Does Foreign Direct Investment Promote Economic Growth?


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Foreign direct investment (FDI) is the movement of capital across national frontiers in a manner that grants the investor control over the acquired asset. FDIs require a business relationship between a parent company and its foreign subsidiary. Out of two primary channels for FDI effects on economic growth, inflows of physical capital and technology spillovers respectively, it is technology spillovers that have the strongest potential to enhance economic growth in the host country. Using panel data analysis the empirical part of the paper finds indications that FDI inflows enhance economic growth in developing economies but not in developed economies. To operate a firm in the intermediate goods sector, entrepreneurs must develop a new variety of intermediate good, a task that requires upfront capital investments. The more developed the local financial markets, the easier it is for credit constrained entrepreneurs to start their own firms. The increase in the number of varieties of intermediate goods leads to positive spillovers to the final goods sector. As a result financial markets allow the backward linkages between foreign and domestic firms to turn into FDI spillovers. FDI provides an inflow of foreign capital and funds, in addition to an increase in the transfer of skills, technology, and job opportunities. Many of the Four Asian Tigers benefited from investment abroad.A recent meta-analysis of the effects of foreign direct investment on local firms in developing and transition countries suggest that foreign investment robustly increases local productivity growth. We propose a mechanism that emphasizes the role of local financial markets in enabling foreign direct investment (FDI) to promote growth through backward linkages, shedding light on this empirical ambiguity. The increase in the number of varieties of intermediate goods leads to positive spillovers to the final goods sector. As a result financial markets allow the backward linkages between foreign and domestic firms to turn into FDI spillovers. Our calibration exercises indicate that a) holding the extent of foreign presence constant, financially well-developed economies experience growth rates that are almost twice those of economies with poor financial markets.

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Does Foreign Direct Investment Promote Economic Growth?

  1. 1. Defination of FDIForeign direct investment (FDI) occurs when an investor based inone country (the home country) acquires an asset in anothercountry ( the host country).Which factors encourages FDI?Political stabilityMarket potential & accessibilityLarge economyMarket size
  2. 2. 3FDIAttracting long-termforeign capital tosupplement domesticinvestment effortsDeveloping attractiveConfigurations oflocational advantagesat global levelPromoting technologyand other linkages toenhance domestic industrycompetitivenessCreating skilled employmentOpportunities and Importof world Class managerialpractices
  3. 3. EconomicGrowthTradeEmploymentand skilllevelsTechnologydiffusion andknowledgetransferLinkages andspillover todomesticfirms
  4. 4. The “confidence” called IndiaOne of the fastest growing economies, second only after China.Fourth-largest economy on purchasing power.3rd in investor confidence for FDI investments.India offers the best return on investment among emergingmarkets.“The Time is be in India. This is perhaps the mostoptimistic I’ve felt about India in the last 10-15 years that I’ vebeen coming here.” – Jeffrey Immelt
  5. 5. 6India – A Good Place to Put Your MoneySecond LargestEmerging MarketLargestdemocracy –politicalstabilityLiberal &transparentinvestmentpoliciesFourth largestEconomy - Asafe placeto do businessLargestreservoir ofskilledmanpowerLong-termsustainableCompetitiveadvantage- High growth rateeconomy
  6. 6. 0100020003000400050006000US$million
  7. 7. 31%13%12%11%10%6%6%4% 4%3%Services SectorComputer Software &hardwareTelecommunicationsHousing & real EstateConstruction ActivitiesPowerAutomobile IndustryMetallurgical IndustriesPetroleum & Natural GasChemicals
  8. 8. 910 year tax holiday for developers of SEZs/IndustrialParks100% tax Exemption for 5 Years and 50% thereafterfor two years for SEZ Units100% Tax holiday for 10 years for infrastructureundertakings100% tax deduction for 10 consecutive assessment years toundertakings providing Telecom servicesInvestment Opportunities (For Ex.-Infrastructure )
  9. 9.  6th position in the basic metals category 7th in chemicals and chemical products 10th in leather, leather products, refinedpetroleum products and nuclear fuel 12th in machinery and equipment and motorvehicles.According to a United Nations Industrial Development Organization (UNIDO)
  10. 10.  Ranked 2nd most favored destination for foreigninvestments after China India ranks among the top 12 producers ofmanufacturing value added (MVA). In textiles, the country is ranked 4th after China, USAand Italy. In electrical machinery and apparatus, it is ranked 5th.According to a United Nations Industrial Development Organization (UNIDO)
  11. 11. Foreign Direct Investment (FDI) up to 100% ispermitted in all manufacturing activitiesexcept:-DefenseIndustryCigars &CigarettemanufacturingWhere theforeigninvestor hasan existingjointventure inIndia in thesame field.Where morethan 24%foreignequity isproposed tobe inductedformanufacture ofitems reserved for SmallScale sector
  12. 12. Current issues Very weak linkages of service sector withthe Indian economy(only few cities) Employee Welfare in time of crisis Telecom Issues: 2GScam(Docomo, Telenor) Retail: 51 % to multi brand and 100 % tosingle brand
  13. 13. FDI may provide better access to technologies for the local economy.FDI can also lead to indirect productivity gains.Multinational firms may increase the degree of competition in host-country marketswhich will force existing inefficient firms to invest more in physical or human capital.MNCs are provideing training of labor and management.The increased flow of FDI in a country has given a major boost to the countrys economy.Hence measures must be taken in order to ensure that the flow of FDI in both thesecountries continues to grow.
  14. 14. Attract‘Quality’ FDIAttracttechnologyand localizeproductionFocus onExport-oriented FDITargetspecificsectorsIncrease easeof doingbusiness