Foreign Direct Investment and Economic Growth



Foreign Direct Investment and Economic Growth

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October 19th, 2013.

Does Direct Foreign Investment speed up economic growth?

It is no doubt that foreign direct investment (FDI) especially in developing world has consistently gone up since the 1980s. Many economies have gone up to offer attractive tax incentives with a calculated aim of netting more foreign cash flow into their countries. However, what remains to be ascertained is, does FDI spur economic growth in a recipient country? Could there be other factors that must be prevalent in a given economy for it to realize positive economic transformation as a result of FDI? Theoretical; literature and empirical has provided divergent and pessimistic predictions as pertains to the implications of direct foreign investment in a given country. The economic justification for the issuance of attractive tax incentives to penitential foreign investors is always informed by the mere belief that FDI comes with beneficial economic growth stimulants like; technological advancements, highly trained and skilled personnel together with a different and unique approach to production matters. There is a strong possibility that the aforementioned, together with other factors can spur economic growth in an economy (Rommer 1993). However, some literature professes otherwise. Four instance, Breacher (1983) and Boyd and Smith (1999) gives a pessimistic prediction that growth effects of FDI will always be dictated by the already prevalent factors within the recipient country.

Firm-level research that has been conducted in some countries has shown that there is no tangible evidence that direct foreign investment has boosted the economic status of a given country.  For example, Hamson (1999) did not locate any serious positive implication of DFI on the recipient country’s economy-Venezuela. In fact, according to other researchers, like Germidis (1977) who notes that, direct foreign investment can be a source of other crude business practices like black market in an economy. 

FDI may not necessarily spur economic growth in a country perhaps due to a number of factors. 

One of the downfalls of FDI is profit repatriation. Levine, Loayza and Beck (2000) argue that number of studies have demonstrated how multi-national organizations, in collusion with corrupt officials have always circumvented legal loopholes to repatriate profits instead of re-ingesting in the recipient country. In such cases, it can be argued that, an organization can heavily invest in an economy. However, the most pertinent question is who will be benefiting from this investment. Therefore, to mitigate this, there ought proper policy frameworks to guide the stakeholders on what ought to be done.

In other instances is when foreign investors, after realizing that the terms of their tax incentives accorded to them is ending, they just pack their things and leave for other countries where they are likely to be offered the same tax incentives. In all these cases, the statistics are there to support capital flow to an economy yet the economy of these countries remains just the same or little growth can be noted.

According to Levine, Loayza; and T Beck (2000) the culture of impunity, corruption and other crude practices can also be other factors that can impede economic transformation as a result of direct foreign investment in a given country. These elements are very pronounced especially in developing world. Take an example of a country that has heavily attracted foreign investment but sadly ridden with corrupt tendencies. The foreign investor may have every intention of not only reaping profits but also positively transforming the economy of the recipient country. However, such noble undertakings of the investor may be overshadowed by the deep rooted corrupt tendencies in the country. In such case, will the investor be held liable as to why that specific country has not experienced economic growth?

The success of direct foreign investment on the economic growth of a country can also be dictated by political events in that particular economy. It is a bit unfathomable that some economies, especially sub-Saharan Africa economies like the Democratic Republic of Congo and others, have continued to lag behind economically yet they keep on receiving heavy direct foreign investment in form of cash flow. In such cases, the effects of FDI is always diluted and down played by issues like coups and counter coups, secessions attempts and other aspects that can compromise the security. Therefore, political developments in an economy can play an integral role in the determination of an economic growth path of a country and that direct foreign investment in a country does not guarantee economic success especially when political stability is elusive. Therefore, economies that are in anticipation of tapping FDI so as develop economically ought to ensure that strong institutions are in place so that FDI can contribute towards economic transformation of an economy and without which, FDI will remain a statistics and not an economic growth stimulant.

Studies have demonstrated that direct foreign investment will have a positive impact on an economy that has higher levels of human capital (Brecher 1983). This is because of the fact that this human capital will be vital in tapping and exploiting the technological advantages that are associated with direct foreign investment.

DFI when perceived from an international business setting will have some implications on the international financial management. Basically, international financial management entails the practice of carrying out trade that involves countries from different geographical areas. These effects in most cases will depend on the volume of foreign investment that is to be invested in a given economy. For instance, if the amount of foreign capital that is being invested in a given country is higher, the effect will be that, the business transaction that is involved in this case will be high and chances are that the profit margins will be high. Therefore, through this, it can be noted that increased capital in form of DFI will affect the international financial management in a positive way. However, when foreign investment is low, the implication will be that, there will be decreased international business meaning that even the profit margins will have to shrink. it is important that DFI is encouraged and it’s complementarities put in place so as to stimulate international financial transactions.

In summary, direct foreign investment especially in the developing world has been going up especially since the 1980s. These upward trends can be attributed to charm offensive measures that have been consistently adopted by respective governments so as to attract maximum direct foreign investments into their economies. These measures are always informed by a belief that FDI comes together with positive packages like; technological advancements, highly skilled manpower and unique approaches towards production matters that can be very beneficial in accelerating the economic growth of a country. Though many microeconomic studies have painted a dull and pessimistic picture of the real effects of direct foreign investment on an economy however, other studies have suggested otherwise.

Finally, after many statistical challenges have been overcome, it is clearly demonstrated FDI inflows critically depend on other prevalent factors like; political stability ethical behaviors and other factors for them to radically and positively transform the economies of the recipient countries

References

Brecher, R., 1983, “Second-Best Policy for International Trade and Investment,” Journal of

International Economics, 14, 313-320.

Levine, R.; N. Loayza; and T. Beck, 2000, “Financial Intermediation and Growth: Causality and

Causes,” Journal of Monetary Economics, 46, pp. 31-77

Romer, P., 1993, Idea gaps and object gaps in economic development. Journal of Monetary Economics 32, No.3.December.