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Truth about FDI

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Foreign Direct Investment can be defined as the investment made to acquire lasting interest in enterprises operating outside the economy of the investor (Wikipedia 2007 [online]). Whether FDI promotes development in the recipient countries is a subject which has enjoyed a vibrant debate from various commentators. There is little sign of agreement among commentators and policy makers as to the true effect of FDI. Yet despite the discordant voices on the subject, FDI has in recent years experienced some form of rebirth. The mistrust of FDI of yesteryears seems to have given way for some guarded faith in the ability of FDI to help foster development, albeit with caveats (Balasubramanyam, Wei). The scarcity of choice for finance especially bank credit may have something to do with it. Most developing countries which have traditionally been willing to bend over backwards to attract FDI do regulate the operations of foreign owned firms, which might include the ownership structure, hiring policies and procurement. The World Trade Organisation has rules on these kinds of things and they are called Trade Related Measures (TRIMS).


FDI, some have said is like cholesterol. There is the good type and the bad type (Kaminsky et al, 1998). The good foreign direct investment should avail the recipient country both the market skills and guarantee some market access to make it worthwhile (Aitken et al, 1997). It should be rooted inside the economy in a way that it should remain there even during bad times. Otherwise, such investment would be the first to take flight when the economy begins experiencing even mild troubles. This is based on the reasoning that FDI first came into that country because it had confidence about the long term prospects of that country. Any other reason would be speculation which would not be good for the economy. The bad FDI is the one which is speculative especially on foreign exchange rates. This kind of FDI is usually the first to bail out of an economy when the bad times come, further exacerbating the problem.


There are many types of FDI, the main types being inward FDI and outward FDI. Inward FDI is when foreign capital is invested on local resources. Outward FDI is when local capital is invested on foreign resources (Wikipedia 2007 [online]).


There are many possible effects of FDI to the recipient country. Usually, investing firms bring with them technological prowess which then can build synergies with other favourable factors available in the recipient country which includes low wages. This way, production becomes cost-effective and can result into the improvement of the local economy and the welfare of the world economy as a whole. FDI may in some cases contribute to the increasing of the country’s output due to the increase in the capital stock. This phenomena is however not limited to the FDI alone. Of the more unpleasant effects of the FDI is that FDI may lead to the displacement of local investment, but, again, this is not limited to FDI. On average, foreign firms pay higher wages than local ones. This alone may lead to a situation where the foreign firms grab the best brains in an economy leaving the rest of the sector malnourished in labour terms, leading to lower levels of productivity in the local investments.




1. Bromstrom, M, Montgomery, E, Moran TH. (2005). Does Foreign Investment Promote Development? Peterson Institute, Washington D.C.


2. Balasubramanyam, VN, Wei Y, (2004). Foreign Direct Investment: Six Countries Studies. 


3. Aitken, B, Gordon H. H, and Ann E. H. (1997). "Spillovers, Foreign Investment and Export Behavior." Journal of International Economics, 43, pp. 103-32.


4. Kaminsky, G, Lizondo, S and. Reinhart, CM. (1998). “Leading Indicators of Currency Crises." IMF Staff papers. Vol. 5 No. 1, pp. 1-48.


5. URL Foreign_direct_investment. Last accessed 25 October 2007.


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