Is Foreign Direct Investment the New Aid - Coursework Example

Is Foreign Direct Investment the new Aid? The current report is sought to provide analysis and empirical evidence as to the extend in which Foreign Direct Investment and Aid have strong and positive impacts on the economic growth of host and recipient countries. The ultimate purpose is to establish valid and credible criteria which suggest not only that the relationship between the two financial ‘instruments’ is weak in establishing a standard cause-and-effect interaction, but also that FDI cannot substitute Aid due to the underlining differences in nature. 1.0 Foreign Direct Investment and Foreign Aid: Definitions and Impacts Growing importance has been attributed to both FDI (Foreign Direct Investment) and Foreign Aid as primary means of promoting and fostering economic growth, economic stability as a result – in some of cases – of minimizing or eliminating poverty in developing and developed countries. (Burnside and Dollar, 2000) Various academics and practitioners have been focusing over the last years on exploring and eventually identifying the merits and the essentials that underline both approaches to economic and consequently social and political environments. To this extend, literature suggests that there are opposing views as to the effective impacts and influences that FDI and Aid can impose to nations, and more significantly that there are critical assumptions raised as to the degree in which there is an emerging substitutability between the two. Prior to analyzing the two modes of financial ‘enhancement’, there should be a reference to the nature and the particular aims that each is sought to provide. Pantelides and Kyrkilis (2005) argue that Foreign Direct Investment from a generic perspective is a means of serving foreign markets as it merely involves the transfer of a ‘package’ of equity capital and intermediate resources of an international firm to a subsidiary or a branch abroad. From an economic perspective, however, FDI is largely viewed as a globalization product of capitalized economies that is eventually developed under the scope of providing benefits to both the multinational corporations and the host countries. Karakaplan et al. (2005) indicate that FDI has been a traditional tool of foreign financing in developing countries, that is continuously gaining a vital role in stimulating economic growth and public welfare. . A major supporting view holds that FDI has significant complementarities with the host country’s economy, and thus it fosters further development in that country. Foreign Direct Investment, therefore, implies capital accumulation in the host state, a fact that underlines the expected increase in economic growth rate by encouraging the commitment of new inputs and technological infrastructures to the productivity of the nation (Pantelides and Kyrkilis, 2005). In addition to that, Harms and Lutz (2006) point out that FDI can increase the level of education and knowledge of the host state as there is extensive focus on labor training and skill development. Kristjansdottier (2006) to this extend, comments that FDI’s influence on the overall socioeconomic development and growth of a country revolves around the increase in production assets and the creation of new work places as a tool of reducing unemployment on the one hand, and the technological advancement of the country as it fosters modernization through the transfer. Foreign Aid is similarly perceived as a way of fostering growth in less developed and poor countries, though within a different conceptual and contextual framework. Sachs (2005) critically stresses that aid has a more humanitarian and social underlying nature, as it ultimately basically aims at reducing poverty statistics and conclusively at building the fundamental grounds for forthcoming economic growth. Aid has been well established and received by various authors and practitioners as a direct financial help that is provided by wealthier states to poor or economically unstable countries for reasons of promoting sustainable economic development and gradually construing a healthier socio-economic environment. (Teboul and Moustier, 2001). To further support this argument, Karakaplan et al. (2006) maintain that aid effectively remains one of the most significant contributors (portions) to the majority of less developed (and developing) countries’ GDP. Easterly et al. (2004) argue that official aid directed from developed to LCDs aims at achieving two fundamental goals. First of all, it targets at establishing the grounds for providing access of the population to social and economic goods and secondly, at formulating favorable conditions for future growth and development. Burnside and Dollar (2000), however, conducting a research in various less developed and developing nations, found that the effects of foreign aid largely depend on the economic polices and conditions that exist in the recipient country. More specifically, they argue that economic growth is fostered only when there is a sustainable macroeconomic environment and a high degree of market openness. Teboul and Moustier (2001) agree that the efficiency and the effectiveness of foreign aid are dependent on exogenous variables that might not constitute a fruitful environment for fostering growth in the socioeconomic area; such as domestic savings. Likewise, they assert that aid should be differentiated and tailored according to the needs of each recipient country in order to meet the requirements in structural and social standards, otherwise it is just another means of spreading capital without any specific objective and intent. 2.0 Relationship Between FDI and Aid Much attention has been focused on the relationship between FDI and Foreign Aid within the boundaries of one promoting the other, on the one hand, or one substituting the other, adversely. Kimura and Todo (2007) place great emphasis to the fact that Aid, in its broader results, fosters Foreign Direct Investment through establishing a growth indicator for the recipient country. To this extend, aid facilitates domestic investments, infrastructure development and social welfare and thus, from the developing country’s perspective FDI is more probable to be attracted; aid, therefore, provides the incentives that drive incoming FDI. This view is supported by various authors, including Harms and Lutz (2006) who argue that aid’s impact on FDI is actually twofold: the recipient nation’s infrastructure with regards to technical, technological, educational and resource-based development is highly stimulated by aid; this in turn, stimulates foreign investment as there is an increase in the marginal product of capital. In opposition, they stress that aid can have an adverse effect on FDI inflows due to the fact that it might result in a decrease in the productivity of the recipient nation, as capital is not properly committed to that end. Collier and Dehn (2001) support that foreign aid generally increases the rate of foreign direct investment in an economy by equipping the country with the necessary resources. To this extend, the country is more favorable in absorbing capital inflows stemming from multinational corporations’ investments. Thus, they conclude that although aid does not directly promote economic growth, it does foster FDI which is largely credited for the growth in account. Nevertheless, at this point it should be stressed that there are many criticisms as to the degree in which eventually FDI can foster growth in economy; raising critical assumptions thus, to the sequential effect of Aid. In more details, it is strongly argued that the flow of FDI is not from the developed countries to the developing ones, but rather to the already developed nations as well. (Kimura and Todo, 2007). This issue raises questions as to whether economic growth has already been achieved and established prior to attracting foreign direct investment; in other words, is it aid that fosters FDI or is it the state of the economy achieved through aid that eventually absorbs inflow of capital? Easterly (2003) holds that aid in LCDs (Less Developed Countries) is directed towards minimizing poverty levels and establishing good economic conditions for future growth. On the other hand, FDI outflows are directed towards rather developed countries (or rapidly developing ones); a fact that cannot justify a direct relationship between the two approaches. The next element underlining the interaction between FDI and Foreign Aid is the substitutability factor. In other words, can FDI substitute aid to an extend that economic growth is sustainably developed? Krisjansdottir (2006) focuses on exploring the issues that relate to substitutability of Aid by Foreign Direct Investment in an attempt to justify the reasons behind limitations emerging. Specifically she states that the effects and overall impacts of FDI and Aid are different in nature and thus it is not recommended to maintain this notion. FDI has short term effects on the economy of the host country as it primarily increases the output by the transfer of technology, capital and resources, whereas Aid is more oriented towards long term goals, as it is used to finance infrastructure projects (Teboul and Moustier, 2001). Additionally, while FDI is sought to increase private investment, aid targets to increase government and domestic investment; this clearly represents a difference in the context of the two subjected issues. Krisjansdottir (2006) also argues that although aid raises economic standards and stimulates further growth mainly through investment, exports and imports, it has a negative impact on savings, while on the other hand, an indirect though highly interrelated aim of FDI is the increase on the country’s savings. Although the issue of substitutability has evidently raised opposite views on the subject, with proponents maintaining a position which recommends that FDI is the new for Aid since the general outcome in both approaches is sought to be the same (economic growth and development) and opponents stating that FDI is either directly or indirectly stimulated by Aid, thus there is no evidence justifying substitution, it should be noted that the general claim is leaned towards the second view. 3.0 Ideologies Underlying Foreign Direct Investment and Foreign Aid: Opposing Views Riddell (2008) presumably supports that aid has a humanitarian character that is often diffused with political interests and complex strategic countries’ postures. Although in its very nature foreign aid can have positive and promising results against poverty and for economic development and growth, there is a critical need to align priorities and allocate properly the assistance provided. In other words, the suggestion lies in the fact that failures in the aid processes and effectiveness are attributed to the political implications that financial, economical or humanitarian aid might entail. (Easterly, 2003) Foreign Aid does not always come with pure altruism intentions; this view is supported by various authors and academics in an attempt to conceptualize the degree to which politics is involved. (Easterly et al., 2004) The influence of the donating economy to the recipient country is sought to be of great importance in determining the decision to provide aid to LCDs and poor nations. In addition, the international political scheme greatly depends on the relationship between states; a relationship built on an exchange process . This process comprises a two way transfer; the transfer of assistance from the developed to the developing (or underdeveloped) and the transfer of political process ‘openness’ from the developing to the developed. Danahel (2004) in his book ’10 Reasons to Abolish IMF and Worldbank’ critically discredits the entire movement towards foreign aid as it merely implies the recipient country’s giving up of political freedom and as a general distortion of the democratization of economies. Specifically, he claims that behind advocating the fight against global poverty, there lies a much deeper political interest of the Western ‘rich’ countries to gain control over the poorest and less developed. Thus, government and political intervention are in the end what is derived from such an aid. Moving on to the Foreign Direct Investment, critics of the approach generally argue that it is a product of high capitalization and globalization effect. Hertz (2002) supports that the shift of power from politics and governments has evidently passed over to multinationals and global corporations, and eventually economies are controlled by capitalist states, which gradually are taking over the future of global economy in their hands. FDI therefore is more of an option to serve the expansion of international companies, rather than provide essential benefits to the host countries. This view is also shared by many authors, like Kristjansdottir (2006) who argues that FDI is not promoted towards LCDs or poor nations, but rather to already developed ones which can offer greater incentives for attraction of investment; this evidently leads to the assumptions that maintain that foreign direct investment is generically directed towards providing total control to the ‘capital’ in a globalized and open market. Hertz (2002) additionally stresses, that the importance of FDI relies in the gradual elimination of power and independence of governments and states to losing freedom over multinational corporations favoring a capitalistic global environment. Conclusively it is not hard to identify the supporters and the opponents of FDI as a new form of Aid. The interests lie in two groups; politics and business related drivers. FDI as a new Aid is thus, evidently favored by governments and political institutions of the Developed countries, and especially Western societies and economies, whereas the opposing view is ultimately held by capitalist- driven international and multinational corporations that in the bottom line are benefited from such activities. The conclusions over the issue of the ideologies behind the two financial and economical ‘assistance’ modes to developing and under-developed countries therefore, highlight that there is a growing importance towards aligning and properly allocating resources through customization of aid on the one hand, and through provision of incentives for FDI to LCDs as well on the other hand. In any case, aside the ideological grounds for discrediting the two approaches, it must be noted that the results in both reducing poverty and establishing the prospects for economic growth and development are promising. 4.0 Conclusive Remarks on FDI and Foreign Aid Both Foreign Direct Investment and Foreign Aid, besides the originating driving force, have managed to deal with economic stability, growth and further development effectively and efficiently in several cases throughout the world. It is a fact, undeniably, that Foreign Aid gives rise to less developed economies and provides incentives for favorable conditions that eventually lead to increased levels of socioeconomic standards and more prospects for establishing infrastructure that will later on result in greater absorption of foreign direct investment. This absorption is reportedly credited for the modernization of the development process of the host country, and thus for the overall economic prosperity to be gained in the future (Karakaplan et al., 2005). However, there is a need to raise ethical considerations in both of these forms of foreign assistance since there is growing concern as to the extend in which FDI and Aid manage to promote sustainable growth under specific and particular pre-conditions and prerequisites. References Burnside, C., and Dollar, D. (2000). Aid, Policies, And Growth. American Economic Review Vol. 90, No.4, pp. 847 - 868. Collier, P., and Dehn, J. (2001). Aid, Shocks, and Growth. World Bank Working Paper No: 2688. Danaher, K. (2004). 10 Reasons to Abolish the IMF and WorldBank. (2nd ed.). USA. Seven Stories Press Easterly, William (2003). Can Foreign Aid Buy Growth?. Journal of Economic Perspectives. Vol. 17, No. 3, pp. 23 – 48 Easterly, W., Levine, R., and Roodman, D. (2004). Aid, Policies, and Growth: Comment.. American Economic Review. Vol. 94, No. 3, pp. 774 - 780. Harms, P., and Lutz, M. (2006). Aid, Governance, and Private Foreign Investment. Economic Journal. Vol. 116, No. 513, pp. 773 - 790. Hertz, N.(2002) Silent Takeover. London. Arrow Books Karakaplan, U.M., Neyapti, B., and Sayek, S. (2005). Aid and Foreign Direct Investment: International Evidence. Bilkent University Discussion Papers No. 05-05, Ankara-Turkey. Bilkent University Kimura, H., and Todo, Y. (2007). Is Foreign Aid a Vanguard for FDI? A Gravity Equation Approach. Discussion Paper Series 07-E-007 prepared for RIETI, Japan. Kristjansdottir, H. (2006). Substitutability Between Foreign Direct Investment and Aid. Working Paper. University of Iceland. May 2006 Pantelidis, P., and Kyrkilis, D. (2005). A Cross Country Analysis of Outward Foreign Direct Investment Patterns. International Journal of Social Economics. Vol. 32, No. 6, pp. 510 – 519 Riddell, R (2008) Does Foreign Aid Really Work. New York. Oxford University Press Sachs, J. (2005). The End of Poverty: Economic Possibilities for our Time. USA. Penguin Press Teboul, R., and Moustier, E. (2001). Foreign Aid and Economic Growth: the Case of the Countries South of the Mediterranean. Applied Economic Letters. Vol. 8, No. 1, pp. 187 – 190 Read More