The Advantages & Disadvantages of External Financing

External Financing - Complete Controller

Between “1990 and 1993,” private currency became oriented in a way to help with the public debt of Third World countries through Foreign Direct Investments, or FDI. Resulting from this, the yearly average of FDI flowing between 1990-1993 more than doubled. Below are a few of the advantages and disadvantages regarding external finance that you must consider before making an investment.

Risks of FDI:

One of the risks usually associated with FDI is the variability of the amount of money that flows in or out of an economy. This cash flow is dependent on whether the market detects signs of consistency or, reversely, an economic emergency. However, the past twenty years have shown that many emerging countries have maintained steady FDI flows. Check out America's Best Bookkeepers

Advantages of FDI: 

  • Job creation
  • Stimulus to GDP growth
  • Positive effects on the balance of payments 
  • FDI multiplier effect on the national economy 
  • Various externalities

    “Megaprojects” and the IED:

    Many Foreign Direct Investments take the form of major projects. Normally viewed opportunistically in the beginning, many end up falling short on long-term processes and do not contribute to the development of the economies of the countries they operate in. One of the biggest risks with these “megaprojects” lies in the fact that excessive dependence on tax-related benefits is created to such an extent that the project may become lavishly viable by merely existing. The receiving countries may then use risk containment mechanisms, such as requiring their presence to be viewed only as a form of a creditor.  

    Multinational Enterprises and FDI:

    Multinationals, organizations that operate in multiple countries, are a suitable form of FDI for recipient countries. This is due to imperfect local markets, where FDI inflows must replace the void created by more developed economies producing a bountiful amount of goods and services in the international market. Check out America's Best Bookkeepers

    Two major strategies for FDIs endorsed by Multinationals:

    “Outsourcing Strategy,” or the hiring of outside companies to conduct work that cannot be handled internally, seeks to minimize costs through investment abroad. These companies have low labor costs, low prices for raw materials and services at production sites, and low energy costs. There then remains two constraints for these multinational corporations: transportation costs and customs duties. These factors should be adjusted to ensure the cost is as low as possible.

    One way to do this is through a process known as “Market Seeking.” This strategy facilitates directly accessing a consumer market. It is preferred by multinationals when transportation and custom costs are high. Another strategy to use is “Outsourcing / Market Seeking.” This is a mixed approach, which combines the two strategies listed above.

    Tax Incentives:

    We must mention, there is the ever-present danger of investors placing short-term profitability above long-term economic sustainability. Therefore, tax incentives such as tax holidays should never be used as a crutch to replace other crucial factors.  

    Advantages of Joint Ventures as a Form of FDI:

    The formation of Joint Ventures with local firms is often more interesting economically for the receiving country than a megaproject. First, this approach can help acquire more local products and services than multinational firms through “outsourcing” or “market-seeking,” especially when they are in the start-up phase of their projects.

    Incentives for “FDI”:

    In addition to the above-mentioned fiscal advantages, the stability of macroeconomic indicators and the existence of secure and reliable ownership records are of vital importance when considering an investment. Some investments may be difficult to obtain, along with not being as profitable, particularly in places such as Guinea-Bissau and Angola, where there have been periods of intense civil war. A country’s political stability is especially relevant when, despite civil unrest, they still attract FDI through the richness of their natural resources, such as in Mozambique or Angola. Be sure to have a detailed awareness of the current sociopolitical state of a nation before investing. Check out America's Best Bookkeepers

    Effects on GDP of FDI:

    GDP also receives a positive impact from the inflow of FDI due to its effect on the consumption of workers, inflow of money required for the investment, administrative expenses, as well as the impact on the dynamics of the port and transport sector. Keep in mind, exports, although a great advantage of FDI, also causes an increase in imports.  This influx cannot be reduced and may have negligible impact on the balance of payments to such an extent that it may even nullify the effect of increased exports.

    Advantage: The construction of infrastructures by the IED:

    In some developing countries, the firms offering investment opportunities are building new transport or energy infrastructures. Their existing ones may not have been suitable for their needs, and this new development may end up favoring the local populations, as well.

    Advantages of FDI: Tax Revenue:

    It is important to note that the rise in economic activity can easily increase tax income, not only in corporate profit rates but also in taxation on consumption and labor.

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