Foreign Direct Investment and the Impact of Terrorism

Foreign Direct Investment and the Impact of Terrorism

Foreign Direct Investment provides many opportunities for both the expanding company and the host country. The host country receives an influx of business into their economy and the expanding company receives the ability to expand into new and emerging markets. There are many factors that weigh into a decision to expand and invest in another country. Of course, one of the key factors is a stable economy. The travel and tourism industry is one of the key industries that engages in foreign direct investment. This is especially true among the big chains. The following research will explore the factors that weigh into a decision to invest in a country, and will then focus on the impact that terrorism, has on this decision.

Patterns of FDI Growth Over the Past 20 Years

As the world moves toward a more global economy, there is a greater trend toward foreign direct investing than at any other time in the past. The flow of foreign direct investments has increased by nearly ten fold over the past 20 years (Stein and Daube, 2001). By comparison, imports and exports have only doubled. This growth has not been linear, but has progressed in spurts followed by period of stagnation, largely due to global factors, such as wars and economic stagnation in certain sectors of the world (Stein and Daube, 2001).

This growth has many benefits for the host country. However in some cases can be troublesome in a weak economy due to the increased competition on native businesses. On the other hand the host country often benefits from increased revenues and taxes by the new enterprise. The new enterprise will supply more employment for the area. It will also bring in new business from other areas. This is especially true in the travel and tourism industry (Stein and Daube, 2001).

Foreign investment can play a significant role in strengthening the economies of developing countries. The foreign investment decisions of Multinational Corporations (MNCs) are a major driver of the foreign country's development. Multi-national hotel chains are one of the most prevalent MNCs (Hong et al., 1999).

They can often the single most important driver of a local travel and tourism trade. There are many factors that enter into the decision of a hotel chain to develop in a particular area. The MNCs usually have sufficient capital to invest in such an enterprise. Some areas of the world are more developed than others in this aspect (Hong et al., 1999). For example, more than 70% of new hotel development in Latin America takes place in two key locations, Brazil and Mexico aspect (Hong et al., 1999).

These countries have many factors that make them attractive tourist spots. They have nice weather, a warm climate and miles of sandy oceanside beaches. The also have an inland tropical paradise, making them a great place to vacation. Other Latin countries have the same things, but are less developed in this aspect. There is a logical reason for this. The other countries often have factors that make them less attractive, such as a poor or highly inflationary economy, the risk of guerilla warfare or a government overthrow. These areas have the natural resources but are lacking the right combination of factors to make them an attractive location in which to expand. In the travel and tourism industry, it must also be remembered that if it were not an attractive place to relocate, it would also not be an attractive place to vacation either, for the same reasons.

For the travel and tourism industry, many hotels consider political risks one of the key factors in the decision to relocate to a particular area (Hong et al., 1999). Political risks are weighted heavily because they can have an influence on the instability of the countries as well, such as the economy or safety of staff and guests. MNCs do not engage in high-risk situations. There is a heavy amount of cash outlay to begin one of these projects and companies are reluctant to take unnecessary risks when there is this amount of risk involved. They will opt for a more suitable location for expansion.

Political risk is different from political instability (Hong et al., 1999). Political instability refers to the possibility of the over throw of the old government and another leader taking over. Political risk refers to a more localized event. Political instability may not necessarily involve a risk for the foreign company (Hong et al., 1999), especially if the transition of power is a peaceful one. On the other hand, political stability is not a guarantee against isolated incidents, such as terrorism (Hong et al., 1999). Hotels are often targets of terrorists and this is a consideration in the decision to relocate. The United States has always been a country that was safe, as far as the risk of terrorism was concerned. The World Trade Tower attack of September 11, 2001 proved to the world that no place is immune from terrorist attacks. However, there do seem to be certain areas of the world, such as the Middle East where these events are more common.

Travel and tourism sells the product of leisure, fun, relaxation, and amenities. The product is a break from the modern stresses and pressures from life. These things do not sell well in an area where there is a perceived risk to one's life. In addition to being able to provide relaxation and safety there is also the necessity of having a sufficient local economy to support this type of enterprise in terms of providing attractions to visit. The local economy must be able to support the building of shops, and other attractions to lure people into the area.

There are many factors that effect the decision of where to relocate a business. The decision must be carefully considered, as there is typically a large amount of capital at stake.

One of the key factors in establishing a presence in a new country is the quality of their government institutions. There must be a stable government and a stable economy. The amount of bureaucratic hassle and tax rates is also important. The inflationary index and general economy of the area all play important factors in the decision to relocate to a certain area.

Political corruption and the quality of the legal system are also an important consideration in this decision (Stein and Daube, 2001). There are other factors such as the living environment, social class system, the risk of terrorism, crime rate and a host of other factors (Stein and Daube, 2001). All of these factors add up into an overall picture of the host country. The amount of weight that company places on each of these determines what constitutes the best host country for a particular enterprise.

Some Real World Examples

Let us now look at some real world examples of location and the features that they offer. Russia and the United States have been working on building relations since the end of the cold war era. They have been trying to establish cooperative relationships and establish trade. However, the United States still wishes to Westernize Russia and Russia still does not wish to be westernized. The two sides are unable and unwilling to abandon the ideas that were held so dear in the Cold War (Bremmer and Zasslavsky, 2001). This inability to work out their differences creates a hostile environment in which to establish a basis for trade including foreign direct investment.

Each country within itself is stable and secure, yet neither is a good place for the other to be because of political tensions. They both have good economies and Russia's economy is experiencing steady improvement. There could also be a perceived risk to visitors due to prejudices of the citizens towards Americans. This is a case where one factor is positive, the economy, but the political situation is not favorable. In time hopefully these differences will work out, but in the mean time, these issues remain a barrier to expansion and this hindersbusinesses in opening new enterprises.

FDI in the Middle East

Pakistan has always been an area ripe for terrorists (Ahmed, 2002). However as far Middle Eastern countries are concerned the terrorism risk is not isolated to Pakistan. The World Bank President, James Wolfenstein expressed his desire to continue to trade with Pakistan. This made Pakistani officials glad as they are now realizing the opportunities foreign investment can provide for their developing country.

This is an important affirmation for Pakistan and their country was the victim of a suicide bombing in Karachi in may of 2002 that left four Frenchmen dead (Ahmed, 2002). These bombings were a topic of discussion at the Shanghai Investment conference that was sponsored by an Asian Development bank. Great Britain still planned on investing large amounts of money into the developing country. This was reassuring to the Pakistanis but it does not determine whether the individual investors will proceed to invest in the country. The government can institute friendly policies, but it is the individual investor that sets the pace and weighs for themselves the risks and benefits that are used to make their recommendations and/or purchases.

Businesses must not only see profitability in the short-term; they must also see the possibility of long-term growth and expansion. By this measure, Pakistan market expansion has been small (Ahmed, 2002). Corporate growth has been low. These are not sound conditions to ensure that the endeavor will be sustainable and profitable in the long run. If a foreign investor already has a facility in this country, they may wish to expand it. However it is unlikely that they well go to the expense of funding a large project. This may be bad news in the eyes of the Pakistani that were counting on the growth that foreign direct investing has to offer.

There are other key roadblocks to making Pakistan an attractive proposition to foreign investors. One of these factors is the lack of a sufficient infrastructure to support these new businesses. Pakistan is attempting to establish export-processing zones to help facilitate a greater amount of export trade. This would make the process more orderly. They cannot support large-scale manufacturers at this time as there is often an infrequent and inadequate supply.

Water is also in short supply. Water must be trucked in, and this necessary life-giving resource is subject to strikes, and is expensive. There is the danger that a small radical group could use water as a means of control. Roads are small or non-existent. An adequate system of roads is essential in the ability to ship large amounts of goods. There is also a 15% sales tax and a high road tax on vehicles. Insurance cost is high and there is even a tax on that. The cost of doing business in Pakistan in high (Ahmed, 2002).

Traffic police are corrupt and driving in Pakistan resembles mass mayhem. There are many accidents. Investors in Pakistan must take extra measures to protect their workers and there is a high incidence of terrorism and kidnappings (Ahmed, 2002). In addition, the Pakistani monetary system is heavily tied to Islamic banking that is known to have a high degree of instability (Ahmed, 2002). Pakistan is plagued by high interest rates, which cuts into company profits. The labor force in Pakistan is cheap, but uneducated and typically has a low productivity. There are many holidays and holy days, which add up to lost time and money (Ahmed, 2002).

Pakistan is a good example of a country that is not attractive to foreign investments. They wish to make themselves more attractive to foreign investors, but they have a long way to go before Pakistan will be a highly desirable place to relocate.

They are far from realizing their goals and must first start with the basics of life such as water and transportation. Pakistan will have to make many internal adjustments in order to attract the foreign investors that they desire. In the case of Pakistan, the threat of terrorist activities is dwarfed by the economic and infrastructure woes that plague the country.

Foreign investment in Pakistan is growing at a slow rate. It totaled $287.4 million USD in March of 2002, which was a 24% increase over the same period the previous year (Ahmed, 2002). Most of this has been from the United States who contributed $164 million of these dollars. It would seem that foreign investors are not overly enthusiastic in investing in Pakistan, not to mention their frequent threats of war with its close neighbor India.

Let us look at another example, Indonesia. This country has previously been considered relatively safe, as compared to the Middle East. They have a thriving travel and tourism industry highlighting the lush forests and rich cultural history. Recent bombings in Bali had a drastic effect on the tourism trade to this small island nation. The Bali terrorist attacks did have an immediate and lasting effect on the travel and tourism sector in Indonesia, This sector has been a dominant force in the Indonesian economy and a downturn in this sector has an impact on the economy of the country as a whole (Finnegan, 2002).

Although the travel and tourism industry was thriving, it was not largely due to foreign investment. Prior to the Bali bombing foreign investment was near zero. Therefore foreign investors are not at stake. Indonesia has had a negative image due to political turmoil for many years. China dominates the interest for investment in Asia and many do not even consider other locations (Finnegan, 2002). Indonesia has had a slower recovery from economic turmoil than other Southeast Asian countries.

The Bali bombings had great impacts on the tourism industry, hotels that are usually packed are down to single digit occupancies. Bali hopes to recover somewhat by mid-year of 2003. Bali is a case where there is a massive tourism industry, but there is not a high degree of foreign investment. However, the effects of terrorism have had a heavy impact on the local economy of the country. These effects are expected to be long-term and will stain the image of Bali in the minds of tourists who many have previously considered Bali a nice place to vacation.

Bali and Pakistan have both experienced negative effects on their economy due to terrorism. These effects had heavy impacts, but different effects on the situations in the two different countries. In Pakistan, terrorism is a major deterrent in its ability of achieving its goals of attracting larger amounts of foreign investment. Pakistan has many other internal problems that must be dealt with first, if they are to become more attractive to foreign investors. However in the end, they will have to deal with the terrorism issue. Even after all of the other issues are resolved, investors must still feel that their assets and people are safe.

The focus of Pakistan is to attract manufacturers as foreign investors. It is not expected to become a popular tourist attraction, but it is in close proximity to a wide array for natural resources including crude oil and gasoline. Pakistan has potential for development in the future, but it also has a long way to go. It is certain that terrorism and their ability to deal with it will play a key role in attracting foreign investors in the future.

Bali had a relatively independent economy, and even though the terrorism incidents there did not effect foreign investors it still had a negative impact on their economy and this is expected to take a long time to recover. Terrorism has a devastating effect on the local economy, but can also have an impact on the image of Bali in the minds of the tourist.

Among the many variables that one must consider in a decision to invest in a foreign country. Economic and political factors play into the equation. However, one of the single most important factors in the decision to relocate is first, personal safety and second, the safety of assets. Foreign investment takes a large degree of capital. Once the hotel or factory is built, an investor wants to be certain that it will not fall victim to a calamity resulting in a total loss. The risk of terrorism makes it difficult to guarantee the security of an investment, not to mention the investment in people. A high risk of terrorism can make an otherwise attractive investment prove too risky to undertake.

The world used to have certain areas that were associated with being subject to frequent terrorist attacks. One of these areas was the Middle East. The Middle East has some countries that are attractive in many aspects to the potential foreign investor, but the fear of terrorism makes them seem less attractive. No one wants to see their $100 million Dollar hotel go up in flames from a suicide bomber.

Just as there were certain areas where one expected a risk of terrorism, there were also areas that were perceived as safe. The United States had never been subject to terrorist attacks. September 11 changed the perception of safety. Now it seemed as if no where was immune from the threat of terrorism. The threat of terrorism has been demonstrated to be a major contributor in the decision to invest in a country. The effects of September changed the face of America and will be sure to have an effect on the desire of firms to relocate to the United States. Is will also have an impact on the desire of U.S. firms to locate abroad. Let us discuss these two scenarios.

The attacks of September 11, 2001 have caused many things to change. What used to be a happy go lucky society now has to be cautious. There are long lines at airports, and long lines at the border crossings to Mexico and Canada (Eichengreen, 2002). Americans must now be more security conscious. This new security consciousness costs an extra amount of money to utilize, but it is now a necessity of life. The easy life style and security made the United States an attractive haven for many foreign countries. It had all of the amenities that a profitable investment would have. Now, since the World Trade Tower attacks, the United States has many of the same concerns as any other country (Eichengreen, 2001). The terrorist attacks had the effect of leveling the playing field as far the long-standing advantage that the United States had in this area.