Table of Contents
Introduction
1. Foreign Direct Investment
1.1 What is FDI
1.2 Types of FDI
2. FDI of BP in Azerbaijan
3.1 The overview of Azerbaijan
3.2 The Effects of BP`s FDI in Azerbaijan
3.2.1 Employment
3.2.2 Community and Social investment
3.2.3 Ethical performance and human rights
3.2.4 Environment
3.3 Summarizing
Introduction
One of the most important factors to develop an economy is foreign direct investment, which is long-term capital investment to create new production facilities or improving existing ones.
There is a rapid increased of foreign direct investment in the last decades. From the second half of the 80`s it increased in 4 times, than production of world gross domestic product, and in 2,5 times quicker, than world trade. According to the Organization for Economic Cooperation and Development (OECD), the annual volume of foreign investments has increased from 48 billion dollars in 1981 to 235 billion dollars in 1997, and their saved-up balance cost has reached 2,6 trillion dollars(OECD, 1998).
Foreign direct investment has enormous impact on state of the economy, prospects of its development and growth rates. FDI has become the main instrument of creating of the goods and services on the foreign markets and a core of system of the international production, in a growing measure influence scales, the directions and structure of world trade.
World experience proves that direct foreign investments have a number of advantages before other forms of investments: first, they give an additional source of capital investments in production of the goods and the services, in some cases carried out in the form of transfer of progressive technologies, a know-how, the latest methods of management; secondly, it does not lie down burden on the state budget, on its external debt (O. Kowalewski, M. Weresa, 2008).
FDI gives the chance to receive higher quality of investments, i.e. higher profitability of capital investments in comparison with the national investment market of the investor (because of transfer technologically more effective assets, smaller risk in comparison with purely national investments).
Foreign Direct Investment
What is FDI?
FDI is an important and big part of international capital movement. There are many definitions of FDI, which describe the different sides of its nature. Imad Moosa (2002. p. 261) defines FDI as the process whereby residents of one country (the source country) acquire ownership of assets for the purpose of controlling the production, distribution and other activities of a firm in another country ) the host country. The International Monetary Fund`s (IMF) Balance of Payments Manual defines FDI as “an investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of the investor, the investor`s purpose being to have an effective voice in the management of the enterprise”. The United Nation`s (UN) 1999 World Investment Report (UNCTAD, 1999) defines FDI as “an investment involving a long-term relationship and reflecting a lasting interest and control of a resident entity in one economy (foreign direct investor or parent enterprise) in an enterprise resident in an economy other than that of the foreign direct investor (FDI enterprise, affiliate enterprise or foreign affiliate). One of the key words of the last definition is the “long-term”, which used here to distinguish FDI from portfolio investment, which has short-term nature.
But, there is another common feature of all FDI definitions, which completely distinguish FDI from portfolio investment, which is “control”. Investors who are involved in portfolio investment do not seek for control or lasting interest, he/she is interested in immediate profit. On the contrary, investor, involved in FDI, is interested in control over firm, lasting interest and stable profit.
Sometimes, another qualification is used to define FDI, in cases, when capital transferring from a source country to a host country takes place. So, activities are considered to be FDI, when is control through substantial equity shareholding and there is a shift or part of the company`s assets, production or sales to the host country. But, sometimes, project may be funded completely by borrowing in the host country.
So, the main distinguish feature of FDI from other international investments is control. Razin et al. (1999) argue that the element of control gives direct investors an information advantage over foreign portfolio investors and over domestic savers. The term “control” means some degree of decision-making by investor in management policy and strategy. But it is possible to control, even if person or company does not have any equity in other company. This type of control is possible to exercise via contractual arrangements as subcontracting, management contracts, franchising, licensing and product-sharing. Lall and Streeten (1977) argue that a majority shareholding is not a necessary condition for exercising control, as it may be achievable with a low equity share even without an explicit management contract.
Hence, problems may arise in measuring FDI. In order to keep secrecy, many countries do not publish much information of their companies. Imad Moosa (2002) argues that because of these problems, inconsistency between measures of FDI flows and stocks are the rule rather than the exception. Furthermore, Cantwell and Bellack (1998) argue that the current practice of reporting FDI stocks on a historical cost basis is unsatisfactory, because it does not take into account the age distribution of stocks, which makes international comparisons of FDI stocks almost impossible. But, nevertheless, there is a big scientific interest in FDI, which resulted in several theories explaining its causes and effects. Moosa (2002) gives three reasons for such an interest in FDI. The first reason is the rapid growth in FDI and the change in its pattern, particularly since the 1980s. This growth is the result of increasing global competition tendency to free up financial and goods markets. FDI flows were not affected much even when world trade slows down. Jeon (1992) and Moore (1993) argue that when the growth of trade is retarded by trade barriers, FDI may increase as firms attempt to overcome the barriers. Lipsey (1999) argues that FDI has been the least volatile source of international investment for the host countries, with the notable exception of USA.
The second reason for interest in FDI by Moosa is the concern it raises about the causes and consequences of foreign ownership. The opinions on this issue are very different from considering FDI as symbol of new colonialism or imperialism to the opinion that the host country cannot survive without FDI.
The third reason is that FDI offers the possibility and creates conditions for transferring resources to developing countries. That means FDI is becoming an important source of funding projects, when other means of financing are inaccessible. Lipsey (1999) argues that FDI also is very important because it is transferring technology and managerial skills to the host country.
White C. and Fan M. (2006) argue that FDI is an ambiguous concept and give three principal reasons. First, FDI includes three related but completely different activities – funding, ownership and operation, and confusion arises because it is unclear which of activities the main activity is. Funding or financial flow usually transferred to the host country by companies, by intermediaries (financial institutions usually), sometimes even borrowed in the host country. Ownership is a matter of who directly owns the productive assets created by the investment, often a large multinational corporation which can own directly through subsidiaries or even through joint enterprises (White C., Fan M., 2006, p 43.). Operation involves the appropriate organization and integration of the relevant resources in the process of creating something of value to a market (White C., Fan M., 2006, p 43.).
White C. and Fan M. (2006) argue that the second source of ambiguity is that each of the terms in the expression, foreign direct investment, lacks a precise meaning. It is unclear to which function foreignness is related – financing, ownership or control, or all three. In theory, subsidiary of a multinational corporation can borrow money from banks in the host country. But such a financial flow usually excluded when estimating foreign direct investment, because funding must occur from abroad. Also how to determine the nationality of a multinational company, simply by location of its headquarter? Then ownership and control do not necessarily occur together. Corporation can own a business, but charge to control it to hired management, and can control a business without hiring. Finally, what does the term ‘investment’ consist of? Is it simply financial flow or movement of ‘real’ resources? If it is also movement of ‘real’ resources then the investment includes managerial experience and technical knowledge.
And finally, White C. and Fan. M. (2006) asserts that the third source of ambiguity is that the analysis of foreign direct investment requires a multidisciplinary approach, involving:
· The financial theory relating to capital markets;
· The management theory relating to strategy;
· The theory of firm;
· Political theory;
· Neoclassical economics relating to production and trade;
· Game theory, applied to strategic problems.
Types of FDI
FDI can be classified from the perspective of the investor (the source country) and from the perspective of the host country. From the perspective of the investor, Caves (1971) distinguishes between horizontal FDI, vertical FDI and conglomerate FDI. The purpose of horizontal FDI is to produce the same or similar products in the host country. So, one of the main elements of horizontal FDI is product differentiation. Also, the purpose of horizontal FDI is to use monopolistic or oligopolistic advantages which it cannot do at home market because of home country laws.
There are two kinds of vertical FDI:
1) Backward vertical FDI, when the purpose is to exploit raw materials in the host country;
2) Froward vertical FDI, when the purpose is to be close to consumers through distribution outlets.
Another type of FDI, conglomerate FDI, includes the horizontal and vertical FDIs. In 1999 horizontal, vertical and conglomerate mergers and acquisitions accounted for 71.2%, 18% and 27% respectively of the total value of mergers and acquisitions worldwide (Imad Moosa, 2006,p.5). From the perspective of the host country, FDI can be classified into:
1) Import-substituting FDI;
2) Export-increasing FDI;
3) Government-initiated FDI.
Import-substituting FDI implies production of goods, which were imported to the host country before by investor. Import-substituting FDI may happen because of the host country`s market size, transportation costs and trade barriers.
Export-increasing FDI implies desire of looking for new sources of input, such as raw materials and intermediate goods. This kind of FDI is occur when the host country is increasing export of raw materials and intermediate goods to investing countries and other countries.
Government-initiated FDI, as appears from the name, is initiated by government usually to eliminate deficit in a balance of payments. Government can initiate such FDI through offering incentives to foreign investors.
Kojima (1985) adopted similar trade-related classification and according to his classification, FDI is ether trade-orientated FDI (which generates an excess demand for imports and excess supply of exports at the original terms of trade) or antitrade-orientated FDI, which has an adverse effect on trade.
FDI also can be classified into expansionary and defensive types. Chen and Ku (2000) suggest that expansionary FDI seeks to exploit firm-specific advantages in the host country. On the other hand, they suggest that defensive FDI seeks cheap labor in the host country with the objective of reducing the cost of production. Chen and Yang (1999) suggested that a multinomial logit model can be used to identify the determinants of the two types of FDI in the case of Taiwan. Their empirical results indicated that expansionary FDI is influenced mainly by firm-specific advantages such as scale, R&D, intensity, profitability and motives for technology acquisition. But, on the other hand, Chen and Yang (1999) in their empirical research showed that FDI is influenced by cost reduction motives and the nexus of production networks. Both types of FDI are affected by the features of industry of the host country.
There is another classification by Chryssochoidis, Millar and Clegg (1997) which implies five different types of FDI. The first type of FDI is occurs when a company want to get access to specific factors, such as raw materials, technical knowledge, patent or brand names. If these factors are not available in the home country, then a company invests to the host country to get access to these factors.
The second type of FDI is developed by Raymond Vernon in his product lifecycle hypothesis. According to his hypothesis a company will invest to the host country in order to get access to cheap production factors, such as low-cost labor or raw material. The third type of FDI implies mutual investment of international competitors, through cross-shareholdings or through establishment of joint venture, in order to get access to each other`s products.
The fourth type of FDI implies that a foreign company tries to get access to consumers in the host country through FDI since export of certain services may be impossible from home country to the host country.
The fifth type of FDI occurs when foreign company has good location conditions in their home country, but it is impossible to export goods to the host country because of tariffs or other barriers of trade. Hence, foreign companies in order to overcome these barriers establish local subsidiaries to get access to local markets.
FDI of BP in Azerbaijan
The Overview of Azerbaijan
Within the last 19 years Azerbaijan develops as the independent country, and takes important place in the region and on the international scene. The main projects in the region, especially energy projects, were initiated by Azerbaijan. All these projects made a huge contribution to energy safety of the region and Europe. Strategically located at an intersection of Europe and Asia, Azerbaijan is washed from the East by the Caspian Sea rich with hydrocarbon resources, on the North borders on Russia, in the West – with Georgia and Armenia, in the southwest – with Turkey and on the South – with Iran. The country has open access on extensive and quickly emerging markets of the countries of Central Asia, Caucasus and Middle East. Excellent infrastructure of Baku (including the largest regional sea and air terminal) is the best choice for every businessman entering the market of the Caspian region.