Foreign Direct Investment (FDI) is an investment involving a long-term
relationship and reflecting a lasting interest and control by a resident entity in one
economy (foreign direct investor or parent enterprise) in an enterprise resident in an
economy other than that of the foreign direct investor (FDI enterprise or affiliate
enterprise or foreign affiliate). FDI implies that the investor exerts a significant degree
of influence on the management of the enterprise resident in the other
economy. Such investment involves both the initial transaction between the two
entities and all subsequent transactions between them and among foreign affiliates;
both incorporated and unincorporated. FDI may be undertaken by individuals as well
as business entities (UNCTAD, 2000). FDI is widely viewed as an important
catalyst for the economic transformation of the transition
economies. The most widespread belief among researchers and policy makers is that FDI boosts growth
through different channels. It increases the capital stock and employment,
stimulates technological change through technological diffusion and generates
technological spillovers for local firms. As it eases the transfer of technology, foreign
investment is expected to increase and improve the existing stock of knowledge in the
recipient economy through labor training, skill acquisition and diffusion. It contributes
to introduction of new management practices and more efficient organizations of
the production processes which, in turn, would improve productivity of host
countries and stimulate economic growth.
The advent of endogenous growth models
(Romer, 1986, 1987; Lucas, 1988; 1990; and Mankiw et al., 1992) considered FDI that would contribute significantly to human capital such as managerial skills
and Research and Development (R&D). Multinational Corporations (MNCs) can have
a positive impact on human capital in host countries through the training
courses they provide to their subsidiaries' local workers. The training courses
influence most levels of employees from those with simple skills to those who
possess advanced technical and managerial skills. Research and development
activities financed by MNCs also contribute to human capital in host countries, and
thus, enable these economies to grow in the long-term (Balasubramanyam et al., 1996; and Blomstrom and Kokko
1998). By and large, there is a direct relationship
between inward FDI in relation to their size and economic development of a
country. One of the strongest statements in that connection was made by Romer (1993)
who suggested that for a developing country that wishes to gain on the
developed countries, or at least keep up with their growth "...one of the most important
and easily implemented policies to give foreign firms an incentive to close the idea
gap, to let them make a profit from doing so...The government of a poor country
can therefore help its residents by creating an economic environment that offers
an adequate reward to MNCs when they bring ideas from the rest of the world
and put them to use with domestic resources".
On the other hand, the FDI can exert a negative impact on economic growth
of the recipient countries. The dependency school theory argues that foreign
investment from developed countries is harmful to the long-term economic growth of
developing nations. It asserts that First World nations became wealthy by extracting
labor and other resources from the Third World
nations. It also argued that developing countries are inadequately compensated for their natural resources and
are, thereby, sentenced to conditions of continuing
poverty. This kind of capitalism based on the global division of labor causes distortion, hinders growth, and
increases income inequality in developing countries (Stoneman, 1975; Bornschier, 1980;
and O'hearn, 1990). Further, the neoclassical growth models of Solow (1956)
typically ascribe negligible long run growth effects for FDI inflows and, with its
usual assumption of diminishing returns to physical capital, these inflows can only
have short run impacts on the level of income, leaving long run growth
unchanged. Moreover, FDI flows may have a negative effect on the growth prospects of
a country if they give rise to substantial reverse flows in the form of remittances
of profits and dividends and/or if the MNCs obtain substantial tax or other
concessions from the host country. These negative effects would be further compounded if
the expected positive spillover effects from the transfer of technology are minimized
or eliminated altogether because the technology transferred is inappropriate for
the host country's factor proportions (e.g., too capital intensive); or, when this is
not the case, as a result of overly restrictive intellectual property rights and/or
prohibitive royalty payments and leasing fees charged by the MNCs for the use of
the `intangibles' (see Ramirez, 2000; and Ram and Zhang, 2002). |
