Inward Foreign Direct Investment (FDI) and the effects it has on the host country has been the subject of debate over the years, producing a wide range of empirical results in academic literature with little convergence whereas policymakers generally accept that inward Forward Direct Investment is valuable to their economy[1]. According to Lall and Streeten (1977), the basic presumption in academic literature is based on neo-classical economics stating that Foreign Direct Investment raises income and social welfare in the host economy unless otherwise negatively influenced by protectionism, monopolies and other externalities[2].
Definition
Before I go any further, my preferred definition of Foreign Direct Investment is described as “the process whereby residents of one country (the source country) acquires ownership of assets for the purpose of controlling the production, distribution and other activities of a firm in another country (the host country)”[3]. Guided by this definition, such investors would typically include multinational corporations, state-owned enterprises, sovereign wealth funds, private equity companies, private equity funds, and various other private investors.
The Debate For and Against Inward Foreign Direct Investment
According to Moosa (2002), there are four main reasons that the debate for and against inward Foreign Direct Investment has been the subject of discussion for academic scholars and policymakers. The first of which is the rapid growth of Foreign Direct Investment which began in the 1980’s resulting from increased pressure from competition due to globalization. The second reason is that inward Foreign Direct Investment raises concerns about the causes and consequences of foreign ownership. The third reason being that Foreign Direct Investment allows for the possibility of channeling resources to developing countries as it is becoming an important source of funds at a time when access to other means of finance is dwindling, particularly in the aftermath of the international debt crisis that emerged in the early 1980’s. Lastly, Foreign Direct Investment is believed to potentially play a key role in the transformation of communist countries as Foreign Direct Investment compliments domestic savings and contributes towards the total investment in the host economy.
Types of Inward Foreign Direct Investment
Inward Foreign Direct Investment mainly occurs in three different forms, namely; ‘Greenfield investments’ which takes place when the investing firm establishes new production, distribution or other facilities in the host country which is normally valued for its job-creating potential and value-added output, ‘mergers and acquisitions’ which is when the investment firm acquires an already established firm in the host country as it may be cheaper than a Greenfield investments and also allows the investing firm to gain quick access to the market, and lastly inward Foreign Direct Investment may also occur in the form of a ‘joint venture’ with either a host firm or government institution, as well as with another company that is foreign to the host country.
The Effects of Foreign Direct Investment
The effects of inward Foreign Direct Investment to the host country will be discussed in greater detail over the course of this article, and maybe classified as ‘Economic’, ‘Political’ and ‘Social’ effects which may lead to costs and benefits to the host economy. The economic effects of Foreign Direct Investment are primarily concerned with variables such as the economic output, the balance of payments (BOP), and the market structure. The political effects are those that may involve the security of national sovereignty as the investing capacity of multinational corporations may be significant enough to influence or compromise national independence. Lastly, the social effects are those that are mainly concerned with the creation of enclaves and a foreign elite society in the host country, as well as having cultural effects on the local population which are more likely to arise if there are perhaps significant economic, political and cultural differences between the investing country and the host country.
Macro-economic Effects of Foreign Direct Investment
The economic effects of Foreign Direct Investment may be further classified into macro-economic effects and micro-economic effects. The usual convention when analysing the macro-economic effects of inward Foreign Direct Investment is to consider it as though it were an increase in foreign borrowing as this may lead to an increase in output and income in the event of a shortage in employment and capital. This practice is common among developing countries because they typically encounter difficulties increasing their savings to match their investment needs and the financing of imports through export earnings as a result of the ‘savings gap’ and ‘foreign exchange gap’ in their economies[4].
Microeconomic Effects of Foreign Direct Investment
The micro-economic effects of Foreign Direct Investment on the other hand, are mostly concerned with structural changes in the economy and industrial organisations as it is important to identify whether the inward Foreign Direct Investment will lead to the creation of a more competitive environment or lead towards the creation of monopolistic or oligopolistic elements in the host economy[5]. The net impact of inward Foreign Direct Investment generally tends to be positive as it leads to an increase in the flow of financial resources available for investment. It must be noted however, that Lall and Streeten (1977) cast doubt on the ability of Foreign Direct Investment to supplement the host country’s provision of capital because Foreign Direct Investment may be considered relatively expensive as capital inflow provided by the multinational corporations may not always be very large but they may still use their influence to source ‘cheap’ funds and crowd out other activities in the host country that may be considered socially desirable[6].
Impact of Foreign Direct Investment on the Balance of Payments Accounts
As previously stated, Foreign Direct Investment is a desirable source of foreign exchange which countries, particularly developing economies, may consider to be a scarce resource. The balance-of-payments accounts of a country records the payments and receipts of the residents of the country in their transactions with residents of other countries. Where balance-of-payments is concerned, the initial ‘one-off’ effect leads to an improvement in the capital account of the host country by the amount invested less the value of any imported machinery and may also lead to a ‘continuing’ effect in the economy[7]. In general, Foreign Direct Investment is often blamed for its balance-of-payments effect in which the investing country may be faced with a sudden deficit when the initial investment occurs while the host country may be left to face a small perpetual deficit as a result of profit repatriation in foreign currencies which normally tends to result in greater outflows of the balance-of-payments accounts than if a similar project was financed domestically.
Impact of Foreign Direct Investment on Employment
Keynes (2016) suggests there exists a direct relationship between investment and employment, therefore, having a direct impact on employment and wages[8]. This is supported by Moosa (2002) who identified three main effects of Foreign Direct Investment on employment and wages. The first of which being that Foreign Direct Investment has the capacity to increase employment directly by starting up new facilities or by indirectly stimulating employment in distribution through its activities. Furthermore, foreign investors recognize the need to train their local employees as remuneration for expatriate employees tends to be significantly higher than local employees. The second is that Foreign Direct Investment can preserve employment by acquiring and restructuring ailing firms. Lastly, Foreign Direct Investment can also have negative effects such as the reduction in employment by means of divestment or the closure of production facilities.
Technology Diffusion
The relationship between Foreign Direct Investment and technology is considered to be particularly important as ‘technology diffusion’ plays a central role in the process of economic development[9]. For this reason, technology diffusion in favour of the host country, is being supported by the ‘Organisation for Economic Co-operation and Development’ (OCED) to ensure that the multinational corporations activities are agreeable with the plans of the host country, adopt practices that allow the transfer and rapid diffusion of technology, address local market needs in an exercise pertaining to technology, license technology on reasonable terms and conditions, and to develop ties with local universities and research institutes. However, despite the OCED’s efforts to promote technology diffusion, most multinational corporations pass on older technologies which are usually too capital intensive for the local economy[10]. If capital intensive technology in relation to factor endowment is indeed passed on to the host country, then technology transfer could result in deteriorating employment rates, worsening of income inequality, distorting influences on the technology used by other firms, and bias in production towards sophisticated and differentiated products.
Conclusion
In conclusion, it is clear that there is evidence to suggest that Foreign Direct Investment may provide opportunities for the host country to benefit economically from the aforementioned investment and operational activities from the multinational corporations. However attractive the allure of inward Foreign Direct Investment may be, the host countries should at the very least be aware of the of the negative externalities associated with the corresponding investment so as to make an informed decision or exercise their negotiating power to ensure both parties enjoy a mutually beneficial relationship.
Disclaimer: Chisha Mwanakatwe. Jr is a Consultant with KPMG Zambia and holds degrees in International Business (MSc) and Economics (BA) but the views expressed therein are his own and not necessarily those of KPMG. |
[1] Lipsey, R. E., & Sjöholm, F. (2005). The impact of inward FDI on host countries: why such different answers?. Does foreign direct investment promote development, 23-43.
[2] Lall, S., & Streeten, P. (1977). Foreign investment, transnationals and developing countries. Springer.
[3] Moosa, I. A. (2002). Foreign direct investment: Theory, evidence, and practice. Basingstoke: Palgrave.
[4] Moosa, I. A. (2002). Foreign direct investment: Theory, evidence, and practice. Basingstoke: Palgrave.
[5] Moosa, I. A. (2002). Foreign direct investment: Theory, evidence, and practice. Basingstoke: Palgrave.
[6] Lall, S., & Streeten, P. (1977). Foreign investment, transnationals and developing countries. Springer.
[7] Stein, H. (2008). Balance of payments. The Concise Encyclopedia of Economics.
[8] Keynes, J. M. (2016). General theory of employment, interest and money. Atlantic Publishers & Dist.
[9] Moosa, I. A. (2002). Foreign direct investment: Theory, evidence, and practice. Basingstoke: Palgrave.
[10] Moosa, I. A. (2002). Foreign direct investment: Theory, evidence, and practice. Basingstoke: Palgrave.