FOREIGN DIRECT INVESTMENT (FDI) IN DEVELOPING COUNTRIES

Foreign Direct investment (FDI) in developing countries

Foreign Direct investment (FDI) in developing countries

Introduction

Especially since the recent financial crises in Asia and Latin America, developing and newly industrialising countries have been strongly advised to rely primarily on foreign direct investment (FDI), in order to supplement national savings by capital inflows and promote economic development. Even harsh critics of rash and comprehensive capital account liberalisation dismiss the option of complete isolation from international capital markets and argue in favour of opening up towards FDI (e.g. Stiglitz 2000). FDI is considered less prone to crisis because direct investors, typically, have a longer-term perspective when engaging in a host country. In addition to the risk-sharing properties of FDI, it is widely believed that FDI provides a stronger stimulus to economic growth in host countries than other types of capital inflows. The underlying argument is that FDI is more than just capital, as it offers access to internationally available technologies and management knowhow(Hausmann 2001).

Discussion

The recent boom in world-wide FDI flows constitutes a major element of economic globalisation. Annual FDI flows increased fifteen-fold from US $55bn in 1980 to US $865bn in 1999. FDI soared not only in absolute terms but also in relative terms. Overall FDI flows accounted for about 3 percent of world-wide exports in 1980-1985. In 1999, the FDI/export ratio exceeded 15 percent. In other words, while exports remain the dominant form of corporate internationalisation strategies, globalisation through FDI has gained significantly in relative importance.

The much-heralded FDI boom has to be qualified in several respects, however. Over much of the period under consideration, FDI increased only moderately, relative to exports. The significant rise in this ratio is largely restricted to recent years (i.e. 1992-1999). As a consequence, the growth in FDI is far less pronounced when world-wide FDI stocks are related to world GDP. Furthermore, while booming FDI clearly points to increased international capital mobility, the contribution of FDI to gross fixed capital formation remained modest(Fernández 2000). World-wide FDI flows still accounted for less than 10 percent of gross fixed capital formation in the second-half of the 1990s. This ratio was only 2 percentage points higher in 1995-1998 than in the second-half of the 1980s. This implies that capital formation continues to be a national phenomenon in the first place.

Traditionally, FDI was a phenomenon that primarily concerned highly developed economies. Developed countries still attract a higher share of world-wide FDI than developing countries. In recent years, however, the increase in FDI flows to developing countries turned out to be higher than the increase in FDI flows to developed countries. Average annual FDI flows to developing countries soared eight-fold, when comparing 1982-1987 and 1994-1999. As a result, developing countries attracted almost one-third of world-wide FDI flows recently. Moreover, in relative terms, FDI plays a more important role in developing countries than in developed countries. In the former, FDI inflows in 1994-1998 represented an average share of almost 10 percent of gross fixed capital formation, compared to 6 ...