Positive and Negative Impact

of FDI inflow to the

competitive advantages of
Host countries

AbstractIn last decades the importance of Foreign Direct Investments (FDI) has increased
significantly due to globalization process, which offers huge opportunities for
mostly developing countries to reach faster economic growth through trade and
investment.
Developing countries have started to see FDI as a source of economic
development and modernisation, income growth and employment. These nations
have liberalised their investment regimes and followed other policies to attract
more FDI.

IntroductionForeign direct investment (FDI) is an important element of international

economics; the flow of capital, technology, knowledge and skills across national
boundaries creates opportunities for host countries, particularly for developing
countries to 'catch up with others.
The literature linking FDI and economic development in the host economy mostly
addresses spillover productivity effects via the dissemination of innovations on
locallyowned firms

Factors influencing FDI1) The extent to which the foreign investment can contribute to the economic
growth depends on a variety of factors. One of them is the host country
characteristics, called "absorptive capacity", - a capability of the host
economy to benefit from technological spillovers from the more
industrialized nations and the ability to accumulate and best utilize
technology and knowledge
2) Trade openness, which is a measure of the competition level in the local
country, also positively influences the level of FDI contribution to growth.
Countries with more open trade policy have less market distortions, high
level of efficiency and competition which enhance the spillover effects of
FDI
3) The level of technological sophistication and human capital stock in the
host country is also one of the main factors of FDI impact on growth. It has
been found that FDI raised the growth in those countries that reached a
minimum threshold level of technological sophistication or the stock of
human capital
4) Other determinants include economic power, industry, type of FDI, and
regional integration, industry specialization, market size, R&D,
geographical location, FDI policy of host country and etc

Positive and Negative effects of FDI in lieu of the below

mentioned factors/scenarios-

1) Domestic EntrepreneurshipRates of entrepreneurship usually go handinhand with competition in the

economy; and both of them contribute strongly to the level of innovation and
technological progress that are vital to economic performance. As a result,
domestic entry may be seen as an important transmission channel to diffuse
technology, human capital and managerial skills accompanying FDI into the host
economy.
For example, skilled workers, innovators and managers might receive their
training and work experience within a foreign firm and then quit to create a new
firm. On the demand side, foreign firms might require higher quality or asset
specific products which can be supplied by new entrants more effectively than
existing firms.
On the other hand, foreign firms may exploit their superior market position in the
domestic and global marketplace to crowd out domestic entrepreneurs. For
example, if they pay higher wages to workers, they will influence the tradeoff
between employment and selfemployment in favor of the former. They may
divert a significant amount of domestic factor endowments (e.g. finance,
managerial and skilled labor) to themselves, raising the costs of entry for
potential local entrepreneurs. Finally, if they act to increase domestic market
power, this will result in higher entry barriers.
2) EfficiencyFDI's contribution to human capital in host countries is significant. MNEs increase
workplaces, thereby reduce the unemployment in the host country. They usually
provide higher wages and working conditions due to their higher productivity
which is explained by greater technological know-how and modern management
skills that enables them to compete effectively in foreign markets. The transfer
of technological and managerial know-how through affiliates also gives rise to
direct benefits and increases competitiveness in host countries. For example,
domestic employees can move from foreign to domestic firms. Local firms might
increase their productivity through learning from foreign firms by collaboration.
The presence of MNEs may also cause a useful demonstration effect, forcing the
government to invest in education more, as the demand for skilled labour by
these firms is very high.
As a further benefit, FDI can lead to technological development in host countries.
As long as MNCs incorporate and provide linkages to host country firms and
workers, then technological advancement will result in long-term economic
growth. Studies have shown that several newly industrialized countries acquired
technology from abroad, rather than "re-inventing the wheel." Although FDI is a
more expensive way to obtain technology when compared to direct purchasing
and licensing, if technology is obtained through FDI, then in reality there is no
cost to the host country and in many cases FDI is the only way for a host country
to obtain technology. Furthermore, FDI brings with it the skills and knowledge

necessary to make technology useful. Through the transfer of technical

knowledge, FDI enhances human capital. As MNCs employ local workers, their
skills and education levels will increase through training and on the job learning.
In addition, as MNCs set up operations in developing countries, local markets
that were initially monopolistic will generally become more competitive.
3) Political, Social and Cultural issuesFDI has the potential to cause cultural tension between the home country and
the host country. For example, in Asia, where Japan is slowly replacing theU.S.as
the leading provider of foreign direct investment in East Asia, cultural tensions
that were already in place before the economic boom in East Asia began, have
now been aggravated by the Japanese saturation of the East Asian market
(Economist, 1993) Although cultural tensions can be fairly benign in more
developed countries, in countries with unstable political environments, cultural
tensions can have destructive consequences. The most recognized cultural clash
has been the rejection of "Americanization" by several middle-eastern societies
that occurred before and after the Sept. 11 attacks on the WTC.
Although underdeveloped countries do not receive the majority of FDI flows, in
the absence of a stable political environment, which is more typical of an
underdeveloped country, the effects on the political structure can be greater
than those of more developed countries. Political unrest occurs in several ways.
In countries with newly instituted political structures, some people may view
foreign investment as an extension of imperialism. In other countries where there
exists a considerable discrepancy between the incomes of the poor and the elite,
FDI will be viewed as favoring the elite. Local entrepreneurs of underdeveloped
countries might view foreign investors as seizing valuable resources that belong
to the indigenous population. For MNCs involved in the removal of natural
resources, the locals may view the MNC as taking the host country's resources
without adequate compensation to the local population. In more traditional
cultures, rapid urbanization is seen as a threat to the local culture. In any of
these situations, an increase in FDI can lead to political conflict in the host
country.
Very few social, cultural or indeed economic factors actually matter in attracting
of FDI. The level of urbanisation matters to the almost total exclusion of all other
factors. Independent of wealth, family structure or cultural background, cities
attract investment and the countryside does not. The way to attract investment
therefore seems to be to encourage people to leave the countryside and move to
towns. This may itself have further policy implications, as the growth of the
megalopolis, already far further advanced in India than in many other countries
will certainly continue to have far-reaching effects, desirable or undesirable, on
social systems, behaviour and education. It may also be prudent to examine the
case for seeking to develop alternative, indigenous sources of investment for
rural areas.

Conclusion-

Although there are contradictory thoughts about the impact of FDI on the
economic growth, it is broadly believed that investments positively contribute to
the economic development of host countries. However, countries do not benefit
from the investments at the same level. Foreign investments are not
advantageous or disadvantageous by themselves. Their contribution depends on
the policy and behaviour of host country governments and MNEs.
The same foreign investment may bring lots of benefits to one country, while it
might be quite harmful for the other. Therefore, it does not mean that if you get
more FDI, your economy will boost

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