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Advantages of Foreign Direct Investment

Foreign Direct Investment has the following potential benefits for less developed countries.

1. Raising the Level of Investment: Foreign investment can fill the gap between desired

investment and locally mobilised savings. Local capital markets are often not well developed. Thus,

they cannot meet the capital requirements for large investment projects. Besides, access to the hard

currency needed to purchase investment goods not available locally can be difficult. FDI solves both

these problems at once as it is a direct source of external capital. It can fill the gap between desired

foreign exchange requirements and those derived from net export earnings.

2. Upgradation of Technology: Foreign investment brings with it technological knowledge while

transferring machinery and equipment to developing countries. Production units in developing

countries use out-dated equipment and techniques that can reduce the productivity of workers and

lead to the production of goods of a lower standard.

3. Improvement in Export Competitiveness: FDI can help the host country improve its export

performance. By raising the level of efficiency and the standards of product quality, FDI makes a

positive impact on the host countrys export competitiveness. Further, because of the international

linkages of MNCs, FDI provides to the host country better access to foreign markets. Enhanced

export possibility contributes to the growth of the host economies by relaxing demand side constraints

on growth. This is important for those countries which have a small domestic market and must

increase exports vigorously to maintain their tempo of economic growth.

4. Employment Generation: Foreign investment can create employment in the modern sectors of

developing countries. Recipients of FDI gain training of employees in the course of operating new

enterprises, which contributes to human capital formation in the host country.

5. Benefits to Consumers: Consumers in developing countries stand to gain from FDI through new

products, and improved quality of goods at competitive prices.

6. Resilience Factor: FDI has proved to be resilient during financial crisis. For instance, in East

Asian countries such investment was remarkably stable during the global financial crisis of 1997-98.

In sharp contrast, other forms of private capital flows like portfolio equity and debt flows were

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subject to large reversals during the same crisis. Similar observations have been made in Latin

America in the 1980s and in Mexico in 1994-95. FDI is considered less prone to crises because direct

investors typically have a longer-term perspective when engaging in a host country. In addition to risk

sharing properties of FDI, it is widely believed that FDI provides a stronger stimulus to economic

growth in the host countries than other types of capital inflows. FDI is more than just capital, as it

offers access to internationally available technologies and management know-how.

7. Revenue to Government: Profits generated by FDI contribute to corporate tax revenues in the

host country.

Disadvantages of Foreign Direct Investment

FDI is not an unmixed blessing. Governments in developing countries have to be very careful while

deciding the magnitude, pattern and conditions of private foreign investment. Possible adverse

implications of foreign investment are the following:

1. When foreign investment is competitive with home investment, profits in domestic industries fall,

leading to fall in domestic savings.

2. Contribution of foreign firms to public revenue through corporate taxes is comparatively less

because of liberal tax concessions, investment allowances, disguised public subsidies and tariff

protection provided by the host government.

3. Foreign firms reinforce dualistic socio-economic structure and increase income inequalities. They

create a small number of highly paid modern sector executives. They divert resources away from

priority sectors to the manufacture of sophisticated products for the consumption of the local elite. As

they are located in urban areas, they create imbalances between rural and urban opportunities,

accelerating flow of rural population to urban areas.

4. Foreign firms stimulate inappropriate consumption patterns through excessive advertising and

monopolistic market power. The products made by multinationals for the domestic market are not

necessarily low in price and high in quality. Their technology is generally capital-intensive which

does not suit the needs of a labour-surplus economy.

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5. Foreign firms able to extract sizeable economic and political concessions from competing

governments of developing countries. Consequently, private profits of these companies may exceed

social benefits.

6. Continual outflow of profits is too large in many cases, putting pressure on foreign exchange

reserves. Foreign investors are very particular about profit repatriation facilities.

7. Foreign firms may influence political decisions in developing countries. In view of their large

size and power, national sovereignty and control over economic policies may be jeopardized. In

extreme cases, foreign firms may bribe public officials at the highest levels to secure undue favours.

Similarly, they may contribute to friendly political parties and subvert the political process of the host

country.