Benefits Of Fdi Direct And Indirect Economics Essay


Definition of FDI

Foreign Direct Investment ( FDI ) is defined as the allotment of resource packages ( combinations of physical, fiscal, human, cognition and reputational resources ) by an MNE in a host state, with the intent of executing concern activities over which the MNE retains strategic control in that state. ( Verbeke, 2009 pp. 31 )

Whereas increases in FDI Inflows are by and large seen as a agency of advancing economic development, some writers argue to the contrary. Kehl ( 2009 pp. 1 ) for case argues out that, “ There is a turning disagreement between the significant foreign investing in the underdeveloped universe and the thin resources available for domestic development. The planetary market entirely has failed to change by reversal this tendency. However, the size of the planetary economic system is expected to quadruple in the following 50 old ages, with the bulk of the growing in foreign direct investing ( FDI ) . This growing has the possible to increase the fiscal and capital resources available to advance development in hapless states. The enlargement of FDI offers developing states the chance to increase their integrating into the planetary market and to develop investing forms that maximize their possibilities for economic growing ”

Benefits of FDI – Direct and Indirect

Benefits of FDI are loosely categorised into two subdivisions:

Direct Benefits – Government Gross from Tax

Indirect Benefits – Technology Transfer etc. frequently referred to as spill over benefits.

Governments are frequently faced with the challenge of equilibrating direct and indirect benefits of FDI, as elaborated by Kehl ( 2009 pp. 22 ) . An effort to maximize direct benefits from Taxation for the intent of advancing Development Expenditure may decrease flows of FDI, therefore cut downing the Indirect Benefits. Contrarily, attempts to increase FDI, and matching Indirect Benefits, by cut downing revenue enhancement will ensue in lesser Government Revenues for Development Expenditure.

Policies to pull FDI

Host states seeking to pull Foreign Direct Investment have two major policy waies to choose to prosecute, these are good defined by Oman 2000 cited by IADB 2001 as:

Beauty Contest

Competition in Incentives

Beauty Contest:

Since OECD, 2007 explains that the factors to pull FDI are by and large tantamount to Business attraction factors ; it is prudent to presume that the considerations that make a state globally competitory will in bend make it proportionally attractive to FDI. Oman 2000 cited by IADB 2001 as quoted in IADB refers to this as the “ Beauty Contest ” attack, where states become attractive FDI finishs by educating their labor force, beef uping institutional capacity and making efficient substructure.

The lone challenge posed by authoritiess that choose to follow this attack to pull FDI is that the procedure of bettering the cardinal factors in a state are a long term enterprise, and the consequences will in all likeliness go manifest long after the initiating authorities has completed its term of office.

The Global Competitive Report 2008 published by the World Economic Forum ( Schwab and Porter, 2008 ) uses 12 pillars to measure the Global Competitiveness of states. These are:



Macroeconomic Stability

Health and Primary Education

Higher Education and Training

Goods Market Efficiency

Labour Market Efficiency

Fiscal Market Edification

Technological Readiness

Market Size

Business Edification


These factors form the footing for the elaborate comparing of states and are graded by the Global Competitiveness Index.

For the intents of this assignment, a broader classification has been used under four Policy Focus subdivisions, viz. Governance and Institutional Capacity ; Human Capital ; Infrastructure, Natural Resources and Raw Materials and Market Factors.

1.1 Policy Focus – Governance & A ; Institutional Capacity

Host states need to heighten Governance and Institutional Capacity to pull FDI and obtain domestic benefits from the Inflows. Factors to see under this Policy Focus are Democracy and Political Stability, Rule of Law and Effective Institutions that provide an Enabling Investment Framework.

An effectual authorities will enable recipient states to use FDI for domestic growing, this as proffered by Kehl, 2009 allows the host authorities to negociate understandings with FDI beginnings which will maximize both direct and indirect benefits to the host state.

Strengthening of Democracy and regulation of Law, is non limited to keeping of free and just elections. This focal point besides includes human rights, answerability and transparence, efficient establishments with limited ruddy tape and regulation of Law.

In Latin America, the sweetening of these factors have led to Chile and Costa Rica pulling a big portion of FDI, in comparing to its neighboring provinces, this is reflected by IADB,2001 Kehl, 2009 and Morrison, 2006. Both these provinces besides rank at the top of the Latin American states, Chile at no. 28 and Costa Rica at no. 59 in front of Brazil, Mexico and Argentina, in the Global Competitiveness Index. ( Schwab and Porter, 2008 ) .

Previous research by Gastanaga et al. , 1998 besides shows strong correlativities between FDI Inflows and what can be grouped as administration factors of absence of corruptness, bureaucratic hold and contract enforceability as holding important effects on FDI Inflows.

This line of idea is besides reinforced in UNCTAD, 2005 where the function of Legislation and Regulation in pulling FDI is highlighted. The major hindrances to Investment are the unsatisfactory degree of disposal of Business ordinance and Commercial Justice. These factors needfully increase the cost of making concern in the host state and besides increase the degree of capriciousness.

Therefore host authoritiess ‘ demand to heighten democracy, establish the regulation of jurisprudence and construct efficient and crystalline bureaucratisms to pull Foreign Direct Investment which will inturn enhance domestic development.

1.2 Policy Focus – Human Capital

The Global Competitive Index ( Schwab and Porter, 2008 ) has a figure of its factors some related to Human Capital in a state, some straight and others indirectly. Factors such as Health and Primary Education, Higher Education and Training and Labour Market Efficiencies may be considered direct Human Capital Factors, whereas Technological Readiness, Financial Market Sophistication, Business Sophistication and Innovation are all dependant on Human Resources and Skills. This goes to underscore the importance of Human Capital in the Competitiveness of a state and by extension its attraction to FDI.

Foreign Direct Investment has flowed liberally to states with a Low cost of Labour such as China, which has now become the mill for the remainder of the universe, where in the southern coastal country of the Pearl River Delta, approximately 30 million people are engaged in production of a assortment of goods runing from dress to electronics. This country and its mills are subcontracted to bring forth goods for Multi National Brands ( Morrison, 2006 ) .

A farther consideration for host states is the quality of human capital in footings of cognition and productiveness. Mody, 2007 explains that Nipponese companies seeking to put in foreign states extremely rate the quality of the human capital in every bit much as the consideration of labour cost. This enhances the fact that the deficiency of complementary human capital will cut down the returns on fiscal capita and therefore act as hindrance to FDI. This observation is of considerable importance since Japan is among the taking beginnings of FDI globally.

The consideration of quality of human capital is besides apparent in the influxs of FDI in the Information and Communication Technology ( ICT ) sectors in emerging economic systems, a cardinal illustration being India. The importance given to developing high tech instruction in India has been instrumental in pulling FDI in the ICT sector, therefore driving economic growing. ( Morrison,2006 ) .

A farther illustration of quality of human capital importance is referred to in UNCTAD,2005 in the placement of Kenya as a services hub for the part. The survey underlines the fact that despite a gradual issue of some Multinationals from the Kenyan fabrication sector, most of them have retained a regional services presence due to the handiness of skilled labor. The survey farther recommends this as a cardinal pillar of pulling investing in Kenya.

In position of the above considerations, host states need to advance the quality of human capital through encouragement of instruction and skill geting. It is of import to detect that this needfully has a compounded benefit. Among FDI ‘s stated benefits are spill overs of engineering and cognition from the beginning of FDI, and if the host state has attracted FDI because of high quality of human capital, the spill over will farther intensify this benefit, doing the host state even more attractive for FDI.

1.3 Policy Focus – Infrastructure

The function of Infrastructure as a cardinal factor for pulling FDI is good documented by assorted surveies and writers. ( EIU, 2007 ) explains that host state substructure plays a major function besides economic factors in pulling FDI. With the EIU study demoing Infrastructure draging merely Political Risk and Corruption, in a list of 17, as cardinal restraints to FDI in Emerging Markets. Infrastructure impairment is besides highlighted conspicuously as cause for concern with Foreign Investors in Kenya ( UNCTAD, 2005 ) . The Global Competitive Index besides lists Infrastructure as the 2nd pillar, puting equal importance on Infrastructure as on the Institutions.

The universe Investment Prospects study of the Economist Intelligence Unit provides a list of 16 factors used to measure substructure effectivity in a host state. This list includes telecommunications – fixed and nomadic, Internet use, Computers, route webs, ports, railroads, airdromes, electricity and commercial existent estate.

Good quality ICT substructure is now playing a critical function in linking makers with international purchasers in what is popularly referred to as Business-to-Business ( B2B ) webs. This is a cardinal determiner for Investors seeking efficient Manufacturing Locations as expounded by Addison et Al. 2006.

The presence and efficient handiness of the above listed infrastructural commissariats enables a cost effectual manner of traveling goods and services to markets, and is an of import factor in the attractive force of investing to a host state.

The deficiency or lack of Infrastructure in some instances may non be a hindrance, specifically in the instance of extraction of minerals, as the handiness of the said natural resource in copiousness may countervail the cost associated with hapless substructure. This fact is nevertheless mostly mitigated by the observation that the planetary FDI influxs in fabrication, trade and services far outweigh the FDI inflows to extraction of minerals.

Host states wishing to pull increased influxs of FDI will therefore demand to guarantee non merely presence, but efficient handiness of substructure to enable motion of people and goods in the signifier of roads, rail, ports and airdromes, but besides productivity factors such as dependable electricity supply, telecommunications and ICT substructure.

It is of import to observe that Infrastructure development in itself is a cardinal finish for FDI influxs to states with the suitably attractive regulative model.

1.4 Policy Focus – Market Factors

Market factors are considered to be the most of import factor in attractive force of FDI. It is accepted by many surveies and writers that the GDP, GDP growing and Market size ( measured in footings of buying power para ) are the largest consideration for FDI attractive force. This is apparent by the fact that 68 % of planetary FDI stock is held in the Developed states of the universe, with the Emergent states merely pulling 31 % of the same to day of the month. ( EIU, 2007 ) .

Whereas this contention holds true for Developed Nations, Addison et Al. 2006 show different correlativities of FDI to GDP in different Developing Countries. The causality is reversed with FDI doing GDP growing in some states and the contrary in others.

Complementary to GDP, GDP growing and Purchasing Power Parity are factors including Fiscal Market Sophistication and Business Sophistication among others. These factors are usually found in Developed state economic systems, nevertheless as observed in the Global Competitive Index, some Emerging economic systems are doing advancement in these countries.

Taking into history that a well big part of planetary FDI stock is in Developed states, with a high GDP and considerable purchasing power, host states have no option to ordaining policies that will bring forth domestic growing. This observation serves to reenforce the proposition by Oman 2000 cited by IADB 2001 that host states that adopt the “ Beauty Contest ” attack will non merely pull FDI, but the steps taken will inherently profit it and promote domestic growing.

Schwab and Porter, 2007 identify Prosperity as the amount of Endowments and Productivity, complemented by Competitiveness. Enumerating Prosperity as GDP, it is appropriate to deduce that GDP growing is a consequence of Productive and Competitive use of Endowments of a state.

It is hence imperative for host states to implement policies that will heighten long term growing chances and make a contributing environment for Market Factors to bloom.

These four Policy Focuses constitute the “ Beauty Contest ” Approach which is mostly accepted as the ideal attack to be adopted by host states to pull Foreign Direct Investment.

In contrast to this attack, host states can follow an attack of Aggressive Incentives.

Competition in Incentives

The alternate policy way that can be adopted by host states seeking to pull Foreign Direct Investment is Competition in Incentives. The primary aim of this attack is to offer FDI beginnings a Lower Cost of operation. This may be accomplishable by the host state through the agencies of Tax Reduction, therefore cut downing the Direct Benefits of FDI as discussed earlier on, it is besides possible to gain this nonsubjective by compromising Environmental, Health, Safety or Key Labour Regulations in the host state.

This attack is considered to be reactive and poses the danger of a “ Race to the Bottom ” as host states try to outpace each other in offering more attractive Incentives to FDI beginnings. In this scenario, non merely will the direct benefits of the FDI influx be lost, the indirect benefits and spill overs will besides be minimised as a consequence of unreasonable inducements and compromised ordinances.

It is besides observed by IADB,2001 that Incentives form a secondary standard, and merely act upon the finish of FDI after the Key considerations have been met, most of these as elaborated in the Policy Focus subdivisions supra. This depicts that following a strictly Incentive attack will non well pull FDI.

An appropriate presentation, as explained by Kehl, 2009, is found in Chile whereby the authorities does non offer Fiscal Incentives but attracts more FDI than its neighbors in Latin America.

OECD farther accent this contention by saying that inducements are by no agencies expected to replace factors that make a state basically attractive to investing in general and FDI in peculiar. However, such inducements may be used to complement these factors or exercised to equilibrate the effects of bing market inefficiencies. Host authoritiess need to utilize this option carefully so as non to eliminate the benefits expected from the FDI influx.

The Competitive Incentive attack is likely to hold a negative impact in the long tally on host state, as the compromised ordinances frequently have far making effects on the economic system, and is therefore defeats the cardinal ground for ask foring FDI i.e. to advance National Development.

The OECD Checklist besides reinforces this by saying that “ OECD members moreover consider that it is inappropriate to promote investing by take downing wellness, safety or environmental criterions or loosen uping core labour criterions. The OECD Guidelines for Multinational Enterprises, which are an built-in portion of the Declaration, province that enterprises should: “ aˆ¦ chorus from seeking or accepting freedoms non contemplated in the statutory or regulative model related to environmental, wellness, safety, labor, revenue enhancement, fiscal inducements, or other issues. ” ” ( OECD,2003 )


This study has explored and discussed the “ Beauty Contest ” attack and the contrasting Competition in Incentive attack, and evaluated the possible benefits and booby traps of each attack by host states seeking to pull Foreign Direct Investment.

It is concluded that host states will harvest the benefits of Economic Development as a consequence of Foreign Direct Investment by systematically and over the long tally by heightening Governance and Institutional Capacity, developing its Human Capital, constructing Efficient Infrastructure and advancing the betterment of Market Factors.