (Jennifer Ackerman 2004). They argue that MNC play a more dominant role in investment hungry economies as these foreign entities sometimes acquire exemption from local laws by demanding substantial subsidies an indemnity that local companies cannot receive. Objections of these analyst is not without merit because it suggests that foreign direct investments by gaining unfair advantages through bilateral investment treaties may be harmful to developing countries in East European block rather than Western Europe. Subsequently, such FDI may have little visible impact on the social-economic environment of developing countries. Further studies have indicated that there is a weak relationship between BIT and FDI because BIT may actually propel foreign entities to bypass law resulting in conflicts with local businesses (p. 34). In contrast, experts have also found a positive relationship in more risky environments where multinational companies may be able to do more good by ratifying rules in their favor.
FDI The Phenomenon Unfolding Itself
Whereas these implications may be a concern for local firms but writers also state that we may be seeing a global phenomenon of internationalization taking place where more efficient firms are taking place of less efficient organizations thus paving way for increase in productivity, wages and GDP (Mayer Ottaviano 2007, p. 1). If this trend continues to unfold, it is not illogical to conceive a future consisting of MNC relying on FDI as their primary source of maintaining competitive advantage. Such theories also paint a brighter picture for companies that are willing to explore international trade as a viable alternative to growth. The following paragraphs will relate how small firms and governments are tackling issues regarding FDI by taking proactive measures and turning their weaknesses into advantage.
What about Smaller Players
Apart from the fact that large MNC play a vital role in sustaining lifeline of international trade, the role of medium and small companies should not be ignored. In their study of Belgium firms, writers from three leading business institutions have theorized that it is the entrepreneur spirit of medium and small firm that propels them to succeed in an international environment. It can be deduced from their argument that internationalization is not restricted to large MNC but it is open to those small players who are willing to undertake risk. According to their work, international learning effort lies at the core of success in international markets (Clercq, Sapiens Crijns 2003). When firms get more comfortable with foreign environment, it acts as a catalyst to increase their appetite for international activity. Secondly, the more knowledge that this firm acquires, the more willing it is to utilize and expand that knowledge (p. 4-5). Despite the fact that their research does not provide evidence of results of FDI from medium and small companies, it helps answers controversy surrounding the conditions for success of these organizations.
Changing Roles of Governments
The role of national governments has increasingly becoming important in an internationalized economy. These governments have to deal with economic and technological changes which may be beyond their regulation sphere. A good example is growth of e-commerce which has given rise to such tribulations as copyright issues and piracy. As indicated earlier in this article, large mergers acquisitions are primarily taking place in electronic sector therefore national governments may find themselves limited to the whims of large corporations who are undertaking an increasingly influential role in determining how to do business. Such undertakings by companies of foreign origins require governments to design regulations which do not curtail the progress of domestic industries in response to international pressure.
Unison of Public Private Sectors in attracting FDI
European Union has tackled this issue by maintaining their steering potential of national institutions in the form of international institutions (Knill Lehmkuhl 2002). These international institutions help alleviate concerns from foreign entities by regulating on a global scale (p. 45). Another constructive idea of European countries is to allow their public institutions to aid private sectors which in turn nurture development among all sectors (p. 51). The unity of private and public sectors of European international institutions became apparent in 1998 on the issue of domain names when US government tried to politicize the issue. Because European governments did not want a system controlled by US interest, it fought hard to reinstate a more liberal policy by applying consistent two fold pressure from private and public institutions. US authorities cracked under this mounting pressure thus relegating responsibilities to ICANN which oversees global cyberspace regulations (p. 54). Such harmonization of Europes public and private sectors can act as a model for international governments on how private sector, recipient of foreign direct investment, and government may integrate to play a more productive role in reinforcing their agenda.
EURO
Study of foreign direct investment in Europe is never complete without the biggest ever economic experiment undertaken in modern era, the introduction of Euro. This combine endeavor by multiple countries has not only resulted in boosting foreign investment but also created new opportunities for new global strategies. On the occasion of EU 10th anniversary, research revealed that the aggregate impact of introducing Euro is in the range of 5.
It is theorized that Euro boosted trade inside the EuroZone since it lowered the price of relative goods coming from within Europe. According to EU report, the lowering of prices either came from reduction of bilateral trade between European countries or due to the increase in competition that reduced prices via pro competitive effect (p. 5). Nevertheless, it is now becoming clear that launch of Euro has a pro-FDI effect on European countries (EU Economic Paper 2008). This FDI effect was much larger in manufacturing than in services therefore it is assumed that when barriers to MA in service sector breaks down, it will have a strong ripple effect which will trigger a new wave of mergers and acquisitions in Europe. As Europe is still suffering from recession which has eroded FDI to 39, such a boost may help Europe come out of recession more quickly than its counterparts. Despite concerns, evidence suggests that Euro also fostered cross border MA activities by both large and small firms. Amid debate, authors have predicted that effects of Euro have largely been pro-FDI constituting 15 for in-to-in flows, 7.5 for out-to-in to 200 and 100, respectively for into in and out to in flows (p. 6).
FDI Transitional Europe
In his book, the impact of FDI on economic growth an analysis for the transition, Marco Neuhaus succinctly describes the positive impact of FDI on the transitional economies of Central and Eastern Europe. The impact of FDI was more profound due to the integration of these economies with Europe and a possibility of future reunion with EU. Economic integration was achieved by increasing trade inflows from other West European countries. As a result, the net inward stock of FDI in these transition economies increased almost eightfold between 1994 and 2002. In numerical figures, it comes out to 155 billion dollars which is 31.8 share of the GDP (Marco 2006). In a comparative analysis on the accumulation of capital stocks, the author proved that level of capital contribution was mainly attributed to in flows from outside countries. Similarly, rapid technological progress was also the direct consequences of FDI inflows (p. 18)
Analysts further argue that FDI became an increasingly important element in internationalization process when transition economies of Central and Eastern European block moved towards Socialism to Capitalism in 90s. As a result of this transition, Eastern Europe benefited from FDI that has since facilitated growth, promoted technical advancement and offered capital accumulation (Alan Saul 2004). During 1994 to 2000, the FDI flows had largely been concentrated in three countries, Czech Republic, Hungary and Poland but the trend is changing to include other countries. Bulgaria is a prime example of such a change which has received a staggering 385 growth in FDI compared to 39 decline in rest of Europe, during 2009.
The role of FDI in transitional economies of Europe is further enhanced by the interdependence of the governments which rely on FDI to cover account deficit, fiscal deficit and supplement capital formation (Krkoska 2001). Although it is true that FDI inflows in transitional economies is low as compared to developed European economies but such a progress should be measured by the percentage of GDP. When comparing inflows as percentage of GDP with other transitional economies, it is revealed that Central and East European block has fared well in terms of monetary benefits. At the top of this list are four East European countries including Azerbaijan, Slovakia, Czech Republic and Bulgaria, each posting more than 6 of GDP due to FDI (p. 3-4).
In Central Europe, a large part of the FDI is generated by the process of privatization. Despite this trend, there are a number of transition countries that have been able to successfully attract FDI without a significant privatization programme. Countries such as Czech Republic and Slovakia have promoted privatization to local investors by debt financing linked to foreign credit.
Europes Reliance on FDI
Beside recession, another major factor in current European FDI crisis is the reliance of European States in capital restructuring from FDI inflows. In Europe subsidiaries of MNE are relatively low (Kalotay Filippov 2009). As these entities are immune to the risk of FDI inflow, their scarcity resulted in amplifying the effect of recent crisis.
Still, a possible solution to Europes future FDI problem may lie in further diversification strategies. Experts argue that, effective and sustainable FDI policies require measures that avoid beggar-thy neighbor solutions. In the context of investment promotion, the challenges are to find new sectoral priorities (for example, replacing the automotive industry), and new measures (including a rethinking of the system of subsidies which in the current form has been to little avail in stopping job losses (p. 32).
It is understandable that FDI in Europe has declined but economic figures indicate that such decline is still respectable in comparison to figures in 2006 and 2007. The region attracted a growing volume of projects from 2003-2008 which has created more job opportunities. Furthermore, FDI projects are beginning to see an increase once more. In September 2009, there were 1,200 new projects initiated which is more than preceding months indicating a possible recovery. Current development strategies still depend on foreign investment but this trend is changing as Europe is shifting its focus on upgrading FDI to higher value added industries and functions.
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