FDI in developing countries

FDI in developing countries



FDI in developing countries

Introduction

Foreign direct investment occurs when a firm invests resources in business activities outside its home country. Many barriers to international trade took the form of high tariffs on imports of manufactured goods. Such tariffs aimed to protect domestic industries from "foreign competition". In addition to reducing trade barriers, many countries have also been progressively removing restrictions on barriers to foreign direct investment (FDI). According to the United Nations, between 1991 and 1996 more than 100 countries made 599 changes in legislation governing FDI.

Some 95 percent of these changes involved liberalizing a country's foreign investment regulations to make it easier for foreign companies to enter the markets. Governments' desire to facilitate FDI has also been reflected in a dramatic increase in the number of bilateral investment treaties designed to protect and promote investment between two countries. Although foreign direct investment (FDI) contributes to growth in developing countries, there is evidence that the benefits are not equally distributed. Foreign-owned firms tend to pay higher wages in developing countries, but skilled workers tend to benefit more than less-skilled workers. This conclusion is based on new research conducted into the effects of FDI on wages in five East Asian economies and the effects of foreign ownership in five African countries. While FDI may support development in the aggregate, more attention should be focused on the distribution of gains from FDI, notably effects on wage inequality.

Discussion

The issue Foreign Direct Investment (FDI) is an important source of private capital for developing countries. The UN conference on Finance for Development (FfD) argues that `private international capital flows, particularly foreign direct investment, along with international financial stability, are vital complements to national and international development efforts. Other international policy documents (e.g. the Cotonou Partnership Agreement, NEPAD) also emphasize the importance of private sector investment for development, both domestic and foreign, for development, and private sector investment features prominently in the UK White Paper Making Globalization Work for the Poor (DFID, 2000). An issue of current interest is whether FDI can contribute to the objective of reducing poverty. This will depend on how the gains from FDI are distributed, among sectors, workers and households. Systematic evidence on the effects of FDI on income distribution and poverty in developing countries is lacking. In principle, there is no direct link between FDI and poverty reduction this does not include `socially responsible' investment which may directly benefit the poor but there are three possible indirect links. If FDI contributes to export growth, productivity growth and finance for the balance of payments, it supports increases in national income that offer the potential to benefit the poor. In this case FDI does not reduce poverty directly, but it helps to create an enabling economic environment. If FDI increases employment it may help some to move out of poverty(Beng, p12).

With the exception of FDI in textiles, a lot of FDI in manufacturing is likely to employ labor that is relatively skilled (in terms ...