Government-Business Relations
Predominantly, free trade entails trade between two or more countries where there is an elimination of restrictions such as import duties, local production subsidies, import licenses, and export bounties. The common argument used to support free trade is that countries have different resources endowment. Therefore, each country should specialize in the production of goods and services in which it has a comparative cost advantage. Varying levels of technology required for resource exploitation necessitate the need for countries with advanced technology to invest in other countries where technological knowledge is less developed.
The decision to allow foreign investment involves some agreements between the national government and the foreign investors. One of such agreement is the free trade agreements where two countries agree to eliminate all the trade barriers between them. There are other clauses contained in free trade agreements that allow foreign investors to sue the local government when a law or policy harms their investments. This essay will discuss some of these clauses and how they influence the power of the national government in policy making.
Effects of free trade agreements on taxation policies of the national governments
Governments make taxation policies for various purposes such as revenue generation, controlling international trade, promoting local production and consumption, and increasing exports demand in the international markets among others. Governments use different instruments to collect the tax and can use a combination of tax alternatives to influence the behavior of economies in the desired directions.
Free trade agreements contain clauses that allow foreign investors to operate businesses in the host countries paying a lower tax than local industries (Devereux, 1995). The national governments remove barriers to entry of products from the foreign investors and use tax incentives to facilitate and attract foreign direct investments. The national governments entitle the foreign investors to tax incentives, tax rebates and holidays and guarantee them investments repatriation to attract them (Loree and Guisinger, 1995). They provide the foreign investors with assurances that the conditions that facilitate their entry into their country will persist.
Foreign direct investors emphasize more on tax incentives to reduce the cost of establishment and operations (Davidson, 1980, pp14). Therefore, when formulating taxation policies, the national governments put special considerations to foreign industries thus compromising the principle of fairness in tax collection. Additionally, fiscal policies aimed at accelerating economic growth by providing subsidies to local industries cannot be efficiently implemented because priority is given to goods and services from foreign firms.
Effects of foreign direct investments in the national governments’ economic growth policies
Developing countries lack the required technology to exploit their natural resources fully. As a result, they formulate growth strategies that attract foreign investors. Such strategies include removal of trade barriers such as tariffs and import duties, the creation of enabling environments, and reduced taxes to create favorable business conditions for foreign companies. The foreign direct investments boost technological growth and the formation of human capital. Also, it creates employment, and triggers the overall economic development of the host country (Figlio & Blonigen, 2000).
However, there are many challenges associated with foreign direct investments, interfering with the implementation of investments policies of the national governments where foreign investors dominate the major part of the economy (Yueh et al., 2006). Governments in the developing countries adopt inward- looking economic policies to promote economic growth. Such policies focus on increasing local consumption and exports while reducing imports.
Free trade agreements tend to favor demand for foreign goods and services by creating environments that facilitate low-cost production. As a result, goods and services produced by foreign investors are cheap compared to local products. Therefore, they are highly demanded, resulting in the closure of domestic industries.
Subsidization policies by the national governments are challenging to implement in free trade agreements. Foreign investors demand full compensation in an event of loss while investing in developing countries. Further, they demand preferential treatment in relation to trade. Therefore, local industries that contribute the greater part of the country’s GDP cannot be subsidized because local products will fight foreign goods in the market (Borensztein et al., 1998). The result is low levels of industrialization, capital formation, investments, high unemployment rates, and slow economic growth rates.
Effects of free trade agreements on pricing policies of the national governments
Government interventions in the markets are essential for the efficient functioning of markets. There are many ways that governments use to prevent imperfections that lead to negative externalities (Moran, Graham, and Blomstrom, 2005). Governments use taxation and pricing policies to prevent the existence of monopolies and facilitate the provision of essential facilities and public goods. With foreign investment in a country, it becomes difficult to implement some pricing policies, especially policies that encourage local consumption since such policies will make imports expensive compared to locally produced goods, thus violating the terms of the agreements.
Conclusion
Free trade agreements are essential for national integration and promotion of international relations. They enhance international exchanges which result in the transfer of technology and human capital, resulting in full resource exploitation and utilization. Direct investments by the foreigners remain the leading and most secure source of private capital for developing countries and economies in evolution. However, there are both benefits and risks associated with foreign investment, and therefore, developing countries should critically analyze their development goals before deciding whether or not to allow foreigners to invest in their countries.
Bibliography
Borensztein, E., De Gregorio, J. and Lee, J.-W. (1998) ‘How does foreign direct investment affect economic growth?’, Journal of International Economics, 45(1), pp. 115–135.
Davidson, W.H. (1980) ‘The location of foreign direct investment activity: Country characteristics and experience effects’, Journal of International Business Studies, 11(2), pp. 9–22.
Devereux, M.P. and Freeman, H. (1995) ‘The impact of tax on foreign direct investment: Empirical evidence and the implications for tax integration schemes’, International Tax and Public Finance, 2(1), pp. 85–106.
Figlio, D.N. and Blonigen, B.A. (2000) ‘The effects of foreign direct investment on local communities’, Journal of Urban Economics, 48(2), pp. 338–363.
Loree, D.W. and Guisinger, S.E. (1995) ‘Policy and non-policy determinants of U.S. Equity foreign direct investment’, Journal of International Business Studies, 26(2), pp. 281–299.
Yueh, l.y. (2009) ‘Multinationals and economic growth in east Asia: Foreign direct investment, corporate strategies and national economic development. Edited by Shujiro Urata, Chia Siow Yue and Fukunari Kimura’, Economica, 76(301), pp. 213–214.
