How can Foreign Direct Investment help developing countries?

Published on by Sevi Fattahpour



What is foreign direct investment? Foreign direct investment (FDI) is an investment directly into production in a country by a company located in another country, either by buying a company in the target country or by expanding operations of an existing business in that country.

FDI provides an inflow of foreign capital and funds, investment in addition to an increase in the transfer of skills, technology, and job opportunities in the receiving country. So if FDI is such a great thing, why don't all countries get it? Well to answer this question, we first need to look at why Companies actually go and invest abroad and why don't they just stay where they are.Companies who invest abroad are mainly looking to take advantage of cheaper wages, advanced infrastructure and skilled workforce and a less regulated business environment, in other words, a business friendly environment which allows greater freedom for businesses and finally, they want to be able to freely buy and sell goods and services freely without any restrictions so in other words, a non protectionist economy. Therefore, in order to boost FDI, we need to create an attractive environment for businesses to come and invest.


Before i go further and suggest a number of ways to boost FDI, we need to make the role of government in this matter very clear. In an advanced economy, the government should not be the provider, but it should be the enabler. Government should create a stable and business friendly environment by achieving macroeconomic stability and fostering policies which favour investment and make job creation much easier. So here are the main factors that affect FDI:


1.Macroeconomic stability: This is the first thing which firms will look at when deciding where to invest. Stability is very important because it make investment easier since when inflation is stable, firms will be able to take into account the anticipated inflation into their future costs where as if inflation is out of control, firms will hold their investment or won't even invest at all. So government need to foster a stable environment for business investment


2.Lower Corporate Taxes: Level of taxation is very important.If taxes are high in a country, firm will not invest because a large proportion of their profits will be confiscated by the state so this is a very strong disincentive to invest. Also, to corporations, corporate taxes are a cost so they will pass it on to consumers through higher prices which lead to a general rise in price levels so lower corporate taxes will make a country more attractive for investment.


3.Skilled Workforce: Skilled workforce is very important to a firm who is transferring its capital to a different place/country because if a country's labour is unskilled, firms who want to invest will have to spend a fortune on training and education of their workforce which costs a lot and will outweigh the likely benefit of moving their production plant/capital to a new country.Also, their costs will also rise due to low productivity which at the end affects their profitability.


4.Minimum Wage: Firms look at labour as a cost and a production unit. When the government imposes a minimum wage, they simply interfere in the labour market and mass unemployment will be the result. Not only minimum wage hurts workers because firms have to lay workers off, but it also leads to a rise in costs which lowers firms profitability and firms have to pay workers the minimum wage regardless of their productivity which leads to lower productivity in general because whatever the worker produces in one hour, he will get the minimum wage. No wonder why United kingdom has a very low productivity among its European trading partners which again leads to a rise in prices. So abolishing minimum wage is a great job creator and makes firms more inclined to invest and unemployment will fall of course. Its very important to know that there is a direct relationship between wage levels and levels of unemployment.


5.Regulation: Some regulations are good and need to be in place but most of the regulations are very costly and often seen as unnecessary to firms.Small businesses will get hit the hardest and often due to these heavy regulations, businesses wont start in the first place. In the case of big firms, they might not be hit as hard but this adds to their costs and these costs are passed on to consumers since corporations wont lower their profit margins so regulations wont in some cases help the consumer but in fact, it hurts them. Employment regulations will actually lead to firms not employing workers in the first place because it costs a lot for firms and the the fact that firms won't be able to get rid of workers easily scares them away from the beginning so they just won't hire from the beginning. Some employment regulations are good such as anti discrimination act  which stops employers from discriminating on the basis of gender, race and disability.Another good regulation is basic health and safety, not the one we currently have.


6.Free Trade: Free trade allows firms to move capital around freely and export their products to wherever they want and also import whatever they want. For the sake of this topic, free trade allows firms to freely trade with no restrictions. Let me give you an example: Imagine a firm in a protectionist country, they cant trade freely due to tariffs, quotas and embargoes. This affect their costs when trying to trade and in some cases, not being able to trade with the world markets means they will have a substantially smaller market to sell their products which minimises their profit levels and they won't be abler to achieve economies of scale.


7.National Debt: If a country has high levels of national debt, this means that the real interest rates are high and if the government doesn't deal with its debts, the investor confidence will fall.Also high levels of taxation will soon follow because the debts will have to be paid of eventually. Now as i mentioned earlier, high taxes are a disincentive to investment and high interest rates will mean lower borrowing which again puts investment off because it costs a lot to borrow so firms will not invest.


So these 7 issues are at the heart of decision making for Foreign Direct Investment. FDI brings jobs, technology, skills, and improved supply side for the economy at the receiving end. FDI is particularly helpful for developing countries such as those in "Africa & Asia" and although countries in Africa don't satisfy all these 7 requirements and usually have corrupt government, it still benefits them in some ways. Think about Vietnam. At first, jobs were low paid and required unskilled workers when FDI first began but as time passed, more firms moved their production plant to Vietnam, competition for labour was increased and real wages rose. Other businesses got started as a result of people having more money to spend, technology was transferred, working conditions improved by itself because more firms were competing for labour and workers had a choice as to where to go considering working conditions and pay. Today Vietnam is an entirely different country which exports all kinds of manufacturing products and computers etc. Millions of people were lifted out of poverty not by government handouts, but with hard work and dedication.


So here are the steps that we have to take to boost FDI:

  • Scrap Minimum Wage to allow higher employment and increase productivity
  • Lower Corporation tax to 10% / Eliminate it if possible
  • Remove tariffs and quotas/ Allow Free Trade
  • Balance the governments budget to allows real interest rates to fall
  • Invest in education & training/Increase competition between schools especially at secondary school level by issuing school vouchers and elimination of public schools
  • Deregulate the economy as much as possible but keep regulations such as anti discrimination act, basic health and safety and other useful regulation.
  • Abolish equal pay act in order to improve productivity among workers
  • Keep inflation at the 2% target CPI 

All these steps will boost Foreign Direct Investment, improve productivity, boost employment and will increase the real standard of living





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