GLOBALISATION

Globalization is the free movement of goods, services and people across the
world in a seamless and integrated manner. Globalization can be thought of to
be the result of the opening up of the global economy and the concomitant
increase in trade between nations. In other words, when countries that were
hitherto closed to trade and foreign investment open up their economies and go
global, the result is an increasing interconnectedness and integration of the
economies of the world. This is a brief introduction to globalization.

Further, globalization can also mean that countries liberalize their import
protocols and welcome foreign investment into sectors that are the mainstays of
its economy. What this means is that countries become magnets for attracting
global capital by opening up their economies to multinational corporations.

Further, globalization also means that countries liberalize their visa rules and
procedures so as to permit the free flow of people from country to country.
Moreover, globalization results in freeing up the unproductive sectors to
investment and the productive sectors to export related activities resulting in a
win-win situation for the economies of the world.

Globalization is grounded in the theory of comparative advantage which states

that countries that are good at producing a particular good are better off
exporting it to countries that are less efficient at producing that good.
Conversely, the latter country can then export the goods that it produces in an
efficient manner to the former country which might be deficient in the same. The
underlying assumption here is that not all countries are good at producing all
sorts of goods and hence they benefit by trading with each other. Further,
because of the wage differential and the way in which different countries are
endowed with different resources, countries stand to gain by trading with each
other.

Globalization also means that countries of the world subscribe to the rules and
procedures of the WTO or the World Trade Organization that oversees the terms
and conditions of trade between countries. There are other world bodies like the
UN and several arbitration bodies where countries agree in principle to observe
the policies of free trade and non-discriminatory trade policies when they open
up their economies.

FPI AND FDI

Capital is a vital ingredient for economic growth, but since most nations cannot
meet their total capital requirements from internal resources alone, they turn to
foreign investors. Foreign direct investment (FDI) and foreign portfolio investment
(FPI) are two of the most common routes for investors to invest in an overseas
economy. FDI implies investment by foreign investors directly in the productive
assets of another nation. FPI means investing in financial assets, such as stocks
and bonds of entities located in another country. FDI and FPI are similar in some
respects but very different in others. As retail investors increasingly invest
overseas, they should be clearly aware of the differences between FDI and FPI,
since nations with a high level of FPI can encounter heightened market volatility
and currency turmoil during times of uncertainty.

Examples of FDI and FPI

Imagine that you are a multi-millionaire based in the U.S. and are looking for your
next investment opportunity. You are trying to decide between (a) acquiring a
company that makes industrial machinery, and (b) buying a large stake in a
company that makes such machinery. The former is an example of direct
investment, while the latter is an example of portfolio investment.

Now, if the machinery maker were located in a foreign jurisdiction, say Mexico,
and if you did invest in it, your investment would be considered a FDI. If the
companies whose shares you were considering buying were also located in
Mexico, your purchase of such stock or their American Depositary Receipts (ADRs)
would be regarded as FPI.

Although FDI is generally restricted to large players who can afford to invest
directly overseas, the average investor is quite likely to be involved in FPI,
knowingly or unknowingly. Every time you buy foreign stocks or bonds, either
directly or through ADRs, mutual funds or exchange-traded funds, you are
engaged in FPI. The cumulative figures for FPI are huge. According to the
Investment Company Institute, in early January 2018, domestic equity mutual
funds had inflows of $3.8 billion, while foreign equity funds attracted over triple
that amount, or $13.7 billion.

Evaluating Attractiveness

Because capital is always in short supply and is highly mobile, foreign investors
have standard criteria when evaluating the desirability of an overseas destination
for FDI and FPI, which include:

 Economic factors – the strength of the economy, GDP growth trends,

infrastructure, inflation, currency risk, foreign exchange controls

 Political factors – political stability, government’s business philosophy, track

record

 Incentives for foreign investors – taxation levels, tax incentives, property

rights

 Other factors – education and skills of the labor force, business

opportunities, local competition

FDI versus FPI

Although FDI and FPI are similar in that they both involve foreign investment,
there are some very fundamental differences between the two.

The first difference arises in the degree of control exercised by the foreign
investor. FDI investors typically take controlling positions in domestic firms or
joint ventures, and are actively involved in their management. FPI investors, on
the other hand, are generally passive investors who are not actively involved in
the day-to-day operations and strategic plans of domestic companies, even if they
have a controlling interest in them.

The second difference is that FDI investors perforce have to take a long-term
approach to their investments, since it can take years from the planning stage to
project implementation. On the other hand, FPI investors may profess to be in for
the long haul but often have a much shorter investment horizon, especially when
the local economy encounters some turbulence.

Which brings us to the final point. FDI investors cannot easily liquidate their
assets and depart from a nation, since such assets may be very large and quite
illiquid. FPI investors can exit a nation literally with a few mouse clicks, as financial
assets are highly liquid and widely traded.

FDI and FPI – Pros and Cons

FDI and FPI are both important sources of funding for most economies. Foreign
capital can be used to develop infrastructure, set up manufacturing facilities and
service hubs, and invest in other productive assets such as machinery and
equipment, which contributes to economic growth and stimulates employment.

However, FDI is obviously the route preferred by most nations for attracting
foreign investment, since it is much more stable than FPI and signals long-lasting
commitment. But for an economy that is just opening up, meaningful amounts of
FDI may only result once overseas investors have confidence in its long-term
prospects and the ability of the local government.

Though FPI is desirable as a source of investment capital, it tends to have a much

higher degree of volatility than FPI. In fact, FPI is often referred to as “hot money”
because of its tendency to flee at the first signs of trouble in an economy. These
massive portfolio flows can exacerbate economic problems during periods of
uncertainty.
Foreign Direct Investment helps in accelerating the rate of economic growth as
follows:

i. FDI provides Capital:

Foreign Direct Investment is expected to bring needed capital to developing

countries. The developing countries need higher investment to achieve increased
targets of growth in national income.

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Since they cannot normally have adequate savings, there is a need to supplement
savings of these countries from foreign savings. This can be done either through
external borrowings or through permitting and encouraging Foreign Direct
Investment. Foreign Direct Investment is an effective source of this additional
capital and comes with its own risks.

ii. FDI removes Balance of Payments Constraint:

FDI provides ‘ inflow of foreign exchange resource and removes the constraints on
balance of payment. It can be seen that a large number of developing countries
suffer from balance of payments deficits for their demand for foreign exchange
which is normally far in excess of their ability to earn. FDI inflows by providing
foreign exchange resources remove the constraint of developing countries
seeking higher growth rates.

FDI has a distinct advantage over the external borrowings considered from the
balance of payments point of view. Loan creates fixed liability. The governments
or corporations have to repay. The resulting international debt of the government
and the corporation parts a fixed liability on balance of payments.

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This means that they have to repay loans along with interest over a specific
period. In the context of FDI this fixed liability is not there. The foreign investor is
expected to generate adequate resources to finance outflows on account of the
activity generated by the FDI. The foreign investor will also bear the risk.

iii. FDI brings Technology, Management and Marketing Skills:

FDI brings along with it assets which are crucially either missing or scarce in
developing countries. These assets are technology and management and
marketing skills without which development cannot take place. This is the most
important advantage of FDI. This advantage is more important than bringing
capital, which perhaps can be had from the international capital markets and the
governments.

iv. FDI promotes Exports of Host Developing Country:

Foreign direct investment promotes exports. Foreign enterprises with their global
network of marketing, possessing marketing information are in a unique position
to exploit these strengths to promote the exports of developing countries.

v. FDI provides Increased Employment:

Foreign enterprises by employing the nationals of developing countries provide

employment. In the absence of this investment, these employment opportunities
would not have been available to many developing countries.

Further, these employment opportunities are expected to be in relatively higher

skill areas. FDI not only creates direct employment opportunities but also through
backward and forward linkages, it is able generate indirect employment
opportunities as well.

vi. FDI results in Higher Wages:

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FDI also promotes higher wages. Relatively higher skilled jobs would receive
higher wages.

vii. FDI generates Competitive Environment in Host Country:

Entry of foreign enterprises in domestic market creates a competitive
environment compelling national enterprises to compete with the foreign
enterprises operating in the domestic market. This leads to higher efficiency and
better products and services. The Consumer may have a wider choice.

GATT
The General Agreement on Tariffs and Trade was the first worldwide multilateral
free trade agreement. It was in effect from June 30, 1948 until January 1, 1995. It
ended when it was replaced by the more robust World Trade Organization.

Purpose

The purpose of GATT was to eliminate harmful trade protectionism. That had sent
global trade down 65 percent during the Great Depression. By
removing tariffs, GATT boosted international trade.

It restored economic health to the world after the devastation of World War II.

Three Provisions

The most important requirement was that all members must be treated equally
when it comes to tariffs. It excluded the special tariffs among members of the
British Commonwealth and customs unions. It permitted tariffs if their removal
would cause serious injury to domestic producers.

Second, GATT prohibited restriction on the number of imports and exports. The
exceptions were:

 When a government had a surplus of agricultural products.

 If a country needed to protect its balance of payments because its foreign

exchange reserves were low.

 Developing countries that needed to protect fledgling industries.

In addition, countries could restrict trade for reasons of national security. These
included protecting patents, copyrights and public morals.

History

GATT grew out of the Bretton Woods Agreement. The summit at Bretton Woods
also created the World Bank and the International Monetary Fund to coordinate
global growth.

Pros

For 47 years, GATT reduced tariffs. This boosted world trade 8 percent a year
during the 1950s and 1960s.

By increasing trade, GATT promoted world peace. in the 100 years before GATT,
the number of wars was ten times greater than the 50 years after GATT. Before
World War II, the chance of a lasting trade alliance was only slightly better than
50/50.

By showing how free trade works, GATT inspired other trade agreements. It set
the stage for the European Union. Despite the EU's problems, it has prevented
wars between its members.

GATT also improved communication by providing incentives for smaller countries

to learn English, the language of the world's largest consumer market. This
adoption of a common language reduced misunderstanding. It also gave less
developed countries a competitive advantage. English gave them insight into the
developed country's culture, marketing and product needs.

Cons

Low tariffs destroy some domestic industries, contributing to high unemployment

in those sectors. Governments subsidized many industries to make them more
competitive on a global scale.

By the 1980s, the nature of world trade had changed. GATT did not address the
trade of services. That allowed them to grow beyond any one country's ability to
manage them
Like other free trade agreements, GATT reduced the rights of a nation to rule its
own people. The agreement required them to change domestic laws to gain the
trade benefits.

Trade agreements like GATT often destabilize small, traditional economies.

Countries like the United States that subsidize agricultural exports can put local
family farmers out of business. Unable to compete with low-cost grains, the
farmers migrate to cities looking for work, often in factories set up by multi-
national corporations. Often these factories can move to other countries with
lower-cost labor, leaving the farmers unemployed.

WTO
The WTO has six key objectives: (1) to set and enforce rules for international
trade, (2) to provide a forum for negotiating and monitoring further trade
liberalization, (3) to resolve trade disputes, (4) to increase the transparency of
decision-making processes, (5) to cooperate with other major international
economic institutions involved in global economic management, and (6) to help
developing countries benefit fully from the global trading system