The Role Of Foreign Direct Investment Business Essay

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Foreign Direct Investment (FDI) is equity funds invested in other nations (Rugman and Hodgetts, 2003). Ngowi (2002) expressed that FDI is a long-term investment in a foreign enterprise with the aim of having an effective impact in its management. FDI is a driver of international business and it's mostly done by Multinational companies (MNCs). Research evidence shows that industrialised countries (United Kingdom, Germany, Japan, Netherlands, and Canada) have invested heavily in other industrialised nations (USA, Western Europe, China)as well as smaller amounts in less developed countries (LDCs)which includes India, brazil, South Africa, malaysia, Thailand, Indonesia and others.

The marked increase in both the flow and stock of FDI in the world economy is believed to have happened in the last 20 years (Hill 2003). The United Nations world investment report 2001 referenced in Hill (2003) shows that “the average yearly outflow of FDI increased from about $25 Billion in 1975 to a record $1.3 trillion in 2000.

Multinational companies engaging in FDI have different entry modes into host countries. Hill (2003) cited that this can be in the form of mergers and acquisition and or green-field investment. Mergers and acquisition entry mode is dominant in unstable environments or less developed countries this is because investors are sceptical of economic, political, financial and other issues associated with such economies where as Green-field FDI can take form of investments in a new facility.

Ngowi (2002) states that merger and acquisition is preferred because it is quicker to execute than the green-field investments. In addition, Hill (2003) noted that these are important consideration in the modern business world where markets evolve very rapidly and most companies believes that if they do not acquire a desirable target firm their rivals will. The case of Standard Chartered bank and IBTC Bank Plc illustrates this. Standard Chartered bank is the largest bank in South Africa and IBTC Bank Plc is Nigeria's largest mutual fund and the only bank in Nigeria that is a pension fund administrator. Now as part of Africa's largest bank, it is able to give its clients access to expertise and on ground presence across the globe. More recently, together with its parent company, Standard Bank, it put together the largest telecommunications deal ever in Africa - a $2 billion syndicated loan for MTN Nigeria. If standard Chartered Bank had relied on green field investments, it could not have become so large so fast.

Foreign direct investment has often been cited to bring about certain benefits such as technology diffusion, management know how, export and marketing access as cited in Garrick Blalock et al (2003) In their paper the researchers argues that many developing countries will need to be more effective in attracting FDI flows if they are to close the technology gap with high income countries or upgrade managerial skills and development of export markets. The inflow of foreign direct investment has been cited to have increased dramatically around the world and in the developing world it has been noted that FDI has become the most stable and largest component of capital flows and FDI is noted to have become the important alternative in the development finance processes as cited in the World Bank report (2008).  It is recognised that FDI promotes economic performance, including the injection of capital, transfer of production technology, employment creation, improved managerial and marketing competence, and enhanced competitiveness of domestic markets a notion cited in Ngowi (2002), Kobrin (2005), Kumar and Pradhan (2002) who all agree that FDI is expected to contribute more relatively to growth compared to investment in a host country.

Literature Review

Rodrik (1999) arguing the extravagant claims of literature on FDI positive technology spillover's to the developing world cited that the claims of the good of FDI are enticing but the hard evidence is sobering. The studies to which Rodrik (1999) was claiming were in summary to the claims that local competitors benefit from positive externalities or technology spillovers generated by multinational entry in the same industry. In contrast to the view of Rodrik (1999) there is a general view that multinationals technology diffusion to host countries is more likely directed to local suppliers than to local competitors as a strategy to build efficient supply chains for their overseas operations. By transferring technology to local suppliers multinational may be able to improve quality and lower the price of non labour inputs. It can be argued that multinational enterprises may invest overseas to obtain low wage labour to avoid costly barriers to foreign markets when they realise the full benefit of expansion only if the efficiency of supply markets abroad match or exceed that of their home manufacturing base. To lower the prices and raise the quality of inputs abroad multinationals could deliberately transfer technology as a benefit to the host country local vendors. This scenario can be likened to that of MTN the leading mobile phone operator in Nigeria. It secured licence to operate digital telephony or GSM in Nigeria in 2001, its subscriber base is at 16.5 million and profit running into billions of Dollars where as NITEL (Nigeria Telecommunication Company) is in tatters. This strategy suggests foreign technology diffuses through supply chains rather than spillovers. It can also be argued that multinational entry may hurt local firms. Foreign firms may hire talent away from local firms thereby creating a brain drain. Multinationals turn to pay high wages which may raise wages for all firms in competitive labour markets as cited in Aitken etal (1996) who have argued that if higher wages do not reflect an improvement in employee capabilities which may be the case multinational firm will face public pressure in its home country to improve overseas worker conditions which may lead to the firms to substitute capital for labour in an otherwise inefficient manner. Kholdy and Sohrabian (2008) cites that preliminary evidence shows that FDI can jump-start financial development in developing countries where as Dollery etal (2010) argues that corruption which is rampant in developing countries has a negative effect on economic growth. For instance, in relation to a country like China, despite its strong performance, corruption still limits the potential investment into this country. The internal issues need to be redressed in China as these directly affect investment (Floyd and summan 2008). This can be in the form excessive patronage, nepotism, job reservations, favour for favours, secret party funding and suspiciously close ties between politics and business. It is important to note that financial development requires a substantial amount of infrastructure for market support. Infrastructure will not develop where the dominant elite consider it as a threat to their power and position. A classical example is the Nigerian power sector which is erratic at its best after huge amounts of money sunk into the sector over the years. The reasons for such sabotage by the ruling elite include the fact that they are adequately capitalized and prefer to limit opportunities for new competitive investors who are the Diesel, petrol and Power generating plants importers.

Ball and Mc culloch (1993) opines that the major function of government is the protection of the economic activities. Hill (2003) cites that governments use policy instruments to regulate FDI activity by MNEs. Such instruments may be in the form of tax concessions, low interest loans and grants and subsidies. Hill (2003) asserted further that these incentives by the host countries are motivated by a desire to gain from the resource transfer and employment effects of FDI. They are also inspired by a desire to capture FDI away from other potential host countries. For example, in 2005 more than 3,000 white farmers were forced off their land as President Robert Mugabe tried to Africanise agriculture. However, other African countries saw it as an opportunity to increase food production and competed with each other on the incentives they offered to them to invest in their respective countries. World Bank (2008) report cites that the dismantling of trade barriers in many parts of the developing world over the past decades has dramatically helped to increase developing countries to foreign technologies and this helped to boost productivity in the developing world economies. According to the world bank (2008) report, by dismantling trade barriers to foreign investments middle income countries have encouraged greater FDI inflows by implementing stronger regimes governing intellectual property rights in which evidence suggest that stronger intellectual property rights are associated with a rise in knowledge to affiliates and FDI flows towards middle income countries and large countries but not poor developing countries. A good example is the EU, the collective GDP of the EU is greater than that of the US or Japan this shows how important EU is in the international arena. A few countries in developing world are encouraging joint ventures rather than FDI technology transfer. In his research Jaejoon Woo (2009) concluded that there is evidence that Foreign direct investment is important and is the form of most of the private capital flows to the developing world and in his empirical study to find out if FDI had a positive effect on (TFP) total factor productivity Jaejoon (2009) found evidence from his econometric results that indicated FDI having a direct and positive effect on (TFP) growth. Adams and Mengistu (2007) found out that there is no conclusive evidence on the effect of FDI economic performance and other studies on the effect FDI economic performance on a host country is dependent on the country absorptive capacity in terms of human capacity, the level of development including financial development.


From the findings of this paper it can be concluded that FDI enter into countries in two major forms namely-merger and acquisition and green-field investment. This determines to a large extent the effect of the investment on the host country. When FDI takes the form of a green-field investment, the result is to establish a new enterprise, increasing the number of stakeholders in the market and thus consumer choice. This effort can encourages competition in a national market, there by driving down prices and increasing the economic welfare of consumers. Increased competition tends to stimulate capital investments by firms in plant, equipment and R&D as they struggle to gain an edge over their rivals. The long-term results may include increased productivity growth, product and process innovations and greater economic growth.

FDI inflows therefore makes a positive impact on economic growth only in the presence of a highly skilled labour, corruption has a negative effect on economic growth and trade openness increases economic growth by means of efficiency gains.


It has also been shown that levels of corruption are preventing foreign firms from investing more heavily in developing countries. As stated differences in regulation across the various nations has been as a result of economic, political and financial factors. In order for improvement to take place economic development is first necessary to prevent people from turning to corruption due to poverty, it is also important to further break up industry and have less corruption in government. Finally international standards need to be encouraged on a worldwide basis and strictly adhered to in order to achieve a more transparent system of global trade. Below is a list of recommendation gathered from research of this paper:

  1. Effective coordination of all aspects of each home country's efforts for the benefit of their small and medium-sized enterprises so as to increase awareness of investment opportunities in developing countries.
  2. Greater transparency, minimization of bureaucracy and simplification and standardization of application and implementation procedures in order to maximize the use of HCMs
  3. Bilateral and multilateral collaboration between home and host country institutions, such as investment promotion agencies and industry associations
  4. A facilitating role to be played by home country governments in building host country capacity to receive and benefit from investment.


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