Chapter Three:

International Capital inflow and

FDI
CH III: International Capital inflow and FDI
Capital inflow and FDI
Capital inflow and FDI
FDI: Inflows
 Foreign direct investment refers to direct
investment equity flows in the reporting
economy.
 It is the sum of equity capital, reinvestment of
earnings, and other capital.
 Direct investment is a category of cross-border
investment associated with a resident in one
economy having control or a significant degree of
influence on the management of an enterprise
that is resident in another economy.
FDI: Inflows FDI Inflows
Country Name Inflows, US $
United States $351.63B
Singapore $105.47B
Germany $72.21B
British Virgin Islands $58.00B
Hong Kong $53.17B
France $51.04B
Canada $47.85B
Australia $40.07B
Japan $37.18B
Netherlands $35.69B
FDI in Ethiopia as % of GDP
FDI in Kenya as % of GDP
FDI in Ethiopia (Billions of USD)
FDI in Kenya (Billions of USD)
FDI in Japan as % of GDP
FDI in Japan (Billions of USD)
FDI in India as % of GDP
FDI in India (Billions of USD)
FDI in USD as % of GDP
FDI in USD (Billions of USD)
FDI: Inflows
Capital inflow and FDI
Capital inflow and FDI
FDI refers to investment in a foreign country where the investor
retains control over the investment.
• The investment made by a company in new manufacturing
and/or marketing facilities in a foreign country is referred to
as FDI.
• UNCTAD’s world investment report defines foreign direct
investment as an investment involving a long-term
relationship and reflecting a lasting interest and control by a
resident entity in one economy in an enterprise resident in an
economy other than that of the foreign direct investor.
• FDI is playing an increasing role in economic development.
• Economic reforms and the far-reaching political changes have
resulted in very substantial changes in the international
capital flows.
Forms of FDI
• Purchase of existing assets in a foreign country.
• New investments in property, plant, equipment.
• Participation in a joint venture with a local partner.
• Transfer of many assets like human resources,
systems, technological know-how in exchange for
equity in foreign companies.
• Export of goods for equity,
Forms of FDI
 Types and Examples of Foreign Direct
Investment
• Typically, there are two main types of FDI: horizontal and
vertical FDI.
• Horizontal: a business expands its domestic operations to a
foreign country. In this case, the business conducts the same
activities but in a foreign country. For example, McDonald’s
opening restaurants in Ethiopia would be considered
horizontal FDI.
• Vertical: a business expands into a foreign country by moving
to a different level of the supply chain. In other words, a firm
conducts different activities abroad but these activities are still
related to the main business.
• McDonald’s could purchase a large-scale farm in Ethiopia to
produce meat for their restaurants.
Types…
Types…
• However, two other forms of FDI have also been observed:
conglomerate and platform FDI.
• Conglomerate: a business acquires an unrelated business
in a foreign country. This is uncommon, as it requires
overcoming two barriers to entry: entering a foreign
country and entering a new industry or market. An
example of this would be if Virgin Group, which is based in
the United Kingdom, acquired a clothing line in France.
• Platform: a business expands into a foreign country but
the output from the foreign operations is exported to a
third country. This is also referred to as export-platform
FDI. Platform FDI commonly happens in low-cost locations
inside free-trade areas. For example, if Ford purchased
manufacturing plants in Ireland with the primary purpose
of exporting cars to other countries in the EU.
Types
The need for FDI
Reasons for FDI
• FDI is the ownership and control over assets
held in foreign countries.
– Increase in sales and profits
– Enter rapidly growing markets
– Reduce costs
– Consolidated trade blocks
– Protect domestic markets
– Protect foreign markets
– Acquire technological and managerial know-how
Cost and Benefits of FDI
• FDI has its costs and benefits to the home
country as well as host country.
– Benefits to Home country
– Costs to Home Country
– Benefits to Host country
– Costs to Host Country
Cost and Benefits of FDI
Benefits to Home Country:
 Inflow of foreign currencies in the form of dividend, interests
etc.
 FDI increases export of machinery, equipment, technology,
etc.
 The increased industrial activity in the home country
enhances employment opportunities.
Costs to Home Country:
 Home country’s industry and employment position are at
stake when the firms enter foreign markets due to low cost
labor
 Current account position of the home country may suffer
if FDI is a substitute for direct exports.
Cost and Benefits of FDI
 The home country’s trade position (its current account) may
deteriorate if the purpose of the foreign investment is to
serve the home market from low cost production location.
 For instance, when a US textile company shuts its plants in
South Carolina and moves production to Central America,
imports into the US rose and trade position deteriorated.
 The current account of the balance of payments also suffers
if the FDI is a substitute for direct exports.
 Thus, in so far as Japan’s Toyota’s assembly in the US are
intended to substitute for direct exports from Japan, the
current account position of Japan will deteriorate.
Cost and Benefits of FDI
Benefits to Host country:
 Resource transfer effects
 Employment effects
 Balance of payments effects
 Technology Effect
Cost to Host country
 Intensifying competition
 Negative effects on the BOP
Cost and Benefits of FDI

Adverse Effect on the Balance of Payment — The possible

adverse effects of FDI on a host country’s balance of payment
position are twofold.
1. To offset the initial capital inflow that comes with FDI must be the
subsequent outflow of income as the foreign subsidiary repatriates
earnings to its parent company. Such outflows show up as a debit on 
the current account of the balance of payments.
2. When a foreign subsidiary imports a substantial number of its inputs
from abroad, which also results in a debit on the current account of
the host’s country’s balance of payments. One of the criticisms
against Japanese-owned auto assembly operations in the US, for
instance, was that they imported many components parts from Japan,
reducing the favourable impact of this FDI on the current account of
the US balance of payment position. The Japanese auto companies
responded by pledging to purchase 75% of their component parts
from US-based manufacturers.
 Implications of FDI for Business
• If the cost of transportation are minimum, it would
be preferable for the companies to export.
• If the cost of transportation and trade barriers are
significant, it would be preferable to go for FDI
• The firm can go for licensing if the know-how is not
available.
• If the company’s skills and capabilities are not
available for licensing, better the company go for FDI.
 Liberalization, Privatization and Globalization

 LPG which is also known as Liberalisation,

Privatisation and Globalisation were the three major
measures that the governments had adopted under
thier New Economic Policy. For this, they approached
International Banks for development and the
betterment of the country and economy.
 When they approached these international banks and
organisations, these agencies asked them to open up
our economy to the world, remove trade restrictions
and trade barriers and foster the private sector.
Objectives Of Liberalization Policy

• Increase competitiveness between domestic

industries.
• Encourage foreign trade with other countries
whose imports or exports are regulated.
• Foreign capital and technological
improvements.
• Expand the boarders of the country’s global
marketplace.
• A reduction in the country’s debt burden.
 Objectives Of Privatization 
• Improve the government’s fiscal situation.
• Reduce the workload on public sector firms.
• Raise capital through divestment.
• Increase the effectiveness of governmental
agencies.
• Provide the consumer with higher quality and
improved goods and services.
• Develop healthy competition in society.
• Encouragement of foreign direct investment (FDI)
Objectives of Globalization 

 Those in favour of globalization theorize that a wider array of

products, services, technologies, medicines, and knowledge
will become available, and that these developments will have
the potential to reach significantly larger customer bases.
 This means larger volumes of sales and exchange, larger
growth rates in GDP, and more empowerment of individuals
and political systems through the acquisition of additional
resources and capital.
 These benefits of globalization are viewed as utilitarian,
providing the best possible benefits for the largest number of
people.
Objectives of Globalization 
 For global companies, often referred to as multinational
corporations (MNCs), common benefits of expanding into
developing markets include unsaturated demand for new
products, lower labor costs, less expensive natural resources,
and other inputs to products.
 MNCs seek to benefit from globalism by selling goods in
multiple countries, as well as sourcing production in areas that
can produce goods more profitably.
 MNCs look for opportunities to realize economies of scale by
mass-producing goods in markets that have substantially
cheaper costs for labor or other inputs. Or they may look for
economies of scope, through horizontal expansion into new
geographic markets.
Liberalization, Privatization and Globalization

Reasons for Implementing of Liberalization,

Privatization and Globalization
 Growing inefficiency in the use of resources
 Over protection to industry
 Mismanagement of firms and economy
 Mounting losses of public sector enterprises
 Low foreign exchange reserves
 Burden of national debt
 Inflation
Liberalization….
Liberalization
• Liberalization refers to relaxation of previous
government restrictions usually in areas of
social economic polices.
• Thus, when government liberalizes trade it
means it has removed the tariff, subsidies and
other restrictions on the flow of goods and
services in the country.
Liberalization….
• Liberalization (Neo liberalization) this is essentially about
making trade between nations easier.
• It is about free movement of goods, resources and
enterprises in a bid always fined cheaper resources, to
maximize profits and efficiency.
• Neo liberalization requires the removal of various controls
deemed as barriers to free trade such as
• Tariffs.
• Regulations.
• Certain standards, laws, legislation and regulatory measures.
• Restrictions on capital flows and investments.
Liberalization….
• To day the dispute on neoliberalization policies are seeing positive
and negatives.
• Under free trade enterprise, there have been many innovative
products.
• Growth and development for some have been immense.
• Unfortunately most of the people in the world there has been an
increase in poverty and the innovation and growth has not been
designed to meet immediate needs for many of the world’s people.
• Global inequalities on various indicators are there.
For example
• Some 3 billon people or half of humanity living under the below
poverty line like 2 dollars per day
• 86% of the world resources are consumed by the world wealthiest
20%.
Liberalization in Ethiopia
• The Ethiopian Government Economic policy has been
liberalized since 1992 to give relaxation and alleviation to
the economy, which had been ruled under command
economy for about two decades during Derg regime (1974-
1991).
• Liberalization is chosen as a reform policy in order to give
the country the easier access to foreign technology by
freeing itself from closed-door policy of 17 years of the
previous government.
• This shift in policy from planned economy( command
economy)to free-market economy has resulted in
fundamental changes in the environment of firms operating
in the country.
Liberalization in Ethiopia
• Liberalization played very crucial role in economic
development of the country. Because of liberalization
attention was focused on the industrial sector during
the first decade of the reform process.
• The basic tenets of the reform process are the
marketization, privatization, liberalization, and
globalization of the economy.
Liberalization in Ethiopia
• According to some Ethiopian writers on
liberalization, the reform process and liberalization
measures have opened up new possibilities for
expansion, growth and profitability though they
threaten the very existence of small and even large
domestic industrial units with the climate of
competition introduced.
• The competition is not only between domestic and
multinational companies, but also between
organized and unorganized sectors of the economy
within the country for survival.
Privatization
• Liberalization of markets and institutions should, logically,
lead to a much greater degree of relaxation of government
control over trade, investment and factors of production
such as land, labor and capital.
• According to some writers on privatization, to encourage
the involvement of private investors in the investment
activities of the country, government should not involve
itself in trade, investment, and production activities.
• As far as different production industries are concerned, the
Government has to privatize them thoroughly to focus its
attention on other strategic matters and on investment in
the areas in which investors are not interested to take up
and still there is demand on the part of consumers.
Privatization
• According to the Ethiopian Privatization Agency, the
Ethiopian Government launched a program for
privatization of state-owned enterprises in early 1995/96.
• Accordingly, the Ethiopian Privatization Agency was
established with a view to implement the privatization
program in the same year.
• The government is highly committed to privatize the state-
owned enterprises to the private sector.
• Privatization is recommended in order to lead towards a
more efficient allocation of resources via the market
system. That is the underlying principle in favor of
privatization.
Privatization

•The objective of privatization is, therefore, to reduce

Government expenditure and raise administrative
efficiency by withdrawing Government presence from
areas which can be managed better by private people.

•Government has to withdraw from the provision of

certain goods and services leaving them wholly or
partly to the private sector
•Another dimension of privatization is opening up of an
industry that has been reserved for the public sector to
the private sector.
 Privatization
• It refers to the transfer of assets or services functions from public to
private ownership or control and the opening of the hitherto closed
areas to private sector entry. Privatization can be achieved in many
ways, franchising, contraction .
• This offers both opportunities and threats to the economy. We have
to privatize in such manner that we made the maximum
opportunities while to the same time minimizing the threats to the
economy.
• Conditions for Privatization:-
• Liberalization and de-regulation of the economy is an essential pre-
requite if privatization is to take off and help realize higher
productivity and profits.
• Capital markets should be sufficiently developed to be able to absorb
the dis-investment in public sector shares.
Forms of Privatization 
• Denationalization or Strategic Sale: When full ownership of
productive assets is transferred to private sector companies,
the law is called denationalization.
• Partial Privatization or Partial Sale: Where the private sector
holds more than 50% but less than 100% of the shares of a
public sector corporation whose transfer has already been
interpreted, this is called partial privatization. In this case, most
of the shares are held by the private sector. Accordingly, the
private sector has significant control over the functionality and
autonomy of the business.
• Deficit Privatization or Token Privatization: When the
government disinvest its share capital to a degree of 5-10% to
compensate for the deficit in the budget is called privatization
deficit.
Arguments in favor of privatization

1. Privatization will help reducing the burden

2. It helps the profit making public sector units to
modernize and diversity their business
3. It helps in making profit sector units more
competitive.
4. It helps in improving the quality of decision making of
management because their decision will made without
any political interference.
5. Privatization may help in reviving sick(unproductive)
units which have become a liability on public sector.
Arguments against privatization

1. Privatization will encourage growth of monopoly power in

the hands of big business houses. It will result in greater
disparity in income and wealth.
2. Private enterprise may not show any interest in buying
shares of loss-making and sick enterprises.
3. Privatization may result in skewed development of
industry in the country.
4. The limited resources of the private individuals cannot
meet some of the vital tasks which affect the very
character of the economy.
5. Private sector may not uphold the principles of social
justice and public welfare.
Globalization

• Globalization means integrating the domestic

economy with the world economy. It is a process
which draws countries out of their insulation and
makes them join rest of the world towards a new
world economic order.
• It involves increasing interaction among national
economic system, more integrated financial
markets, economic trade, higher factor mobility,
free flow technology and spread of knowledge
through out the world.
 Benefits of Globalization
1. It is argued that with globalization of under developed countries will
improve the efficiency of resources allocation , reduce capital
output ratio and increase labor productivity, help to develop the
export culture, increases the inflow of capital, updated technology,
that gives a boost to the average growth rate of the economy.
2. It will help to restructure the production and trade pattern in a
capital scarce, labor abundant economy in favor of labor intensive
goods and technologies.
3. Foreign capital and foreign technology will be attracted
4. With the entry of foreign competition and removal of import tariff
barriers, domestic industry will be subject to price and quality
improving effects in the domestic economy.
5. It is also believed that the efficiency of banking and financial sectors
will improve, as there will be competition from foreign capital and
foreign banks.
6. cheaper and high quality consumer goods will be manufactured at
home. Besides employment opportunities would also go up.
 Advantages and Disadvantages of
globalization
ADVANTAGES DISADVANTAGES
1. Easier to communicate throughout 1. Delocalization creates unemployment in
the boundaries developed countries
2. Easier to travel 2. Non-controlled circulation of money
(free market) – no ethics
3. Cultural interchange
3. The businessmen and the big companies
4. International Trade are the only winners in globalization
5. Better and cheaper products 4. Exploitation of the workers in the
6. Improvement of new technologies developing countries – incl. children
7. The cheaper products increases the 5. Money problems can easily be spread
purchase power 6. The mix of cultures can lead to racism,
intolerance and loss of national identity
8. The transport of the products is
easier and faster 7. Small companies have to go out of
business because they cant compete
9. Globalization creates a political and with the multinationals
an economical union, which 8. As a result the gap between the poor
facilitates the agreement between and the rich people increases
the countries
Globalization and its impact on Ethiopian
economy
• It is an important element in the economic reform package of
Ethiopia.
• It means integrating the economy of a country with the world
economy.
• It implies opening up the economy to foreign direct investment by
providing facilities to foreign companies to invest in different fields
of economic activity in Ethiopia.
• It is removing obstacles to the entry of MNC’s in Ethiopia; allowing
Ethiopian companies to enter into foreign collaborations in Ethiopia
and also encouraging them to setup joint ventures abroad.
• The effects of globalization on Ethiopian economy could be
analyzed in terms of increase in exports, foreign investments flow,
growth rate, Poverty reduction, High growth GDP