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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Questions and Answers Ask our experts your Economics related questions here... Ask 200 Characters left Why has most foreign direct investment gone into acquiring existing companies rather than establishing new ones? How many countries are developing countries ? What are the developing countries in the world ? Rate this Article 1 2 3 4 5 vote(s) 0 vote(s) Feedback RSS Print Email Re-Publish Source:  http://www.articlesbase.com/economics-articles/significance-of-foreign-direct-investment-on-developing-countries-5595798.html Article Tags: foreign direct investment Related Articles Latest Economics Articles More from Abey Francis Foreign Direct Investment

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The Least Developed Countries as the Net Exporters of Capital to the Developed World Posted By : Wolassa L. Kumo

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The Least Developed Countries as the Net Exporters of Capital to the Developed WorldBy: Wolassa L. Kumo

    

[ Posted On: 2011-05-22 ]  
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Dr. Wolassa KumoIntroduction

A Report by the United Nations Development Programme released in May 2011 revealed that the world's 48 Least Developed Countries (LDCs) of which 33 are in sub Saharan Africa, 14 in Asia and 1 in Latin America and the Caribbean, illegally transferred a net capital of about US$197 billion mainly to the developed world between 1990-2008. During this period, all the 48 LDCs received about US$118 in remittances and about US$94 billion in new loans, Foreign Direct Investments (FDIs) and other related capital inflows while they paid back US$162 billion in debt services leaving them with net capital inflows of US$50 billion. However, this was sharply offset by a gross massive illicit capital flight estimated to be about US$246 billion for the period stated. This could have wiped out the entire LDC debt of about US$155 billion in 2009 with over US$91 billion being saved for investment in economic development.

These illicit financial flows involve the cross boarder transfer of the proceeds of corruption mainly by local kleptocracies; trade in contraband goods and criminal activities by local households and businesses; and tax evasion mainly by multinational corporations.

The Report identifies three major drivers of illicit capital flows from LDCs. Macroeconomic drivers, structural challenges and overall governance. Macroeconomic factors such as high fiscal deficit, high and volatile inflation rates, overvalued real effective exchange rates, negative real interest rates, low real GDP growth and high indebtedness are believed to positively contribute to higher illicit capital flows. So do structural weaknesses such as growing income inequality, increasing trade openness without adequate regulatory oversight, as well as, poor overall governance including corruption, inimical business climate, prevalence of the shadow economy and political instability.

The Report emphasizes further that the illicit capital flows from the LDCs vary both by region and structural characteristics. The following section describes the regional pattern of such flows.

The Regional Pattern of Illicit Capital Flows

Regionally, about 69% of the total illicit capital flows originates from the 33 LDCs in sub Saharan Africa while about 29% originates from the 14 Asian LDCs. Latin America and the Caribbean contribute the remaining 2%. Among the top ten exporters of illicit capital, 6 countries belong to Africa while 4 belong to Asia. One of the poorest countries in Asia, Bangladesh is the world's top exporter of the illicit capital with the cumulative outflow of US$ 34.8 billion followed closely by Angola, Africa's second largest oil reducer, with a cumulative outflow of US$34 billion during 1990-2008. This accounted for about 11% and 3.4% of Angola's and Bangladesh's GDP during the period respectively.

The Report indicates that trade mispricing accounts for about 65-70% of the illicit capital flows from all LDCs while unrecorded leakages from the balance of payment accounts for the remainder. The Report stresses further that in countries with weak overall governance, i.e. high corruption, and low transparency and accountability, trade mispricing increases with increasing trade volume exacerbating further the illicit capital outflows.

Structural characteristics such as being landlocked or small island nation LDC does not necessary imply higher illicit capital outflows.

Illicit Capital outflows from sub Saharan Africa

The 33 LDCs from the world's least developed continent, Africa, exported a net illicit capital of US$135 billion to the developed world during 1990-2008 alone. And previous estimates suggest that the African continent as a whole had exported roughly about US$1.8 trillion in illicit capital outflows during the past 50 years while it received roughly about US$ 1 trillion in all forms of international capital inflows. Africa therefore was a net exporter of roughly US$ 0.8 trillion during the past half century. This massive loss of capital to the rest of the world explains why the continent remained the poorest and the least developed region in the world. After over 50 years of decolonization Africa's resources continue to fuel development in advanced economies, while the owners of the resources on the continent, the broad masses, continue to languish under perpetual poverty.

The six countries in Africa which are among the top ten exporters of illicit capital include: Angola (US$34 billion), Lesotho (US$16.8 billion), Chad (US$15.4 billion), Uganda (US$8.8 billion), Ethiopia (US$8.4 billion), Zambia (US$6.8 billion) and Sudan (US$6.7 billion). It is saddening to observe that a small, land locked country of Lesotho with a total population of about 2 million lost a staggering amount of capital totaling US$16.8 billion in illicit capital outflows during the past 19 years. Equally astonishing is the size of the illegal capital flight from Ethiopia, the country often regarded as one of the poorest countries in the world in terms of per capita income, although the size of its GDP ranks it as the 86th biggest economy in the word.

Ethiopia cannot afford to export US$8.4 billion illegally aboard while the country is unable to feed close to 5 million of its citizens every year bad weather befalls on it.

Angola, Chad, Zambia and Sudan's size of illicit capital flight is a symptomatic of the natural resource curse and reflect the need for the governments to take urgent actions to improve transparency in their extractive industries.

Other net exporters of illicit capital from sub Saharan Africa include Equatorial Guinea (US$6.5 billion), Liberia (US$5.8 billion), Guinea (US$4.9 billion), Malawi (US$4.2 billion), Djibouti (US$3.9 billion), Mozambique (US$3.8 billion), Madagascar (US$3.7 billion), Congo Democratic Republic (US$3.5 billion), Burkina Faso (US$ 2.9 billion), Tanzania (US$2.3 billion), Sierra Leone (US$2.1 billion), Mali (US$1.7 billion), Gambia (US$1.6 billion), Rwanda (US$1.6 billion), Central African Republic (US$ 1 billion), Niger (US$1 billion), Burundi (US$ 969 million), Guinea Bissau (US$847 million), Togo (US$ 678 million), Mauritania (US$ 428 million), Senegal (US$ 334 million), Benin (US$264 million), Comoros (US$ 154 million), Sao Tome and Principe (US$142 million), and Eritrea (US$118 million).

Equatorial Guinea, one of the largest oil producers in Africa, is in fact not a least developed country in terms of the size of its GDP per capita. With GDP per capita of over US$ 16000, it is the only non-OECD high income country in Africa. However, due to weak overall governance that resulted in illicit capital outflows of over US$6.5 billion over the past 19 years, among other things, nearly 77% of its citizens live under abject poverty. Equatorial Guinea is not even a member of Extractive Industries Transparency Initiative while other countries such as Liberia and Mozambique are making necessary efforts to improve transparency and accountability in the use of revenues from natural resources.

The preceding figures of net illicit capital outflows from the world's least developed countries partly explain why these countries remained poor. The constant rhetoric of aid and FDI to Africa is nothing more than a cheap political propaganda. Poor countries like Ethiopia and Lesotho have been subsidizing economies of the developed nations for the past 50 years at the expense of millions of their own citizens who go to bed every day without a single meal.

It is now abundantly clear that the west not only cannot save Africa, to use the wise words of Professor William Easterly, but in fact is helping the kleptocraceis to kill the continent's people by facilitating the robbery of its meager resources.

Concluding remarks

In spite of continued inflows of aid, foreign direct investments and remittances, the least developed countries of the world continue to be the net exporters of capital to the developed world which denies them crucial resources needed to provide jobs, alleviate poverty and enhance economic development. Cross border illicit outflows of proceeds of corruption by African kleptocracies, contraband trade and criminal economic activities by households and businesses and tax evasion by multinational corporations fueled by structural weaknesses, macroeconomic instability and poor overall governance by the least developed countries led to loss of nearly US$ 200 billion in net capital during the past 19 years. This could have wiped out the entire LDC debt stock of about US$155 billion estimated in 2009 leaving billions of net resources for further investment.

Africa is the hardest hit with nearly 70% of the stated net capital loss originating from the LDCs in sub Saharan Africa.

The UNDP report on illicit capital flows shed new light on challenges of underdevelopment in LDCS and particularly in Africa. The fundamental challenge for the LDCs in Africa and elsewhere is to put effective measures in place to improve overall governance including democratization, fighting corruption and improving transparency and accountability in the generation and use of revenues from natural and other resources, promoting inclusive economic growth, ensuring macroeconomic stability and implementing effective mechanism for trade regulation.

The proliferation of free trade areas with neighbors or the west will not bring sustainable development if the bulk of locally mobilized resources continue to be lost in illicit outflows due to unregulated open trade.

Neither will tax holidays for few FDIs. Continued provisions of tax holidays for multinationals would result in double loss of capital if there is no effective mechanism to control tax evasion by those who have already graduated from the incentives.

The developed world would help the LDCs escape from the vicious circle of poverty not by promising more aid, and technical assistance but by closing down the offshore capital safe havens most notably the Swiss Banks which have continued to gladly receive stolen funds from the Africa's hungry people.

And it is only when Africans stop stealing from their own poor and the west stops aiding and abating the kleptocracies and be part of the process that the least developed countries will ever develop.

References

UNDP: Illicit Financial Flows from the Least Developed Countries: 1990-2008. Discussion paper: May 2011

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About The Author: Dr. Wolassa L. Kumo -- is a development practitioner and researcher. His research interests include risk and uncertainty, productivity and efficiency, finance and investment, currency substitution and development problems of Africa. Currently, he is working as a researcher in a public institution with a primary responsibility in econometric modelling. Previously, he taught Principles of Economics in an academic institution. before and after the --> | View Profile & All Articles By: Wolassa L. Kumo |

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