Foreign direct investment (FDI) refers to form of investment that is made by an entity that is headquartered in a particular country into another entity that is headquartered in a different country. This form of investment has grown into prominence due to the advent of globalization. Companies have been witnessed to increasingly invest in foreign entities particularly the ones based in the emerging economies with the hope of expanding their customer base and augment the market share. As such the level of FDI net inflows have increased considerably over the last decade or so. This fact can be justified by the data provided within the World Bank database (refer to figure 1).
Figure 1: Net inflow (all countries)
(Source: The World Bank Group, 2014a)
The level of FDI has a direct association with various economic factors related to a country. The extent to which a country’s economic factors are favourable determines the level of foreign investment inflows to be received by that country. However, off late FDI has become exposed to various types of risk out of which the common ones are foreign exchange risk, country risk and sovereign risk. It is undeniably true that FDI has lots of advantages but it has to be kept in mind that such investments are associated with fair share of disadvantages as well. With regards to these facts, what follows is a detailed review of literatures that emphasizes on the advantages and disadvantages of FDI with particular focus on German companies.
Figure 2: Net FDI outflow as a percent of GDP (Germany)
(Source: The World Bank Group, 2014b)
As is evident from figure 2 given above, FDI outflow from Germany has been decreasing since 2006 when the country reached the maximum level in terms of FDI outflow as a percent of GDP. The investment has since then decreased abruptly and hit a record low of 2.34% and 1.26% in the year 2008 and 2011 respectively (The World Bank Group, 2014b). Such abrupt decrease in FDI outflow can be largely attributed to the global financial crisis during 2007-08 as well as the euro zone crisis in 2010. Majority of the German companies have accrued the benefits of FDI during the course of their international operations. Regardless of such benefits, FDI is still associated with a quite a number of disadvantages. Therein lies the relevance of this research as the researcher endeavours to identify the advantages and disadvantages of FDI for Germany.
The research will be entirely qualitative in nature where the researcher will be attempting to identify the key advantages and disadvantages of FDI for Germany through an extensive review of empirical literature. The factors that will be identified will then be documented in the findings and discussion section. These findings will then be translated into evidential conclusions.
FDI has a significant contribution towards the economic development and growth of a nation (Li and Liu, 2005). According to Choe (2003), such forms of investment are heavily reliant on several macro and micro economical factors associated with a country. Academic scholars have conducted a significant amount of research on FDI and have concluded that some of the major determinants of FDI include productivity and cost of labour, availability of natural resource, level of private, public and government debt, inflation, political scenario, interest and exchange rates. Alam and Shah (2013) have argued that the factors which have a significant impact on FDI vary from country to country. This is precisely because of the dissimilar macro and micro economic situation that prevail in those countries. The authors have put forward the perspectives of investors who believe that FDI is an instrument of investment diversification which is done to reduce a company’s exposure to home country risk factors. The rationale behind making investment in a foreign country is to exploit cheaper resources available in those countries and increase the rate of return (Globerman and Shapiro, 2002). This provides investor companies with the option to spread their risk as the adverse impact of country risk is balanced by the encouraging opportunities available in the foreign country (Estrin and Meyer, 2004; Estrin and Bevan, 2004).
It is undeniably true that FDI has a profound significance towards the development of the home country. It plays a crucial role in improving the economic scenario of the home country by allowing investors to attain higher rates of return, enhances the working environment considerably, creates new employment opportunities, fosters innovation and facilities development of technology (Markusen and Venables, 1999). Empirical theories have suggested that multinational corporations mainly engage in FDI activities with the underlying aim of attaining first mover’s advantage (if it is a relatively unexplored market) or to explore a market with prospective growth opportunities (Calhoun, 2005). In that way investors are able to create firm specific benefits.
According to Shatz and Venables (2000), the major reasons behind foreign investment it to capture the local market and serve the customers’ needs as well as to obtain inputs from cheaper sources. Capturing the local market provides firms with a wider customer base whereas obtaining a cheaper source of input enables investors to increase their margin of profit (Chakrabarti, 2001).