Foreign Direct Investments

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The aim of the essay is to critically analyze why foreign investment appear to be more productive than domestic investment and to give the advantages and disadvantages of a less developed countries dependency on foreign direct investment. The paper will start by giving the definitions for major concepts in the question. Secondly, a critical analysis of why foreign investment appear to be more productive than domestic investment will be given followed by advantages and disadvantages of a developing country dependency on foreign direct investment. Lastly, a conclusion will be drawn. Foreign direct investment (FDI) is defined as a long-term investment by a foreign direct investor in an enterprise resident in an economy other than that in which the foreign direct investor is based (Economy Watch: 2010). The FDI relationship consists of a parent enterprise and a foreign affiliate which together form a transnational corporation (TNC). In order to qualify as FDI the investment must afford the parent enterprise control over its foreign affiliate. The United Nations defines control in this case as owning 10 percent or more of the ordinary shares or voting power of an incorporated firm or its equivalent for an unincorporated firm (United Nations: 1991). Historically, FDI has been directed at developing nations as firms from advanced economies invested in other markets, with the US capturing most of the FDI inflows. While developed countries still account for the largest share of FDI inflows, data shows that the stock and flow of FDI has increased and is moving towards developing nations, especially in the emerging economies around the world. FDI involves the decision of which activities to keep internal to a firm, and which to contract on the market: only the activities internal to a firm will be included in FDI, while activities can be pursued by arms-length transactions between unrelated firms. For example, a firm investing in a country might bring with it some knowledge that cannot be effectively leased or sold on the market. Instead, it will set up a plant for local production and also export, so as to profit from the knowledge it has; in this case FDI leads to a transfer of intangible assets (knowledge) from the parent to the foreign subsidiary (De Beer: 2001). This argument can work equally well in reverse, whereby the acquisition of a foreign firm can bring with it some knowledge of value to the purchaser, that could not be obtained by simply buying the products of that foreign firm. Existing literature identifies three main channels through which FDI can bring about economic growth. The first is through the release it affords from the binding constraint on domestic savings. In this case, foreign direct investment augments domestic savings in the process of capital accumulation. Second, FDI is the main conduit through which technology transfer takes place. The transfer of technology and technological spillovers leads to an increase in factor productivity and efficiency in the utilization of resources, which leads to growth. Third, FDI leads to increases in exports as a result of increased capacity and competitiveness in domestic production. Empirical analysis of the positive relationship is often said to depend on another factor, called “absorptive capacity”, which includes the level of human capital development, type of trade regimes and the degree of openness (Borensztein et al., 1995, 1998). Based on the above facts, FDI appears to be more productive in that it comes with the most advanced technology than the local technologies in most of the countries. For instance, in Zambia there have never been any advanced local based companies or firm which has invested in the mining industries simply because they lack the necessary technology to compete with the advanced technology coming with FDI (Pigato: 2001). Foreign Direct Investment, or FDI, is a measure of foreign ownership of domestic productive assets such as factories,...
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