Institutional Drivers and FDI

Discuss about the Restructuring of Global Value Chains.

For many years, scholars have made attempts in explaining and exploring the primary factors responsible for determining the suitability of establishing FDI (Paul & Benito, 2018). Traditionally, scholars concentrated on economic factors such as the size of the market, exchange rates, and infrastructure as the main factors responsible for determinant the suitability to attract or deter FDI. The relationship that exists between the institutional drivers and attractiveness of FDI can be described through the effects generated that are either positive or negative. Such factors include democratic units, the rule of law, political stability and the rule of law in attracting FDI.

Contrary other factors deter the attractiveness and establishment of FDI include corruption, high taxes, and cultural distance (Bush, 2017). While such studies have facilitated to a great extent our understanding of the institutional factors that influence the establishment of FDI attractiveness, there have been some consistencies in the studies and findings among various scholars (Clegg & Voss, 2018). For instance, some scholars find that there is a positive correlation between the political stability and FDI, other scholars find no relationship at all between the two variables. There are also other inconsistencies for instance in the issue of tax rates and FDI where some scholars find a negative and a substantial relationship between the rates and FDI, others find no substantial relationship whatsoever.

Strategic alliances and joint enterprises have been associated with providing local knowledge of the market which is beneficial to the foreign firms as it enhances the competitiveness of the OFID (Rasel,2018b).In one of the studies that were conducted in the U.S., the report revealed that enterprises that had the U.S. as their partner had their sales up to 33%  while businesses that had non-U.S. joint partnerships recorded sales of 23% (Bailey, 2018).The elements that are industry-specific play a pivotal role in OFDI as OFDI impacts positively on creating employment opportunities in the home country.

 However, researchers have identified some trends in the operation of multinational companies that originate from the emerging economies such as China that engage in OFDI (Paul & Benito, 2018). Such multinational companies are employing strategies that are asset-oriented with the aim of taking control of resources in the host market. Such a trend of OFDI in emerging nations is as a consequence of the contradictory environment of firms at the local level and the resources employed by such firms over time (Bailey, 2018). In order for such firms to attain international expansion, such firms require valuable resources that are distinct from the resources that enable growth domestically (Zhen, 2016). Such elements can be termed as pull factors for enterprises from developing countries as firms tend to internationalize in order to have access to strategic resources and use this as leverage against the stiff competition in the domestic market.

Determinants of FDI Suitability

Conversely, enterprises in the emerging markets in the past engaged in OFID aiming to boycott transaction costs that arose from the activities in the domestic markets (Bailey, 2018). Such push factors are considered as negative push factors and entail macro-level enterprises that are inefficient in the home nation also referred to as ‘institutional voids’. However, there are other push factors that can be categorized as positive push factors and entail policies made by governments to propagate OFDI and institutions that monitor OFDI.

However, some researchers have contended that the current literature has not researched on the OFDI phenomena with regards to misalignment that exists between the needs of the enterprise and the institutional environment in the home country (Clegg & Voss, 2018). The researchers suggested that some of the Chinese enterprises in sectors such as real estate and insurance engage OFDI in the quest for risk diversification opportunities. The state should thus promote OFDI so that the living standards of its citizens can be improved. With the increased global competition in the domestic market, failure to engage in OFDI may exit some of the EMNEs out of the market.

Most of the developing nations have a huge population and jobs are scarce thus there are many people willing to work at the prevailing wage rate (Clegg & Voss, 2018). Establishment of MNE in developing nations follows the logic that such firms want to cut down the cost of production which has the effect of maximizing profits.

Establishment of MNE in developing economies has the benefit of enjoying a ready market as there is a large population willing to purchase the products at the set price.

China’s level of investment in Africa is increasing at an alarming rate raising eyebrows from the Western colonies. One of the primary motives behind China’s move to invest heftily in Africa lies on the desire to establish and secure a solid ground of raw materials that will fuel China’s growing economy, the passion to intensify China’s political influence globally and the potential exhibited by the emerging economies in African nations.

China has been hailed as one of the emerging nations and the health of its economy will impact the global markets. China being the largest nation in the world as it propels its economic expansion, its leaders understand that the increased demand for natural resources, food, and a market for its products is vital for economic expansion. The primary focus on a resource-rich continent such as Africa is logical. Investments in the mining sector accounted for more than one-third of China’s FDI in African countries. The securing of a solid ground where China can source crucial raw materials will be fundamental in strengthening China’s economy for many years to come.

Emerging Trends in OFDI

Africa is one of the continents that China can have faith in spreading its geopolitical influence. Currently, China is one of the incumbent powers in Asia (Doku, Akuma, & Owusu-Afiriyie, 2017). The hefty investments in terms of infrastructure in Africa reveal the political agenda steered by China. The rise of China to some positions where it can have control over critical economic factors such as the utility units and the telecommunication in African nations, then it means that China can exercise political influence in such countries.

China has been recognized through its pragmatism and economic agendas (Chen, Dollar, & Tang, 2016). While China stands for a primary emerging market avenue for developed nations, China has to prioritize where its main emerging marketing avenues exist. China already has invested heavily in other emerging markets in Asia and also markets in Latin. Economies in Africa avail another option that China can take advantage due to numerous growth avenues. According to the recent reports, it has been found that the rate of return for foreign investment in Africa is higher than in any other territory of a developing region globally.

There are few legal frameworks in developing nations making such nations favorable for running businesses as there are few lengthy procedures (Bailey, 2018). It is also in such nations that there are stringent property laws as the governments of developing economies understand the implication that MNEs have on the economy of their countries.

Vertical integration is a competitive strategy employed by a firm where the company takes control of more stages in the production and also the distribution channels (Verbeke, 2018). One of the motives for vertical integration would be to take control of the supply of raw materials to produce products. A firm will also employ vertical integration so as to take control over the distribution channels of the manufactured products (Czinkota, Ronkainen, & Moffet, 2011). With vertical integration, a firm is better positioned to streamline its supply chain by ensuring regular supplies of its products. It also facilitates distribution and after-sales services efficiently as the firm can open showrooms.

Horizontal integration, on the other hand, refers to a competitive mechanism employed by companies where firms acquire business activities that are of the same level of chain value in identical or distinct industries (Dlabay & Scott, 2011). With this strategy, a firm can increase differentiation of its products as the firm is able to avail more product features to its clients. The firm also enjoys increased market power as the new firm due to merging with local firms become a large customer for ancient suppliers. As such the firm enjoys a large market and has great influence over distributors.

Benefits of MNE Establishment in Developing Economies

The last few years have seen the rise of global value chains where factories are established in the faraway nations such as China, Mexico and Vietnam manufacturing, and shipping products for markets in the U.S. and the European Union (Kee & Tang, 2016). Normally, being part of global value chain means that enterprises import materials that are to be processed further before being exported to other nations. This means that in tandem with the engagement of GVCs, these countries encounter the inevitable decline in the value of their domestic products embedded in the exports (McCaffrey, 2016). This means that less there is less value produced and tapped locally per dollar of exports despite rising in the value of exports with regards to participation in GVC. All factors remaining constant, most developing nations would favor increasing the value of their domestic products leading to an overall wellbeing of such nations. The confusing question is how most countries will move up the ladder of value chains.

According to one of the recent studies that were conducted, China exhibits an intriguing exception to the decline witnessed in the world despite its profound engagements in the GVC. The share of domestic elements in exports from China rose from 60% in 2000 to more than 70% in 2007 (Azmeh & Nadvi, 2014).The increase is even higher in the processing sector which saw the share of domestic elements move from 45% in 2000 to more than 50% in 2007 (Sun & Grimes, 2016).

China has made it up the GVC due to the structural transformation integrated via trade and FDI openness of China since early 2000.Such trade liberalization motivated intermediate producers in China that enhanced expansion of a variety of products (Xing, 2016). Thus, exporters in China purchase more home products that are intermediate inputs relying less on imports. Generally, trade and liberalization of FDI explain the bulk component of the increases experienced in value added of the domestic Chinese exports.

Foreign direct investment can be defined as an investment that is made with an aim of acquiring an interest in an enterprise that is operating beyond the borders investor (Bailey, 2018). A good number of literature reviews base the concept of institutional frameworks and the FDI from the economic perspective point of view. Specifically, it is the cost of doing business in one host country as compared to another different host country. The impact of institutions, policies by the government and other factors that are institutionally oriented can either increase or decrease costs that ultimately impact on the profitability of the FDI (Rasel,2018b).Host countries that have institution elements that are market-based that limit opportunistic behavior promote foreign competition allowing MNEs to enjoy the advantages associated with broad-based ownership and are more likely to reduce the costs of doing business thus attracting FDI.

China and Africa’s Raw materials

Institutions that are market-supported are beneficial since they permit investors that are seeking efficiency to experience the benefits of cost saving that come along with internalizing production while protecting the patent rights from misappropriation. Various scholars have expressed their opinions that the general MNEs favor a liberal general atmosphere for FDI. Conversely, institutional factors that raise the cost of doing business develop inefficiencies in both markets and in resource allocation deterring FDI. Unpredictable institution environments tend to create uncertainties making a particular environment less favorable and thus a deterrent for FDI (Rasel,2018c). Thus, it is the host governments that provide a stable political atmosphere where institutions that are market-based become successful in attracting FDI.A stable environment ensures that the environment is predictable and that the public institutions that permit MNEs to tap on benefits from the home country thus improving efficiency and cutting down costs. In summary, a good government is responsible for attracting FDI.

Political stability is the likelihood that a government gets overthrown. FID from China will favor political institutions that are more stable, credible and trustworthy in their dealings since this promotes legitimacy in the host nation. Political instability tarnishes the reputation of a country making it less attractive due to the unpredictable environment as it may disrupt economic activities. It is the unpredictability caused by political instability that increases costs associated with internalizing production which hurts the profitability of the firm. Though underpinnings from theoretical frameworks suggest that political stability should be positively correlated to the FDI, there are mixed reactions in this concept.

The enforcement of the law by the citizens, good quality of the legal system and protection of intellectual property rights encourage FDI in a particular country (Verbeke, 2018). One of the prerequisites for FDI prioritization is the existence of an effective and impartial legal framework that protect the intellectual property rights. It is the presence of robust legal institutions that decrease the costs associated with transactions for MNEs since such environments allow external enforcement and reliability of the monitoring systems. Strong rule of law has the effect of removing uncertainties thus protecting MNEs allowing foreign competition through addressing failures from the market. Such a rule of law thus increases efficiency and raises the profitability. According to previous results, it is suggested that the rule of law and a robust legal system protects the intellectual property rights and positively correlates to FDI. Categorically, protection of property rights is linked to inflows from FDI in developing nations (Fetscherin, Voss, & Gugler, 2010). The level of contract enforcement is also linked to FDI.

Vertical and Horizontal Integration in Competitive Strategy

The presence of fiscal policies that are developed to raise government revenue such as high rates of taxes deters FDI due to the increases in costs linked to MNEs (Paul & Benito, 2018). Consequently, most host countries strive to attract FDI through tax subsidies since such incentives lower the tax burden for the MNEs sending a signal to the outside world that a particular host nation is business friendly and has an enabling business environment. Low tax rates can also cushion MNEs for the externalities they create in the host nation.

MNEs that are seeking investment opportunities in host nations that are culturally distant from the MNCs home nation may encounter huge barriers when they try to understand the local traditions and customs, cognitions and behaviors (Paul & Benito, 2018). In some cases, the distance may be to physical and difficult to be overcome making MNE redirect their location to locations that resemble their home country. Cultural distance has been associated with increased costs associated with information and management deterring FDI in such host nations that have wide cultural distance gaps from home countries. Though many studies on cultural distance are based on relationships based on a firm performance with the entry mode strategy there is substantial evidence of the relationship between the impact of cultural distance and FDI (Verbeke, 2018). Scholars reveal that the cultural distance is conversely related to FDI based on a country such as China. The OFID, however, has defied the odds by venturing in countries that had huge gaps in culture, for instance, the US where LENOVO merged with IBM presenting two different cultures.

The motive for internationalization and OFID by firms from the emerging economies vary distinctly as per the needs of the enterprise. It is worth noting that most EMNEs are driven by strategic motivation and thus knowledge seeking and market avenues are the main goals for such enterprises. For instance, the acquisition of GE appliances by Haier is a perfect illustration of a global strategy that aimed at gaining design and marketing strengths with regards to a domestic market that was saturated. On the other hand, there are those EMNEs that are majorly driven to expand globally through OFDI with a motive of diversifying risks. A good number of OFDI operations are as a result of infrastructure initiatives at the national level, for instance, rail and road construction and power plants that normally engage a joint venture where the local partner commands a majority of the ownership stakes.

Global Value Chains and the Decline of Domestic Value

According to a report by McKinsey, it is approximated that about 90% of enterprises from China in Africa are privately owned enterprises. Such firms work towards achieving profit motives, refuting the belief that most of the enterprises from China in Africa are facilitated by the state. One such private enterprise is the development of the mobile phone Tecno, owned by Transsion Holdings a China-based firm that has achieved commanding more than 40% of share in the mobile industry in East African nations despite the establishment and presence of global rivals.

Techno develops devices that are affordably priced and the devices have features that are specifically tailored for the African nations where it has the presence. For example, Tecno introduced the first brand that had a keyboard in Amharic and its devices have a photo software that captures the darker skin with better resolution enhancing a clear image.

A ready market as the African market is not saturated and there are many customers for its ready products. Tecno also benefits from a large customer base due to the affordable prices charged for its devices and thus many people are able to purchase its devices.

One of the biggest challenges that Tecno encountered was the lack of infrastructure in terms of physical assets and human capital to run its operations in Africa. Tecno had to go an extra cost establishing its premises and retail outlets in Africa before gaining solid ground in Africa. Even as of today, Tecno does not have its manufacturing facilities in Africa and it ships it devices in retail outlets.

One integration challenge arises in the change of policies when Tecno develops its products. This is more the case as Tecno showed concerns in establishing a multi-billion plant in Egypt. However, the main problem whenever the Tecno takes a move initiating the setting up the plant, policy changes arise affecting its operational plans.

Conclusion

China as one of the emerging economies has experienced economic growth over the past few years. It is such economic growth that drives firms to compete on a global level. However, recent and existing literature has not expounded on the concept of OFDI fully and there are gaps in whether it is the government intervention that has led to the successful operation of MNEs in both developing and developed economies. The suitability and attraction of FDI in host countries depend on some factors such as legal frameworks, political stability and cultural distances among other factors. MNEs are also affected by institutional factors from the economic perspective.

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