FDI & Fiscal Policies

Session #1 – International Business - Review

Part 1: Main topics covered and their explanation -
1) Foreign Direct Investment –
a) What is Foreign Direct Investment (FDI)?
FDI is “investment for control” in a foreign country – foreign investment where control is acquire, vs. Portfolio Investment which includes purchasing securities or bonds of a firm without exercising control over the firm. Most Intl’ units (MFI, UNCTAD) classify an FDI if the foreign investor holds at least 10% of the firm’s equity.
b) Why FDI?
Because FDI will use existing: customer base, licenses, IP, workforce, language, competitive position, branding, logistic – location advantage – proximity to market, cheaper production facilities, Finance – premium then you get monthly ROA.
In addition: “buy” capability, government incentive, government connections, and relationships.
No need to deal with: currency differentials, import barriers, taxes, tariff barriers, delays
c) Why not FDI?
In some cases governments will be against FDIs fearing/concerning the following: national security, loss of control, bad influence, market exploitation, competition, profits leave host country.
In addition: some protected sectors are – telecom, energy, military & supply.
Detailed Example:
In the Swedish model we analyzed the different sources to attract FDIs, such as:
Using the existing workforce in Sweden that have strong social cohesion (“us”) = low risk for FDI’s, economic stability, wage policy-stability and maintaining their competitive advantage, greater ability to take risk due to a strong safety feeling, greater use of talent (minority, and women), immigrants coming into the work force, enhanced intergenerational mobility, income distribution, large middle class = strong domestic demand, high GDP per capita – all of these parameters (directly and/or indirectly) attract FDIs.
On the other hand, the Swedish model also demonstrates how the cost of the welfare constitutes a burden thru high taxes, and therefore somewhat contributes to the deterrence of FDIs:
Guaranteed employment – shift economic growth and reduce the motivation to work hard, reduced risk taking because of high taxes on high income, taxation based against SMEs, high taxes discourages business investment, cost of welfare = burden, government regulations/subsidies = domestic industries stay uncompetitive.
2) Fiscal policy/taxation-
a) Understanding the economic system/structure – the differences between communism, socialism, and capitalism -
Communism = no private ownership
Socialism = private ownership of business, state ownership and control over key industries (transportation, education, telecom), and state regulation.
Capitalism = private ownership of means of production and real-estate, state role = regulation.
Detailed Example:
The Swedish Model = Capitalism + Re-distribution: full employment, social cohesion, equal pay for equal work, access to education, access to healthcare, high taxes + re-distribution through taxes, EFO – union agreement, wages based on export sector, export orientation, pension, childcare, and social services – all of these, will position Sweden’s Fiscal Policy on the spectrum, as follows:

b) Taxes – Flat Tax vs. Progressive Tax –
b.i) What is Flat Tax?
Flat Tax is a fixed rate that is developed to have an equal tax rate regardless of the social economic classes and income bracket (in opposed to Progressive Tax), also no deductions or exemptions are allowed.
b.ii) Why Flat Tax?
Reasons for Flat Tax are: used to simplify, encourages FDI, creates business/investment friendly environment, raises overall standard of living, makes it easier to collect taxes, reduces public sector, broadens tax base, encourages local/domestic investments, increases consumption – creates demand.
Detailed Example:
Slovakia – in the early 90’s Czechoslovakia broke into two independent parties (Czech republic & Slovak Republic), not so long after Berlin’s wall and the “break-up” of the Soviet Union.
Flat Tax was Slovakia’s chosen way, following are the benefits - it brought FDI interest, gained economic stability, raised their GDP, improved the control of spending, all social economic groups benefited, it was a good marketing strategy – as it showed that they are on the right track to meet EU guidelines, it radically simplified their tax system and increased their transparency.

Part 2: Cases analyzed this week enhanced my understanding as follows -
1) Case #1 – “The Welfare State & its Impact on Business Competitiveness: Sweden Inc. For Sale?”
Analyzing the “pros & cons” of the Swedish model, based on this case, helped me to understand the different possible impact(s) in regards to FDI & Fiscal Policies.
In details – On one hand we can see in the Swedish model many different sources to attract FDI:
Low unemployment (less than 2%), social cohesion (“us”) = low risk for FDI, economic stability, equal access to education – high education levels = global competition, equal access to healthcare - life expectancy increase, lower overall healthcare costs, increase of quality of life, security, wage policy-stability, maintaining competitive advantage, greater ability to take risk due to a strong safety feeling, greater use of talent (minority, women), immigrants coming into the workforce, enhanced intergenerational mobility, income distribution, large middle class = strong domestic demand, high GDP per capita – all of these (directly and/or indirectly) parameters attract FDIs.
On the other hand, Swedish model also demonstrates how the cost of welfare constitutes a burden thru high taxes, and therefore somewhat contributes to the deterrence of FDIs:
Guaranteed employment – shift economic growth and reduce the motivation to work hard, reduced risk taking because of high taxes on high income, taxation based against SMEs, high taxes discourages investment, government regulations/subsidies = domestic industries stay uncompetitive. The crisis in Sweden teaches us about it’s fiscal policy and its long-term implications – different factors came into the “Swedish formula” that caused the bubble to burst: deregulation, beginning of the breakdown of the collective mentality, external-economic collapse, changes in pegged currency & fixed exchange rate - until 1971 currency was fixed to the $US, in 1979 - 8 different ways to determine how you want to value your currency – they didn’t know what to do, productivity declined, inflation, devalued currency of 25%, less political stability with issues of confidence in the elected party (parliament government = a party is elected, and call a vote for the party head).
The above set ground for individuals & companies to leave Sweden, in addition to the following factors/reasons: geographic proximity to market out of Sweden (EU & out), taxes lower in the EU- for both corporate and personal, shortage of certain skills in Sweden (for certain companies), easy access to communication and transportation. Today Sweden is doing well, they reduced both corporate and personal tax rates, no double taxation – Swedish people trust their state.
Conclusion - analyzing this case enhanced my understanding of how great are the implications of fiscal policies – taxation & distribution - on our day-to-day life. The state’s fiscal policy/taxation has a major effect on determining the level of which FDIs will (or will not) enter the state, which constitutes a main parameter to determine the state’s economic growth and success.
2) Case #2 – “Rovna Dan: The Flat Tax in Slovakia”
Analyzing the Slovakia case helped me to understand the implications and unique features of a different fiscal policy – the Flat Tax.
Since its inception, in the early 90’s, Flat Tax is the method used in Slovakia. Learning in this case about the whole Slovakian Development Strategy package demonstrates this Fiscal Policy’s rewards & drawbacks.
Details are as follows: Slovakia went thru labor reform (increased # of hours/week) & social reform (cut social welfare benefits), decentralization & privatization, with Flat Tax of 19%.
These parameters helped to promote FDI, including tax breaks of 10 years for FDI.
Conclusion: it is the whole Slovakian package in general that attracted the FDI, not just the Flat Tax, yet the Flat Tax is a major component effecting the economic growth of the country. (Detailed list of implications & benefits is presented in the “detailed Example” for Part 1 in this review),