Is FDI always beneficial for developing countries?

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The impact of foreign direct investment (FDI) on development is a much-debated topic. Over decades, many international financial institutions, such as the World Bank and the IMF, have increasingly promoted FDI. However, on the other hand, many NGOs, labor unions and civil society groups have emphasized the negative effects of FDI. Thus, to answer this question, we should always consider both of the pros and cons of FDI.

 Written by Ting Chen

In principle, foreign direct investment is usually considered the most desirable form of capital inflows for developing countries. It directly adds capital stocks to host countries, and therefore contributes to investment and growth in host countries through various channels

The mainstream economic argument in favor of FDI is the existence of positive spillovers. It is argued that domestic companies benefit from the information and knowledge about advanced technology, marketing and management techniques that MNCs bring into the host country. Spillovers may occur through various channels, such as the movement of employees from MNCs to domestic companies and the technical support of MNCs to domestic suppliers.

In contrast, positive spillover effects
are limited in some sectors because these MNCs are powerful and less regulated, and therefore have little incentive to invest in training and education of their workers. In addition, instead of joint venture with local firms, MNCs usually set limited linkage with the local economy, demonstrated by large numbers of foreign employees and heavy reliance on imports for machinery and intermediate products. If that were the case, MNCs would take advantages on host countries without making contribution to human capitals.

Further, FDI is believed to ‘crowd in’ domestic investment. In general, crowding in takes place when MNC presence stimulates domestic investment which otherwise would not have occurred. This happens, for instance, when MNCs purchase intermediates and raw materials from local suppliers or when spillovers lead to the expansion of local firms. Yet, on the other hand, FDI can also ‘crowd out’ investment, when local competitors are driven out of the market.

FDI may also have social and environmental consequences. The main social argument in favor of FDI is that it creates employment. But critics argue that there can be limited creation of employment, or even a decrease in employment if local firms are driven out of the market when competition is increased, or acquired companies are rationalized after takeovers.

In addition, foreign investment also impacts on human
and labor rights. Proponents have emphasized that MNCs bring best-practice social standards to host countries. 
In contrast, critics have argued that MNCs only engage in a ‘race to the bottom. Such behavior only results in a deterioration of basic labor rights, such as the prohibition of trade unions and the right to collective bargaining, diminishing working conditions,
or even outright violations of human rights.

Finally, it is argued that MNCs diffuse information on clean production technologies to developing countries. In addition, general knowledge spillovers may improve the efficiency of domestic firms, in turn, leading to a reduction in pollution and production of waste. Again, civil society organizations have refuted this argument, referring to evidence of severe pollution and environmental destruction, mostly caused by companies in the extractive and energy sector.

After this long analysis of FDI’s advantages and disadvantages, I would say in theory, FDI may have a positive economic, social and environmental impact on developing countries. But more importantly, in most developing countries, the impact of FDI is only limited or even negative. So, should we advocate or against FDI in developing countries? My answer is: “it depends.”

Source:

https://www.imf.org/external/pubs/ft/fandd/2001/06/loungani.htm

http://www.etsg.org/ETSG2012/Programme/Papers/204.pdf

http://somo.nl/publications-en/Publication_2478

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