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Foreign Direct Investment and Its Effects


Development is a key goal for most countries. This has seen a myriad of strategies being erected to ensure that economic growth is augmented in most parts of the world. These efforts have always targeted developing countries with weak economies that need support and foreign aid. As a result, foreign companies get attracted to invest in other states abroad due to the foreseen opportunities and other “pull factors” in these countries. This is commonly referred to as Foreign Direct Investment (FDI) (Sawyer & Sprinkle, 2009). Under this arrangement, the investing company usually regulates the operations of the company even though the company operates in a foreign country. Although FDI exists across the board, most developed countries establish such programs in third-world countries in order to achieve a wide range of goals. In some cases, it has been arguably mentioned that investing companies may exploit the host, although most of the benefits realized are said to finance economic development in developing nations.

This paper explores the impact of Foreign Direct Investment in developing countries with special emphasis on how such programs boost economic development in these countries through investment activities. To achieve this task, the essay synthesizes information covering the topic in an organized and coherent manner.

Foreign Direct Investment

Throughout the history of international economics, there are organizations, countries or individuals who have opted investing in foreign countries instead of establishing local businesses. This is known as FDI and is common in developing countries whose economies have growth opportunities for interested investors. In most cases, the investor is referred to as a foreign direct investor by the host country (Sawyer & Sprinkle, 2009). Due to their participation in the operations of the company, a direct investor may have considerable influence especially in the overall management of the companies that are in agreement.

It is worth noting that foreign direct investors normally have different stake values in the host company, and this may be low or high depending on agreeable business terms and conditions. Best on the stock value, it is possible for the foreign investor to control the company or not. Additionally, some countries have adopted legislations, which determine the amount of stakes that can be owned by foreign investors. This is aimed at ensuring that the host company and country take lead in benefiting from the investment (Sawyer & Sprinkle, 2009). A good example is in India where the government allows a maximum of fifty percent stake ownership by foreign investors. Moreover, the Reserve Bank of India does not allow any form of foreign direct investment in the mining of certain minerals like manganese and iron. In the understanding of the operations of Foreign Direct Investors, it is imperative to mention that they always target to control ownership of stakes in specific companies invested in. As a result, there is a clear distinction between foreign direct investors and other ordinary investors (OECD, 2002).

FDI vs. Growth in Developing Countries

In the current global economy, FDI activities have heightened especially in developing countries, where this approach is considered as a major boost for economic development. International economic analysts argue that FDI plays an immense role in augmenting development in these countries and has to be encouraged in order for such nations to achieve their set development strategies. What are some of these benefits? The following segments give a thorough analysis of some of the advantages of FDI and why developed countries have to be encouraged to invest in third-world countries.

National economy stimulation

In a wider perspective, FDI is thought to have immeasurable benefits on the economies of most developing countries. According to international economic experts, FDI can play a principal role in contributing towards a nation’s Gross Domestic Product, Gross Fixed Capital Formation and balancing of payments. There are several studies and researches, which have been conducted supporting the direct relationship between high FDI inflows and high GDP in developing countries. However, it is important to note that this link is not always positive in all regions (Sawyer & Sprinkle, 2009).

Besides this positive link, developing countries would also find FDI to be essential in debt servicing and repayment, promotion of export markets and generation of revenue from foreign exchange. In line with this potential, FDI further encourages corporate strategies in business between the parties involved. These strategies include transfer pricing and protective tariffs, which can be factored in order to lower corporate tax felt by host governments (OECD, 2002). It can therefore be argued that the overall impact of FDI solely depends on certain conditions prevailing in the host country, some of which may include the level of domestic investment, the sector involved, mode of entry and the ability of a particular country to monitor foreign investment activities.

Social development

Another sector that is vital in determining economic growth of any nation is employment. In most cases, employment rates have been used to gauge the performance and stability of an economy in the world. If FDI promotes the expansion and thriving of business, this would directly stimulate employment, improve salaries for employees and ensure stability of falling markets in these nations. When combined together, these factors can have a far-reaching impact in augmenting economic stability and development (OECD, 2002).

Technology transfer and infrastructure development

Under FDI agreements, most parent companies support their hosts in a wide range of ways, like ensuring that there is a reliable workforce to perform duties and responsibilities necessary for the running of the company. Apart from support of human resource, foreign companies invest in infrastructure and technology, which are considered as growth and development pillars of most economies today. This is very important for both the foreign company and the host economy in advancing other development sectors. Additionally, such developments can lead to other beneficial results like improvement of social and environmental status of the economy. In other words, the impact of the foreign investor does not only benefit the host company, but they can also be channeled into the entire economy in pursuit of economic development and stability (Sawyer & Sprinkle, 2009).

Moreover, when foreign direct investors focus on research and development, this usually has a significant potential of initiating processing and production techniques in the host nation and in promoting growth and economic development. In understanding technology transfer, it is vital to put into consideration the four channels through which diffusion and transfer of this technology occur when a foreign entity invests in a country (Sawyer & Sprinkle, 2009). These channels include vertical connection with business suppliers, horizontal linkages with competitors, movement of skilled labor and internationalization process of research and development.

Human capital enhancement

It has been arguably discussed that FDI has an indirect impact on human capital in most developing economies. When individuals are hired by multinational enterprises, the enhancement of human capital can basically be enhanced through advanced training or via job experience, gained after employment when one is performing his or her assigned duties and responsibilities (OECD, 2002). As a result, subsidiary companies are likely to have an immense positive impact towards the enhancement of human capital in other enterprises within the host country. This would mainly occur in cases where the subsidiaries have developed operational links with other companies operating locally. The sole purpose for this is to create the best atmosphere for the operations of FDI to be workable and profitable to both parties involved in the business.


One of the benefits of FDI as discussed by economists would be the promotion of a competitive business environment, especially in the presence of other multinational enterprises in the host country. This can only be inferred from empirical evidence based on the fact that there is no universally acceptable method of determining the degree of competition in any given market (OECD, 2002). What would be the impact of such competition? Under normal circumstances, the presence of foreign investors would spur enormous economic development through domestic competition that would emerge. The ultimate results for this scenario would be high productivity in different industries, lower prices for products and effective allocation of resources. This would definitely be a key ingredient in promoting economic growth and development.

Besides these benefits, FDI would also encourage global integration of economies. Developing countries usually stand a better chance of gaining from the global economy through FDI by having the freedom to access all global markets. This would allow developing economies to develop business linkages with other stable economies that would be effective in augmenting economic growth and development. It can therefore be viewed that endorsement of FDI would play a major role in augmenting growth and development in third world economies.


OECD. (2002). Foreign Direct Investment for Development. OECD. Web.

Sawyer, W., & Sprinkle, R. (2009). International Economics. Upper Saddle River, NJ: Pearson Prentice Hall.

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