Issues raised about OFDI
The value and benefits of OFDI have sometimes been questioned, and there have even been suggestions that OFDI should be discouraged. The concerns raised are reasonable and need to be taken into consideration, though they may also not be as problematic as sometimes alleged, and it is often possible for governments to manage any associated risks. Three problem issues are typically raised:
Concern no. 1: “OFDI transfers money, employment, opportunities etc. abroad, at the expense of the home country.”
OFDI involves an outflow of capital, raising the concern that money is diverted for investments abroad instead of being invested at home, where it could directly build domestic capacity to the immediate benefit of the home country. While this this replacement of domestic investment might happen in some cases, companies do often invest at home and abroad simultaneously, with both investments potentially benefiting each other and domestic capacity built up in parallel with expanding OFDI. If a company’s mix of domestic and foreign investments is optimal from the perspective of its business, its investments are likely to generate the best overall results. At the same time, a firm undertaking OFDI may actually stimulate or ‘crowd-in’ domestic investment by other firms in the home economy if, for instance, OFDI results in greater exports and thus demand for inputs into production (Hejazi and Pauly 2003).
After some time, investments overseas are also likely to generate financial returns, which can benefit the home country if repatriated. In addition, OFDI has the potential to generate important non-financial benefits to the home country, such as greater flows of knowledge and resources from overseas to the home country and improvements in domestic innovation, productivity and standards. These non-financial aspects are particularly important for economic and sustainable development.
Similar concerns are often raised about the employment impact of OFDI. There have been cases where offshoring of productive activity shifted jobs overseas, making domestic workers redundant, or putting downward pressure on domestic wages and working standards. This problem is, in particular, seen to affect blue-collar workers. The ultimate impact of offshoring is, however, not clear cut and may depend on the extent to which governments can cushion such negative employment effects and avoid distributional consequences that affect blue-collar workers negatively. Offshoring is also an opportunity to upgrade domestic economic activity to involve more high-skilled and better paid employment. This might require government investment in appropriate training and human capital development. Job losses from offshoring might happen in the short term, with long-term gains in employment and wages, again a situation in which the government would need to cushion the intermediate negative consequences.
It should also be noted that companies sometimes have no other option but to engage in OFDI and associated offshoring, especially if labour costs are too high in the home country to sustain cost-effective production there. High labour costs may well necessitate layoffs and potentially the closure of production sites in the home country, so that re-building these production sites in cheaper overseas locations might actually save some jobs in the host country that would otherwise have been lost, such as jobs that provide inputs or expertise to the new production sites.
Firms conduct OFDI in the basis of market considerations and the cost pressures of their own business, and sometimes they can only be successful, confront the international competition and expand their business if they internationalise through OFDI. Rather than unduly restricting OFDI, any government response should aim at maximising associated opportunities and containing any associated risks. This Toolkit provides vital information for governments and firms to facilitate corresponding decisions.
Section E of this Toolkit (Section E: Potential risk factors) further elaborates on these concerns about OFDI and presents associated empirical evidence. This evidence on negative financial and employment effects is, however, dwarfed by the empirical evidence on the various positive home-country effects outlined in Section A (Section A: Home-country effects). This suggests there is an overall case to be made that OFDI should be endorsed as an economic activity that firms undertake, potentially promoted by government to maximize associated opportunities, with the associated risks being managed by government to reduce any unfavorable implications for domestic investment and employment.
Concern no. 2: “What is good for the outward investing firm may not be good for the country.”
This problem, sometimes referred to as “macro-micro dilemma”, emerges when companies conduct OFDI activities that benefit themselves but may not necessarily benefit the home country. This can include activities from shifting production offshore to investments in tax havens that minimise tax obligations in the home country. Companies may also decide to make investments abroad that could have been feasible in the home country.
While this problem may emerge in some circumstances, it is not necessarily a problem associated only with OFDI. Even companies operating domestically – at least when they are private – may at times engage in business activities that the government does not consider desirable or in its strategic interest. Examples are large mergers that distort competition or activities that harm the environment. Just as governments can intervene domestically only to some degree to prevent these undesirable activities, they could regulate OFDI activities to some extent to prevent certain risks. But as with domestic government intervention, which is at times necessary but can curtail entrepreneurship and harm the business environment, OFDI should also not be unduly restricted just because some companies may not fall entirely in line with government priorities. This would result in curtailment of entrepreneurship and positive OFDI as well.
Moreover, OFDI may have undesirable implications in one area (e.g., capital outflow, loss of tax income), but be in line with the home country interests in other areas (e.g., generating valuable home-country effects, such as knowledge inflows and innovation). While there may be instances where the interests of companies and the government diverge, they will in many other instances converge. The large number of positive home-country effects outlined in section 1 (Section A: Home-country effects) are an indication that convergence is very common.
It should be added that companies internationalizing to expand their business is a simple matter of fact – unless the home country has tight OFDI restrictions in place, which are increasingly rare. Rather than resisting what has become a general trend in international investment, it may be more viable to focus on developing policies and measures aimed at maximizing associated opportunities and benefits, both for the firm and the home economy.
Concern no. 3: “OFDI is harmful to the host country”
Every OFDI is, at the same time, an inward investment in the host country. There are concerns that such investments could be damaging to the host country in many ways – outcompeting domestic firms so they go out of business, exploiting workers, employing low environmental and labour standards, harming local communities etc. These concerns ought to be weighed against the positive impacts of inward investment, such as capital inflow, employment creation, transfer of know-how and technologies, etc, which the evidence has shown generally far outweigh the risks, especially with appropriate policy and regulatory frameworksa. These implications of (O)FDI for host countries should not only be a concern of the host country government; the home country government should also assume responsibility to ensure that the home-country multinationals investing abroad engage in appropriate corporate behaviour (known as Responsible Business Conduct) when overseas.
Similarly, some might suggest that OFDI is a zero-sum game, benefiting only the home country at the expense of the host country. That OFDI generates a variety of home-country effects as presented in this Toolkit might fuel such concerns. However, in first instance OFDI involves a capital outflow and an investment in a host country, so any positive effects are likely to be more immediate in the host country and precede the generation of home-country effects. In other words, OFDI can be win-win, generating benefits for both host and home countries. These benefits may or may not be in the same area. For example, (O)FDI could transfer capital and technology to the host country but increase home-country exports and productivity. (O)FDI might transfer capital to the host country long before some earnings are repatriated to the home country years later. And (O)FDI might bring technology to a host country for extraction of its natural resources, generating income for the host country and the potential multinational, and possibly returning some resources to the home country much later. Despite the existence of positive effects for both home and host countries, this Toolkit focuses only on the home-country effects of OFDI, simply because the host-country effects have been widely covered in the literature and there is a deficit of information on home-country effects, home-country measures, and influencing factors.
The contradiction between the concerns 1 and 2 above and the third concern is noteworthy, as it illustrates how similar criticisms are raised against inward and outward investments. The first two concerns argue that OFDI can be problematic for the home country, whereas the third suggests the opposite, that the corresponding inward investments are a problem for the host country and a zero-sum game in favor of the home country. According to this logic, each side claims that the other country gains and the own country loses out. But this is certainly unlikely and inaccurate – there is much empirical evidence that inward investments have many positive effects in host countries, and the empirical evidence presented in this Toolkit shows that such investments also generate home-country effects. In other words, OFDI can lead to win-win outcomes for both home and host countries. What matters more is that both home and host country governments individually address, and even collaborate on, how to maximize opportunities from such investments and how to reduce any associated risks.