Governments always attempt to attract foreign investment for expected beneficial impacts on wages, employment, technology, balance of payments, and growth. Most of the times, it is also advantageous for the nations to encourage free trade to ensure prosperity and cultivate healthy economic environment. It is worth mentioning that the positive impacts of free trade and free foreign investment significantly offset the cost of allowance which ultimately comes forward in the host nation during the investment. Most of the governments around the world view free trade and foreign investment as having significant potential in improving total factor productivity compared to an equivalent quantity of domestic investment. This would be considered as axiomatic in transition and developing economies and also relying upon the origin of foreign firm.
Foreign investment and free trade is mostly considered as the primary driver of economic development and growth. Most of the government regards the attraction of foreign investment as a priority, especially in transition and developing economies. It is given such significance not just because it supports capital formation but also because it improves the quality of capital stock. The main reason is that in encouraging free trade, firms are assumed to cultivate best practice along with better practice technology and management. Furthermore, it is also possible that a specific foreign firm will not be successful, in the long-run, protecting its superior management or technology completely to prevent some of the aspects from being absorbed by domestic indigenous organizations. Most of the times, they provide significant external benefits from free trade and foreign investment that governments are anticipating to secure. However, this could, as well, take place that researchers are focusing in the wrong place.
Consensus in the policy issues regarding foreign trade and investment is relatively clear; most of the general policy issues focused at changing the fundamentals are more significant compared with particular policies focused at attracting foreign investment and encouraging free trade. These policy issues seem to impact mainly the distribution of rents. At times, most of the governments around the world compete in offering attractive investment incentives, such as giving export subsidies, and in the process create rents for foreign firms. Available econometric evidence suggests that the features of the economic environment are normally much more significant; domestic labor market scenario, infrastructure, and reliability of the communication systems, the trade policy and macroeconomic climate. (Helpman 201)
Should Free Trade and Investment be Pursued
In addition to the continuous robust export growth, domestic consumption is a widely accepted phenomenon favoring sustained economic development. Even though export performance could be impacted by global economic scenario, a government’s own trade policies, especially its policies towards imports can be vital to its overall export performance. Furthermore, in a dynamic world, connections among foreign investment, export growth, technical knowledge, macroeconomic development, accumulation of productive resources, and development matter significantly. Exports, in economic theory, can be substantially restricted by the government’s own policies towards imports. Moreover, protection enforced through different measures such as quantitative restrictions, tariffs, and non-border measures like qualitative or industrial standards for products applied primarily to imports, in fact, hinders the specific capability of domestic producers for selling their goods in other nations. In other words, protection has been regarded by many scholars equivalent to a tax on exports. Therefore, for encouraging free trade, governments should allow buying and selling goods freely, leaving adjustments in their exchange rates. The governments should also leave alterations in domestic prices to ensure equilibrium in balance of payments primarily to market forces. (Resiman 580)
It is pertinent to mention that open economies not only benefit from static, convention trade gains but also gains from free trade involving multinational firms along with foreign investments. Therefore, in response to high-level integration with the global economy under free trade and foreign investment policies, consumers and producers allocate resources more effectively. Especially, producers seem to adopt specific technologies that are suitable to not only national economic circumstances but also economic scenario prevailing globally. These tendencies support in ensuring that the greatest achievable output is attained from the available resources, maximizing economic development and economic well-being.
Export performance, from this perspective, sustained by a free trade and free foreign investment policy regime is more an ‘engine’ of economic growth. Economic growth and development are related to several dynamic factors. Among these factors, the most significant are growth in inputs of labor, technology, and physical capital to production. Furthermore, long-term development of labor input is often regarded given by nature, but may be subject to economic policies imposing on education, employment and population growth. It is pertinent to mention that rate of growth related to technology inputs and physical capital are often regarded subject to alternation economic policies of government. Domestic investment, traditionally, has been a focus of certain economic growth theories.
In recent years, however, with the initiation of the new growth theory, certain factors impacting general knowledge, growth of technology, and technical and managerial know-how have come to the forefront in endeavors to understand why countries develop at different rates. Foreign investment in industrial as well as different other commercial projects are regarded vital for the growth prospects in the modern international economy. Foreign investment, today, is viewed among the primary forces transforming the globalization process which means increasing specialization of trade as well as production through specialized global networks of production along with distribution, operated by foreign firms. (Feenstra 198)
Foreign investment, according to neoclassical economic theory, primarily involves the movement of capital from one nation to another. Whenever capital moves to capital-scarce nations from capital-overflowing nations, it results in greater production and economic well-being in the similar way as expansion of global trade in products under free trade, and accordingly, free trade and free foreign investment has significant impact on the economic scenario. There are many policy alternatives available for governments through which the benefits of foreign investment can be made to reach the bottom line of economy. These include continuous maximization of employment opportunities and learning impacts in domestic firms through promoting significant linkages in rules set by global regulations and utilizing fiscal receipts to spend on social sectors such as health and education. Foreign investment, nowadays, is viewed as instrumental and effective in promoting free trade, specifically in the host countries with open economies, few restrictions on the transactions of foreign exchange, stable macroeconomic scenario, and protection for civil property rights. Particularly, foreign investment and free trade, under favorable conditions seem to promote export-oriented production following factors of comparative advantage. (Sornarajah 357)
Should Governments Attract or Discourage Foreign Investment
Governments should strive to formulate such policies that are supportive in attracting foreign investment. It is pertinent to mention that foreign investment leads to economic prosperity which in turns leads to poverty reduction. Foreign investment could be beneficial to the economy; however, foreign investment could be distinctive in qualitative terms. Therefore, governments confront two types of challenges; to attract foreign investment and also to secure certain advantages from such flows. Growth in foreign investment will also increase the overall demand for skilled labor. Appropriate and qualitative education in this situation requires continuous increase in secondary education to provide basis for tertiary technical and vocational education. Foreign firms, in fact, offer extra training compared with the domestic organizations, and as such, should be encouraged to offer something extra to low-skilled labor.
If governments need to ensure that some advantages of foreign investment should go to the lower class directly, they may encourage free trade so the foreign firms may employ unskilled labor and also attract investment in those areas that can benefit the poor. Foreign investment that supports agricultural sectors and employment in less-developed as well as rural areas is expected to benefit the lower class, even if the benefits gained are unequally distributed. While free trade and free foreign investment have remained extensive over the last two decades, opening up additional borders would ultimately increase integration of foreign investment among nations. It would imply removing restrictions on foreign trade and increasing competition domestically.
Feenstra, Robert Advanced International Trade: Theory and Evidence Princeton University Press, 2003, p. 198.
Helpman, Elhanan Market Structure and Foreign Trade: Increasing Returns Imperfect Competition, and the International Economy The MIT Press, 1987, p. 201.
Resiman, Michael Foreign Investment Disputes: Cases, Materials And Commentary Kluwer Law International, 2005, p. 580.
Sornarajah The International Law on Foreign Investment Cambridge University Press, 1994, p. 357.