Evaluate the Advantages and Disadvantages of Foreign Direct Investment (FDI).
Advantages of Foreign Direct Investment (FDI):
Supplier of Capital: Developing countries suffer from shortage of capital required for economic development. FDI goes directly into investible resources of the host country. Foreign direct investment results in capital formation and helps in pushing up the rate of growth of the economy.
Foreign Exchange: Most of the developing countries face adverse balance of payment position because their imports exceed their exports. Developing countries need foreign exchange to meet their development needs. FDI helps the host countries to increase their foreign exchange reserves by bringing their resources in foreign exchange. Foreign Direct Investment (FDI) reduces the dependence of economy on the imports of raw materials technology etc.
Further, FDI helps to increase the exports of the developing countries. As a result balance of payment of host countries improves. Foreign Direct Investment (FDI) is better than the external borrowings. External borrowings create a fixed liability and are repayable after sometime. External borrowings need payment of interest regularly. Foreign Direct Investment (FDI) does not require payment of principal and interest thereon.
Vehicle of Technology Transfer: Developing countries are technologically backward. Developing countries do not have sufficient resources to carry on research and development. Foreign Direct Investment (FDI) brings modern technology and efficient management methods. FDI promotes inventions and innovations in developing economies. As a result of advanced technology, developing countries speed up the process of economic development.
Promoter of Exports: Foreign Direct Investment (FDI) acts as a promoter of exports of host developing country. Foreign enterprises enjoy a number of market superiorities over the national firms in promoting the exports. They possess a more reliable and upto date market information system. They enjoy global network of marketing.
Provider of Employment: Developing countries face a serious problem of unemployment. When Foreign Direct Investment (FDI) comes to an underdeveloped country, there is an increase in the investment level. In this way, FDI results in large scale employment opportunities. FDI promotes employment indirectly also. Foreign enterprises stimulate the growth of local enterprises to support them in their operations. Foreign enterprises offer excellent pay-scales and career opportunities to their employees.
Higher Wages: Foreign Direct Investment (FDI) results in higher wages of employees particularly of skilled employees. FDI promotes modern management techniques and trained managers. Foreign enterprises help to professionalize management in host countries. Relatively higher skilled jobs receive higher wages.
Competitive Environment: Foreign Direct Investment (FDI) facilitates entry of foreign enterprises in. domestic market. This creates a competitive environment. Thus, FDI increases competition and thereby break domestic monopolies. Foreign enterprises compel the domestic firms to improve their efficiency or withdraw from the market. Competitive environment is beneficial to consumers. Consumers will have a wider choice of products at lower prices.
Disadvantages or Limitations of Foreign Direct Investment (FDI).
Following are the disadvantages or limitations of FDI:
Dependence on Domestic Capital: It has been observed that foreign enterprises do not bring much capital. In spite of bringing capital, they raise capital through borrowings from domestic capital markets and banks. Thus, there is not much increase in the capital resources of the host countries.
Foreign enterprises compete effectively with the domestic enterprises for scarce capital available in the domestic capital markets. Thus, national firms are deprived of needed financial resources.
Balance of payments constraint in the long run FDI: provides inflow of foreign exchanges resource and removes the constraints on balance of payment in the initial stages. But a large sum of money flows out ofthe country in terms of payment of dividends, profits, royalties, technical fees and interest to the foreign investors.
Further many foreign enterprises take recourse to loan finance rather than equity finance. Loan finance is a fixed liability and involves payment of interest regularly and repayment of principal amount. This puts a constraint on the balance of payments in long-run. Further there is a heavy strain on foreign exchange reserves when foreign enterprises decide to move their capital out of the country.
Absence of Effective Transfer of Technology: Foreign enterprises often transfer outdated technology to their collaborators in host countries. In a number of cases, technology transferred by foreign enterprises has been found unsuitable causing waste of scare capital. In many cases, foreign enterprises do not engage in R and D activities within host countries.
Their R and D activities continue to be centralized in the home country or in other industrialized country. In many cases the technology transferred is of a capital-intensive nature which is not useful for a developing economy, which is generally labor surplus economy.
In fact, continued insistence on the import of such technology can have serious consequences for the economy of the host country since unemployment will increase. Foreign enterprises have failed to develop local skills and technology suitable for host country.
Not a Provider of Additional Employment: It is Wrong to say that Foreign Direct Investment (FDI) creates additional employment opportunities. In fact, FDI is not a provider of additional employment particularly when FDI substitutes national investment. When FDI substitutes national investment, there will be no addition to existing employment opportunities.
Another point to be noted is that foreign enterprises bring capital-intensive technology, which fails to generate sufficient employment opportunities. Some foreign enterprises prefer to employ skilled personnel belonging to home country of foreign enterprises.
Special Concessions: The government of the developing countries have to provide special facilities and concessions to the foreign investors to attract them. These may include tax concessions, provision, of subsidized inputs, financial assistance, freedom to remit profits in foreign exchange etc. Measures such as import quotas, tariffs, exchange restrictions etc. may suppress the demand for imports, but they, do so at the cost of productivity and efficiency.
Elitist Orientation of Production: Foreign investment is more interested in quick profit yielding consumer goods sector. The emphasis of FDI is on producing goods for the cash-rich, but small elite sector of the developing countries like cosmetics, toiletary items, televisions, music system, mobile phones, luxury cars etc. This results in the inversion of scarce economic resources to the production of non-essential items.
Bad Business Ethics: The activities of many foreign enterprises often fall outside the domain of proper business ethics and the legal system of the host countries. For example, some American TNCs have paid bribes to influence people to get things done.
Further, foreign enterprises have gained necessary strength to influence the decision-making processes in the developing countries. The governments of developing countries are threatened by the direct and indirect interference of foreign enterprises in their internal affairs. Thus autonomy and sovereignty of the host countries is in danger.