The positive and negative impact of Foreign Direct Investment (FDI) on the Home and Host countries. (2024)

Impact of Foreign Direct Investment (FDI) on Home and Host Countries:

Foreign direct investment is an investment in the form of a controlling ownership in a business in one country by an entity based in another country.

In the last decades, the importance of Foreign Direct Investments (FDI) has increased significantly due to the globalization process, which offers huge opportunities for most developing countries to reach faster economic growth through trade and investment. FDI assists foreign investors in utilizing their assets and resources more efficiently as well as host countries in the acquisition of better technologies and getting involved in international production and trade networks. In the last decades, the importance of Foreign Direct Investments (FDI) has increased significantly due to the globalization process, which offers huge opportunities for most developing countries to reach faster economic growth through trade and investment. FDI assists foreign investors in utilizing their assets and resources more efficiently as well as host countries in the acquisition of better technologies and getting involved in international production and trade networks.

So the impact of FDI on the economy ofHost countriesare :

Positives effects of FDI:

1. Trade Effects:FDI influences economic growth by increasing total factor productivity and the efficiency of resource use in the host country. It increases the capital stock of the host country and thus raises the output levels.
2. Human capital contribution:FDI's contribution to human capital in host countries is significant. MNEs increase workplaces, thereby reducing unemployment in the host country. For example, domestic employees can move from foreign to domestic firms. Local firms might increase their productivity by learning from foreign firms through collaboration.
3. Spill Over Effects: MNE's usually possess a higher level of technology, especially "clean," which is the main factor of their higher productivity. One of the positive effects of FDI is that it generates significant technological spillovers in the host countries. Local firms might increase their productivity as a result of gaining access to modern, improved, or cheaper intermediate inputs produced by MNE in upstream sectors.
4. Competition Level: FDI exerts a significant influence on the competition level in the host country. The presence of MNEs assists economic development by stimulating the domestic competition and thereby leading to higher productivity, innovation, lower prices, and more efficient resource allocation.
5. Management and government practice: FDI through the acquisition of local firms, resulting in the changes in management and corporate governance. MNEs generally impose their company policies, internal reporting systems, and principles of information disclosure. This effect improves the business environment and develops corporate efficiency.

Negatives effect of FDI on Host country:

A.Crowding out the effect of FDI: FDI can have both crowdings in and crowding-out effects in host country economy. The main adverse impact of crowding out effect is the monopoly power over the market gained by MNEs. In general, crowding out might take place due to two reasons:

1) when domestic firms disappear because of higher efficiency and better product quality of foreign subsidiaries.

2) when they are wiped out because these foreign affiliates have better access to financial resources or engage in anticompetitive practices.

B. Profit Repatriation: When MNEs make investments in foreign countries, their main objective is to maximize their profit. Some advantageous characteristics of these countries, such as cheap labor force, natural resource abundance, or high-quality expertise, allow MNEs to enhance their economic performance. MNEs regularly repatriate their profits from investment to the account of their parent companies in the form of dividends or royalties transferred to shareholders as well as the simple transfer of accrued profits. It also helps them avoid larger taxes by using transfer prices. However, this profit repatriation results in huge capital outflows from the host country to the home country and negatively affects the balance of payment of the former. Thus the host countries often set limits on the number of profits that MNEs can repatriate in order not to have the balance of payment deficits or reduced foreign exchange reserves. Such a policy can induce these MNEs to invest profits in different projects within the host country.

c. Dual Economy Effect: FDI, specially made in the developing countries, can lead them to have a dual economy, which has one developed sector mostly owned by foreign firms and underdeveloped sectors owned by domestic firms. Since the country's economy becomes overly dependent on the developed sector, its economic structure changes. Often this developed sector is capital-intensive, while another one is labor-intensive. Therefore, the dual economy effect hampers the economic development of countries as most of their citizens are located in the non-developed labor-intensive sector. This effect is visible in most oil-rich countries, where foreign investments made in the oil and gas sector resulted in the resource boom and left the agriculture and manufacturing sectors underdeveloped.

D. Environmental Issues: A large volume of FDI is concentrated in natural resource sectors of developing and less developed countries. Most of these countries have a less strict or non-existent regulatory regime. Sometimes countries deliberately attempt to exempt or loosen their regulatory requirements to attract FDI. The solution to these problems is to raise the host country's capacity to regulate and construct international environmental standards.

The impact of FDI on the economy ofHome countriesare :

FDI brings in dollars into an economy; this raises the demand for labor, which can cause a rise in wages in the economy. It helps in the expansion of the economy required for revenue growth of local governments so that they can raise their citizen directed programs. The demand for a local currency can boost its purchasing power like seen in China, so that wealth of citizen doesn't erode in high frequency, that is a person's labor doesn't go unrewarded as time progress.

The adverse effects are severe. This leads to uncontrolled wealth creation, which destabilizes the peaceful fabric of society. The reason for this is the myopic leaders who lack perception and experience of the West, blindly believe what they do has only relevance in the natural realm.

Secondly, Due to FDI, the home country is mainly affected by capital and employment. Suppose a country 'A' decides to invest in country 'B,' using it's capital and technology; there will be an addition of financial position to the host country than the home country. Even in the future, if the country 'A' wants to make any advancement, much focus will be given to the company in the country 'B' and implement changes. As a result, the production in the home country decreases and it sometimes results in shutting down all its operations and completely concentrate on the host country. This severely affects the home country's economy and employment.

In conclusion, FDI will increase investment in the economy, leading to an increase in income and employment. While it is a direct benefit for the country, sometimes it is apprehended that the foreign investors will exploit a country's natural resources and offer less work as such industries are capital incentive in nature. Besides, the displacement of the population is a significant cause of social unrest.

Thus sometimes, the loss due to FDI will be more than the gain. It is advisable to make a cost-benefit analysis before making such an investment in the economy.

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