Effects of Foreign Direct Investments (FDI)

What are the effects of Foreign Direct Investments (FDI) on economic growth in developing countries?

What’s Foreign Direct Investment?

According to the IMF, FDI is defined as the decision to invest by a resident entity of one economy (direct investor) in an enterprise that is resident in another economy (the direct investment enterprise). The aim of this investment is to establish long-term relationship between the direct investor and the direct investment enterprise and to exert significant degree of influence on the management of the latter investment enterprise (Duce, 2003).

Why is it so important?

Foreign Direct Investment has been growing over the last four decades. Developing countries are increasing implementing policies that attract FDI and trade and dropping their dependency on aid, while developed countries are competing for FDI by offering firms incentives in the form of subsidies and tax breaks in order to attract investments and promote growth (UNCTAD, 1996). As a result, FDI has become the favoured investment attraction policy tool for many countries throughout the world as it’s considered to lead to:

  • Technology transfers in the form of knowledge spill-over
  • Innovation and efficiency in firms
  • Improves competition and productivity in the economy.
    What role does it play in economic growth?

Since the world economy is increasingly becoming knowledge-based and scarce skills are in short supply, many countries in the developing world are trying to find ways to attract investments in knowledge production and skills development. This is where FDI comes into the play.

FDI creates positive externalities in the form of knowledge spillover, thus filling crucial “idea gaps” between rich and poor countries and helping transfer crucially needed technological knowhow to poor countries (Romer, 1993).

As mentioned in the preceding paragraphs, this knowledge spill-over improves the level of innovation, efficiency and competitiveness in the receiving country, thereby enhancing productivity and growth in the economy. There are, however, researchers who disagree with this conclusion, arguing that benefits can only be realized if the labour force of the receiving country is educated.

Why I’m interested in this topic

As a result of the many benefits associated with FDI, I’m interested in exploring the role it plays in accelerating economic growth in the developing world, particularly in Africa which is where I’m from. The African continent is rich in resources and emerging economically. Consequently, many countries in Africa have been promoting FDI policies in order to transform their economies. Therefore, I want to investigate whether literature on this subject confirms empirical evidence and analysis. I plan to complete this project during the course of this semester.

Method

I will use for this research cross-sectional data with subsequent diagnostic test. Data will be based on over 50 observations of developing countries that are 10 years average. This data will be collected from World Bank data-base and other relevant bodies.

References:

Duce, M. (2003). Definitions of Foreign Direct Investment (FDI): a methodological note.

UNCTAD (1996). Incentives and Foreign Direct Investment, Current Studies, Series A, No. 30, New York and Geneva: United Nations.

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

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