Foreign Direct Investment
The effects of FDI on economic growth depend on the domestic conditions of the host country. Precisely, the governments of host countries are responsible for establishing conditions that support FDI activities. These conditions can also mitigate the negative effects of FDI on economic growth. Generally, some studies suggest that FDI boosts the economic growth of a host country. Others associate FDI with negative effects on the host country’s economy. Original research indicates that these effects depend on the internal conditions. Therefore, the effects of this investment can be positive or negative. The host country’s government should create an environment that supports FDI. Government policies should also mitigate the negative effects of such investments.
Effects of Foreign Direct Investment on Host Countries
FDI helps to transfer key resources to a host country. This transfer can affect a host country’s technology, capital, or management resources. Precisely, these effects can stimulate the host country’s economic growth. MNCs take risks and invest in long-term projects in anticipation of high returns. These firms contribute to the free flow of capital and access to financial resources (Verbeke, 2013). Also, these firms contribute to unrestricted capital flow that has several benefits for a host country. Unrestricted capital flow allows owners of capital to diversify their investment and lending. It reduces the risk faced by capital owners as they invest in various long-term projects. In addition, FDI facilitates the global integration of capital markets. This approach helps spread the best practices such as accounting rules and corporate governance.
Many countries lack adequate research and development resources to develop various products. Also, less developed nations lack the technology to process their native products. FDI facilitates the transfer of technology to host countries (Forte and Moura, 2013). Technology transfer boosts these countries’ productivity and growth. Precisely, technology transfer is the most important avenue through which foreign investors can benefit the host economy. MNCs are the main sources of R&D activity for developing countries. The technology of these firms is more advanced than that of domestic enterprises. Therefore, MNCs can generate technological spillovers that benefit domestic firms (Rugman and Verberke, 2001). The extent to which these companies generate such spillovers depends on the context and sectors. Technology transfer takes place through four interrelated channels. For instance, it may occur through the linkage between a foreign firm and local suppliers or buyers. This transfer can occur through horizontal linkages with competitors in the same industry. It can also occur through the internationalization of R&D and the migration of skilled labor.
Vertical linkages provide the strongest evidence of positive technology spillovers. Specifically, original research shows that technology transfer mainly occurs through vertical linkages with suppliers in the host country. Several MNCs help local suppliers in purchasing raw materials and intermediate goods. Also, these firms assist domestic suppliers in upgrading or modernizing their production facilities. The local market structure changes when an MNC enters a less developed country (Loungani and Razin, 2001). Therefore, it is difficult for researchers to obtain reliable information about horizontal spillovers. Few studies and written essays on this dimension have generated mixed results. This situation may be due to foreign enterprises avoiding the flow of technical knowledge to their immediate competitors.
Technology transfer can generate externalities in the host country. However, the technologies must be relevant to the domestic business sectors. The business sector’s technological level should be reasonable for the technology to generate externalities (Daniels et al., 2007). Specifically, the technology gap between foreign investors and domestic enterprises should be limited. Domestic enterprises may not absorb foreign technologies if the technological level is low.
FDI has an indirect effect on human capital in host countries. This effect does not occur due to the efforts of MNCs. Specifically, this effect occurs due to government policies that seek to attract FDI through enhanced human capital. MNC subsidiaries enhance the human capital of local workers by offering training and on-the-job learning. Also, these subsidiaries can help to enhance human capital in other enterprises such as local suppliers (Zhang, 2004). These enhancements can generate further benefits in the host economy. Labor can move to other firms and help some employees become entrepreneurs.
Investment in human capital helps to create a conducive environment for FDI. A host country should aim at achieving a certain level of educational attainment. Specifically, such an achievement enables host countries to attract FDI. It also helps a host country maximize the human capital spillovers generated by foreign enterprises (Nunthirapakorn, 2020). The minimum level depends on the industry and other features of the local environment. Therefore, education may not be enough to make a country attractive to foreign enterprises. Significant spillovers may not occur if there is a big knowledge gap between local firms and foreign enterprises.
The host government should eliminate abuse and discrimination from the labor market. Also, the authorities should help employees upgrade their human capital. Such an approach can contribute to human capital development (Forte and Moura, 2013). Also, the presence of MNCs helps host authorities identify the skills in demand. These authorities should develop strategies to meet this demand on time. However, these authorities should provide general use education and do not favor certain enterprises (Daniels et al., 2007). MNCs provide training and help to upgrade human capital than domestic firms. Host governments should develop policies that enhance labor-market flexibility. Also, these authorities should introduce policies that encourage entrepreneurship. Such policies can support human capital spillovers from foreign enterprises.
FDI facilitates the transfer of knowledge to a host country. This transfer increases the stock of knowledge in the host country. Also, FDI can provide such a country with management skills. Precisely, the transfer of management skills can provide the host country with several benefits. Local personnel can be trained to assume managerial, technological, and financial positions in a subsidiary of a foreign MNC (Rugman and Verberke, 2001). These individuals can leave such positions and establish local companies. Also, local companies may acquire knowledge on how to improve their management skills. Workers can also acquire better skills after undergoing training in foreign firms. These skills will enter the domestic labor market and improve the knowledge base.
FDI has direct and indirect effects on employment in a host country. It creates employment in countries experiencing job shortages. For instance, the direct effects of employment arise when MNCs employ the host country’s citizens. Indirect effects occur when FDI enables local suppliers to create jobs (Kurtishi-Kastrati, 2013). Such a situation arises due to an increase in local spending by MNC employees. Also, the domestic private sector can enter into business relationships with MNCs. Domestic companies can supply foreign investors with inputs or process their products. Both approaches can create new jobs and encourage further economic activity in the host country. Specifically, the domestic private sector engages in production linkages with foreign investors (Loungani and Razin, 2001). Every direct job created by FDI adds more jobs to the host country’s labor market. Foreign enterprises increase competition in the host country. In this way, these enterprises promote economic development and increase the efficiency of resource allocation. Increased competition stimulates capital investment as firms seek a competitive advantage.
Foreign enterprises have superior technology compared to firms in the host country. As a result, these enterprises produce higher-quality goods and services. These enterprises can produce goods at lower costs or in larger volumes. This situation results in higher consumer welfare in the host country. Also, FDI adds to the host country’s existing capital stock and increases productivity. An increase in output levels promotes economic growth in a host country. Actual FDI activity acts as a macroeconomic stimulus in the host country. In addition, this investment boosts economic growth by raising a host country’s factor productivity. It facilitates the efficient use of resources in the host economy. FDI provides a host country with several economic benefits (Verbeke, 2013). Moreover, this investment helps to improve a host country’s social and environmental condition. It boosts economic growth and helps to alleviate poverty in the host country.
FDI boosts income growth and factor productivity beyond the level achievable by domestic investment. The impact of FDI inflows coincides with high growth rates associated with other factors. However, it is not clear whether the crowding out of domestic investment mitigates the positive effects of FDI. Some studies suggest that FDI can help to increase domestic investment while others indicate that it crowds out local enterprises. These academic studies indicate that the net effect of FDI is beneficial even if crowding out takes place (Nunthirapakorn, 2020). Specifically, the replacement releases domestic funds to other investment activities. The least developed economies derive only few benefits from FDI due to the existence of threshold externalities. Also, developing countries must have reached a certain level of development to benefit from FDI. Imperfect financial markets may prevent a country from getting maximum benefits. Specifically, weak financial intermediation has a greater effect on domestic firms than MNCs. A scarcity of financial resources can also harm domestic firms (Rugman and Verberke, 2001). Such a situation can prevent these companies from seizing the opportunities provided by foreign investors. However, foreign investors can solve these problems by participating in the financial sectors. The participation of such firms in physical infrastructure can also help address these issues.
The effects of FDI on host countries should be viewed broadly. Precisely, researchers should not only focus on the effect of FDI on imports and exports. Host countries benefit by integrating their economies into the global economy (Lipsey and Sjöholm, 2004). Precisely, this process is likely to include an increase in imports and exports for the host country. Investment and trade are mutual channels that promote cross-border activities. Host governments must consider the effects of such investment on foreign trade. For instance, these authorities should assess the effects of FDI when experiencing current-account pressures. Host governments should also determine whether foreign transactions may reduce foreign reserves.
Several countries continue to develop and become industrialized. FDI boosts foreign trade flows and integrates these economies into the global economy. Also, FDI helps develop and strengthen international networks of related firms (Lipsey and Sjöholm, 2004). Foreign subsidiaries are important in MNCs’ distribution, sales, and marketing strategies. Host governments should develop a policy that promotes openness to international trade. Precisely, such a policy can help a host country benefit from the presence of foreign investors. Host governments should develop a strategy that attracts FDI. These authorities should adopt policies of regional trade integration and liberalization.
FDI can help to improve the balance of payment accounts of a host country. For instance, an MNC can establish a foreign subsidiary in a certain country. The initial capital inflow from such an investment will benefit the host country’s capital account. The FDI can be a substitute for the goods and services the host country imports. Precisely, such an investment will help to improve the country’s current account. An MNC can also export goods and services through a foreign subsidiary. Such an investment will improve the current account of the country’s balance of payments.
FDI affects a host country’s position in the international market. However, these effects depend on the motive of the investment. Also, FDI can support a host country’s export growth and boost economic growth (OECD, 2002). Efficiency-seeking FDI generates output meant for export. Such a situation will increase the local content of value-added exports. Also, efficiency-seeking FDI can increase imports and exports if intermediate goods come from outside the host economy. Some value-adding processes will occur within the host economy (Zhang, 2004). Such a situation can help to improve the host country’s balance of trade in the long run.
FDI increases a host country’s exports in the short and medium-term. For instance, such investment helps financially-constrained countries utilize their resource endowment. Also, FDI can help such countries make use of their geographical locations. FDI helps to integrate host economies into international trade flows. Also, FDI helps raise exports and imports of developing countries (OECD, 2002). However, it is not clear whether these benefits justify the limitations of FDI in such economies. Some of its drawbacks include the cost of maintaining EPZs and widening the gap between foreign and domestic enterprises.
The presence of MNCs can raise the level of competition in host-country markets. Such a situation may spur domestic competition and boost economic development. Also, the presence of MNCs can increase productivity and lead to more efficient resource allocation. The entry of such firms can raise concentration levels in the host country market and hurt competition. Several factors can exacerbate this risk in host-country markets. For instance, the host country may have a different geographic market with high barriers to entry. It may also have a weak competition law framework. These factors can lower the level of competition and limit the benefits provided by MNCs.
Research suggests that FDI leads to host-country concentration. However, this effect is disproportionately stronger in developing countries. This situation shows that MNCs may hurt competition in less-developed countries. Moreover, sufficient evidence shows that FDI increases productivity in host countries (Verbeke, 2013). Such evidence is weaker among developing countries. Precisely, such spillovers may be found in these countries. However, the magnitude of their effects is associated with the existing levels of competition. The direct effect of such concentration varies among host countries and sectors (OECD, 2002). Only a few industries have expressed concern for competition due to global concentration. Also, high levels of concentration may not reduce competition in well-defined markets. Such a situation is possible if there are low entry barriers or customers can protect themselves from higher prices.
Host country authorities should replace less-productive domestic firms with high-performing foreign enterprises. However, these authorities should maintain healthy competition in the market. The best way to achieve this objective is to make the host economy more open to international trade (OECD, 2002). Also, the host country authorities should introduce competition laws that enhance efficiency. Enforcement agencies should also reduce the anti-competitive effects of less-productive firms. The authorities should focus on protecting competition instead of competitors.
Host countries can benefit from FDI through enterprise development. FDI can help local enterprises achieve synergies and reduce costs. Also, unrelated enterprises can benefit from efficiency gains. Evidence shows that enterprises acquired by MNCs experience an improvement in economic efficiency. However, the degree of this improvement varies by sector and specific host country. Foreign investors are often willing to try new business opportunities and improve efficiency. Host country authorities can encourage FDI to make their business sectors more economically efficient.
FDI can provide host countries with several environmental and social benefits. MNCs introduce technologies and promote good practices in the host country. However, these enterprises may export production that is prohibited in their home countries. Such a situation may lower or freeze regulatory standards in the local economy but there is little evidence to support such a scenario. Generally, the direct environmental impact of FDI on the host country is positive. Environmental policies must be adequate to protect the host country from negative environmental effects. Some sectors and industries have, however, experienced such effects. Therefore, host countries require adequate local capacities to get maximum environmental benefits of FDI. Host country enterprises should have sufficient technological capabilities and good environmental practices.
FDI transfers modern and environmentally friendly technologies to the host country. Also, evidence shows that MNCs help improve the general environment of host economies. These enterprises generate positive externalities that benefit the host economy (OECD, 2002). However, some MNCs have moved environmentally unsuitable equipment to their subsidiaries in developing countries from their home country. Such technology demonstrates the type of environmental risks that FDI may pose to the host country.
There is no sufficient evidence on the social effects of FDI. Generally, empirical evidence suggests that FDI can help to improve social conditions and reduce poverty. FDI has significant effects on the growth of host countries (Kurtishi-Kastrati, 2013). It can reduce poverty when used to develop labor-intensive industries. Also, MNCs must adhere to labor laws and international labor standards. Some studies suggest that the presence of MNCs in developing countries deteriorates social values. However, there is little evidence to support these claims. Several studies indicate that FDI promotes workers’ rights. Low labor standards may deter FDI due to social unrest concerns in host countries.
FDI provides host countries with several economic benefits. However, these benefits do not accrue automatically and require an enabling environment. Host country authorities must create an enabling business environment to support FDI. These authorities should encourage domestic and foreign investment. Also, the authorities should provide incentives for innovation and create a competitive business climate. Some factors prevent host economies from maximizing the benefits of FDI. Therefore, local authorities should build an enabling environment to benefit from the entry of MNCs. Such an approach will help the host country reap the full benefits of FDI.
Daniels, J., Radebaugh, L. and Sullivan, D., 2007. International business: environment and operations. 11th ed. Uppers Saddle River, N.J: Pearson Prentice Hall.
Forte, R. and Moura, R., 2013. THE EFFECTS OF FOREIGN DIRECT INVESTMENT ON THE HOST COUNTRY’S ECONOMIC GROWTH: THEORY AND EMPIRICAL EVIDENCE. The Singapore Economic Review, 58(03), p.1350017.
Kurtishi-Kastrati, S., 2013. The Effects of Foreign Direct Investments for Host Country’s Economy. European Journal of Interdisciplinary Studies, [online] 5(1). Available at: <https://www.ejist.ro/files/pdf/369.pdf> [Accessed 15 December 2021].
Lipsey, R. and Sjöholm, F., 2004. The Impact of Inward FDI on Host Countries: Why Such Different Answers?. [online] Available at: <http://www.piie.com/publications/chapters_preview/3810/02iie3810.pdf> [Accessed 15 December 2021].
Loungani, P. and Razin, A., 2001. How Beneficial Is Foreign Direct Investment for Developing Countries?. [online] Available at: <https://www.imf.org/external/pubs/ft/fandd/2001/06/loungani.htm> [Accessed 15 December 2021].
Nunthirapakorn, T., 2020. Effects of Foreign Direct Investments on the Host Country. NIDA Business Journal, [online] Available at: <http://mba.nida.ac.th/en/books/read/3b5d71c0- c257-11ea-8718-717ec99f241d> [Accessed 15 December 2021].
OECD, 2002. Foreign Direct Investment for Development: Maximising Benefits, Minimising Costs. [online] Available at: <https://www.oecd.org/investment/investmentfordevelopment/foreigndirectinvestmentfor developmentmaximisingbenefitsminimisingcosts.htm> [Accessed 15 December 2021].
Rugman, A. and Verberke, A., 2001. SUBSIDIARY-SPECIFIC ADVANTAGES IN MULTINATIONAL ENTERPRISES. Strategic Management Journal,.
Verbeke, A., 2013. International Business Strategy. 2nd ed. Cambridge: Cambridge University Press.
Zhang, K., 2004. Maximizing Benefits from Foreign Direct Investment and Minimizing its Costs: What Can We Learn from China?. Foreign Investment in Developing Countries, pp.78-91.