FDI: Exploring Theories to Understand Its Impact on Host Countries - Essay Sample

According to Bajrami (2019), not each country has the capacity to attract the right foreign direct investment, and not each investor can risk investing in any country. An investor has to first study the host nation’s conditions. The attraction of FDI entails both monetary and fiscal incentives (Bajrami, 2019). Therefore, the theories that explain the impact of Foreign Direct Investment on the host country include the General FDI theory, exogenous growth theory, endogenous growth model, and comparative advantage theory.

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Different theories can be utilized in explaining FDI, and the first one is the General FDI theory. The theory investigates the major motivations in certain locations and entry modes (Bajrami, 2019). The General FDI Theory comprises of other essential theories, including Monopolistic Advantage Theory. According to the theory, some companies engage min FDI intending to compete in foreign nations against native companies (Bajrami, 2019). The issue of competition can positively or negatively affect the host nation. It will positively make the indigenous firms work towards providing quality goods and services because of stiff competition (Bajrami, 2019). However, it might also result in the collapse of some companies in the host nation if they cannot heed to the high competition pressure.

According to Denisia (2010), FDI is an essential tool for economic development, especially for developing nations. The exogenous growth theory created by Solow in 1956 and 1957 assumes that economic growth is achieved by accumulating exogenous aspects of production (Mahembe & Odhiambo, 2014). The factors of production include labor and stock capital. Furthermore, the exogenous model uses the function of aggregate production established in 1928 by Cobb and Douglas in demonstrating against technological progress rate, capital input, and labor input that change with time (Mahembe & Odhiambo, 2014). The theory indicates that capital accumulation contributes to the growth of an economy in the capital share proportion of the federal output (Mahembe & Odhiambo, 2014). Economic growth also relies on the augmentation of technological progress and the labor force (Mahembe & Odhiambo, 2014). Therefore, this theory implies that FDI results in the host nation’s increased capital structure and further impacts economic growth.

FDI can be beneficial to a developing country when new technology is introduced according to the exogenous model (Mahembe & Odhiambo, 2014). The introduction of the new technology will result in increased capital productivity and labor, and it will result in the consistency of returns on investment and growth of labor (Mahembe & Odhiambo, 2014). The exogenous model argues that there is a positive relationship between output and capital accumulation. FDI enhances economic growth through the neoclassical growth model by introducing foreign technologies and new inputs in the host nation’s production function. Furthermore, the exogenous growth theory argues that the introduction of new goods in a country can result in the economic growth of the host country.

The endogenous growth model enhances the stocking of information in the host country through transferring skills (Mahembe & Odhiambo, 2014). FDI is good for a developing country's economy as it increases its investment capital through technological spillovers (Mahembe & Odhiambo, 2014). FDI is also considered as a source of workable development and growth through its capacity to generate technology spillovers and helping in the development and human capital creation. It is regarded a source of sustainable development and growth because it assists the host nation in worldwide economic trade and plays a role in establishing a competitive environment and increasing business development (Mahembe & Odhiambo, 2014).

The theory of comparative advantage is another essential theory. In the model, nations export goods or products using their cheap and abundant factors of production. It also does this by importing goods using the scarce factors of a nation (Kurtishi-Kastrati, 2013). Comparative advantage is established in FDI since foreign investors enhance international knowledge diffusion (Fan et al., 2019). Furthermore, some kinds of knowledge are considered explicit, meaning they are indirectly transmitted through a form such as international trade of services and goods. The transmitted knowledge is tacit and disembodied, and tacit knowledge plays a vital role in the distribution of income and economic growth (Fan et al., 2019).

One of the essential impacts of FDI in the society is improved labor conditions quality as explained by exogenous growth theory. It is achieved through the creation of employment opportunities for men and women in society. Moreover, some of the FDI work towards investing in the educational sector of a society, which, in the end, improves their wellbeing. Also, introducing new technology to sustain staff can improve society as it will make them stay informed on an important issue. FDI can also positively impact society if it respects the law, the environment, and the employees' human rights. However, FDI has raised some concerns about the host country's society like unfair competition and disrespecting the rights of the employees and encouraging pollution, which affects the environment of the host and the members of society.

In summary, the different models, including General FDI theory, exogenous growth theory, endogenous growth model, and theory of comparative advantage, play a role in explaining the impact of FDI on the host country. According to the theories, FDI can positively and negatively affect society through advanced technology and pollution. Also, FDI enhances stiff competition among the host and foreign countries.

References

Bajrami, H. (2019). Theories of foreign direct investment (FDI) and the significance of human capital. International Journal of Business and Management, 7 (1), pp.11-24. DOI: 10.20472/BM.2019.7.1.002

Denisia, V. (2010). Foreign direct investment theories: An overview of the main FDI theories. European journal of interdisciplinary studies, (3).

Fan, Z., Li, H., & Pan, L. (2019). FDI and International Knowledge Diffusion: An Examination of the Evolution of Comparative Advantage. Sustainability, 11(3), 581.

Kurtishi-Kastrati, S. (2013). Impact of FDI on economic growth: An overview of the main theories of FDI and empirical research. European Scientific Journal, 9(7).

Mahembe, E., & Odhiambo, N. M. (2014). Foreign direct investment and economic growth: A theoretical framework. Journal of Governance and Regulation/Volume, 3(2). DOI: 10.22495/jgr_v3_i2_p6