There are still many countries which consider the economic development a dream. A lot of attempts have been made to improve their material conditions with the help of effective use of such resources as fertile lands, real capital, and labor use. It is evident that the economic success of most developed countries was due not only to the domestic, but also foreign resources. Many countries seek to attract foreign direct investment as they rely on foreign capital in order to solve and overcome domestic issues (Akrami 2008, p. 3)
The role of foreign direct investment in the process of a country’s growth has been a hotly discussed topic. The studies show controversial results as foreign direct investment increases economic growth in some host countries whereas no effect is shown in others (Moran, Graham & Blomström 2005, p. 5) International production growth is driven by technological and economic forces, trade policies, and the liberalization of FDI (Ray 2012, p. 187).
FDI is a physical investment of a company in another country (Graham & Spaulding 2005). It may also be defined as an investment that is made in order to get a long-term interest in an enterprise which operates in the economy of a country. FDI is a process of getting the asset ownership by the residents of one country, which is called a source country, with the aim to control production, distribution, and other activities of production in another state, which is called a host country (Ray 2012, p. 187). In case foreign investors establish business inside a foreign country, it means that FDI occurs (World Bank Group, Data and Statistics 2002). There exist such forms of FDI as greenfield investments, brownfield investments, cross-border merger, and acquisition type of investment (Vickers 2002).
FDI gives an opportunity to small and medium-sized companies to become involved in the activities of international business. More than 2/3 of FDI is made in the form of machinery, fixtures, equipment, and building, the same as it was 15 years ago. Large conglomerates and multinational corporations still manage to get a huge FDI percentage. However, rapid development and useof the Internet, direct investment restrictions loosening, the increasing role of technology, and communication costs decrease means that investment forms, which are considered to be non-traditional, will never play an important role. That is why the governments of developed and industrialized countries pay great attention to FDI (Graham & Spauling 2005).
It has been stated that in general FDI has a positive effect on economic growth of a country. However, it is necessary to take into account the magnitude of this effect as it depends on the human capital stock, which is usually available in the host economy. It should be noted that the interaction of human capital with FDI has a negative effect for the countries with very low human capital levels (Borensztein, Gregorio & Lee 1998, p. 123).
In spite of the fact that FDI has a huge potential in economic development of a country, it cannot provide answers to all problems related to development. Poor society segments need to be supported by public policies. The FDI role is to generate the resources which should fund the governmental programs with the aim to improve the networks of social safety and provide basic social services. The social service delivery to the poor, including access to energy, water and insurance schemes, can also take an advantage from the support of foreign investors. In this case, it becomes imperative for the government to create the preconditions in which FDI is able to flow in. A competitive and liberal climate of investment can easily create the basis for FDI in order to raise productivity growth potential in the host economy. Nevertheless, the improvement may occur only in case domestic leaders are ready to respond to these new incentives (Ray 2012, p. 199-200).
Some scientists consider that FDI may lead to restricted development whereas others find it a positive feature as it can bring technology and capital, as well as develop skills and increase employment level and income (Kiely 1998). The following examples can illustrate employment increase in different countries. In 2010, a new hotel construction gave 1441 jobs in Brazil; Spain (Fiesta Hotel Group) invested $230 million in Salvador; a bus and truck assembly plant of Hyundai Motor’s built in Kazakhstan guaranteed 1197 jobs; Tepotzotlan was invested $ 200 million by Coca-Cola (USA) and others (Hornberger 2011).
Last year, high commodity prices and the strength of the world economy caused the flux of FDI. But it still remains unclear whether the benefits have any relation to the people of poor countries. It was mentioned during the UN Conference on Trade and Development (Unctad) that the FDI inflows rose to $1.306 trillion (it is 38%). The rise is said to happen because of high commodity prices and the strong world economy as these factors increased oil activity, activities in mining and gas sectors mostly operating in such areas as Africa. FDI is continuing to grow surpassing the record of 2000. The US takes the first position in FDI destination and is followed by Britain and France. It has become evident that the rise of FDI reached $379 billion (21%) in developing countries and $ 857 billion (45%) in developed ones (Seager 2007).
Since recent years, the FDIs have become one of the major economic drivers of globalization. The growth rate of FDI is constantly increasing. A good example may be provided when analyzing developing countries. It has been increasing from less than $10 billion (1970s) and it already reached $ 636 billion in 2006. China, Russia, Brazil and Mexico are at the forefront of FDI growth (Foreign Direct Investment (FDI) 2010). In 2010, the volume of FDI to rich economies was lower than FDI to developing and transition economies.
It is widely believed that the FDI effects on host economy are beneficial as foreign direct investments usually increase employment, productivity, exports, amplified pace of technology transfer, introduces modern management techniques, facilitates exploitation of local raw materials, and make it easier to access new technologies, etc. However, FDI can put forth an effect on the output level per capita, but not on the rate of growth. A new theory of economic growth defines FDI as a growth engine of mainstream economies. It has been studied that FDI is able to promote the development of the host country economy with the help of promoting growth and export productivity. The main determinants of FDI’s net benefit are the characteristics of the policy environment and the host country (Ray 2012, p. 188).
It has been stated that FDI is the most important source of flows into an external resource to developing countries. It plays a vital role in the formation of capital in these countries in spite of the fact that the global distribution share of FDI is continuing to be small and even declining. FDIs provide foreign funds and capital, but also give domestic countries a skillset exchange, job opportunities, expertise, information, and improved levels of productivity (Foreign Direct Investment (FDI) 2010).
Increasing FDI may be used in order to grow economic globalization. The largest flow of FDI happens between the industrialized countries, such as Japan, North Europe, and North America. The governments of industrialized and non-industrialized countries have agreed that foreign direct investment is important for the economic growth of a country and reduction of poverty. Despite all these factors, there are still many questions concerning the regulation of FDI (Zarsky 2002).
It has been studied that FDI does have positive effects on economic growth, but they are not universal. Diverse effects are influenced by such differences in the host country as the sophistication of private sector, indigenous human resources which are varying, policies of the host country toward investment and trade, and competition. It also greatly depends on the country itself (Moran, Graham & Blomström 2005, p. 5).
Large FDI may have a huge adverse effect on the welfare of any economy. On the contrary, there can be another example of the countries which have low trade barriers and few operational restrictions. Foreign firms have ability to increase the existing economic activity efficiency and introduce new activities which have favorable effects on the development of a host country. As the result, the government of a host country should adopt the policies of open trade and investment (Moran, Graham & Blomström 2005, p. 13).
Among the potential risks FDI may have are the following: FDI benefits may be limited; it can be reversed with the help of financial transactions that may appear excessive due to adverse selection and fire sales. If inflows to the total capital of a country have a high share of FDI, it shows the weakness of its institutions (Loungani & Razin 2001; Hausmann & Fernández-Arias 2000). However, the past decade has demonstrated a dramatic increase in the technology startups. Together with the internet usage, it boosted the chances of FDI.