Understanding the Causes and Effects of Foreign Direct Investment in Developing Countries

Abstract

This paper focuses on a particular type of financial flow to developing countries known as Foreign Direct Investment (FDI). FDI has been increasing in importance as a source of financial resources for developing countries over the past couple of decades. As official development assistance (foreign aid) has been falling since the end of the cold war, and the stability of portfolio flows has been put into question by several financial crises, flows of FDI to developing countries have been increasing in both size and as a portion of total capital resources. However, FDI flows to the developing portion of the world are highly concentrated in a few of the more advanced developing countries. The defining characteristic of FDI is that it implies foreign control of domestic productive resources. This fact combined with the observation that the vast majority of FDI is carried out by multinational corporations, has suggested to some that FDI is simply a new form of exploitation of the developing world. Others, however, see foreign control as a beneficial characteristic of FDI, suggesting that FDI may be a particularly potent channel of technology transfer from more to less developed countries. This paper begins with a review of theoretical and empirical work pertaining to the existence, locational determinants, and effects of FDI on host developing countries. It then discusses host country characteristics that tend to increase both the attractiveness of the country to FDI and the probability that the domestic economy will benefit from the entrance of foreign firms. The paper concludes with a case study of India and of the policy changes that might help the Indian economy take greater advantage of the potential benefits of FDI. Link to PowerPoint? presentation