Foreign Direct Investment (FDI) refers to capital expenditures by companies (with their head office in another country) to either acquire assets of an existing firm in a foreign country with the intention of playing a role in managing those assets, or to establish a new firm. Put more simply, a firm in one country invests in another country in order to control and manage an actual productive capacity that will generate output.
There are a number of causes of FDI, some of which can be applied to almost all foreign investment, and others that are specific to the country in which the investment is being undertaken. The more general causes of FDI are:
This refers to the comparative advantages or natural resource advantages held by a particular country compared to another. If a country has a comparative advantage over another, (i.e. higher factor endowments compared to the other country) then it makes sense for the country with the lower factor endowments to invest in the other country and benefit from the higher productivity there.
For example lower labour costs or higher labour productivity in one country would encourage firms in another country (without these benefits) to invest and produce in this country in order to gain from this comparative advantage.
Ownership, Location and Internalisation Paradigm
A firm may wish to produce in another country, the OLI paradigm explains why it does this through FDI as opposed to other methods of production such as licensing a domestic firm to produce you good.
The ownership factor indicates that a firm may wish to purchase an existing firm and use takeovers as a means of expansion rather than starting a new firm from scratch.
The location argument implies that a firm may benefit from having production facilities outside the domestic country. By being able to produce in different areas of the world the firm can reduce transportation costs and may open up new markets for its good.
The internalisation argument refers to how the production method or ingredients (etc) may be ownership specific, as a result the firm is unwilling to pass this superior knowledge on to other firms. In addition to this the investing firm may be unwilling for other firms to produce under their brand due to the possibility of poor quality production etc.
The combination of these factors points towards FDI instead of other methods of foreign production.
New Trade Theories
These theories recognise other determinants of FDI such as:
Economies of Scale
Transport Costs and benefits arising from good infrastructures
Access to other markets (geographical location)
There are other common factors that vary from country to country that affect FDI. For example tariffs, subsidies, tax levels, regulation, safety standards, international relations, language difficulties etc.
The above determinants of FDI can be applied to both Ireland and Spain (aswell as most other countries receiving FDI). However there are a number of more specific determinants of FDI to Ireland and Spain individually.
Lower labour and capital costs in Spain (compared to other EU countries) are thought to have encouraged FDI. However, growth in wage rates during much of the 1980 s meant that this advantage is not as important today. On the other hand, productivity in the 1990 s has risen more quickly than wage rates, meaning that Spanish labour market will continue to attract FDI. In addition to this Spain is considered to have a good human capital resource base, that is to say that there is skilled labour avaliable.
Spain joined the European Community in 1986. This led to unrestricted trade between Spain and other EU members. As a result, there was an increase in attractiveness for firms (wishing to sell in Europe) to invest in Spain. Trade liberalisation, in general, between Spain and other countries has promoted FDI in Spain. It can be seen that trade liberalisation has helped to encourage FDI in Spain
Small to medium sized, family owned businesses make up a large proportion of the Spanish markets. These small firms find it hard to compete with larger firms achieving economies of scale. As a result of this there are few barriers to entry in many of the markets, and so foreign firms can enter the market cheaply and easily. There is also the potential for larger, investing firms to takeover the smaller domestic producers and enter the market in this way. Here we can see how the structure of Spain s markets encourages and enables FDI.
European Monetary Union in Spain will encourage investors from outside of the EU if they wish to aim products at other countries within EU. The risks and problems associated exchange rate fluctuations will be eliminated and so FDI in Spain will be encouraged.
Both the Spanish government and the EU provide incentives for foreign firms to invest in Spain. The Spanish government offers grants to attract FDI away from Barcelona and Madrid in an attempt to develop poorer regions of Spain. The European Union will pay up to 80% of the start up costs of foreign firms who locate in particular Spanish regions.
Spain is a large country and possesses many valued raw materials. Firms may choose to locate in Spain due to the availability of these raw materials.
Spain has a good infrastructure. This means that it has good transport links by road, sea, air and rail to all of Europe. Spain also has close links with other mediterranean countries such as Africa. Spain also has many cultural links with both North and South America. Spain attracts FDI because of its geographical location and good infrastructure.
There are also factors affecting FDI that are specific to Ireland:
Ireland is considered one of the best in Europe for its quality of education. It places a large emphasis on academic achievement. 70% of university students choose engineering, computer science or commerce as a course to study, leaving the country with a highly educated and eager workforce in the areas where industrial growth is at its highest. Dell is one such company that has benefited from these advantages. This highly skilled and educated workforce is clearly a factor that will encourage FDI in Ireland.
Ireland’s operating costs are very competitive. Direct and indirect labour costs are amongst the lowest in Europe. The workforce is flexible and can achieve high levels of productivity. Quality and reasonably priced office and factory premises are available, with low costs for the everyday running of firms (i.e. power and water).
It has a sophisticated and competitive telecommunications infrastructure that offers low tariffs to volume users; high regulated competition keeps these costs down. In recent years over $15bn has been invested in its telecommunication infrastructure, leaving Ireland with one of the most advanced digital networks in Europe.
These wise investments in infrastructure allow rapid access to world markets for manufacturers.
Ireland also has a good transport infrastructure. This means that it has good transport links to Europe, especially by sea; there is scope for large-scale, low cost, exporting of goods to Europe and further abroad. These infrastructural advantages encourage FDI.
In Ireland there is a very low corporate-profits tax rate, (currently around 10 percent, compared to an EU average at least three times as high). This replaced an earlier policy (which had to be changed under EU rules) of zero corporate profits tax on manufactured exports. These low levels of taxes where and still are very conducive to FDI in Ireland.
The Irish government offered investment grants to foreign firms locating in Ireland during the 70 s and 80 s. These investment grants remain in various forms today and are set at levels close to the EU average rate. Therefore there are financial gains for firms locating in Ireland, encouraging FDI.
Successive Irish governments have been committed to keeping the business environment competitive. It has been most noticeable in the last 10 years when a growth rate in excess of 10% per annum has been observed. 70% of GDP is exported to established European and US markets, Ireland is the only English speaking country in the EMU that has a export orientated economy. These facts will especially encourage FDI by English speaking firms so as to avoid potential problems associated with language difficulties. English is the most widely spoken language in the world and so firms are unlikely to be discouraged from locating in Ireland on these grounds.
Ireland developed an Industrial Development Authority (charged with the attraction of foreign industry to Ireland) which is second to none in the world in carrying out this task. The IDA tends to target particular sectors in accord with its strategic vision. In recent decades these have tended to be relatively high-skill sectors, particularly in the fields of computers and chemicals. Obviously this direct attempt to encourage FDI in Ireland will and has helped to encourage firms to locate in Ireland.
European Monetary Union in Ireland will encourage investors from outside of the EU if they wish to aim products at other countries within EU. The risks and problems associated exchange rate fluctuations will be eliminated and so FDI in Ireland will be encouraged. Ireland is a member of the European Community. As a result there is unrestricted trade between Ireland and other EU members. This increases Ireland s attractiveness for firms (wishing to sell in Europe). Trade liberalisation, in general, between Ireland and other countries (e.g. US) has promoted FDI in Ireland.
Ireland is located towards the edge of the EU and is in an ideal geographical location for export (by sea because on an island, which is cheaper than road) orientated firms wishing to develop markets in Europe.
Ireland has a liberal policy towards FDI regulation. There are no limits on how much a single firm is allowed to invest in Ireland. Irish policies also allow the return of almost all (minus taxes) profits to the home country. These policies are conducive to FDI.