29.08.2022

The Role of Foreign Investment in Innovative Emerging Economies.

Nowadays, access to knowledge and information is becoming increasingly important. Year after year, spending by companies and countries on research and development activities is increasing. In any market, at any time, a technological gap may appear, which each player will try to fill, using its advantages. Countries such as South Korea, China, India, Malaysia and Singapore have in recent years become countries with the most innovative economies in the world. The reasons for this can be traced to foreign direct investment (FDI). They are considered the fastest way for domestic companies to integrate into the global world and compete in the international market. A popular method is the establishment of specialized investment promotion agencies to attract foreign companies to locate their businesses in the country and to encourage domestic companies to expand abroad. Rational and coordinated policies build the country's image as attractive and facilitate the attraction of capital.

The most important factors of FDI efficiency

The efficiency of capital transfer is affected by both endogenous and exogenous factors. External ones, i.e. those that are not directly influenced by the company, include the structure of the market (degree of market differentiation and types of entry barriers), technological conditions for the operation of a specific sector (consumer or investment goods) or government economic policy. Internal ones include: scale and area of operation, absorption potential, financial capacity, strategy used, etc. The reasons for the popularization of FDI are the liberalization of foreign economic policies, the high cost of innovation and the control and protection of intangible assets. Especially in developing markets, they have become the main channel for accessing valuable technology. Direct investment differs from indirect investment in that its primary features are the transmission of production knowledge, technological solutions, transfer of new technologies, know-how, adaptation of modern management techniques, etc. There are 4 basic motives for foreign expansion.

  • The first is the search for natural resources, labor or intangible resources (technological solutions, marketing and management expertise, and organizational skills) when these factors are not available in the home country or are relatively more expensive.
  • Another strategy is what is known as "market seeking," which is the pursuit of gaining, expanding or maintaining markets, as well as restricting access by competitors.
  • The next motive may be efficiency-oriented, when an investor notices better conditions abroad for exploiting its capabilities, e.g. the location may have more favorable economic policies.
  • Also, the motive may be to increase capital through mergers and acquisitions. This may enable an investor to expand its capital portfolio to maintain or strengthen its competitive position.

The curious case of India

Emerging economies have a very specific structure, quite different from developed countries. In India, there is a great need to equalize the standard of living of the population, and one way to do this is through innovation. In addition, India, thanks to its location, significantly interacts with neighboring countries. India's position in terms of international competitiveness has improved in recent years. An improvement in quantitative indicators relating to human capital has been pointed out, but at the same time attention has been drawn to the relatively low quality of education at various levels of education and the consequent scarcity, relative to needs, of talent on the market.

Interestingly, India allocates a small percentage of GDP to R&D (less than 1%). By comparison, China has allocated 2.4% in 2020, and OECD countries average 2.6%.

We can see the positives in the gradual transformation of the entity structure of R&D funding, i.e. the increasing number of companies. There are very few patent applications in India, while the country's strengths include the number of scientific articles and their number of citations. The country specializes in disciplines such as:

  • organic chemistry,
  • Pharmaceuticals and Biotechnology,
  • medical equipment,
  • computer techniques.

This is where foreign entrepreneurs are most likely to place their capital because of low labor costs. Nearly 50% of all investments went to the processing industry sector. Investors are also increasingly willing to invest in research, testing and technical services, where the value added is much higher than in other sectors. If a foreign entrepreneur chooses India as a destination country to expand his business, there may be three reasons why he does it there:

  • First, because of the cost,
  • Secondly, these investments can be tied to meeting local market demand, and the market in India is huge.
  • The last option is to look for local talent, which is extremely important in the R&D sector.

When it comes to overseas expansion by Indian companies, it should be noted that they are modest compared to companies from other emerging economies, such as China. What they are mainly looking for in other markets is know-how, new production lines, a global portfolio of intangible assets and highly skilled employees, and the industries of greatest interest are those involving advanced technology, namely pharmaceuticals, transportation equipment, electronics, IT and telecommunications services. Capital is mainly located in highly developed countries, which have a more mature market due to more demanding and educated consumers.

Detailed research showed that most R&D projects conducted in India by the world's leading innovators did not require high expenditures.

It can also be conjectured that the presence of foreign investors, has greatly accelerated the country's innovation, but there is still not enough research to confirm this thesis. The active internationalization of Indian companies has a positive impact on their innovation. They have acquired technological knowledge mainly through brownfield investments or in the course of interaction between the Indian investor and the innovative environment in the host country, the so-called greenfield investments. Much greater prospects for growth exist in developed countries, where Indian companies can count on the greater availability of advanced technologies and highly skilled labor.

Good prospects for emerging economies

Countries in emerging markets have very strong prospects. There are a lot of gaps to be filled like know-how, intensification of R&D spending and equalization of the population's standard of living. It is not without reason that the nickname "country of contrasts" has stuck to India. However, it should be noted that in recent years there has been an improvement, and the country is developing rapidly. This can be seen, for example, in the value of the flow of foreign direct investment into India. It is estimated that in 2021, foreign companies invested 50% more capital in India than in 2014. The example of this country well demonstrates the significant impact of foreign direct investment on the development and innovation of entering economies.

Piotr Vozovich

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