2
Table of Contents:
Introduction ............................................................................................................................... 3
1. Financial impact on the host country ................................................................................. 3
2. FDI & Economic growth ...................................................................................................... 5
2.1 Impact of trade ............................................................................................................................. 6
3. FDI & Technology transfer : ................................................................................................ 8
4. Recommendation of MNE’s to improve domestic productivity ......................................... 9
5. Conclusion ......................................................................................................................... 11
Reference List: ......................................................................................................................... 12
3
Introduction
Globalisation has improved cross-border investment where a resident in one economy
invests in an enterprise resident in another economy with the objective of obtaining a
lasting interest. This is known as a foreign direct investment. OECD (2013) claims that this
type of investment creates direct, stable and long-lasting links between economies. It
encourages the transfer of technology and know-how between countries, and allows the
host economy to promote its products more widely in international markets. FDI is also an
additional source of funding for investment and, it can be an important vehicle for
development. During the recent years, the trend of Foreign Direct Investment in emerging
economies has been increasingly growing, for example in China it accounts for US$ 61 billion,
followed by Hong Kong (34), Brazil (18), Mexico (16) and Singapore for US$ 16 billion (Meyer,
2005).
This report aims to analyse how Foreign Direct Investment (FDI) affects emerging economies.
It will focus firstly on the financial impact that it has on the host country, then its
relationship with the economic growth of the domestic market with an insights on its impact
on exportations and outsourcing. Followed by an analysis on the relationship between FDI
and the domestic employment, and finally some recommendations will be explained on
different ways that multinational enterprises (MNE) could do to improve the productivity of
the emerging economy. To conclude a summary of the main literatures will be presented.
The rationale behind this research question is that, after some research I found that FDI is
the most popular way where MNE’s invest in emerging economies (Caves, 1971 ; Jackman,
1982; Meyer, 2005) so my interest was to understand whether there is any
positive/negative impact on the domestic economies.
1. Financial impact on the host country
In order to understand the type of financial impact that FDI can have on an economy, it is
important to identify if the development of financial system in a host country is a
requirement to the successful implementation of FDI. According to James (2008) analytical
4
framework that studies the impact of FDI on the economy of Thailand by controlling the
level of financial development, argues that the development of financial system is important
in stimulating economic growth, as well as an increase in the level of financial development,
followed by a financial liberalisation, will lead to higher output growth (Gurley & Shaw, 1955;
Goldsmith, 1969; Hicks, 1969). However this might not happen automatically, as it depends
on the absorptive capacity of the host country, such as the human capital, infrastructure,
trade system or the development of financial markets. The author argues that the provision
of different credit facilities enables entrepreneurs who lack internal funds to adopt new
technology, hire better skilled labours, and the fact of having developed domestic financial
markets can help foreign firms extend their financial activities easily. Thus, these methods
can help the host country exploit FDI more efficiently. Therefore the level of financial
development in the host country affects its ability to absorb the benefits of FDI (James,
2008). After collecting different empirical data and an econometric methodology, the author
concludes that there is a strong correlation between domestic financial development and
output expansion, however FDI exerts a negative influence on output in the long term.
While the results highlight that FDI has no direct positive effect on output, it has an indirect
effect in stimulating economic development in Thailand for example through financial sector
development. As a result James’s literature confirms that a developed domestic financial
system is a crucial prerequisite in order to have efficient and positive FDI.
Similarly Chee & Nair (2010) conducted a study to find out if financial sector development is
an important condition for FDI to improve economic growth in the region of Asia-Oceania,
and whether the impact is related on the stages of development of the countries. This
research was conducted on a sample of 44 Asia and Oceania countries for the period 1996-
2005. The authors argue that the positive growth impact of FDI is dependent on the extent
of financial sector development, as the impact of FDI on economic growth depends on
development of the financial sector. The study supports that financial sector development is
crucial for FDI to have positive effects on economic growth in the long term, and this is in
seven out of the nine countries examined such as the East Asian countries, UK, US and Japan.
On the other hand, Alfaro et al. (2006) studies mechanism that emphasises the role of local
financial markets in allowing FDI to promote growth, through for example through
5
backward linkages. This author argues that financial sector development influences the
extent to which FDI promotes higher economic growth in host countries via backward
linkages such as lower lending and borrowing rates. The financial sector development is able
to facilitate the flow of information between multinational enterprises and local companies.
The results of the study concluded that countries with highly developed financial sector
tend to have higher returns of FDI on economic growth. However other studies supported
that these hypothesis are not supported. Durham (2004) conducted a study that examines
the effects of FDI and equity foreign portfolio investment (EFPI) on economic growth in 80
countries from the period (1979-1998) and he pointed out that the complementary effect
between FDI and financial sector development was not statistically significant in economic
growth. In fact some data are consistent with the view that the effects of FDI and EFPI are
contingent on the ‘absorptive capacity’ of host countries, but following an analysis of the
simultaneity bias and financial variables such as the stock market, FDI and EFPI do not have
a positive impact on the economic growth. However leaving financial markets alone is not a
good way to encourage the economy, but the unconstrained capital flows do not necessarily
improve growth. Finally, some data suggests that cross-border investment is harmful to
development, under certain conditions (Durham, 2004).
After discussed whether the development of the financial sector is a condition to efficient
FDI, many authors discussed the financial impact of FDI. De Mello (1997) argued that FDI
enhances long run economic growth, capital accumulation, and financial development. The
development of the financial sector plays an important role in further enhancing the
contributions of FDI on the economy. In addition, the impact on the economy and on the
financial sector is complementary, however the growth impact of FDI and financial sector
development is most important for least developed countries, while being equally important
for developing and developed economies (Chee & Nair, 2010).
2. FDI & Economic growth
Theoretically, it is easy to argue that FDI impact positively the host economy. However, the
results of different studies provide mixed views (Meyer, 2005).
6
Recently, many foreign investors seek local markets and export platforms due to different
advantages in the domestic market, such as low labour wages, prosperous economic
conditions etc. In the host economy, local companies benefit potentially from the FDI in
different ways: labour employment, improved supply bases, transfer of infrastructure and
technology. However, the impact of FDI varies depending if the local stakeholders will take
advantage of the potential benefits of FDI – as discussed before as ‘the absorptive capacity’.
In the other hand, the local government has to provide competitive conditions that will
encourage local entrepreneurship, and avoid market power from foreign investment firm
(Meyer, 2005).
Meyer (2005) examines the impact of FDI in emerging economies through different
literature, and on a macroeconomic level, he claims that FDI offer positive outcomes but yet
affect indirectly local employment, capital and gross domestic investment.
FDI play an important role in providing capital flows, and tends to be less volatile than other
forms of capital inflow (United Nations, 1999), but at a later stage it is repatriated through
profit remittance, which finally makes the host country pays for the costs of capital. For the
gross domestic investment, Meyer (2005) claims that even though the capital inflow may
increase the exchange rate, which might affects the costs of international borrowing; both
effects can lead to crowding out of local investment. However Johnson (2005) argues that
inflows of capital could improve the rate of economic growth but the most important effect
comes from spillovers of technology. MNE operations in the host country can result in
technology spillovers from FDI, which enables them to improve their productivity as they
generate a positive externality that should allow the host country to enhance its long-run
growth rate.
2.1 Impact of trade
The effects of FDI spread on different levels of trade, from imports, exports, production,
employment, and general welfare of the country that finally impacts the whole growth of
economy. Mehra (2013) conducted a study with the regression tool and multiple regression
analysis to find out the impact of FDI on employment and gross domestic product in India.
She claims that there are many arguments verifying that inflows of FDI improves flows of
7
trade and economic growth potential, and consequently enhances employment for the local
market. It is true that FDI provides technological advances that increases the Gross
Domestic Product (GDP) but it also improve employment opportunities that widen the
scope for the domestic market (Mehra,2013). Similarly Craigwell (2006) studied the impact
of FDI on the Caribbean region, confirmed that an increase in FDI leads to an increased
employment rate. From his empirical results, it is estimated that FDI has the greatest impact
during the first year, which is improved after the consideration of trade policies and
financial development, that in a healthy environment positive returns of FDI are generated.
In contrast, another literature by Rizvi and Nishat (2009) analysing the impact of FDI on
employment in India, China and Pakistan, argues that expecting FDI to create direct impacts
on employment is not enough, but suggests that in addition to FDI enhancement policies,
other measures should be taken to boost employment growth.
According to Fontagne (1999) that studies the relationship between FDI and international
trade, found out from his empirical results that until the mid-1980s, international trade
generated direct investment. After this period, the cause-and-effect relationship seems to
have been reversed, with direct investment heavily influencing trade. The study was
conducted in 14 countries demonstrating that each dollar of outward FDI produces about
two dollars’ worth of additional exports. The evidence indicates that foreign investment
abroad stimulates the growth of exports from investing countries and, consequently this
investment is considered complementary to trade.
Theoretically there are two different types of FDI, depending on the way the MNE organises
its international business, either horizontally or vertically. FDI horizontal, is associated with
bilateral flows of investments between developed economies. The parents company
reproduce the whole process of production in different countries. Vertical FDI occurs when
the home company fragments the production process across different countries. Vertical
investments are mostly present in FDI flows from developed to less developed economies
and refers to less sophisticated stages of production (Magalhaes & Africano, 2007).
According to Balasubramanyam et al (1996) analyses the effects of FDI on economic growth
in 46 developing economies through cross-section data, finds out that FDI has a positive
8
impact of economic growth using an export promoting strategy but not in countries where
import substitution strategy is implemented in the host country. However De Mello (1997)
finds a weak positive impact of FDI on the economy despite using time series and panel data
fixed effects estimations in a sample of 32 developed and developing countries.
Finally the difficulty in analysing the positive impact of FDI on economic growth provides a
strong incentive for further empirical studies. However based on the previous literatures,
most authors claims that technology spillovers provide the strongest potential for FDI to
boost the economy (Johnson, 2005) which will be discussed in the following part.
3. FDI & Technology transfer :
According to Glass & Saggi (2002), traditionally MNE have a superior technology comparing
to the local firms, where workers acquire knowledge from that superior technology. As a
result FDI is considered one of most important channels where technology can be
transferred, and later on by developing production facilities, this technology can also be
transferred to local firms. Glass & Saggi (2002) argues that the best way to transfer
technology successfully from MNE to local firms is through labour mobility as knowledge is
shared to different stakeholders. However since labour and employment factor has already
been discussed above, the focus will be on technology spillovers.
Lee & Tan (2006) studied the intensity of international technology transfer in some ASEAN
economies through import of machinery and FDI, and claims that empirical results showed
that knowledge spillovers regarding FDI channels has mixed results. For instance
Borensztein et al. (1998) studied FDI flows from OECD countries in 69 developing countries
and found that FDI had a positive effect on income growth only for the countries that
reached a minimum human capital threshold. However for Indonesia (Sjoholm, 1997),
Mexico (Blomstrom & Persson, 1983; Kokko, 1994), United States (Branstetter, 2000) found
that MNEs had positive effects on local productivity; however, studies for Morocco (Haddad
& Harrison,1993) and Venezuela (Aitken & Harrison, 1999) concluded that there was no
evidence that MNEs had a positive effect on the productivity growth of local firms.
9
Lee & Tan (2006) claims that there is not enough empirical evidence for the ASEAN
countries to study how beneficial FDI is for technology spillovers. Past literatures about this
topic, although abundant, are inconclusive. However the old and existing policies in ASEAN
countries contributed to the growth of their economies, through attracting the inflow of FDI
and enhancing technology transfer. The rapid economic growth was driven by exports, but
foreign firms did not encourage sustainable development. Most of the time, local
competencies were not developed sufficiently in the export sectors as it was dominated by
MNEs, which led the host country to be vulnerable to changes. The competition for
investment increased mainly from other countries (Lee & Tan, 2006).
In the contrast to that, van Pottelsberghe de la Potterie and Lichtenberg (2001) conducted a
research study about research and development and productivity in 16 OECD countries,
stating that FDI inflows does not affect the host country productivity through international
research and development spillovers, but creates significant technology spillovers. As a
result, they conclude that FDI transfers knowledge in only one direction (Bitzera & Kerekesb,
2008).
On the other hand, Bitzera & Kerekesb (2008) studied the relationship between FDI and
technology transfer in 17 OECD countries, argues that it is inward FDI that acts as a channel
for knowledge spillovers. Comparing to van Pottelsberghe de la Potterie and Lichtenberg
(2001) there is no empirical evidence found for positive technology sourcing effects, related
to FDI. Finally the authors results proves that the output elasticity of outward-FDI-weighted
foreign research and development capital is negative for non-G7 countries.
From the previous literatures discussed, it is possible to conclude that technology spillovers
have different effects on the FDI depending on the development of the economy of each
country as well as the different economic and social factors and its relationship with the
MNEs.
4. Recommendation of MNE’s to improve domestic productivity
Other than providing capital investment, trade, technology inflows and domestic
employment, MNE can improve the productivity of the host economy in different ways.
10
Different literatures claims that one factor can have different results depending on the
country and the economic situation, so the recommendations will be based on the actions
the MNE should take in order to make a positive impact on the host economy without
relating it to a specific country. The successful development of an economy depends on the
engagement and interaction of MNE with their environment globally. Slaughter (2009)
suggests that MNE should provide their products/services to local consumers instead of
focusing mainly on the home market where the parent company remain. Since the MNE are
dedicated to provide mainly lower cost, higher quality products, they could also engage in
selling their products/services locally in order to boost the demand and create a sort of
competition with the local producers that will boost the economy. In addition the author
claims that the engagement of MNE should be mainly by taking the opportunity and
supporting the operations in the host market as they enhance the productivity and average
standard living of the host country.
In addition, Mujih (2012) suggests that MNE should try to develop corporate social
responsibility (CSR) actions to help the domestic economy. Unfortunately most of the MNE
tend to just focus on the need to survive in a different economy and satisfy the economic
necessities. Indeed the perception of CSR in the home country vary from the actions taken
in the host country, for example in the home country (mostly developed countries) tend to
focus on sustainability and environmental issues whereas host countries (generally third
world countries) might not take these concepts as a priority but will focus more on the
socio-economic challenges that the country face. However understanding the new market
requirements and implementing CSR activities according to the market demand with
emphasise the relationship between the MNC and the host economy, improve the brand
image of the company and avoid the worst examples of labour exploitation and moreover
improve the productivity of the economy. Pimpa et al (2015) illustrates the example of
Thailand from his literature recommending that MNEs can contribute to the local economy
by alleviating poverty and improving social conditions. The corporate initiatives should
however be directly related to their core business, and with the help of local authorities
they should focus on key social and economic issues such as health promotion, labour, and
infrastructure development as they are linked with poverty alleviations strategies. Key CSR
11
activities from MNCs may focus on social and economic development of the local
community. Finally Pimpa et al (2015) claim that key issues such as poverty alleviation and
social development must be among the core strategic moves of MNE, if they need to
constructively engage with key stakeholders in both countries.
Many researchers found that MNEs should interact with local community and create
rigorous value in the host country, towards the reduction of poverty and dependency. MNE
tend to have a multiplier effect towards poverty reduction through their contribution to
relevant schemes such as the Red Cross scheme that implement humanitarian actions and
other social corporate responsibilities (Tirimba & Macharia, 2014).
5. Conclusion
This report reviewed and analysed various literatures about the different ways that FDI
affects the emerging economies and its impact, through the following framework: the
financial impact, the impact on the economy, trade, technology transfer, and finally some
recommendations about the various ways that FDI can improve domestic productivity of the
host country. Different authors debated on the positive impact that FDI has on the host
economies, whereas other authors argued on the negative impact. The aim was to discuss
both parts and provide future recommendations. More and more foreign companies see the
opportunity to invest in another country however the impact produced might vary from a
country to another depending on the socio-economic situation of the host country,
therefore it is recommended that governments take into consideration both impacts on the
productivity of the economy before accepting the FDI.
12
Reference List:
Aitken, J. & Harrison, E. (1999) Do domestic firms benefit from direct foreign investment?
Evidence from Venezuela. American Economic Review. 89, P. 605–618. (Accessed: 23/08/15)
Alfaro et al. (2006) How Does Foreign Direct Investment Promote Economic Growth?
Exploring the Effects of Financial Markets on Linkages. (Online) Available from:
http://www.hbs.edu/faculty/Publication%20Files/07-013.pdf (Accessed: 18/08/15)
Balasubramanyam et al (1996) Foreign direct investment and growth in EP and IS countries.
The Economic Journal, 106, P. 92-105. (Accessed: 22/08/15)
Bitzera, J. & Kerekesb, M. (2008) Does foreign direct investment transfer technology across borders? New Evidence. (Online) Available from: http://www.sciencedirect.com/science/article/pii/S0165176508000608 (Accessed: 23/08/15)
Blomstrom, M. & Persson, H. (1983) Foreign direct investment and spillover efficiency in an
underdeveloped economy: evidence from the Mexican manufacturing industry. World
Development. 11, P. 493–501. (Accessed: 23/08/15)
Borensztein et al (1998) How does foreign direct investment affect economic growth?.
Journal of International Economic. 45(1), P. 115–135. (Accessed: 23/08/15)
Branstetter, L. (2000) Is foreign direct investment a channel of knowledge spillover?
Evidence from Japan’s FDI in the United States. NBER working paper No. 8015. (Accessed:
23/08/15)
Caves, R. (1971) International Corporations: The Industrial Economics of Foreign Investment.
Economica. New Series, Vol. 38, No. 149 () , pp. 1-27.(Online) Available from:
http://www.jstor.org/stable/2551748 (Accessed: 12/08/15)
Chee, Y. & Nair, M. (2010) The Impact of FDI and Financial Sector Development on Economic
Growth: Empirical Evidence from Asia and Oceania. International Journal of Economics and
13
Finance. Vol. 2, No. 2; May 2010. (Online) Available from: http://www.ccsenet.org/
(Accessed: 18/08/15)
Craigwell, R. (2006) Foreign Direct Investment and Employment in the English and Dutch-
speaking Caribbean. (Online). Available from:
http://www.ilocarib.org.tt/cef/background%20papers/FDI_.pdf (Accessed: 22/08/15)
De Mello, R. (1997) Foreign Direct Investment-Led Growth: Evidence from Time Series and
Panel Data. Oxford Economic Papers. P.133-151. (Accessed: 21/08/15)
Durham, J. (2004) Absorptive Capacity and the Effects of Foreign Direct Investment and
Equity Foreign Portfolio Investment on Economic Growth. European Economic Review.
(Online) Available from:
http://www.sciencedirect.com/science/article/pii/S0014292102002647 (Accessed:
18/08/15)
Fontagné, L. (1999) Foreign Direct Investment and International Trade: Complements or
Substitutes?. OECD Science, Technology and Industry Working Papers. 1999/03. OECD
Publishing. (Online) Available from: http://dx.doi.org/10.1787/788565713012 (Accessed:
22/08/15)
Glass, A. & Saggi, K. (2002) Multinational Firms & Technology Transfer. The Scandinavian
Journal of Economics. 104(4), 495-513.(Online) Available from:
http://onlinelibrary.wiley.com/doi/10.1111/1467-9442.00298/epdf (Accessed: 23/08/15)
Goldsmith, R. (1969) Financial Structure and Development. The Economic Journal. Vol. 80,
No. 318, pp. 365-367 (Online) Available from: http://www.jstor.org/stable/2230134
(Accessed: 12/08/15)
Gurley, j. & Shaw, S. (1955) Financial aspects of economic development. The American Economic Review. Vol. 45, No. 4, pp. 515-538.( Online) Available from: http://www.jstor.org/stable/1811632 (Accessed: 12/08/15).
Haddad, M. & Harrison, A. (1993) Are there positive spillovers from direct foreign
investment?. Journal of Development Economics. 42(1), P. 51–74. (Accessed: 23/08/15)
Hicks, J. (1969) A theory of economic history. Oxford University Press, Oxford. (Accessed:
12/08/15)
Jackman, R. (1982) Dependence on Foreign Investment and Economic Growth in the Third
World. World Politics, 34, pp 175-196. doi:10.2307/2010262. (Accessed: 12/08/15)
James, B. (2008) Foreign direct investment and its impact on the Thai economy: the role of
financial development. Springer Science. Business Media.( Online) Available from:
http://download.springer.com/ (Accessed: 12/08/15)
Johnson, A. (2005) THE EFFECTS OF FDI INFLOWS ON HOST COUNTRY ECONOMIC GROWTH.
Jönköping International Business School. (Online) Available from:
http://www.etsg.org/ETSG2005/papers/johnson.pdf (Accessed: 21/08/15)
14
Kokko, A. (1994) Technology, market characteristics, and spillovers. Journal of Development
Economics. 43(2), P. 279–293. (Accessed: 23/08/15)
Lee, H. & Tan, H. (2006) Technology Transfer, FDI and Economic Growth in the ASEAN
Region. Journal of the Asia Pacific Economy, 11:4. P. 394-410.(Online) Available from:
http://dx.doi.org/10.1080/13547860600923593 (Accessed: 23/08/15)
Magalhaes, M. & Africano, A. (2007) A panel analysis of the FDI impact on international
trade. NIPE- Research Unit in Economic Policies. CEMPRE, Faculdade de Economia. FEP
Working Papers. Research Work In Progress. (Online) Available from:
http://www.fep.up.pt/investigacao/ (Accessed: 22/08/15)
Meyer, K. (2005) Foreign Direct Investment in Emerging Economies. Policy Discussion Paper.
Emerging Markets Forum. Templeton College Oxford. University of Reading. (Online)
Available from:
http://www.klausmeyer.co.uk/publications/2005_meyer_EMF_Templeton.pdf (Accessed:
12/08/15)
Mujih, E. (2012) Regulating Multinationals in Developing Countries. A Conceptual and Legal
Framework for Corporate Social Responsibility. London Metropolitan University, UK.(Online)
Available from: http://www.ashgate.com/pdf/SamplePages/Regulating-Multinationals-in-
Developing-Countries-CH3.pdf (Accessed: 25/08/15)
OECD (2013) OECD Factbook 2013: Economic, Environmental and Social Statistics. Foreign
direct investment. OECD iLibrary.(Online) Available from: http://www.oecd-ilibrary.org/
(Accessed: 12/08/15)
Pimpa et al (2015) Multinational Corporations, CSR and Poverty Alleviation: Views from Lao
PDR and Thailand. Academia. (Online) Available from: http://www.academia.edu/1990234/
(Accessed: 25/08/15)
Rizvi, S. and Nishat, M. (2009) The Impact of Foreign Direct Investment on Employment
Opportunities: Panel Data Analysis. pp. 8. (Online) Available from:
http://www.pide.org.pk/psde/25/pdf/Day3/Syed%20Zia%20Abbas%20Rizvi.pdf (Accessed:
22/08/15)
Sjoholm, F. (1997) Technology gap, competition and spillovers from direct foreign
investment: evidence from establishment data. Working Paper Series in Economics and
Finance. No 211. Stockholm School of Economics. (Accessed: 23/08/15)
Slaughter, M. (2009) How U.S. Multinational Companies strengthen the U.S. Economy.
United States Council Foundation. Business Roundtable. (Online) Available from:
http://www.uscib.org/docs/foundation_multinationals.pdf (Accessed: 24/08/15)
Tirimba, O. & Macharia, G. (2014) Economic Impact of MNCs on Development of Developing
Nations. International Journal of Scientific and Research Publications, Volume 4, Issue 9.
(Online) Available from: http://www.ijsrp.org/research-paper-0914/ijsrp-p33105.pdf
(Accessed: 26/08/15).
15
United Nations (1999) World Investment Report 1999: Foreign Direct Investment and the
Challenge of Development. UNCTAD. (Online) Available from:
http://unctad.org/en/Docs/wir1999_en.pdf (Accessed: 21/08/15)
Van Pottelsberghe de la Potterie, B. and Lichtenberg, F. (2001) Does foreign direct
investment transfer technology across borders? Review of Economics and Statistics. 83, P.
490–497. (Accessed: 23/08/15)