Riordan: Financial organizations and regional trading blocs

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OTA # 105428

Foreign direct investment (FDI) is the investment that a company makes to obtain lasting interest in companies operating outside of its native economy. The FDI relationship comprises a parent company which provides the investment capital and a foreign affiliate company in which the capital is invested. Together these two enterprises form a transnational corporation. The investment must give the parent company control over its foreign affiliate in order to qualify as FDI. By United Nations definition control in this case is when the parent company owns 10% or more of the ordinary shares or voting power of an incorporated firm or its equivalent for an unincorporated firm. If ownership shares are lower the relationship is called a portfolio investment (Konopielko, 1999).

FDI can be beneficial to host countries because it can make an important contribution to development. For example, FDI can afford developing countries better access to technology, research and development, and marketing knowledge, which are vital factors in successful industrialization. This in turn can help to create badly needed finance, employment, and foreign exchange. Increased FDI means better access to international financial markets, which is crucial for less developed countries whose domestic capital is not enough to meet their development needs (Oxfam International, 2003).

Foreign direct investment is very important in promoting foreign trade, especially in host countries that sustain liberalized economies, stable macroeconomic conditions, limited restrictions on foreign exchange transactions (and repatriation of investment earnings), and protection for private property rights. Under these favorable conditions, foreign direct investment by multinational firms will promote export-oriented production particularly if there are underlying comparative advantage factors, such as the relative abundance of low-wage labor in developing countries (DeRosa, 1998).

FDI can be categorized based on the direction of its flow, inward (within a geographic area or trade bloc) or outward (going from one geographic area or trade bloc to another) and also based on the motive behind the investment from the perspective of the investing company. Companies like Riordan who are thinking about acquiring means of production that are more efficient than those in their home economy are said to be motivated by resource-seeking. Riordan seeks resources such as cheap labor and natural resources abroad because they may not be available in its home economy, the US, but readily and cheaply available in the Middle East, Southeast Asia and Eastern Europe. Riordan is also seeking to penetrate new markets via its globalization strategy. This makes Riordan's potential FDI a market-seeking - investment, an investment Riordan can use employed as a defensive strategy to counter the danger of shrinking domestic markets. Another motivation for FDI is efficiency-seeking where companies hope to increase their efficiency by exploiting the benefits of economies of scale and scope, and also those of common ownership. Riordan may choose this type of FDI after it has realized the goals of its resource and market seeking investments to further increase the profitability of the company. Efficiency-seeking FDI is best accomplished with developed economies, especially those within closely integrated markets such as EU. Riordan can also consider FDI as a tactical move to prevent the loss of resource to a competitor (Konopielko, 1999).

A factor essential to the stability of world trade is the existence of major international financial organizations such as the International Monetary Fund (IMF) and the World Trade Organization (WTO). The IMF, an international financial organization of 184 countries which was established in 1945, works to assure the stability of the international monetary and financial system. The IMF's mandate includes working to smooth the progress and the expansion and balanced growth of international trade, maintaining exchange stability, and correcting of countries' balance of payments problems. The WTO is another international organization of 149 countries came into being in 1995. The WTO regulates trade between nations. The organization helps international trade to flow smoothly, predictably, and freely, and gives countries a constructive and fair venue for managing disputes over trade issues. The WTO followed the General Agreement on Tariffs and Trade (GATT) an international treaty that was established in 1947.The missions of the IMF and the WTO ...