Essay on Foreign Direct Investment

4588 Words May 13th, 2012 19 Pages
Determining FDI Potential:
Are National Policies and Incentives Sufficient?

Foreign direct investment (FDI) is increasingly becoming a preferred form of capital flows to developing countries in recent years, as compared to other forms of capital flows. The reasons for this are not hard to seek. In the context of the gloom and despair of the heavy debt burden plaguing these countries, FDI promises to be the bright ray of hope for harnessing capital flows to the country’s economic development without the pangs of capital repayment with interest. In this context Feldstein and Razin (2000) and Sodka (forthcoming) note that the gains to host countries can take several other forms: • FDI allows transfer of capital and technology,
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The greater the supply and distribution links between foreign affiliates and domestic firms, and the stronger the capabilities of domestic firms to learn from the presence and competition from foreign firms, the more likely it is that the qualities/attributes of FDI that enhance productivity and competition will spread.
Recent evidence
A comprehensive study by Bosworth and Collins (1999) on the effects of capital inflows on domestic investment for 58 developing countries during 1978-1995 covering nearly all of Asia and Latin America as well as most of Africa finds that an increase of one dollar in capital flows is associated with about 50 cents increase in domestic investment, while the ratio is about one-for–one between FDI and domestic investment. There is virtually little or no impact or relationship between portfolio inflows and investment.

FDI has also proved to be resilient during financial crises. Loungani and Razin (2001) point out that such investment was remarkably stable in East Asian countries during the global financial crises of 1997-98 in contrast to portfolio equity and debt flows, which were subject to large reversals during the same period.

UNCTAD, in its recent World Investment Report, asserts that FDI has the potential to generate employment, raise productivity, transfer foreign skills and technology, enhance exports and contribute to the long-term economic

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