Foreign Direct Investment Analysis - Essay Example

Define foreign direct investment (FDI). Discuss and evaluate five different effects (positive and negative) that FDI can have on host country economies. Introduction Foreign direct investment is essential since it plays a significant role in global business. FDI provides an entity with marketing channels and new markets, low cost production facilities, new technology, access to new products and financing. In addition, for a host nation or the foreign entity, which receives the investment, Foreign Direct Investment is capable of providing a source of products, processes, new technologies, capital, management skills and organizational technologies. Foreign Direct Investment significantly contributes to economic growth and development. This assignment will cover the definition and effects of foreign direct investment on the host country’s economy. Definition Foreign direct investment refers to a form of investment, where a company from one country decides to make a physical investment in another country by putting up an industrial unit in another country. The direct investment in machinery, buildings and equipment contrasts a portfolio investment that is considered as making an indirect investment (Gregory 1997, p. 33). Currently, with the rapid growth and transformations in global investment patterns, the definition has widened to include the acquirement of a lasting management interest in an entity outside the investing company’s home country. Going by this definition, therefore, Foreign Direct Investment may take various forms such as; direct acquisition of a foreign entity, building of a facility, or investing in a joint venture with a local firm. Positive Effects of Foreign Direct Investment on the Host Country Economy One of the principal effects of the foreign direct investment is diffusion of technology. A foreign direct investment encourages the entity seeking investment in the foreign country to use different technologies in the production process (Razin 2008, p. 64). The firm uses its own technology in buildings and the way of doing business. In so doing, people in the host country acquire new technologies and skills from the foreign entity, which they apply in the production process. Use of the acquired skills and technology in the production process assist the host country increase its productivity. Through the increment in production, the Gross Domestic Product (GDP) of the host country is increased considerably, which promotes economic growth (Moran 2005, p. 64). FDI provides the host country with increased physical stock. The increase in the physical stock increases the productivity rate of the host country. This adds up to the country’s income. In addition, the FDI provides the host country with finances for investment, which adds up to the development of the economy (Gregory 1997, p. 34). Through the foreign direct investment, the host country is likely to benefit from the creation of job opportunities. Most firms that invest directly in foreign countries create job opportunities to the individuals in the host country. Sometimes, transfer of labour from one country to another is relatively expensive compared to hiring labour from within the country of investment. Hence, the entity investing in a foreign country will provide job openings to individuals in the host country (Moosa 2002, p. 47). Through job provision, the host country is relieved from the burden of unemployment; this helps the government to rank high in terms of development since most of its people will have better living standards emanating from employment opportunities. Through foreign direct investment, the host country obtains new products that it could not produce. The foreign entities usually invest in foreign countries; through establishing products that are not produced in the country. For example, in order for a motor company to find market for its products not produced in another country, the motor company will invest in the country (Moosa 2002, p. 49). The company will introduce its products to the host country; this will benefit the host country. The host country does not require importing the commodity, and this will save on importing costs. Foreign direct investment promotes healthy competition, which helps in improvement of the products offered by the host country (Chen 2000, p. 66). Through the improvement of the host country’s products, the country will increase its exports, thus improving its balance of payment. Negative Effects of Foreign Direct Investment on Host Country Increase in human and physical capital increases production. Therefore, increase in size of human and physical capital stock will augment the productive power of the host nation (Frenkel 2003, p.94). Although there is a rise in the productive ability, the income per capita will drop in the long run while the increment in production will have an effect only in the short run (Froot 1993, p.56). This is because, large number of individuals lead to reduced income per head. Hence, the increase in physical and human stock leads to reduced income per head. Mitchel (1994, p.53) concludes that FDI leads to environmental degradation. Construction of industries in the host country by a foreign firm increases the rate of pollution in the host country leading to environmental degradation. The industries constructed in the host country may emit greenhouse gases that lead to environmental degradation. Industries involved in resource extraction can also lead to environmental degradation. Another negative effect of FDI on the host country is the introduction of policies that lead to human rights abuse. A foreign company can bring policies that promote abuse of rights of some people such as women. This was the case in Hungary with the introduction of parliamentary democracy and market economy (Zejan 2000, p. 78). Through Foreign direct investment, the foreign investors influence the political situation of the host country. Through the intervention of the political policies, the foreign investors may formulate policies, which may cause instances of political unrest in the host country. The political unrest in the host country can lead to various adverse effects on the host country (Bora 2002, p. 53). In addition, foreign direct investment can lead to increased tensions in the host country. As a result of foreign influence, some policies applied by the investors may promote insecurity issues such as terrorism. This will have a negative effect on the host country since there will be tensions in the country. This may lead to destabilisation of the country (Gregory 1997, p. 35). Conclusion Foreign direct investment refers to a form of investment, where a company from one country puts up an industrial unit in another country. It provides an entity with marketing channels and new markets, low cost production facilities, new technology, access to new products and financing. FDI encourages economic growth on the host country through the provision of job openings to individuals in the host country. It also leads to increased production through adoption of new technologies and production skills from the foreign investor. Through the increment in production, the (GDP) of the host country increases considerably; this promotes economic growth. References List Bora, B. (2002). Foreign Direct Investment: Research Issues. London, Routledge. p. 43. Chen, J. (2000). Foreign Direct Investment. London, Continuum Publishers. p. 66. Frenkel, M. (2003). .Foreign Direct Investment: theory, empirical evidence and policy. London, Palgrave Macmillan. p. 94. Froot, K. (1993). Foreign Direct Investment. London, University of Chicago Press. p. 56. Gregory, N. (1997). Foreign Direct Investment. London, Chicago University Press. pp. 33-38. Moran, T. (2005). Does Foreign Direct Investment Support Development? London, Peterson Institute Press. p. 64. Mitchel, W. (1994). Foreign Direct Investment and Host Country Productivity. London, Routledge. p. 53. Moosa, A. I. (2002). Foreign Direct Investment: theory, evidence, and practice. London, Palgrave Macmillan. pp. 46-50. Razin, A. (2008). Foreign Direct Investment: Analysis of Aggregate Flows. Princeton, Princeton University Press. pp. 64-67. Zejan, M. (2000). Foreign Direct Investment: firm and host country strategies. London, Palgrave Macmillan. pp. 78-80. Read More