Cost of Capital and Competiveness
In international trade, competition and ability to attract foreign direct investment based of cost of capital are critical and important. However, in the quest to make a country reap from comparative advantage, a number of economic issues must be put in place. These issues include, interest rate, cost of capital, factor cost among other economic variables. This calls for free market economy which eliminates many trade barriers and increase competitions among firms. In this regard, when a country charges high taxes and interest rate, it therefore means that factor costs are high and the profit margin for firm is little. Firms there will tend to move a way to other favorable place where factor cost is low (Jonathan & Wren 2006). Low factor cost attracts firm hence increase competiveness of a country to attract foreign direct investment. The increased freedom of entry and exist in international product markets has profound impact on a country factor markets. This also goes along way in determining demnd and supply of factors of production. In addition, it provides firms with more time to supply the product market from any where in the world.
Relatively high factor prices in any given country will reduce demands factor of production. It is economical for a firm to shift to areas where factor costs are low to reap economies of scales. Multinational Corporation such as Coca-Cola Company has found it beneficial to invest in Africa where there is a low factor price and interest rates are generally low. “Coca-Cola, the soft drinks giant, will spend $12 billion €8.9bn; £7.6bilion in Africa during the next decade, as it seeks to heighten its regional presence” (Sun &Tipton, 1998). Paradigm shift toward minimizing costs has seen firm relocate to where firms are relocating their production units to place where interests and factor cost or cost of capital are low. This strategic plan has seen unprecedented move to areas perceived to be business friendly in the world.
Traditional trade theory predicts that factor prices attain equilibrium under free trade. This theory prediction is possible to unskilled workers in the industrialized countries who think that free trade may lead to unemployment. Another critical factor in determining the competitiveness of a country as destination for production is taxes levied on business. It is prudent to note, that there is no reason to establish production where taxes are high. Therefore countries which levy low taxes and tariffs tend to be completive in the attraction of local and foreign direct investment. Cost of capital significantly influences both local and foreign direct investment (OECD 2010). FDI growth relationship has attracted the interest on a large number of researches and generated vast literatures for the developed as well as developing countries. Most of the literatures on FDI lean towards indigenous and neoclassical growth models. However, a number of articles abide in the fact that FDI serves as an important source of capital for most countries.
Researchers argues that whereas the FDI-economic growth linkage is not universally accepted, macro-economic indicators seem to point out the role of positive contribution of FDI in economic growth in specific environments. The authors provided an examination of three channels through which FDI catalyzes in economic growth. First, it releases a country from limitations of domestic savings. Borensztein, De Gregorio and Lee (1998) argued that FDI plays a significant role in complementing domestic savings and therefore rejuvenates the process of capital accumulation supports this position. The second role of FDI in economic growth relates to its role in technology transfer. In conclusion; however, there is wide acknowledgment that international competitiveness in relation to both costs and taxes greatly determine factor demands within a country, there is scanty empirical evidence to authenticate their quantitative significance.
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