FDI and Balance of Payment Relationship in Canada

FDI and Balance of Payment Relationship in CanadaChapter OneIntroductionHistory of FDIForeign enthronement was in truth common in the late ni pull ineenth century. It was a strategy from British to provide fund for frugal schooling in other acres, as salubrious as to gain ownership of financial assets. Godley 1999 menti wizd in his research that the bulk of FDI that was establish on British manufacturing industry before 1890 was in industrial goods field. He also mentions that most investors failed as a result of narrow focus and their major concern his to enhance British grocery store. Singer Manufacturing Comp nigh(prenominal) was an exception receivable to its commitment to FDI and being the first biggest and modern Multi publish Corporation in the humanness (Moosa, 2002).During the era of interwar in the twentieth century, FDI redressd and later rose except in that location was an astonished development in that period, British status was lost as a world creditor, and the States became the economic and financial power and FDI was favoured by USA levy law. After the world war, FDI increased as a result of two reasons firstly, good technology in the argona of communication and transportation that bring off distance barrier. Secondly, the need of reconstruction of war damages by European countries and rest of the rich realm around the world. (Moosa, 2002).In the 1980s, there was a decline in FDI (outward). This was due to the fact that most host countries started resisting U.S control and ownership of domestic hards. Also, host countries rec everyplaceed by initiating FDI in USA which affect US net inflow. In the 1970s, there was a big f alone in the U.S FDI but British was back to FDI condescension as a result of northward sea oil boom and the abolition of abroad exchange controls in 1979. In 1980s, changes in FDI occurred in which USA became a net debtor nation and major recipient of FDI with an unfavourable net outside(a) couch. This was caused by depreciation of U.S dollar, restrictive trade policy and low saving rate in U.S miserliness. This disenabled the U.S in financing its own investment in its economy, giving rise to needs of FDI from other nations like Germ some(prenominal) and Japan. Also, in the 1980s Japan became a major provider of FDI to U.S.A, Europe and South East of Asia. Most countries embrace Japanese investors because of its provision of cheap stab. The revolution of FDI in the 80s dissolve be attributed to world-wideization. (Moosa, 2002).In the 1990s, there was bonny improvement in the investment climate which exposed most countries to the benefits of FDI. Some of the reasons that led to the improvement FDI of be removal of FDI obstacles, changes in attitude and increases in FDI intensive. The removal of local hindrances by means of deregulation and privatization was favourable to FDI. Another remarkable thing that happened in the 1990s was the fall in the logical implicationance of Japan as a front runner of FDI. This caused economic doom in Japanese economy. Finally, FDI has gone through many reforms from countries to countries, in the late 90s, the number of treaties for the avoidance of double impose reached a total of 1871. In 1998 and 1999 some measures like protection, liberalization and promotion was brought in by the host nation (policies) on FDI. (Moosa, 2002).Globally, the economic development of deeper and to a greater extent sophisticated internal and international financial grocery store, improvements in information network and technological advancement attain made contribution to sound financial and economic integration. For a nation to partake in any of the economic gains arising from these processes it need to adopt reform policies to improve efficiency.Most countries advocate FDI to move on economic development because of its indirect mend in the host economy due to increase in competition, technical know-how and technological spill-ove r via multinational corporations to domestic strongs. Gorg and Greenway (2002, stated in Morris 2008, p.4) that a possible channel is one in which domestic firms ar thought to imitate the technology used by the companies. This give result to purify ways of local firms of making their production. Competition is another positive effect of FDI. The entry of unusual companies compels the domestic ones to be more(prenominal) efficient in all ramifications. The latter gains better skill entrust from employee training through new improved technology requirement in the production process. (Morris 2008).FDI helps local firm to rotate organization bureaucracy, sub judiceity and financial obstacles encountered in the host economy. International organisations always recommend that little developed countries rely mainly on FDI as a source of external finance. Hericourt Poncet (2008, p.1) confirm that the development of cross border kinship with foreign countries help private domesti cs firms to bypass both the financial and legal obstacles that they event at homeAt the same time, many whitethorn not be pleased with the policies that encourage FDI which might be unfavourable to host economy since foreigners will incur allot in domestic economic participatingness. According to Holden (2007), there was an argument that foreign-controlled investments may be bias and not act in the best interest of locals and nationals that profit may be exported out of the kingdom and that foreign ownership could score national security implications in situation where industries or products are of strategic momentance. These concern links to energy and natural resource sector. The concerns may lead to countries to place restriction on investment in sector that involves strategic importance.Canadian Chamber of vocation had an annual general meeting in 2007. A resolution was passed Attracting FDI to Canada, among the issues discussed in the meeting was an advise for Canadian government to adopt policies that encourage foreign investor to Canada, even though some call for tighter restrictions for FDI due to its demerits (Morris, 2008).Canada was among the countries that provided a shield for his economy with the provision of 1985 Investment Canada Act. This Act states that any proposed foreign direct investment above a certain amount is subject to review and approval from the industry Minister. For the proposed investment to be approved, it must mental testing that its proposed investment provide a net benefit to Canada, some of the things the industry Minister will consider are employment, investment in Canada to compete in the world marketplace, the compatibility of the investment with national industrial, economic and cultural policies and many others (Holden, 2007).Using Canada (a res publica that has benefited from FDI in all ramifications from the perspective of macro economics level charge to the micro level, from one sector to another secto r) as a case study. It is obvious that Canada has gained so much in FDI both in forward linkages and converse linkages. According to the Daily (May 6, 2008), the stock of FDI in Canada sky rocketed in the last eight years, and the sector that had the biggest share were the resource based industries.The Canadian Chamber of Commerce Annual General Meeting (2007) passed a resolution titled Attracting Foreign Direct Investment to Canada. The meeting called for the Canadian government to send a nominate and positive message to foreign investors that Canada wants inbound investment through a proactive investment strategy and promotion champagne (Morris, 2008).AimMost forward studies focused on the role of FDI on economic growth but their findings shows that FDI is not significant to economics growth. Carkovic and Levine (2002), prove that FDI does not independently influence on economic growth. However, economic growth and balance of payment (BOP) as a macro-economic objectives of any rational nation, in which there is sort of trade-off in both objectives.(this will be condone in the literature review section ).(pass et al. 1995). Countries calls for FDI coming between the two objectives as result nation rationale of protectionism ( quotas ,high import duties and embargo) to resolve balance of payment problem, and to gain import substitution and export promotion agenda. Keynesian economic growth model, which is measured with Gross Domestic intersection (GDP), be possessed of many parcel much(prenominal) as government expenditure, consumption level, investment, and export minus import (BOP current account). Changes in any of these components will have multiplier effect on the economic growth. (Moosa, 2002). FDI will have direct effect on host nations balance of payment which will indirectly impact the host country growth. The question being asked in this research is there any relationship between FDI and BOP? The aim of this dissertation is to determine the r elationship between FDI and Balance of Payment in Canada over the period of 1990 to 2008. This aim will be achieve by building a model to explain the casual relationship between dependent variable and independent variables to figure out the relationship between FDI and BOP. Also, hypothesis will be formulated to test some of the objectives of the study. Robin says in Saunders (2007) that with deductive research its necessary to deduct a hypothesis. The study explores six possible issuesObjectivesTo determine the property of Canadian cracking account explained by growth in FDI in Canada over the period of 1990 to 2008.To determine the proportion of Canadian Current account explained by growth in FDI in Canada over the period of 1990 to 2008.To determine the proportion of Canadian Import explained by growth in FDI in Canada over the period of 1990 to 2008.To determine the proportion of Canadian Export explained by growth in FDI in Canada over the period of 1990 to 2008.To ascertain the relationship between Canadian FDI and Canadian BOP over the period of 1990 to 2008.To examine the major (countries) contributor to Canadian FDI over the period of 1990 to 2008.Significant of the studyThe significant of this study is to know the role of FDI in achieving one of the macro economic objective. This to ascertain if FDI will affect BOP in Canada positively or negatively. If the effect is positive, there will be needs of up(a) scope or magnitude for FDI in Canada for the future .However if it is negative there may needs for government policies to restrict the inflow of FDI to Canada so as to achieve a favourable bop.The consecutive chapters will structure in the following ways chapter two discusses the theoretical background information related to FDI, chapter three examines the donnish literature relevant to the topic and also describes the methodology while chapter four presents the empirical analysis and discusses the econometrics result. The concluding chapter pro vides a conclusion of the research work.Chapter two literary productions ReviewTheoretical Background(Moosa,2002) defines Foreign Direct Investment (FDI) as the process whereby residence of a country (the source country) acquire ownership of asset for the purpose of controlling the production, distribution and other activities of a firm in another country (the host country). It involves the transfer of financial capital, technology and other skills such as managerial, marketing, accountancy, and so on. International Monetary Funds Balance of Payment Manual defines FDI as an investment that is made to get a long pertinacious interest in a organisation operating in an economy difference the investor.(Canada Statistics, 2008) defines FDI as a component of a nations international investment position which explains a countrys investment position the difference between aggregate financial assets and aggregate financial liabilities. Direct investment, portfolio investment and other invest ment are the component of financial asset and financial liabilities. (Frankel and Romer, 1999) describe FDI as one of the all-important(a) catalysts for economic growth in a nation especially in less developed countries. This statement describes the significance of FDI to a nation.FDI can also be descri bang as a company from one country making animal(prenominal) investment into building a factory in another country. It is the establishment of an effort by a foreigner. (UNCTAD, 2002) defines FDI as investment made to acquire lasting interest in enterprise operating outside the investors economy. In short, a business or firm that undertake FDI become a multinational national company (MNCs) because of it ability to own many subsidiaries in many foreign countries. Foreign Direct investment (FDI) plays a crucial role in any host economy in the aspect of economic prosperity and building wealth. It also leads to increase in capital flow and, highly skilled humans power, and reduction in unemployment and importation of advanced equipment and technology to enhance output level. This has a direct impact on the nations gross domestic product by promoting economic development. Mutenyo (2008), said most less developed countries now adopt policies that encourage FDI. Among these policies are privatization, trade and exchange rate liberalization, and, tax rebate and incentives for foreign investors to enjoy the business environment.FDI is different from other components (such as international financial assets, portfolios and so on) of international investment. International Monetary Fund (IMF 2003, p.6) define FDI as a category of international investment that reflects the objective of a resident in one economy (the direct investor) obtaining a lasting interest in an enterprise resident in another country (p.6). IMF further explained that a direct investment is established when a foreign investor has more than 10% ordinary share or voting right of a host country enterp rise (IMF 2003, p6-7). In Canada, direct investment is measured as the total value of equity, net long-term claims and net short-term claims held by the enterprises border (Canada Statistics, 2008). FDI has been increasing globally over the last two decades. Especially in the 90s, FDI increased more than the world economic growth. According to United Nations Conference on Trade and Development (UNCTAD) data collection pertaining to FDI regulations in 1991, it shows that between January 1991 and December 2002, total of over 1600 measures were introduced by 165 countries more that 90% of them was in favour of FDI in terms of changes the nature of the introduced measures ranging from security for investors, to liberalization of rules governing the inflow of foreign investors, to measures that are promotional in nature(UNCTAD, 2003). The measures were extended to the international level through double taxation treaties (DTT) and bilateral investment treaties (BIT).Over the last four dec ades, FDI have gone through series of transformation in Canada. Gellaty 2006 (in Morris, 2008, p6) explained the reason for the emergence of the Foreign Investment Review Agency (FIRA). Due to growing concern of FDI in the late sixties and early 1970s, the Foreign Investment Review Agency (FIRA) was established to regulate and monitor FDI. The regulation governing FDI and FIRA was replaced with Investment Canada in 1985. The regulation was aimed at protect and promoting FDI in Canada. There was also an implementation of Canada-U.S Free Agreement (CUFTA) and North American Free Trade Agreement (NAFTA) to promote FDI further in Canada.FDI expect to be a topic that covers both narrow and broader area. Feenstra (1999,quoted in Liebscher 2007, p.3) expresses FDI as the combination of both international trade in goods and international financial flows, and as a phenomenon more complex than either international trade or international financial flow. From micro-economics perspective, FDI raises the issues of location consideration and ownership. From the macro-economics angle, FDI considers the fear of unemployment and the loss of freedom. For Policy makers, FDI is an issue to balance the benefits of spillovers with growing concern of the public. The concern authorities will be rational in policies that will favour FDI and all concern parties. FDI is one of the chance upon features of the modern globalized world. According to (Peter 2008), most industrialists believed that there is international links in the late medieval and early modern era. They were also of the opinion that multinational firms became crucial in numerous industries in the late nineteenth century but the period since World War II and in particular, since 1985 have seen an explosion in FDI both in relative and absolute terms to the levels of trade and gross domestic product.However, economic possibleness provides an extensive economics literature which was developed to canvas the causes, nature and consequences of FDI. One of the reasons for the creation of FDI is as a result of cheap cost of production in the host economy. FDI occurs when the benefits of producing in a foreign market out weighs the cost of economic of scale from producing exclusively in the firms home plant (Neary 2008, p.13). This benefit can be explained by the concept of proximity tightness trade-off. That is foreign firms take avail of trade off in production in home countries which will expose them to high exportation cost and international trade barriers relative to proximity to customer and low transportation cost. There are some conflicting predictions about the effect of FDI on economic growth. Blomstrom and Kokako (1998, quoted in Mutenuyo 2008, p.3) explain that spillover occurs if the entrance of multinational enterprises (MNE) result to efficiency and productivity benefit to the domestic firms in the host country and MNE is not able to internalize the expert value of these benefits. On the other hand, negative externalities exist if the activities of FDI result to loss in efficiency, productivity and profitability among the local firms and the alien investors do not set them for their loss. In a nutshell, FDI can be detrimental to an economy.MNE are assumed to compete favourably with the more advanced local firms since the local firms will have an edge over the foreign investors in local market share, skills, export contracts, cordial relationship with suppliers and the customer and so on. On the other hand, the foreign firms may be more advance in technological know-how, research and development, and the financial resources for their home economy.(Hericourt and Poncet ,2009) confirms that the development of cross-border relationships with foreign companies helps private firms to bypass both the financial and legal hindrance that they face at home.Types of FDIThe types of FDI can be considered from dual angle from the perspective of foreign investor country and from the perspective of host country. Since the study is focused on Canada, FDI will be examined in both ways. There are three types of FDI- vertical, horizontal and conglomerate- from the perspective of the source nation (investors).Vertical FDI (Hill,1998) provides a clear object lesson of vertical FDI by dividing into two Forward vertical FDI and Backward vertical FDI. The former is applicable in a situation where a local firm invest into another industry abroad that sells the output product of the local firms production process, while the latter is used when the foreign sales of a firm provide inputs for the downstream operation of the local firms.Horizontal FDI is applicable when the goods produced in the host country are the same as in the home country for horizontal expansion (Caves, 1971). (Hill,1998) defines it as firms invest in the same industry as the same operational activity in their homeland.Conglomerate FDI is the combination of horizontal and vertical FDI. That is, firm operating in separate business, (Luladhar 2008).FDI FROM THE ANGLE OF HOST ECONOMYExport-increasing FDI is caused as a result of items produced in host country as an input for home country such as warm material or intermediate goods. This type of FDI will enhance the exportation of the host nation if there is high demand for the raw material or intermediate goods from the home country.Import- substituting FDI This type of FDI is applicable when the goods previously imported from the home country are now been produced from the host economy which will generate more employment .This is caused as a result of host government policy on trade barriers, market size, labour cost and so on.Government initiated FDI This is when the policy makers provide some incentive that attracts foreign investors into the host economy. This incentive could be tax holiday, tax discount and so on.The Determinant of FDI (Motives)There are four motives that determine FDI. These determinants provide reason why firms should use FDI to tap in business globalization. These motives are acquired inputs (raw material orientation), market orientation, cost orientation, and strategic asset seeking motives orientation.Raw Material Orientation According to Dunning (1993), availability of raw material is the bed rock of any firm, especially the manufacturing firms. Usually the cost of importing raw material from the source to where is needed is outrageous, even the duration cost of getting the raw material to host firm is another visible problem that affects the overall performance of production. Therefore, it is more economical for firms to produce in an environment that has easy portal to raw material.s (Atik et al., 2008).Market Orientation This is when firms produce goods in a host country instead of shipping it directly from the home country. This occurs when foreign market is protected by the government restriction goods importation or high importation duties. It will cost less to produce in the host economy market to avoid international restriction and unnecessary cost. Market orientation draws foreign supplier closer to the buyers in the host economy. (Atik et al., 2008).Cost- Orientation Motive Cost minimisation is one the firms strategy to optimize profit. Porter (1998, stated in Atik et al.2008, p 29) explains that among the generic strategies of a firm, cost leading is the best strategy. In cost leadership strategy, a firm will prefer to become the lower cost producer in its industry. So firm prefer to site their location where they will enjoy the lower cost of factors of production. Good examples of this firm from developed nation prefer to locate their firms in less developed nation because of cheap labour and other cost of production.Asset Seeking FDI Foreign firms prefer to have access to gain industrial asset in host country which will more profitable to have in there home country. The foreign firm will sustains or advance its international competitivenes s, technological advancement, and opening up the new market though its asset accusation from the host nation (Atik et al., 2008). There fore, a firm that owes foreign asset is better positioned in global market competition compare to its counterpart.Theories of FDIMost literature reveals why investors prefer to produce abroad instead of staying in the home country. Dunning 2003 p.278) assert that the growth of existing foreign value activities in service might require a different set of explanations than to follow initial decision to invest abroad. There are some theories that explain FDI and MNEs in global business especially in goods sector.(Helldin ,2007) is of the opinion that FDI theory is fragmented and consists of various economic theories. There are no complete theories that explain FDI it was just the bits by bits from numerous authors. Hymer was one of the first authors to explain the theory of FDI in 1960(mention in Na, Lv Ligthfoot, 2006). Hymer believes that the multi national national companies (MNCs) have the potential to expand the business due their oligopolistic nature. He said MNCs have firm specialized advantages that establish market power on global market due to their technical know-how, product differentiation, RD and so on.Dunnings Eclectic Paradigm (Professor John H. Dunnings 1977 OLI-framework also called Dunnings eclectic paradigm)Dunning 1977,Helldin 2007, p8), explains that the three factors that constitute to MNEs location in host country. These factors are Ownership Specific Advantage (O), reparation-Specific Advantage (L) and internalisation Advantage (I). Ownership specific are business advantages such as capital, advance technology, well know brand names and product with dominant standard (p8). It further explained that the higher the level of business competitive advantage are compare to foreign competitors on a specific location the more the business will be involved in foreign production. Location will also be based on the countries competitive advantage, originated in the partners home countries (Helldin, 2007). Ekstrom (1998 stated in Helldin 2007) is of the opinion that the combination of O with L is why a specific location is elect to make FDI. The third (internalization) advantage is meeting demands on global market by trading. (Dunning 1977, Helldin 2007, p8).Ownership Specific Advantage (O) MNEs enjoys business advantage in some area such as size, established position, and monopoly power. MNEs also have some specific advantage in some business area such as capital, advance technology, research and development, highly skilled human capital, trade marks, receipt of government grant and property right over intellectual property (Bennett, 1999).Location Hypothesis (L)This hypothesis explains the existence of FDI which is a result of international immobility of factors of production labour, natural resources and weather. The immobility factors result to location-related differences in the cost of production. Horst (1972b, quote in Moosa, 2002, p.33) used this hypothesis to explain US FDI in Canada. Most MNEs prefer to locate their production facilities in an area where there is cheap labour. Lucas (1993) proves that there is reverse relationship between FDI and wages. He explained that a rise in wages in the host economy will increase the cost of production and have adverse effect on production and FDI. This will shift the host economy from labour incentive to capital incentive and will also encourage FDI Lucas (1993).The advantages of location specific (L) include low transport cost, low purchase input, economics of large scale, good communication, low labour cost, near to market advantage, availability of local business support ( market research firm) and the avoidance of trade restriction (artificial barriers) impose by host nation to reduced import (Bennett, 1999).Internalization HypothesisInternalization hypothesis explains that FDI arises due to the impact of MNEs. MNEs is established to replace market (external) transaction with internal transaction. Coase (1973, says in Moosa, 2002) is of the opinion that market cost can be saved by forming a firm (p, 32). He gave an example of bottleneck encountered in purchasing oil product while compelling a firm to buy a refinery. These problems are caused by market failure and imperfection in intermediate goods, including technical know how, marketing and management enterprises (Moosa, 2002). MNEs invest in host countries in order to boycott expensive suppliers and distributors. Foreign government import restrictions will be avoided through local subsidy earlier than exporting direct. Also the marketing aspect will be managed and controlled by the producing firm there will be no intermediate sales or Value Added tax (Bennett, 1999). According to Dunning (2003), internalization incentive advantages are to protect or exploit market failure (p.99).The Product Cycle possiblenessThe theory was invented by Vernon in 1966. This theory explains the competitive advantage possessed by MNEs or potential MNEs originated in a country instead of another. The competitive advantage move from a stage of local production in home market, to exportation, and then to FDI (Dunning 2003). His theory was a based on U.S. directs investment in import substitution producing activities standards and economics structure. Also the ownership advantages of firms that produces or supplies a product had a little say about the advantages of common governance (Dunning, 2003). The theory is more useful in analysis of MNEs in FDI activities such as capital exportation, services activities, inward outward investment and so on.Core Asset TheoryCore Asset Theory was propounded by Hymer in 1976. Dunning said the theory explains the territorial expansion of a firm in terms of its exclusive or privileged possession of intangible assets, which it perceived could be utilized in a foreign country Dunning (2003, p.279). Se veral writers have to identify which O specific right were the most significant in determining the ability of MNEs to compete in foreign market. The theory examines the role of Foreign Service firms in market seeking sector, which is different from Product Cycle Theory focus on resources based industries or manufacturing sector. Also the theory was less concerned with where firms or MNES are located. According to Dunning (2003), the theory underestimates the important of the organizational mechanism by which the competitive advantage (Product Cycle Theory) is exploited (Dunning, 2003). The theory is limited to FDI or MNEs in technological advancement ,RD, position, product quality and so on, but it just examines the growth in foreign firms in global oriented and integrated service industries (Dunning ,2003). system Related the TheoriesKnickerbocker, in 1973, was the first person to examine the strategy of MNEs. His analysis was that MNEs activities will be a function of high seller concentration. Dunning (2003) stated that Knickerbocker hypothesized that MNE activity would tend to be concentrated in industries characterized by high seller concentration, and that firms in those industries will engage in follow my leader tactics in the timing of their foreign investments, to protect or advanced their global competitive position (Dunning, 2003, p.280). Most studies on MNEs, the area of extraction, manufacturing and the likes was in support of this theory but the theory was less relevant in foreign firms activities in service industries because of its less oligopolistic nature (Dunning, 2003). However, these theory was fragile in MNEs with high level of variegation since one of the main aims of MNEs is expansion and diversify in area like service sector which may be outside their main activities which will create problem for the theory.The Risk Diversification HypothesisThe theoretical background of this hypothesis can be traced back to the theory of portfolio sel ection by Markowitz (1959) and Tobin (1958). The risk variegation hypothesis was propounded by Grubelin in 1968, but the idea was revisited and made known by Rugman in 1979. The hypothesis was that MNEs reduces the portfolio risk by diversification, which is investment in foreign assets that usually consist of service industries like banking, insurance, communication and so on. Most construction firm may want to make their working capital active by buying financial assets (Dunning, 2003). This kind of investment is not capital intensive.The Aliber ThesisAlibers (1970 1971, quoted in Dunning, 2003, p.280) seek to determine why firms pay their foreign assets in local currencies when they produce abroad. The theory explains that foreign firms take advantage of the home stronger currency to acquire ownership of assets in host economy due to their flea-bitten currency. Albert also argues that fluctuation in foreign exchange market that result to undervaluation or overvaluat