Significance of Foreign Direct Investment on Developing Countries

Posted: Jan 23, 2012 |Comments: 0 |

It has been increasingly recognized that growing foreign direct investment inflows can contribute to economic development and promise a variety of potential benefits to poor country recipients. Due to the potential role foreign direct investment can play in accelerating growth and economic transformation, many developing countries seek such investment to accelerate their development efforts. Consequently, foreign direct investment has become an important source of private external finance for developing countries.

The foreign direct investment can increase growth in two ways. The investment increases total investment by attracting higher levels of domestic investment. Also, through interaction of the more advanced technology with the host country's human capital, foreign direct investment is more productive than domestic investment.

Indeed, the most significant channel through which foreign direct investment contributes to productivity growth is perhaps increased access to technology, through market transactions such as joint ventures, licensing, and goods trade.

While foreign direct investment represents investment in production facilities, its significance for developing countries is much greater. Not only can foreign direct investment add to investible resources and capital formation, but, perhaps more important, it is also a means of transferring production technology, skills, innovative capacity, and organizational and managerial practices between locations, as well as of accessing international marketing networks. In addition, the foreign direct investment can improve overall growth by promoting competition in the domestic input market.

In particular, the foreign investment could increase competition in the host-country industry, and hence force local firms to become more productive by adopting more efficient methods or by investing in human and/or physical capital. Multinational firms' large size, advanced technology, and advertising expertise often enable them to invest in industries in which barriers to entry, such as large capital requirements coupled with trade restrictions, reduce the access of potential local competitors.

Multinational corporations can promote the transfer of technology, with possible spillovers to the rest of the host economy or domestic firms. Technology spillover is a channel through which capital account liberalization can have a positive impact. These spillovers are most clear in the case of foreign direct investment, especially through foreign firms incorporating new technologies in their subsidiaries. As new technologies are generally developed and adapted by firms in industrial countries, foreign direct investment may be the most efficient way for developing economies to gain access to them. In addition, this knowledge may become more widely available in the country over time, as employees with experience in the techniques used in foreign companies switch to other firms.

Furthermore, foreign direct investment can help boost host country exports. Multinational enterprises may help developing host countries process and export locally produced raw materials, using their marketing skills, superior technology, and general know-how. They facilitate the export of local production through their distribution networks, and they often account for a significant share of host country exports.

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