The Role of Fdi in Economic Development

Topics: Economics, Macroeconomics, Investment Pages: 28 (9561 words) Published: July 5, 2013
Nordic Journal of Political Economy
Volume 28 2002 Pages 109-126

The Role of FDI in Economic Development
Kjetil Bjorvatn Hans Jarle Kind Hildegunn Kyvik Nordås

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Kjetil Bjorvatn NHH, Hans Jarle Kind, SNF and Hildegunn Kyvik Nordås, SNF*

The Role of FDI in Economic Development
This paper deals with two questions: First, what are the determinants of foreign direct investment (FDI)? Second, what is the role of FDI in economic development? In order to provide some answers to these questions, we draw upon the existing theoretical and empirical literature as well as insights derived from five country studies that we have conducted. Important location advantages include a stable social, political and economic environment, liberal trade policies, and geographical proximity to large and growing economies. On the host country effects of FDI, we conclude that while FDI is not necessary to achieve economic development, the entry of foreign firms may play an important role in adding technology and competition to the host economies. However, foreign entry may lead to a loss in market shares, and thereby a loss in profits, for local firms. This problem is likely to be more important if foreign entry takes place in markets shielded from the competitive pressures of international trade. JEL Classification: F23, O57

Growth in foreign direct investment (FDI) is perhaps the clearest sign of globalization in the past decade. The average annual growth rate of FDI has been 23 percent since 1986, which is twice as much as that of trade. Most international investments take place within the OECD area. However, during the 1990s, and until the Asian financial crisis in 1997, the share of FDI hosted by countries in the developing world increased.1 Measured as a share of host country GDP, FDI flows to *

developing countries are typically greater than those to the developed world. Some people view the presence of multinational enterprises (MNEs) in poor countries as a threat to economic development. Others see FDI as a potential source of economic growth. The present paper aims at clarifying the role of FDI in economic development and derive lessons and policy implications. We base our study on general theoretical and empirical literature and on

Kjetil Bjorvatn NHH, Department of Economics, The Norwegian School of Economics and Business Administration, Helleveien 30, 5045 Bergen, Norway. Hans Jarle Kind, SNF and Hildegunn Kyvik Nordås, SNF, Institute for Research in Economics and Business Administration, Helleveien 30, 5045 Bergen, Norway. 1. The share increased from about 18 percent in 1990 to about 40 percent in 1994, but slipped back to about 25 percent in 1999.


Kjetil Bjorvatn, Hans Jarle Kind and Hildegunn Kyvik Nordås must exist some Internalization advantages making ownership preferable to more armslength contracts. These advantages typically include a greater control over technology and reduced transaction costs. Vertical FDI FDI is commonly classified as vertical or horizontal. Vertical FDI involves a geographical decentralization of the firm’s production chain, where foreign affiliates in low-wage countries typically produce labour-intensive intermediates that are shipped back to highwage countries, often to the parent company itself. Vertical FDI is sometimes referred to as “efficiency seeking” FDI, since the main motive for the investment is to improve the cost effectiveness of the firm’s production. In the textile and clothing industry, for example, global supply chains are common. The capital-intensive stages (textiles) are located in relatively capital rich countries, human capital-intensive stages (design and upmarket apparel) are located in human capital rich countries, and labour-intensive stages (apparel) are located...

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