Question

2. Discuss two economic arguments in favor and two economic arguments against foreign direct investment (FDD, Given your answers, if you were the minister of the economy of a developing country, would you encourage FDI unambiguously or only under certain conditions? Be as specific as you can and try to defend your arguments using empirical evidence or economic theornes discussed in class. 10 points

Answer 1

Foreign direct investment (FDI) is an investment from a firm or corporation into a business or corporation in another country with the intention of establishing a lasting interest. Lasting interest differentiates FDI from foreign portfolio investments, where investors passively hold securities from a foreign country. A FDI can be made by obtaining lasting interest or by expanding one's business into a foreign country.

Typically there are two type of FDI : Horizontal FDI and Vertical FDI

Horizontal: A business expands its domestic operation to a foreign country. In this case, the business conducts the same activities but in a foreign country. For example McDonald's opening restaurant in India would be considered a horizontal FDI.

Vertical: a business expands into a foreign country by moving to a different level of the supply chain. In other words, a firm conducts different activities abroad but these activities are still related to the main business. Using the same example, McDonald could purchase a large scale farm in Canada to produce meat for their restaurants.

Advantage of FDI to the host country

1) Economic stimulation and increase in employment

FDI is considered to be a significant driver of economic growth in developing industry by infusing capital to build infrastructure and industry which in turn increase employment of local unskilled workers.

2) Access to management expertise, skill and technology and development of human capital

FDI supplement host countries with new technologies, skillful and knowledge-enabled human capital, improvement in labor qualification access to external markets.

Disadvantage of FDI

Displacement of local business

1) FDI leads to displacement of local business

As local businesses are not able to compete with FDI on scale of large production and even on selling these final product to end use consumer, they are thrown out of business due lack of revenue generation.

2) Host country becomes the dumping ground for the FDI

Many times FDI dump obsolete technology to the host countries which hampers the growth of host countries.

If I were minister of a developing economy like India, I would encourage FDI in those sector where investment is needed in capital goods industry and recruit large scale unskilled labor and helps in creating large scale infrastructure like education, healthcare, transportation.