Foreign Direct Investment in the Global Economy | tutor2u Economics
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Foreign Direct Investment in the Global Economy

  • Levels: AS, A Level, IB
  • Exam boards: AQA, Edexcel, OCR, IB, Eduqas, WJEC

Many countries rely on inflows of foreign direct investment (FDI) as a key source of aggregate demand and also as a driver of real economic growth. In 2017, total foreign direct investment was $1.43 trillion globally.

Developed economies

  • FDI Inflows: $712.4 billion
  • FDI Outflows: $1,009.2 billion

Developing economies

  • FDI Inflows: $670.7 billion
  • FDI Outflows: $380.8 billion

Google public data on net foreign direct investment measured as a % of a nation's GDP (Source, World Bank)

Strategies to attract inward investment include:

  • Attractive rates of corporation tax
  • Soft loans and tax reliefs / other subsidies
  • Trade and Investment Agreements
  • Flexible labour markets + up-skilling of workers
  • Creation of Special Economic Zones (SEZ)
  • Investment in high quality critical infrastructure such as ports and telecoms
  • Open capital markets to allow remitted profits from the FDI of multinational businesses
  • Attraction of relatively low unit labour costs e.g. for labour intensive manufacturing

Whilst many countries have tried to make their economy more favourable and open to inward investment, it is also important to realise that others have tightened up the regulations required for inflows of FDI to happen. Some national governments are worried about national security and foreign ownership of land and natural resources. Others are fearful of the consequences of allowing takeovers of technology firms.

Google public data on net flows of foreign direct investment (measured as a % of GDP)

Some advantages of foreign direct investment

Foreign direct investment can help overcome a domestic savings gap and therefore increase the rate of capital investment for developing / emerging countries.

  1. Infrastructure improvement
  2. Capital deepening - i.e. there is more capital per worker to use in production
  3. Better training for local workers leading to improved human capital
  4. FDI can help grows a country’s export capacity (e.g. via special economic zones) and develop new areas of comparative advantage
  5. Technology & know-how transfer can help to diversify an economy and reduce primary product dependency
  6. More competition in markets which might then lead to lower prices and higher real incomes for consumers
  7. Creates new jobs leading to higher per capita incomes and household savings
  8. Lift in level of factor productivity which also increases GNI per capita
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Risks / Downsides from Foreign Direct Investment (FDI)

There are also risks / potential downsides from attracting foreign direct investment into a country:

  1. Inequality – the gains of FDI are often captured by powerful elites and the benefits may not flow equitably to people and families at the bottom end of the income and wealth scale
  2. Land grabs / extractive FDI which generates little extra tax revenues for the government
  3. Ethical standards from TNCs may be poor – especially in industries such as mining and textiles
  4. Volatile / footloose FDI flows – e.g. FDI is more volatile than remittances
  5. Limited job creation effects / perhaps with a small spillover for local content suppliers. TNCs may bring in their own managers and specialists favouring them over employing local people
  6. Monopsony power of TNCs who are able to negotiate highly favourable terms of trade with domestic suppliers and bid for tax relief from host governments.
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