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GREENFIELD INVESTMENT (FDI) FOR SUSTAINABLE DEVELOPMENT OF INDIA: INCREASING BENEFITS & REDUCING COSTS

GREENFIELD INVESTMENT (FDI) FOR SUSTAINABLE DEVELOPMENT OF INDIA: INCREASING BENEFITS & REDUCING COSTS

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    Greenfield fdifor sustainable development of india Greenfield fdifor sustainable development of india Document Transcript

    • GREENFIELD INVESTMENT (FDI) FOR SUSTAINABLE DEVELOPMENT OF INDIA: INCREASING BENEFITS & REDUCING COSTS Ms. Roopali Fulzele (Assistant Professor) Management Department, Tecnia Institute of Advanced Studies, Institutional Area, Madhuban Chowk, Rohini, Delhi-110085, India E-mail: roopali.fulzele@gmail.com Contact No. – 9582425298 Mr. Chandan Parsad (Assistant Professor) Management Department, Tecnia Institute of Advanced Studies, Institutional Area, Madhuban Chowk, Rohini, Delhi-110085, India E-mail: chandanparsad@gmail.com Contact No. – 9868907936 ABSTRACT FDI to developing countries in the 1990s was the leading source of external financing and has become a key component of national development strategies for almost all the countries in the world as a vehicle for technology flows and an important source of non-debt inflows for attaining competitive efficiency by creating a meaningful network of global interconnections. This paper evaluates that what are the various factors contribute to Greenfield FDI which provide opportunities to host countries to enhance their economic development and opens new opportunities to home countries to optimize their earnings by employing their ideal resources. Greenfield Investment is the most typical modes in internal and external growth process of a business organization, and is thus most commonly used when investment decisions are being made. The present paper also attempts to analyze significance of the Greenfield FDI Inflows for sustainable development in India. The research consists of study of Greenfield FDI for sustainable development in INDIA, analysis of factors affecting Greenfield Investment responsible for increasing benefits and reducing costs. Thus, the mobility of international capital flows has gained importance not only from a development point of view but also from a point of sustainable development, especially with respect to maximizing revenues and minimizing costs. Key Words: Greenfield Investment, Foreign Direct Investment, Employment, Technology transfer and Sustainable Development 1. INTRODUCTION
    • Foreign direct investment (FDI) or foreign investment refers to the net inflows of investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor. It is the sum of equity capital, reinvestment of earnings, other long-term capital, and short-term capital as shown in the balance of payments. It usually involves participation in management, joint-venture, transfer of technology and expertise. There are two types of FDI: inward foreign direct investment and outward foreign direct investment, resulting in a net FDI inflow (positive or negative) and "stock of foreign direct investment", which is the cumulative number for a given period. Direct investment excludes investment through purchase of shares. FDI is one example of international factor movement. 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. Broadly, FDI are of two types: Horizontal and Vertical FDI. Horizontal FDI occurs when the MNE (Multi-National Enterprise) enters a foreign country to produce the same product(s) produced at home (or offer the same service that it sells at home). It represents, therefore, a geographical diversification of the MNE’s domestic product line. Most Japanese MNEs, for instance, begin their international expansion with horizontal investment because they believe that this approach enables them to share experience, resources, and knowledge already developed at home, thus reducing risk. If FDI abroad is to manufacture products not manufactured by the parent company at home, it is called conglomerate FDI. For example, Hong Kong MNEs often set up foreign subsidiaries or acquire local firms in Mainland China to manufacture goods that are unrelated to the parent company’s portfolio of products. The main purpose is to seize emerging-market opportunities and capitalize on their established business and personal networks with the mainland that Western MNEs do not have. Vertical FDI occurs when the MNE enters a foreign country to produce intermediate goods that are intended for use as inputs in its home country (or in other subsidiaries’) production process (this is called “backward vertical FDI”), to market its homemade products overseas, or to produce final outputs in a host country using its home-supplied intermediate goods or materials (this is called “forward vertical FDI”). An example of backward vertical FDI is offshore extractive investments in petroleum and minerals. An example of forward vertical integration is the establishment of an assembly plant or a sales outlet overseas. The liability of foreignness represents the costs of doing business abroad that result in a competitive disadvantage vis-à-vis indigenous firms. An example of this liability is the lack of adaptation to European customs, from transportation models to food, by the Walt Disney Company when establishing its first park in Europe, Euro Disney (renamed Disneyland Europe since then). Utilizing established competencies abroad in the same product or business as that at home helps the firm overcome the liability of foreignness and thus reduces the risks inherent in foreign production and operations. Horizontal FDI enables the MNE. Greenfield investments occur when multinational corporations enter into developing countries to build new factories and/or stores. Developing countries often offer prospective companies tax-breaks, subsidies and other types of incentives to set up green field investments. Governments often see that losing corporate tax revenue is a small price to pay if jobs are created and knowledge and technology is gained to boost the country's human capital. If a firm enters the foreign market through Greenfield investment, it has to pay a fixed investment cost and its technology level is reduced in the foreign market due to technology transfer costs. 2. RESEARCH REVIEW a. Foreign Direct Investment: A Critical Appraisal 1) While the FDI approvals reveal quantum jump since the liberalisation of policy in 1991, the actual inflow has been much less. Thus the foreign investors have not matched their intent with performance. In fact, actual inflows have been less than half of the approvals.
    • 2) The major issues are that a substantial part of these resources are going into mergers and acquisitions and not in the formation of fresh capital (Greenfield Investment). 3) There is regional disparity in the country. There is a large inflow of FDIs in certain parts of India mainly Delhi, Maharashtra, Dadra and Nagar Haveli, Haryana, Orissa and selected parts of U.P. 4) The smaller project receive a very small proportions of FDI approvals, over two-third of the total value of FDI approvals goes to projects of size greater than Rs100 core. Therefore very little of the FDI has gone to augment exports that are mostly from labour-intensive unregistered manufacturing. 5) There is also a question that whether investment in FDI necessarily lead to a higher growth rate. The biggest risk faced is that given the massive inflow of FDIs in the country in recent times might raise concern with their macroeconomic implications and the danger of an equally sudden reversal. b. Foreign direct investment in India Starting from a baseline of less than USD 1 billion in 1990, a recent UNCTAD survey projected India as the second most important FDI destination (after China) for transnational corporations during 2010-2012. As per the data, the sectors which attracted higher inflows were services, telecommunication, construction activities and computer software and hardware. Mauritius, Singapore, the US and the UK were among the leading sources of FDI. FDI for 2009-10 at USD 25.88 billion was lower by five per cent from USD 27.33 billion in the previous fiscal. Foreign direct investment in August dipped by about 60 per cent to approx. USD 34 billion, the lowest in 2010 fiscal, industry department data released showed. [6]In the first two months of 2010-11 fiscal, FDI inflow into India was at an all-time high of $7.78 billion up 77% from $4.4 billion during the corresponding period in the previous year. c. Foreign direct investment and the developing world FDI provides an inflow of foreign capital and funds, in addition to an increase in the transfer of skills, technology, and job opportunities.[citation needed] Many of the Four Asian Tigers benefited from investment abroad.[citation needed] A recent meta-analysis of the effects of foreign direct investment on local firms in developing and transition countries suggest that foreign investment robustly increases local productivity growth.[7] The Commitment to Development Index ranks the "development-friendliness" of rich country investment policies. 3. FDI and Economic Growth The IMF definition of FDI includes as many as twelve different elements-equity capital, reinvested earnings of foreign companies, intercompany debt transactions, short-term and long-term loans, financial leasing, trade credits, grants, bonds, non-cash acquisition of equity, investment made by foreign venture capital investors, earnings data of indirectly-held FDI enterprises, control premium and non-competition fee. India, however, does not adopt any other element other than equity capital reported on the basis of issue or transfer of equity or preference shares to foreign direct investors. Figure - 01 exploring the process how FDI is important in utilizing of our economic resources and generating the employment in country as well as important for creating economic prosperity.
    • Figure – 01 Link Model: FDI and Economic Growth 3. GREENFIELD FDI a. Concepts and Definitions Foreign direct investment (FDI) constitutes three components; viz., equity; reinvested earnings; and other capital . Equity FDI is further sub-divided into two components, viz., greenfield investment; and acquisition of shares, also known as mergers and acquisitions (M&A). 1) Reinvested earnings represent the difference between the profit of a foreign company and its distributed dividend and thus represents undistributed dividend. 2) Other capital refers to the intercompany debt transactions of FDI entities. Equity FDI may also include “Brownfield investment”, a term often used in the FDI literature. This represents a hybrid of greenfield and M&A foreign investment. Such investment formally appears as M&A, though its effect resembles greenfield investment. In brownfield investment, the foreign investor acquires a firm and undertakes nearcomplete renovation of plant and equipment, labour and product lines (UNCTAD 2000). The motives behind cross-border M&As include: the search for new markets, increased market power and market dominance; access to proprietary assets; efficiency gains through synergies; greater size; diversification (spreading of risks); financial motivations; and personal (behavioural) motivations. In a cross-border merger, the assets and operations of two different firms belonging to two different countries join together to form a new legal entity. The stocks of the companies are surrendered during the amalgamation process and the new company’s stocks are issued in the process. One such example is the merger of Essar and Hutchison to form Hutchison Essar. As another example, Daimler-Benz and Chrysler ceased to exist when the two firms merged,
    • and a new company, DaimlerChrysler, was created. In a cross-border acquisition, the control of assets and operations is transferred from a local to a foreign company. The local company ceases to exist and becomes an affiliate of the foreign company. An acquisition can be forced through a majority interest in the management, by purchasing shares in the open market, or by offering a take-over proposal to the general body of the shareholders (Beena, 2000). For instance, Ranbaxy Laboratories as part of its expansion strategy in the US market acquired the New Jersey-based Ohm Laboratories in 1995. Vodafone’s acquisition of Hutchinson Essar and Lenova’s takeover of IBM´s PC business. There has been a continuing, though unresolved, debate between the impacts of greenfield investment versus M&A on the host economy. While these two modes of entry for direct investment are generally considered to be alternatives, there may be situations where only M&As appear to be the realistic option. For instance, in the absence of any domestic buyers for a large firm that has been declared sick, a cross-border M&A is the only viable choice. Greenfield FDI may not necessarily have a positive impact on the host economy if the development objectives of the host country do not coincide with the commercial motives of the foreign investor. However, it goes without saying that under normal circumstances with the two entry modes as plausible alternatives, Greenfield FDI is more useful to developing countries. Ceteris paribus, greenfield FDI is more likely to furnish the host country with financial assets, technology and skill resources, enhance productive capacity and generate additional employment. b. Global Trends Much of the FDI is realised either through the greenfield or the M&A route. According to the information provided in UNCTAD (2008), the number of greenfield investments is far ahead of the M&A deals realised during any year (Table 2). This clearly indicates the preference for a new establishment as against choosing from the acquisition of an existing one or a merger. However, the greenfield investment itself may be used to set up a new unit altogether or to fund the expansion of an existing unit. While information is available for a number of greenfield projects, the value of these projects is not reported by UNCTAD in its World Investment Report, because the investment for a new or expansion activity could materialise in the following year(s). The value of cross-border M&A sales touched $1,637 billion in 2007, posting a growth of 46.42 per cent over 2006.2 During Jan-Jun 2008, the value of crossborder M&A sales amounted to $621 billion. The number of cross-border M&As touched 10,145 in 2007, compared to 9,075 in 2006. In 2008 ( Jan-Jun), as many as 66 cross-border M&A deals were reported. The average size of the M&A sales increased from $123.2 million in 2006 to $161.3 million in 2007. In the case of India, the value of crossborder M&A sales touched $5.5 billion in 2007, posting 17.72 percent growth over 2006. In 2008 ( Jan-Jun), the value of cross-border M&A sales amounted is $2.3 billion and the average size of the M&A sales increased from $29.44 million in 2006 to $33.41 million in 2007.
    • c. Profile of Greenfield FDI – India The number of greenfield investments in India increased from 247 projects in 2000 to 980 projects in 2006, but declined to 682 projects in 2007. Greenfield investment is India is largely destined for new facilities rather than for expansion of existing units. The share of expansion projects has been declining steadily over the period, from 22 per cent of the reported projects in 2002 to 11 per cent in 2006.During the period 2002 to 2006, 15 of the 300 greenfield projects that were reported exceeded $1 billion in their worth. These investment projects were concentrated in heavy industries, property, tourism and leisure, and electronics. Further, a classification based on their business function indicates their spread among manufacturing, construction, resource extraction and R&D. The investor countries included Canada, Germany, Japan, Luxembourg, the Netherlands, Singapore, South Korea, Venezuela, the UAE, the UK and the US. The beneficiary industries of these Greenfield investments included a wide range of industries such as steel, electronic components and semiconductors, construction, mining, real estate and machinery. 4. GREENFIELD INVESTMENT FOR SUSTAINABLE DEVELOPMENT: FACTORS RESPONSIBLE FOR INCREASING BENEFITS AND REDUCING COSTS Beyond the initial macroeconomic stimulus from the actual investment, Greenfield influences growth by raising total factor productivity and, more generally, the efficiency of resource use in the recipient economy. This works through three channels: the linkages between Greenfield Investment (FDI) and foreign trade flows, the spillovers and other externalities vis-à-vis the host country business sector, and the direct impact on structural factors in the host economy. The existence of an “additional” growth impact of Greenfield investment is widely accepted. Most empirical studies conclude that Greenfield investment contributes to both factor productivity and income growth in host countries, beyond what domestic investment normally would trigger. It is more difficult, however, to assess the magnitude of this impact, not least because large FDI inflows to developing countries often concur with unusually high growth rates triggered by unrelated factors. This section compares the possible costs and benefits to host economies of the greenfields investment of entry under various headings. A realistic counterfactual must go beyond the individual investment to take account of the economic context in which investment takes place. This depends on the particular situation of each country as well as on the general context of trade, technology and competition in the developing world. As noted, the latter is changing. Trade liberalization, intensifying competition, accelerating technical change and increasingly integrated global production systems all mean that firms have to rapidly upgrade, restructure and become internationally competitive. This is true of all economies, regardless of the macroeconomic situation. Following are the various factors responsible for increasing benefits and reducing costs :-
    • i. Competition FDI and the presence of MNEs may exert a significant influence on competition in host-country markets. However, since there is no commonly accepted way of measuring the degree of competition in a given market, few firm conclusions may be drawn from empirical evidence. The presence of foreign enterprises may greatly assist economic development by spurring domestic competition and thereby leading eventually to higher productivity, lower prices and more efficient resource allocation. Conversely, the entry of MNEs also tends to raise the levels of concentration in host-country markets, which can hurt competition. This risk is exacerbated by any of several factors: if the host country constitutes a separate geographic market, the barriers to entry are high, the host country is small, the entrant has an important international market position, or the host-country competition law framework is weak or weakly enforced. Export Competitiveness Greenfield FDI can be a powerful instrument for developing host countries to exploit their existing comparative advantages and build new advantages, as long as the countries are able to create new skills and capabilities and attract MNEs into higher value activities. In the case of most new export-oriented activities including those located in EPZs, greenfield entry is the only feasible mode since there are no local firms to take over. In the case of existing activities that are oriented to domestic markets and can be restructured to become export-oriented, greenfield provides alternatives. It is not clear; however, which mode is more desirable for the host country. The outcome could go either way, depending on the value of capabilities, skills and routines in existing local firms and the cost involved in bringing them to best practice levels. ii. Technology Transfer Economic literature identifies technology transfers as perhaps the most important channel through which foreign corporate presence may produce positive externalities in the host developing economy. MNEs are the developed world’s most important source of corporate research and development (R&D) activity, and they generally possess a higher level of technology than is available in developing countries, so they have the potential to generate considerable technological spillovers. However, whether and to what extent MNEs facilitate such spillovers varies according to context and sectors. Technology transfer and diffusion work via four interrelated channels: vertical linkages with suppliers or purchasers in the host countries; horizontal linkages with competing or complementary companies in the same industry; migration of skilled labour; and the internationalisation of R&D. The evidence of positive spillovers is strongest and most consistent in the case of vertical linkages, in particular, the “backward” linkages with local suppliers in developing countries. MNEs generally are found to provide technical assistance, training and other information to raise the quality of the suppliers’ products. Many MNEs assist local suppliers in purchasing raw materials and intermediate goods and in modernising or upgrading production facilities. Reliable empirical evidence on horizontal spillovers is hard to obtain, because the entry of an MNE into a less developed economy affects the local market structure in ways for which researchers cannot easily control. The relatively few studies on the horizontal dimension of spillovers have found mixed results. One reason for this could be efforts by foreign enterprises to avoid a spillover of knowhow to their immediate competition. Some recent evidence appears to indicate that horizontal spillovers are more important between enterprises operating in unrelated sectors. A proviso relates to the relevance of the technologies transferred. For technology transfer to generate externalities, the technologies need to be relevant to the host-country business sector beyond the company that receives them first. The technological level of the host country’s business sector is of great importance. Evidence suggests that for FDI to have a more positive impact than domestic investment on productivity, the “technology gap” between domestic enterprises and foreign investors must be relatively limited. Where important differences prevail, or where the absolute technological level in the host country is low, local enterprises are unlikely to be able to absorb foreign technologies transferred via MNEs. To the extent that a foreign investor enters a country to undertake productive activity over the long-term, there is no reason to expect different effects in terms of technology transfer by mode of entry. The MNEs are presumably committed to operating efficiently in either case and will do whatever is needed to ensure this. However, a greenfield investment necessarily involves the setting up of a new facility and so new equipment embodying new technologies (though some MNEs may bring in used equipment where this is appropriate to local conditions). Using
    • these new machines and technologies in turn involves the creation of new skills and information. A merger or acquisition involves taking over an existing stock of equipment with an accompanying body of skills, routines and work habits. iii. Human Capital Development The major impact of FDI on human capital in developing countries appears to be indirect, occurring not principally through the efforts of MNEs, but rather from government policies seeking to attract FDI via enhanced human capital. Once individuals are employed by MNE subsidiaries, their human capital may be enhanced further through training and on-the-job learning. Those subsidiaries may also have a positive influence on human capital enhancement in other enterprises with which they develop links, including suppliers. Such enhancement can have further effects as that labour moves to other firms and as some employees become entrepreneurs. Thus, the issue of human capital development is intimately related with other, broader development issues. Employment quantity: At first sight, a greenfield investment raises employment. However, the picture becomes more complex if other factors and counterfactuals are considered. If the investment is aimed at the domestic market – which is by definition limited– the greenfield investment will (once it enters the market) necessarily reduce the activity of competing firms and so lead to a loss of employment in the latter. At the same time, if the entry raises efficiency and competition in the market, it may create additional employment. If the investment is aimed at (virtually unlimited) export markets, the greenfield venture is likely to add to employment in the short term. The long-term effect of both modes is likely to be similar. Employment quality: Employment quality refers to wages, employment conditions, gender issues and the like. MNE’s generally offer high quality employment, unless they are in low technology export-oriented activities outside the purview of normal labour laws. A greenfield venture is likely in the short run to offer better quality Skills: MNE’s generally invest more in training than comparable local firms, and tend to bring in more modern training practices and materials. They also bring in expatriates with specialised skills, and tend to strike strong linkages with training institutions and schools. As with employment quality, the difference between the two modes is likely to lie in the short term inertia associated with the acquisition of a local firm. In the long-term there is no reason to expect any difference in impact. A greenfield venture can bid workers away from other firms and send them abroad, or foreign firms may hire workers without having to invest locally at all. For instance, the substantial movement (often temporary) of software specialists from India to the United States is not mainly by means of FDI, and certainly not due to acquisitions of local firms. iv. Enterprise development FDI has the potential significantly to spur enterprise development in host countries. The direct impact on the targeted enterprise includes the achievement of synergies within the acquiring MNE, efforts to raise efficiency and reduce costs in the targeted enterprise, and the development of new activities. In addition, efficiency gains may occur in unrelated enterprises through demonstration effects and other spillovers taking to those that lead to technology and human capital spillovers. Available evidence points to a significant improvement in economic efficiency in enterprises acquired by MNEs, albeit to degrees that vary by country and sector. The strongest evidence of improvement is found in industries with economies of scale. Here, the submersion of an individual enterprise into a larger corporate entity generally gives rise to important efficiency gains . v. Greenfield Investment and environmental and social concerns Greenfield Investment has the potential to bring social and environmental benefits to host economies through the dissemination of good practices and technologies within MNEs, and through their subsequent spillovers to domestic enterprises. There is a risk, however, that foreign-owned enterprises could use Greenfield investment to “export”
    • production no longer approved in their home countries. In this case, and especially where host-country authorities are keen to attract Greenfield investment, there would be a risk of a lowering or a freezing of regulatory standards. In fact, there is little empirical evidence to support the risk scenario. The direct environmental impact of Greenfield investment is generally positive, at least where host-country environmental policies are adequate. There are, however, examples to the contrary, especially in particular industries and sectors. Most importantly, to reap the full environmental benefits of inward FDI, adequate local capacities are needed, as regards environmental practices and the broader technological capabilities of host-country enterprises. 5. CONCLUSION Developing countries, emerging economies and countries in transition have come increasingly to see Greenfield investment as a source of economic development and modernisation, income growth and employment. Countries have liberalised their Greenfield investment regimes and pursued other policies to attract investment. They have addressed the issue of how best to pursue domestic policies to maximise the benefits of foreign presence in the domestic economy. The study of Greenfield Foreign Direct Investment for Development attempts primarily to shed light on the second issue, by focusing on the overall effect of Greenfield investment on macroeconomic growth and other welfare-enhancing processes, and on the channels through which these benefits take effect. The overall benefits of Greenfield investment for developing country economies are well documented. Given the appropriate host-country policies and a basic level of development, a preponderance of studies shows that Greenfield investment triggers technology spillovers, assists human capital formation, contributes to international trade integration, helps create a more competitive business environment and enhances enterprise development. All of these contribute to higher economic growth, which is the most potent tool for alleviating poverty in developing countries. Moreover, beyond the strictly economic benefits, Greenfield investment may help improve environmental and social conditions in the host country by, for example, transferring “cleaner” technologies and leading to more socially responsible corporate policies. REFERENCES 1. Bresman, H., Birkinshaw, J. and Nobel, R. (1999) ‘Knowledge transfers in international acquisitions’, Journal of International Business Studies, 30(3), 439-462. 2. Buckley, P. and Casson, M. (1998) ‘Analysing foreign market entry strategies: extending the internalisation approach’, Journal of International Business Studies. 3. Capron, L. (1999) “The long-term performance of horizontal acquisitions: empirical evidence of US and European firms”, Draft: INSEAD, Fontainebleau.
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