 Policy Debate: Does
foreign direct investment hinder or help economic development?
Issues and Background
...foreign investment brings higher wages, and is a major source of technology
transfer and managerial skills in host developing countries. This contributes to
rising prosperity in the developing countries concerned, as well as enhancing demand for higher
value-added exports from OECD economies.
~OECD Policy Brief No. 6, 1998
As investors search the globe for the highest return, they are often drawn to places endowed with bountiful natural resources but
handicapped by weak or ineffective environmental laws. Many people and communities are harmed as the environment that
sustains them is damaged or destroyed -villagers are displaced by large construction projects, for example, and indigenous
peoples watch their homelands disappear as timber companies level old-growth forests. Foreign investment-fed growth also
promotes western-style consumerism, boosting car ownership, paper use, and Big Mac consumption rates toward the untenable
levels found in the United States-with grave potential consequences for the health of the natural world, the stability of the earth's
climate, and the security of food supplies.
~ Hilary
French
One of the requirements for economic development in a low-income economy is an increase in
the nation's stock of capital. A developing
nation may increase the amount of capital in the domestic economy by encouraging
foreign direct investment (FDI). (Foreign direct investment occurs when foreign firms either
locate production plants in the domestic economy or acquire a substantial ownership
position in a domestic firm.)
Many developing economies have attempted to restrict foreign direct investment
because of nationalist sentiment and concerns about foreign economic and political
influence. One reason for this sentiment is that many developing countries have
operated as colonies of more developed economies. This colonial experience
has often resulted in a legacy of concern that foreign
direct investment may serve as a modern form of economic colonialism in which
foreign companies might exploit the resources of the host country.
In recent years, however, restrictions on foreign direct investment in
many developing economies have been substantially reduced as a result of
international treaties, external pressure from the IMF or World Bank,
or unilateral actions by governments
that have come to believe that foreign direct investment will encourage
economic growth in the host country. This has resulted in a rather dramatic
expansion in the level of foreign direct investment in some developing
economies.
Foreign direct investment may encourage economic growth in the short run by
increasing aggregate demand in the host economy. In the long run, the
increase in the stock of capital raises the productivity of labor and leads to higher
incomes (and further increases in aggregate demand). Another long-run impact,
however, comes through "technology transfer," the transfer of technological
knowledge from industrial to developing economies. Many economists argue that
this transfer of technology may be the primary benefit of foreign direct investment.
It is often argued, however, that it is necessary to restrict foreign direct
investment in a given industry for national security purposes. This serves as
a justification for prohibitions on investment in defense industries and in other
industries that are deemed essential for national security. Most governments,
for example, would be concerned if their weapons were produced by companies owned by
firms in countries that might serve as future enemies.
Environmentalists are concerned that the growth of foreign direct investment in
developing economies may lead to a deterioration in the global environment since
investment is expanding more rapidly in countries that have relatively lax
environmental standards. The absence of restrictive environmental standards, it is
argued, is one of the reasons for the relatively high rate of return on capital
investment in less developed economies. Technology transfer from the developed
economies, however, may also result in the adoption of more efficient and environmentally
sound production techniques than would have been adopted in the absence of foreign
investment.
This World Bank page contains links to research papers that investigate the determinants of foreign direct investment.
Primary Resources and Data
- OECD, "International Investments"
http://www.oecd.org/topic/0,2686,en_2649_34863_1_1_1_1_37467,00.html
This OECD web page contains a collection of links to statistics, working papers,
and other information related to foreign direct investment. Unfortunately, while a few OECD documents
are available on the web, most OECD publications are available only in print editions. This site, however,
provides descriptions of OECD studies that may be available in your college or university library. To
view most of the online documents available on this site, you will need the Adobe Acrobat plugin for your
browser. If this viewer is not installed on your computer, you may download it by clicking here.
- Overseas Development Institute, "Foreign Direct Investment Flows to Low-Income Countries: A
Review of the Evidence"
http://www.odi.org.uk/publications/briefing/3_97.html
In this September 1997 online document, the Overseas Development Institute examines the impact of foreign
direct investment spending in developing countries during the period between 1970 and 1996. This document
notes that foreign direct investment spending is relatively low in most low-income economies. Reasons
for this disparity in foreign direct investment spending are examined in this paper.
- Progressive Policy Institute, "Foreign Direct Investment Is on The Rise Around The World"
http://www.neweconomyindex.org/section1_page04.html
This page, provided by the Progressive Policy Institute, describes the increase in foreign direct investment
inflows and outflows that have occurred in the U.S., Germany, and Japan. A bar chart illustrates the expansion
of the role of foreign direct investment in these economies from the 1970s to the mid 1990s.
- Bureau of Economic Analysis, "US Direct Investment Abroad"
http://www.bea.gov/bea/di/usdiainc.htm
This table provides information on the levels of foreign direct investment by the U.S. in the rest of
the world from 1994 through 2006. This document also provides a breakdown of U.S. FDI by country and industry
for each of these years.
- Bureau of Economic Analysis, "Foreign Direct Investment in the United States"
http://www.bea.gov/bea/di/fdi21web.txt
This table provides information on the levels of foreign direct investment in the U.S. from 1994 through
2003. A breakdown of FDI in the U.S. by country of origin and industry is also provided for each of these
years.
- Bureau of Economic Analysis, "Direct Investment Positions for 2005"
http://bea.gov/bea/ARTICLES/2006/07July/0706_DIP_WEB.pdf
This document contains information about the total levels of foreign direct investment in the U.S. and U.S.
foreign direct investment in the rest of the world from 1982 until 2005. (To view this
document, you will need the Adobe Acrobat plugin for your browser. If this viewer is not
installed on your computer, you may download it by clicking here.)
- Magnus Blomström, Gunnar Fors, and Robert E. Lipsey, "Foreign Direct Investment and Employment:
Home Country Experience in the United States and Sweden"
http://www.iui.se/wp/wp490/wp490.htm
In this Stockholm School of Economics working paper, Blomström, Fors, and Lipsey compare the effects of
FDI on domestic employment in the United States and Sweden. This study is interesting in that it shows
substantial differences in the pattern of FDI expenditures by these two countries. U.S. foreign direct
investment tends to be focused on investments in relatively labor-intensive production in developing economies.
Swedish foreign direct investment tends to be focused on investment in developed economies. (While this
study is no longer available for downloading, the abstract available at this link provides an overview of the analysis.
The original paper is available in print in The Economic Journal, Vol. 107, No. 445, 1997.)
- OECD Country site
http://www.oecd.org/countrieslist/0,3025,en_33873108_33844430_1_1_1_1_1,00.html
This collection of links to OECD documents and studies relating to specific countries (both member and non-member countries are
included).
- Development Gateway
http://topics.developmentgateway.org
The Development Gateway is a project designed to share information concerning economic development. It was
begun as a World Bank initiative in 2001. This site contains links to an extensive collection of information
relating to economic development. Of particular interest is the collection of links to studies
dealing with foreign direct investment.
- Jeffrey A. Frankel, "Determinants of Long Term Growth"
http://ksghome.harvard.edu/~.jfrankel.academic.ksg/Apecgrow.PDF
In this November 30, 1997 paper, Jeffrey A. Frankel examines the evidence concerning the determinants
of long-term economic growth. This essay provides a very useful discussion of all of the major factors
(including FDI) that appear to be important in affecting the rate of economic growth. (To view this
document, you will need the Adobe Acrobat plugin for your browser. If this viewer is not
installed on your computer, you may download it by clicking here.)
- World Bank, "Foreign Direct Investment: New Trends in Transition Countries"
http://www.worldbank.org/html/prddr/trans/so99/pgs7-8.htm
This page containts a discussion of the effect of foreign direct investment in transition economies. Statistics are provided
on the levels of FDI in these countries.
- United Nations Conference on Trade and Development (UNCTAD), "Foreign Direct Investment"
http://www.unctad.org/Templates/StartPage.asp?intItemID=2527&lang=1
The United Nations Conference on Trade and Development provides links to statistics, data, the text of treaties, and research papers
related to foreign direct investment on this website. (These are available from the menu appearing on the left side of the screen.)
- World Bank, "Policies to Attract Direct Foreign Investment"
http://rru.worldbank.org/PapersLinks/Policies-Attract-Foreign-Direct-Investment/
This website, provided by the Wold Bank contains a list of suggestions that countries may use to increase
foreign direct investment in their economies. Links are provided to working papers, case studies,
and other websites that contain material that is relevant to this topic.
Different Perspectives in the Debate
- International Labour Organization, "Southern Strategies: Two-Pronged Approach"
http://www-ilo-mirror.cornell.edu/public/english/bureau/inf/pkits/wer3.htm
In this press release, the International Labour Organization argues that foreign direct investment
in physical capital alone is not the best strategy for improving the wellbeing of workers in the developing
economies. A balanced strategy is recommended that combines investments in physical capital with investments
in human capital. This article argues that unemployment and poverty programs should be introduced as part
of the development program.
The International Labour Organization also notes that most foreign direct investment spending in
developing economies goes to the 10 most advanced developing economies. Lower income developing
economies receive a very small share of FDI.
- Rainer Geiger, "An Investment Strategy for the New Millenium"
http://www.oecd.org/dataoecd/10/1/1952985.pdf
In this April 11, 2000 speech, Rainer Geiger argues that foreign direct
investment encourages economic development. He notes that privatization
and government reform help to facilitate investment and sustainable
development. (You will need the Adobe Acrobat plugin for your browser
to view this document. If this viewer is not installed on your computer,
you may download it by clicking here.)
- Center for International Private Enterprise, "Prosperity Paper Two: Attracting Foreign Investment"
http://usinfo.state.gov/products/pubs/archive/prosper/prosper2.htm
This article contains a discussion of the advantages of foreign direct investment. Although
it is primarily designed to convince foreign countries of the advantages of encouraging foreign
direct investment, this article also contains a good discussion of the history of barriers to
FDI. A discussion of factors that encourage FDI is also provided in this article.
- Fabienne Fortanier and Maria Maher, "Foreign Direct Investment and Sustainable Development"
http://www.natural-resources.org/.../FDI%20and%20SD.pdf
In this July 2001 OECD article, Fabienne Fortanier and Maria Maher examine the relationship between foreign direct investment
and environmental problems. They argue that foreign direct investment is not the cause of environmental problems. They
note, however, that multinational enterprises play an important role in determining
the pattern of investment spending when foreign direct investment is a major source of investment funding. Fortanier and Maher observe that these multinational enterprises have become
increasingly sensitive to public demands concerning environmental issues. Detailed statistics on
trends in foreign direct investment are also provided.
- Prakash Loungani and Assaf Razin, "How Beneficial Is Foreign Direct Investment for Developing Countries?"
http://www.imf.org/external/pubs/ft/fandd/2001/06/loungani.htm
Prakash Loungani and Assaf Razin examine the effects of foreign direct investment on economic development in this
June 2001 IMF article. They note that
foreign direct investment is a much more stable source of finance than internal funding in times of financial crisis. Loungani
and Razin note that this method of finance also results in human capital accumulation as workers receive training, the
transfer of state-of-the-art technology, and the use of environmentally sound production methods. They also discuss some
of the potential risks (such as adverse selection and "fire sales") associated with foreign direct investment.
- Jialin Zhang, "An Assessment of Chinese Thinking on Trade Liberalization"
http://www-hoover.stanford.edu/publications/he/he18.html
In this essay, Jialin Zhang, a fellow of the Shanghai Institute for International Studies and a
visiting scholar at the Hoover Institution, examines recent trends in China's trade
protection policy. He argues that Chinese policymakers have reduced restrictions on foreign
trade and foreign direct investment because they have recognized the advantages of the
resultant technology transfer.
- Shujiro Urata, "Japanese Foreign Direct Investment in Asia: Its Impact on Export Expansion and
Technology Acquisition of the Host Economies"
http://www.jcer.or.jp/eng/pdf/discussion53.pdf
In this March 1998 study, Shujiro Urata analyzes the extent of the technology transfer resulting from
Japanese foreign direct investment in Asia. He finds that the host economies experienced significantly
higher growth as a result of Japan's FDI. (You will need the Adobe Acrobat plugin for your
browser to view this document. If this viewer is not installed on your computer, you may
download it by clicking here.)
- Magnus Blomström and Ari Kokko, "The Impact of Foreign Investment on Host Countries: A Review of the Empirical Evidence"
http://www.worldbank.org/html/dec/Publications/Workpapers/WPS1700series/wps1745/wps1745.pdf
In this December 1996 World Bank working paper, Magnus Blomström and Ari Kokko provide a summary of
the results of studies of the effect of FDI on host countries. They find that there
is evidence that FDI benefits host countries by encouraging productivity growth and stimulating
exports. Blomström and Kokko, however, note that the impact of FDI varies across industries and
across economies. (You will need the Adobe Acrobat plugin for your
browser to view this document. If this viewer is not installed on your computer, you may
download it by clicking here.)
- Mark Vallianatos, "Multilateral Agreement on Investment"
http://www.fpif.org/briefs/vol2/v2n39mai_body.html
This article describes several concerns with the Multilateral Agreement on Investment. Vallianatos argues that
this agreement is flawed because it benefits corporate interests at the expense of the public interest.
He suggests that the MAI protects the interests of large multinational corporations at the expense of
workers and the environment in host countries.
- Nick Mabey and Richard McNally, "Foreign Direct Investment and the Environment:
from Pollution Havens to Sustainable Development"
http://csdngo.igc.org/finance/fin_WTO_FDI_mabey.htm
Nick Mabey and Richard McNally of the World Wildlife Federation discuss some of the
environmental problems associated with foreign direct investment in this online article. They
argue that the removal of
barriers to trade and capital mobility through international treaties has lead to a substantial
increase in environmental damage in developing economies. Mabey and McNally argue that resource
extraction and pollution intensive industries are more likely to migrate to those countries that
have fewer environmental restrictions. They argue that there is a need for more extensive international
regulation to reduce this problem.
- Hilary French, "In Focus: Capital Flows and the Environment"
http://www.foreignpolicy-infocus.org/briefs/vol3/v3n22env.html
In this article, Hilary French of the Worldwatch Institute addresses some of the environmental concerns
associated with the growth in foreign direct investment in developing economies. French argues that there
has been a massive inflow of foreign investment funds into economies with weak or ineffective environmental
laws. The author suggests that this environmental damage often directly reduces the quality of life received
by citizens in these developing economies. On the other hand, this foreign investment also provides these
countries with access to technology that is more efficient and produces less waste and environmental harm
than would exist under the production technology that would otherwise have been available in these economies.
French also argues that too many resources are being used to extract raw materials from developing
economies. The author suggests that this provides short-term benefits to political elites, but is not
in the long-term interest of the general population.
French suggests that there is a need for greater governmental involvement to ensure that foreign
direct investment in developing countries does not result in substantial harm to the global
environment. She argues that environmental standards should be required as a condition for
loan guarantee programs and other development aid programs provided by developed economies, the
World Bank, and the IMF.
- Allen Blackman, "New Investment Abroad: Can it Reduce China's Greenhouse Gas Emissions?"
http://www.rff.org/Documents/RFF-Resources-133-newinvest.pdf
Allen Blackman, a fellow at Resources for the Future, argues that foreign direct investment in
the Chinese electricity generating sector has substantially reduced greenhouse gas emissions from coal-powered
generating plants. Blackman suggests that foreign direct investment has provided China with both the technology
and the funds needed to introduce more efficient production methods in this sector of the economy.
(To view this document, you will need the Adobe Acrobat plugin for your browser. If this viewer is not
installed on your computer, you may download it by clicking here.)
- OECD, "Foreign Direct Investment and the Environment: An Overview of the Literature"
http://www1.oecd.org/daf/mai/pdf/ng/ng9733r1e.pdf
This December 1997 OECD report summarizes research findings on the relationship between FDI and the environment. It is noted that
there is no substantial evidence of a "race to the bottom" in terms of environmental standards. Concerns are expressed, though,
over the environmental consequences of the economic development that may be expected to result from FDI. (To view this
document, you will need the Adobe Acrobat plugin for your browser. If this viewer is not
installed on your computer, you may download it by clicking here.)
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