Foreign Direct Investment and its Roles in Economic Development

Foreign Direct Investment and its Roles in Economic Development


Foreign direct investment or popularly known as FDI, is a key component in global economics integration. FDI is an investment made by a resident enterprise or direct investor, into the enterprise that resides in another country this often involves establishing operations or acquiring tangible assets, including stakes in other businesses. This is not just a transfer of ownership as it usually involves the transfer of factors complementary to capital, including management, technology and organisational skills. The main objective of FDI however is to establishing lasting interest. This implies the existence of a long term rapport between direct investor and the direct investment enterprise Along with significant degree of influence on the management of the enterprise. According to OECD, an ownership of 10% of voting power by foreign investor is evidence of such a relationship. Now, there are 2 types of FDI. first, a greenfield investment. second, a brownfield investment. Let’s focus on the greenfield investment first. A green field investment is a form of foreign direct investment where a parent company starts a new venture in a foreign country by constructing new operational facilities from the ground up. In addition to building new facilities, most parent companies also create new long-term jobs in the foreign country by hiring new employees. Companies like McDonalds and Starbucks are the prominent example of greenfield investment. Brownfield Investment
also known as cross-border mergers and acquisition. The purchasing of an existing production or business facility by companies or enterprises for the purpose of starting new product or service. This type of investment does not involved the new construction of plant operation facilities. An example of this investment can be found in the Indian truck company, the Tata Motor. in 2008 where the enterprise acquired Land Rover and Jaguar from Ford Motor Company. From a strategic viewpoint, there are 3 types of FDI Horizontal FDI occurs when the company carries out the same activities abroad as at home. for example, Toyota assembling cars in both Japan and the US. Vertical FDI occurs when different stages of production chain are added abroad. Forward vertical FDI is when the FDI takes the firm nearer to the market for example, Toyota acquiring a car distributorship in America Backward Vertical FDI is when international integration moves back towards raw materials To use Toyota as an example once more, it acquire a tyre manufacturer or a rubber plantation. Once a firm undertakes FDI, it becomes a mutinational enterprise(MNE). For the rest of this video, we would focus on what are the specific benefits of FDI inflows into a country, and what policies can a country pursue to maximise the benefits of FDI. But first, some clarification, In practice, many countries take a pragmatic stance towards FDI though specific policies, these policies would vary from nation to nation often with mixed results. Countries that adopt a pragmatic stance often pursue policies designed to maximise national benefits. For the host country (the receiver of FDI), the main benefits of inward FDI include: Let’s begin with Resource-transfer effects Foreign Direct Investment can contribute positively to the host economy by supplying the Capital, Technology, and Management Resources that would otherwise not be available and hence boost the country’s economic growth rate. Let’s move on to Employment effects FDI is often associated for its positive employment effects on the host country. The effects of FDI can be both direct and indirect. We will begin with the direct. Direct effects occur when a mulitinational enterprise (MNE) employs a number of the host-country citizens. Indirect benefits occur when the employees of the multinational enterprises start spending money locally. Additionally, jobs are created among local suppliers as a result of the MNE’s operations. Let’s talk about the Balance-of-payments Effects There are 2 ways in which FDI can help a counrty run a current account surplus. First, if the FDI is a substitute for imports of goods and services, the effect can be to improve the current account affect on competition and economic growth When FDIs takes the form of a greenfield investment, that is to establish a new operation in the foreign country the number of competitors in the market increases thus giving consumers more choice and increasing the level of competition. The theory is that within the national market would help to spur innovation and drive down prices thus, creating the conditions for greater economic growth. Host countries often adopt policies that are crafted to both restrict and to encourage inward FDI. Governments may offer incentives to foreign firms to invest in their countries. Incentives may include tax breaks, low-interest loans, grants, subsidies or state spending on infrastructure. Host countries can often employ a variety of controls to restrict FDI, in order to maximise it’s potential benefits while limiting its costs. The two most common policies include ownership restriants and performance requirements. One of the main reasons behind ownership restrains is the idea that local owners can help to maximise the resource-transfer and employment benefits of FDI for the host-country. A good example would be Japan. The Japanese government right up to the early 1980s, prohibited most FDI. It only allowed for joint ventures between Japanese and foreign MNEs, if the latter had valuable technology. Performance requirements are constraints places upon the local subsidiary of the MNE to control its behaviour. Many countries often implement performance requirement policies to suit the country’s needs. Common performance requirement policies include, the requirements on product content, technology transfer and local participation in top management. Singapore is one of the 4 original Asian Tiger countries These are countries that experienced rapid growth between 1960’s and 1990’s. Singapore’s economy relies heavily on foreign investment to maintain its competitiveness and drive its economic growth. Among the other Asian Tigers , Only Singapore have chosen to use Foreign Direct Investment (FDI) as its principal source of external capital The data on foreign direct investment in Singapore reflects the foreign ownership of its production facilities. In 2012, there was a fall in Singapore’s FDI But gain was made on the run up to 2014 Working at the data from 2014, we can see Singapore has a high GDP growth of 3.9% despite having a small population and lack of natural resources. The United States is a major investor country in Singapore, followed by Japan, British Virginia Islands and Cayman Islands. Due to its strategic location close to the Malacca Straits and well developed port facilities, Singapore’s merchandise exports involve a large volume of trade which consists of re-exports. Singapore attracts foreign investment due to its highly developed physical and regulating infrastructure, skilled man power and easy access to rapidly expanding Asian markets. Singapore seeks FDI to not only provide employment for its people but also gains useful foreign technology that would help drive growth of its local companies. In summary, FDI has assisted Singapore to become a country with one of the highest per capita income in the world. There are a number of dangers that can be associated with FDI. The employment benefits that MNEs provide may not last forever. There is no guarantee that the MNEs will stay for a prolong period in the countries that they invested in. If thing was to go sour, the investor can choose to pull out causing harm to the local economy Being over dependent on MNEs may lead to loss of soverignty The MNEs may gain the upper hand when it comes to making deal with the host country government Leading to an exploitative relationship, that may not be apparent in the early stages Harms include environmental damage and human rights violation In an increasingly interconnected world, the process of globalization have presented an economic challenge for developing countries. It is in this context that FDI have been accorded great importance as the driver of economic growth. Although some countries have benefited from FDI many other nations have yet to see its fruit Governments should trade likely and pursuit pragmatic policies in order to maximize the benefit of FDI.

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