Foreign Direct Investment Essay

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Pages: 10

Discussion of the implications of foreign direct investment (FDI) on recipient countries paying particular attention to developing economies

In the context of the increasing multinationalisation of firms and markets, foreign direct investment (FDI) inflows have provided strong incentive for economic development across countries, especially for developing countries (Liargovas and Skandalis). FDI is considered as an important source of supplying funds for domestic investment, which promotes capital formation in the host country (Liargovas and Skandalis). This article will firstly analyze the role of FDI and its impact on economic growth in developing countries by using different theoretical approaches. There are many evidences show that FDI can positively affect economic growth. It also demonstrates that FDI brings much more than just a source of economic development in developing countries, but spillover effect is noteworthy, including transfer of production technology, improving managerial and marketing competence, injecting capital resources and enhancing competitiveness of local firm (Berhanu and Samuel 2007). Inevitably, there are a number of defects, FDI has had a net crowing-out effect on domestic investment, which limits the benefit of FDI. In this article, it will further discuss some changes that are made by developing countries to attract FDI, including government policies, legislations and institutional or governance infrastructure (Berhanu and Samuel 2007). In addition, this article will investigate two examples, China and Latin America, to review their experience with FDI.

In developing countries, FDI has become the most stable and largest component of capital flow. FDI is an important vehicle of technology transfer from developed countries to developing countries. It improves managerial and marketing competence, as well as stimulates domestic investment and facilitates improvements in human capital and institutions in the host county (Makki and Somwaru 2004). Modernization theory, which is based on the neoclassical and endogenous growth theories, indicates that FDI can promote economic growth in developing countries (Berhanu and Samuel 2007). Based on the neoclassical approach, capital investment is an essential element for long-term economic growth, because FDI can multiply domestic capital accumulation, thus has a positive effect on the total level of investment (Berhanu and Samuel 2007). As a result, it can enhance the potential for production level and economic growth. In addition, the new growth theories or endogenous growth model assume that knowledge and technology are factors of production (Berhanu and Samuel 2007). In these models, FDI still plays an important role. FDI provides labor training and facilitates the incorporation of new inputs and technologies into the production system. Consequently, the transfer of technology and the introduction of new management practices and organizational arrangements could remove the gap between developed and developing countries (Makki and Somwaru 2004). Some other studies reports that the level of financial development and the accumulation of human capital caused by FDI are dependent on a host county’s economy (Berhanu and Samuel 2007). Dependency theorists argue that reliance on foreign assist and investment may be expected to have a negative effect on economic growth and may accelerate income inequality (Berhanu and Samuel 2007). It is argued that FDI would crowds out domestic investment in the developing world, because monopoly is the dominant industrial structure for foreign investment. As a result, local firms are incapable to compete with them due to limitation in size, financing and marketing power (Berhanu and Samuel 2007). Even though foreign investment erodes part of market share of domestic investor, it provides a positive effect on domestic investment in later periods as the generation of backward linkages (Berhanu and Samuel 2007). Thus, FDI is