Political Economy Term Paper

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Foreign Direct Investment

Why has foreign direct investment (FDI) increased in recent decades?

According to the OECD, (Organization for Economic Co-operation and Development), one of the major trends in the global economy during the recent decades is the increase in the foreign direct Investment (2001, p.101). Foreign direct Investment is the process of establishing, owing and controlling the production of goods and services in the foreign country or in simple words, it can be defined as the real assets which are abroad. It is associated with the transitional corporations which expand their global activities.

If we go back 50 decades, we find out that foreign direct Investment was considered as an unhelpful, unconstructive, negative and a method of introducing improper technology for the developing countries. However, a completely different view of FDI has emerged in the last two-three decades and today it is considered as very beneficial for the economic growth. This shows that the foreign direct investment has suffered through various stages & levels and its importance has fluctuated with the passage of time. It was considered of high importance in the beginning of 20th century, negative in the middle of the century and today its importance is growing higher and higher.

The increase in the importance of foreign direct investment is evident from the fact that since last 15 years, countries have realized the significance of FDI and its positive role. FDI contributes to the development strategies for the technology and make available the capital needed by the countries for the development. This is the reason that countries have started competing for FDI. They have started designing and formulating liberal investment policies at both national and regional levels. Furthermore, different home country measures, including matchmaking and guarantee funds are also pushed by the home countries to the developing countries in order to increase FDI. However, no extensive and comprehensive network is designed for foreign direct investment at the multinational level.

Foreign Investment has shown an impressive growth in the recent decades which has resulted in the genuine independency of the global economy. It has also played a crucial role in declining the cost of transport and communication and has helped in diffusing new products, latest technologies and improvement techniques across the different parts of the world. It is a fact that making foreign investments is very essential for increasing the productivity of the country; therefore, economies that are 'open' and have a liberal attitude towards the foreign investment are performing better than the 'closed' ones which are not availing this opportunity.

Keeping in mind, its benefits, almost all countries of the world provide a welcome environment to the investors and expect more and more investments. Countries have also realized that they need to redesign their general economic as well as FDI policies in order to attract more investors.

As mentioned above, foreign direct investment plays an important role in driving the economic growth, increasing productivity and promoting development of the country. However there are also some views against it and some argue that FDI destroys the local capability and natural resources are extracted without sufficiently compensating the poor and needy countries.

Despite above arguments, the importance of foreign direct Investment in the international economic activities has increased in the recent decades due to the reason that foreign direct investment is increasing at a much faster rate than the Gross Domestic Product (GDP) of the world. If we observe from 1980s to current time, we find out that the foreign direct investment has increased 11 times while the GDP has increase only four to five times (Urata et al., 2000, p.80).

It was also mentioned in "The Economist" that the Foreign Direct Investment grew five times faster compared with the world trade and ten times faster than the output of the world (The Economist, 1995)[footnoteRef:1]. There are several reasons behind the rapid increase of this global Foreign Direct Investment. [1: The Economist 'Survey on multinationals' (June 24, 1995) p.3.]

For instance, Foreign Direct Investment has greatly contributed towards the economic growth of the FDI recipients. Foreign Direct Investment helps in generating production which results in employment opportunities. Moreover, it also helps in transferring the technology and the management techniques which play a critical role in enhancing the economic growth. A number of countries of East Asia, particularly China, have shown impressive performance in attracting Foreign Direct Investment. This has resulted in the extensive economic growth of China giving it a position of a star performer in the world economy since that last two-three decades (Urata et al., 2000).

It is expected that if they continued growing with the same pace than Chinese living standards will double after every seven years approximately. According to experts, one of the main factors behind the success of Chinese economy is its largest recipients of foreign investment in the globe. Its world export share was 1.9% in 1990 which increased to around 8.5% in last few years. This has placed China as the third successful economy throughout the globe; just behind USA and Germany, which are the leaders. Today China is the producer of seventy five percent of the world's photocopying machines, DVD players, textiles; fifty percent of the world's refrigerators and digital cameras and almost forty percent of the world's personal computers. This is a big success which China is able of to achieve by increasing its foreign direct investment; and today China has around forty percent of all the foreign direct investment flows to developing countries.

It is also important to note that the quick expansion of foreign direct investment in all parts of the world, at both regional and national levels is also due to liberalization of FDI policies. Looking at the various benefits of the foreign direct Investment, several countries have liberalized their foreign direct Investment policies, so that they can attract more FDI. A few countries have also executed the incentive policies for FDI; for instance exemption of corporate income tax.

It is also important to note that countries who have enhanced their local potentials and capabilities by doing foreign direct investment, are also getting benefit in the long run but those countries that do not built up the local potentials and relations, achieve very few long-term benefits. Countries that have enhanced their local capabilities include Ireland and Singapore; their local suppliers have now become the global exporters.

A lot of literature has been written about the relationship of foreign direct investment and the growth & development. As stated above, there are a number of areas in which foreign direct investment plays a role in the development (UNCTAD, 1999). Some of these include; Income and employment level, access to market, structure of markets, technology, revenues, social issues, cultural issues etc. Foreign direct investment uses all of these channels to enhance the economic growth. Following paragraphs will explain how foreign direct investment is beneficial in different areas which help in the growth and development of the economy:

Increase in Growth

Several empirical studies have proved that foreign direct investment contributes to the factor productivity as well as to income growth in the host countries, a lot more than what domestic investment would have generated (Aghion and Howitt, 1998). It is difficult to calculate the magnitude of the impact of FDI because some studies have also concluded that FDI results in a situation of overcrowding. However, most of the researchers concluded that foreign direct investment plays a positive role in the growth and development and it actually helps in increasing the domestic investment. Although overcrowding does take place at some places but the net effect is positive and beneficial.

It is also important to note that the effect of FDI on the least developed countries cannot be greater on growth because in order to get maximum benefit from foreign direct investment, developing countries have to reach at a certain level of development in different areas, for instance education, infrastructure, technology and technical knowledge, health etc. Similarly countries with underdeveloped financial markets also face difficulty in reaping the full benefits of FDI.

Enhancement of Trade and investment

Foreign direct investment also helps in integrating the developed and industrialized countries into the global economy by stimulating and increasing their foreign trade flows. There are several factors which play the role; for instance strengthening the international networks of the organizations and increasing the significance of foreign subsidiaries in multinational enterprise's strategies for marketing, sales and distribution. In simple words it can be concluded that the ability of the developing country to attract FDI is very much dependent by the access of entrant to engage in the import and export activities. This is the reason that host countries welcome international trade in order to get benefit from FDI. The main trade benefit the developing countries get from FDI is the long-term contribution of FDI by incorporating the economy of host country closely with the world economy in such a process which includes high imports and high exports.

Transfer of Technology

Technology transfers that result due…

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