Critically examine “Foreign Direct Investment and the strategic logic behind it for the development of a country, especially for Pakistan.

Critically-examine-Foreign-Direct-Investment-and-the-strategic-logic-behind-it-for-the-development-of-a-country-especially-for-Pakistan

CSS Solved Business Administration Past Papers | Critically examine “Foreign Direct Investment and the strategic logic behind it for the development of a country, especially for Pakistan.

The following question is attempted by Miss Nimra Masood, the top scorer in CSS Business Administration papers. Moreover, the answer is written on the same pattern, taught by Sir to his students, scoring the highest marks in compulsory subjects for years. This solved past paper question is uploaded to help aspirants understand how to crack a topic or question, how to write relevantly, what coherence is, and how to include and connect ideas, opinions, and suggestions to score the maximum.

Topic Breakdown:
There are different sources of financing in an economy; foreign direct investment is believed to be the most reliable and effective.
Subject: Finance
Chapter: Global Context of Business

Introduction

In the era of globalization, foreign investment has emerged as the prime factor behind economic growth. Especially, the developing world finds it tough to find sufficient financing for sustainable economic growth; therefore, they prefer creating a suitable environment for foreign companies and individual investors to invest in their country. Foreign direct investment is the key to success for developing countries like Pakistan; however, there are several drawbacks that must be considered before arriving at a decision. While foreign investment creates jobs and brings technology and much-needed finance; on the other hand, it may result in environmental challenges and exploitation of natural resources in the host country.

Definition

“Foreign Direct Investment (FDI) involves an arrangement in which a firm buys or establishes tangible assets in another country.”

OR

“FDI implies the existence of a long-term relationship between the direct investor who is a resident entity in one economy and the direct investment enterprise, an entity resident in another economy, with a significant degree of influence of the investor on the management of the enterprise.”

Types of Foreign Direct Investment

  • Green Field Investment:
    A parent company starts a new venture in a foreign country by constructing new operational facilities and acquiring new fixed assets.
  • Mergers and Acquisition:
    In mergers, the assets and operations of two firms from different countries are combined to establish a new legal identity. In case of acquisitions, the control of assets and operations is transferred from a local to a foreign company. The local company ceases to exist and a foreign company takes over.
  • Joint Venture:
    Refers to a venture by a partnership or conglomerate designed to execute a particular business undertaking and share the profits, risk or expertise. The parties create a new entity by both contributing equity, and then sharing the revenues, expenses, and control of the enterprise.

Problems with foreign direct investment:

  • Threat to local industry:
    One of the biggest problems with foreign direct investment is its ability to threaten and compete with the local industry. Unfortunately, developing countries like Pakistan do not have a considerate and substantial local industry; therefore, it becomes easier for foreign companies to compete.
  • Outflow of Foreign direct investment:
    Another recent challenge that has emerged is the outflow of FDI from Pakistan and other developing world. Companies, instead of investing within the company, are shifting their capital to other countries. Recently, the textile industry of Pakistan was one example that had shifted to mainly Bangladesh.
  • Poor policymaking:
    Another major hurdle in foreign direct investment is poor policy-making in the host country. While on the one hand, complicated legal and policy matters discourage foreign investment; on the contrary, poor policies by the host may result in exploitation by the investors. Recently in Pakistan, the two cases of Reco diq and Sandiq are two examples where the host nation suffered due to poor policymaking. Moreover, the instability in monetary policy and the exchange rate has also been a long outstanding issue.
  • Environmental and other challenges:
    Recently environmental challenges and the depletion of natural resources have given a new angle to foreign direct investment. Developing countries have under severe scrutiny as they host the majority of foreign investment, hence the industry. Moreover, Pakistan has failed to meet the energy requirements to attract any substantial foreign investment.

Why foreign direct investment is important for developing countries.

Developing countries see foreign direct investment as a source of economic development, income growth and employment opportunities. Although, it is a fact that foreign direct investment alone cannot deliver goods without a sound and resounding monetary and fiscal policy. However, foreign direct investment has provided the much-needed impetus to the developing world for international trade integration and utilizing human capital.

  • Technology transfer:
    Unsurprisingly, the developing world has lagged far behind in technological endeavours; nonetheless, foreign companies have fully filled this gap by investing in those countries. Pakistan also benefited from such foreign direct investments in past, for e.g. Honda and Toyota, apart from financing, brought with them much-needed technology.
  • Human capital formation:
    Another significant advantage of foreign investment, especially for Pakistan, is the utilization of human resources. Pakistan, unfortunately, has witnessed uncontrolled population growth in the past few decades; on the flip side, the local industry is not of considerable volume to employ such a big number. Thus forth, foreign investment has been a blessing for Pakistan to utilize its uncapped human resource and reduce poverty.
  • Helps in managing current account balance and monetary policy:
    Pakistan, since its independence, has struggled to maintain a positive balance of payment, meaning its imports supersede its exports almost every year. Foreign direct investment can help overcome this hurdle by helping the rise of exports. Pakistan, unfortunately, has focused more on exporting agricultural and unfinished products that have a very low profit margin and market.
  • International trade integration and political benefits:
    One of the most credible and long-term benefits of foreign investment is international trade integration which in turn leads to an unprecedented political benefit. In the modern world, the economic rise of China and its political clout is an evident example of how foreign investment can do wonders for a country. The recent rise of different trade associations and alliances is also a signal of the economy’s influence the political interests.

Critical Analysis:

Foreign direct investment can do wonders, especially for a wobbling economy like Pakistan’s. It can help break the shackles of un-surmounting debt and fiscal deficit by reducing poverty, increasing exports and building a competitive environment within the country. However; unfortunately, Pakistan has failed to take advantage of this advantage due to its weak policy-making, legal hurdles and; above all, the energy crisis is adding to the misery. Nonetheless, Pakistan, like other developing nations, can still utilize this window of opportunity to its advantage as it has substantial human capital and natural resources. 

Conclusion:

Foreign direct investment has emerged as the biggest catalyst for economic growth in this era of globalization. There are several types of foreign direct investment depending on the host environment, industry and investors finances. Although, foreign investment has done in the majority of cases; ironically, it also has a cost for the host nation. Developing countries have cashed in on this opportunity, but Pakistan sadly has failed to gain an advantage mainly due to its internal weaknesses. A stable monetary policy, exchange rate and overcoming legal hurdles can help a great deal in Pakistan’s economic ambitions.

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