Impact Of FDI On Host Economy

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This undertaking critically examines the negative effects that FDI poses to the host economic system. The impact of FDI on the host economic system can be understood with the aid of The Standard Theory of International Trade and The Theory of Industrial Organisation. FDI has both positive and negative impacts on the host-country. FDI has an inauspicious consequence on the host state ‘s economic system, environment, domestic houses, political environment, labour market and trade balance. Through this undertaking, it is concluded that the authorities policies should be such that they exploit the benefits of FDI wholly in order to overturn its drawbacks.

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There is an increasing recognition to acknowledge the forces of economic globalisation which first requires looking at Foreign Direct Investment ( FDI ) by transnational corporations ( MNCs ) : that is, when a house based in one state locates or acquires production installations in other states. ( Blonigen, 2006 ) .

Over the past decennary Foreign Direct Investment ( FDI ) has grown perceptibly as a major signifier of international capital transportation. Between 1980 and 1990, universe flows of FDI- defined as cross-border outgos to get or spread out corporate control of productive assets – have about grown three times ( Froot, 1993 ) . “FDI has turned out to be a major signifier of net international adoption for Japan and the United States, the universe ‘s largest international loaner and borrower respectively” ( Froot, 1993, pp. 1 ) .

The most introverted consequence of FDI has been seen in developing states, wherein one-year Foreign Direct Investment flows have increased from an norm of less than $ 10 billion in the 1970 ‘s to an one-year norm of $ 208 billion in 1999 ( Beginning: UNCTAD ) . A big part of planetary FDI is driven by amalgamations and acquisitions and internationalisation of production in a scope of industries ( Graham and Spaulding, 2005 ) .

Despite the noticeable importance of FDI and MNCs in the universe economic system, research on the factors that decide FDI forms and the impact of MNCs on parent and host states is in its early phases. The most important general inquiries are: what factors determine where FDI occurs, and what impacts do those MNC operations have on the parent and host economic systems? This study chiefly analyses the negative impact of FDI ‘s on host economic systems.


“Foreign Direct Investment reflects the aim of obtaining a permanent involvement by a resident entity in one economic system ( “direct investor” ) in an entity occupant in an economic system other than that of the investor ( “direct investing enterprise” ) ” ( OECD ) . In other words, it is a direct investing made by a corporation in a commercial venture in another state.

What separates FDI from portfolio investing is the control over the investing ( Gillies, 2005 ) . In instance of FDI at least 10 per centum of the vote rights must be held by the foreign investment company ( Daniels et al. , 2004 ) . The difference between FDI and other ventures in foreign states is chiefly that the new venture operates wholly outside the economic system of the company ‘s place state.

The chief incentives behind FDI are resource acquisition, gross revenues enlargement and hazard minimization. Besides this authoritiess may besides promote FDIs due to assorted political motivations ( Daniels et al. , 2004 ) .


Foreign Direct Investment can be classified into three wide classs on the footing of way, mark or motivations.

On the footing of way FDI can be classified into Inward or Outward FDI. When foreign capital is invested in local resources, it is referred to as Inward FDI, on the other manus when investings are made by local houses in foreign resources it is referred to as Outward FDI. Outward FDI is besides known as “direct investing abroad” and is ever backed by authorities support in instance of any hazards.

On the footing of mark FDI can be classified into Greenfield Investments, amalgamations and acquisition, horizontal and perpendicular FDI. Greenfield Investment refers to direct investing in new spheres or the development of bing comfortss. This leads to creative activity of production capacity, employment chances, transportation of engineering and expertness every bit good as linking of the host economic system to the planetary market place.

Amalgamations and acquisition are a major sort of FDI whereby there is a transportation of bing resources from local concerns to foreign concerns. Cross boundary line amalgamations take topographic point when the direction of resources and concern operations is relocated from a local company to a foreign company, with the local administration going an associate to the foreign administration. Acquisitions take topographic point when the foreign company takes over a domestic company, and establishes itself as the new proprietor of the domestic company.

Horizontal FDI refers to an investing made by a foreign company in the same industry in which it operates in its place state. Vertical FDI can be classified further into backward and frontward perpendicular FDI. Backward Vertical FDI occurs when a domestic house is provided input by a foreign house in order to help its production procedure whereas Forward Vertical FDI occurs when the end product of a domestic house is sold by an industry abroad it is known as frontward perpendicular FDI.

Last on the footing of motivations, FDI can be classified into four types. The first type is of FDI takes topographic point when the assorted factors of production may non be available in the place state of the house or be more efficient in the host state, thereby encouraging houses to do investings. This is known as Resource seeking FDI. The 2nd type of FDI which can be used as a defensive scheme is Market-seeking FDI.

These investings are made either to keep bing markets or to perforate into new markets. The 3rd type is Efficiency Seeking FDI, where the houses hope to increase their competence by working the advantages of economic systems of graduated table and besides common ownership. The houses therefore try to accomplish the aim of net income maximization. the last type is Strategy -asset seeking FDI, which is a common maneuver used by houses to halt their rivals from geting resources. Thus these are the assorted types of FDI.


There are two attacks in economic theory which contribute to analyzing the effects of Foreign Direct Investment on host states.

One is the standard theory of international trade by Macdougall ( 1960 ) . This theory is a “partial equilibrium comparative-static attack intended to analyze how fringy increases in investing from abroad are distributed” ( Blomstrom, 1997, p.1 ) . The chief premise of this theoretical account is that there is an addition in the fringy productiveness of labor and a lessening in the fringy productiveness of capital.

The other theory was proposed by Hymmer ( 1960 ) and is called the theory of industrial administration. The chief inquiry of the theory is why houses make investings in other states in order to fabricate the similar goods they manufacture at place. The reply to this inquiry has been justly devised by Kindleberger, 1969, p.13 ) , who says, “for direct investing to boom there must be some imperfectness in markets for goods or factors, including among the latter engineering, or some intervention in competition by authorities or by houses, which separates markets” . Thus houses of place states must hold some plus which is traveling to be moneymaking for its associate in the place state ( Blomstrom, 1997 ) .

Foreign Direct Investment has both positive and negative effects on the host economic system.


FDIs have a figure of positive impacts on the host state. It encourages economic development by increasing the productiveness and exports of the host states. There are four channels which help in increasing the productiveness of host state, viz. imitation, skill acquisition, competition and exports ( Gorg & A ; Greenaway, 2004 ) .

The local houses in the host states benefit by the indirect engineering transportation that takes topographic point between the MNC and the domestic companies. Local houses can vie more successfully in the export markets by copying the superior engineering or direction techniques used by the multinationals ( Blomstrom, 1991 ) .

Domestic houses become more open to the foreign markets and later their cognition of the international markets increases. The Managers and other qualified employees of the domestic houses get the superior managerial and proficient accomplishments, which increases their efficiency.

Multinationals increase the bing market competition, inciting the local houses to go more efficient by puting in physical or human capital. They help to increase industrial efficiency and better resource allotment in host states by come ining markets which had many entry barriers. Therefore by come ining these monopolistic markets they increase competition and coerce the local houses to go more adept. This is how, domestic houses are provoked by multinationals and other abroad houses to better their public presentation and productiveness.

Multinationals besides influence the local providers of intermediate merchandises to go more efficient with bringing velocity, quality and dependability of the merchandises so as to run into the high criterions of the abroad company.

It is seen that FDI has a positive impact on labour market. If the productiveness of domestic houses additions by copying the multinationals production manner which is based on increased labor productiveness, so the domestic houses will non waver from paying higher rewards to the labor ( Lipsey & A ; Sjoholm, 2010 ) . Multinationals besides increase the criterion of the host state ‘s labour market by supplying the laborers with preparation and doing them qualified adequate to manage complicated machinery and increasing their productiveness.

Last FDI affects the economic system of the host state positively by increasing their grosss in the signifier of revenue enhancements, beef uping the exchange rate of the state and inciting the authorities to do policies which would pull more MNCs towards it.


As seen above FDI has a figure of positive effects on the host economic system but these effects do non come free of cost. FDI brings along with it a figure of negative effects which prove harmful to the state in assorted ways. Extend of the negative effects of FDI depends on the features of the transnational companies, the host state and the policies of the host state.

Some of the negative effects have been highlighted below:


With increasing competition all over the universe, companies are switching their production base to developing states where they can transport out the production of goods that are pollutant to the environment. These states have flexible environmental ordinances and are less rigorous with their enforcements. Therefore by transporting out production in such states they are able to acquire a competitory border over companies which carry out production elsewhere. Lowered trade obstructions are taking to a displacement of fouling industries from states with severe environmental ordinances to states with moderate environmental ordinances.

This leads to an addition in pollution in states with indulgent environmental policies because they refuse to fasten them in order to derive a stronger place over others in international trade. Trade may modify the environmental results through a figure of different channels. The scale consequence is one such channel that has harmful deductions to the environment. This is because when multinationals set up fabrication installations or outsource these to other local concerns, it leads to an addition in end product which in bend leads to an addition in pollution ( Liang, 2006 ) .


FDI has a negative impact on the market construction every bit good. As the multinationals enter the market, it leads to the addition of concentration degrees within the economic system which in bend shackles market control. Therefore hazard is prevailing. FDI ‘s tend to piece in extremely concentrated industries. The relationship between presence of foreign administrations in the host states and the concentration within the economic system is indebted to the nature of transnational ownership benefits instead than to anti-competitive activities.

In little economic systems, adept development of modern advanced engineering leads to concentrated market constructions. If such economic systems have lenient trade disposal so the hazard of anti-competitive activities is diminished to a great extent ( Lall, 2000 ) . However it is apparent that successful competition schemes are really of import as multinationals have the capableness to merely command an industry in a host economic system.


FDI ‘s unfastened the doors for the host state to entree new engineering but this engineering is controlled and possessed merely by the MNEs. MNCs by and large invest in capital-intensive engineerings and have strict proprietary rights which prevent its spill over to local houses.

The engineering bought in by the MNC may non be favorable to conditions of the host state. For illustration if the host state is a labor-intensive state and the engineering used by the transnational is capital-intensive so bit by bit it will hold a negative consequence on the host economic system. Once the domestic houses start copying the foreign house and get down utilizing the same engineering used by them, laborers will lose out on their occupations.

Therefore this would take to unemployment jobs which will negatively impact the economic system of the host state. A state attracts FDI so that the national economic system grows by making new occupation chances but in this instance it would work in the opposite way. Pollution-intensive engineering may besides be exported from states where they are banned.


FDIs have an inauspicious affect on competition and halter the predominating market equilibrium. In developing states, the domestic houses may non be able to get by up with the competition put up by the MNCs. Thus they would lose out on concern.

Some multinationals get monopoly position in extremely profitable sectors. With their monopolistic power they wipe out all rivals from the market. New endeavors are non willing to come in these markets because of the immense capital and hazards involved. Thus these multinationals are able to demand unreasonable monetary values form the clients, go forthing them with no other pick but to pay overly higher charges due to the limited picks available. These monopolistic companies do non even put in new engineerings to convey down their costs since they are already basking the luxury of irrational monetary values.


Atiken and Harrison ( 1999 ) and Konings ( 2001 ) , have suggested that MNCs decrease the productiveness of local administrations through competition effects. MNCs are able to transport out productions at lower costs since they bring along some proprietary cognition which is house particular. In add-on they have superior managerial and selling accomplishments, reduced production costs, majority purchases, etc which helps them cut down their fringy costs. Therefore, the demand for goods produced by MNC ‘s additions, which in bend reduces the demand for locally produced goods. This finally leads to a lessening in domestic production increasing the norm costs.

With the constitution of multinationals, the demand for foreign inputs additions in comparing to local inputs which hinder the domestic house from bring forthing to its optimal capacity. Thus the domestic houses are non able to take advantage of economic systems of graduated table.

Domestic houses may non be speedy plenty to hold on cognition from the foreign houses, losing out on competition in the short tally ( Gorg & A ; Greenaway, 2004 ) .

MNCs normally offer higher rewards to domestic workers, thereby pulling all the skilled 1s, go forthing behind merely the semi or unskilled labor for the local houses. It is a common tendency amongst MNCs to offer higher rewards in comparing to the domestic houses in developed every bit good as developing states.


The workers in the host states may non be comfy with some of the foreign policies adopted by MNCs.

One of the most attractive characteristics for FDI in a host state is inexpensive labor. They take advantage of the inexpensive labor by bring forthing labour intensive goods and thereby diminishing their costs of goods. With the constitution of labour intensive engineering by MNCs, a state becomes extremely dependent on them for its employment. Now multinationals are ever seeking to cut down their costs, so if they are able to happen topographic points with cheaper labor, they shift their base to that state. Therefore there is ever a fright of unemployment due to FDI backdown.


The authorities of the host state may confront jobs due to the constitution of FDIs. The authorities has less control over the operations of the foreign company that is working as the entirely owned subordinate of an abroad company. Taking advantage of this, the MNC may non stay by the economic policies of the host state. They hamper the assorted environmental, administration and societal ordinances laid down by the authorities of the host state. With FDI there is hazard that confidential information of the host state could be leaked out to rest of the universe. It has been seen that due to FDIs the defense mechanism of a state has witnessed assorted hazards.

It is besides noticed that multinationals are really loath to pay revenue enhancements of the host state. MNCs exploit the revenue enhancement construction of the state by taking advantage of the indulgent revenue enhancement ordinances of the host state and deficiency of enforcement by the authorities ( Velde, 2001 ) .

Another immense job faced by host states is that of transportation pricing which is a fiscal accounting device used by MNCs to maximize net incomes. Transfer pricing refers to the monetary value charged by one associate of a company to another associate of the same company. Transfer pricing relates to all minutess that take topographic point within a company including natural stuffs, direction fees, royalties, finished merchandises, etc. Transfer pricing is an illegal manner of doing immense net incomes for the MNCs. Transportation monetary values can be fabricated, therefore different from the monetary value that unrelated houses would hold to pay. Therefore by utilizing transportation monetary values as a arm, MNCs manipulate their books of entry and get immense sums of net incomes without an existent alteration in their physical capital.

Net income transferring is a manner of avoiding or salvaging revenue enhancements by MNCs through illegal ways. If the MNCs wage lesser revenue enhancements in the place state of their foreign affiliates in comparing to their host states, so in order to increase net incomes, MNCs manipulate their book of histories. They will blow up their outgo on import of stuffs from their foreign spouses or subordinates, this will demo higher net incomes in the books of histories of the foreign affiliates and less net income in the MNC ‘s history in the host state. Therefore hedging revenue enhancements and at the same clip they will unnaturally reassign net incomes to the place state.


FDI crowds out domestic investings by making a monopolistic environment. This can be explained in two ways. First MNCs raise financess locally in the domestic market, increasing the demand for money and in bend increasing the involvement rates, which crowds out domestic investings. Second when MNCs enter a new state, they bring with them immense investings which increases the overall money flow of the state. This increases the aggregative demand, taking to an addition in monetary values, i.e. rising prices, which will so increase disbursals, cut down nest eggs and finally force people to borrow money, taking to higher involvement rates. Therefore is this manner the local investings are crowded out ( Borensztein et al. , 1997 ) .

Foreign houses have better advertisement powers, ability to rule the market and marauding pricing to forestall entry.

Infrastructure CONSTRAINTS

Multinationals come in the manner of a state ‘s substructure development. It is seen that multinationals are ever attracted towards the more favorable parts of a state. Now with the constitution of multinationals in these parts, more attempts are put towards the improvement of these parts. As a consequence the rural and hapless parts are ignored and they continue to stay developing.


FDI has an inauspicious consequence on the Balance of Payment of the host state ( De Mellow, 1997 ) . Fiscal influxs raise the exchange rates, doing it unfavorable for exports. When MNCs enter a state, they bring along foreign exchange and therefore increase their supply, which strengthens the host-country currency, doing the domestic merchandises more expensive in the international markets, and as a consequence of this the entire exports of the host state reduces. Therefore there is a lessening in the net exports ( Entire Exports- Total Imports ) of the state. Hence the BOP may go unfavorable.

The capital and current history are besides hampered. When the MNC enters the host state, it might hold old natural stuff providers, or intermediary merchandise providers, from whom it continues to purchase its secondary stuff ; this would take to an addition in the import of the state doing the BOP unfavorable. Second MNCs reassign their net incomes, direction fees, royalty fees, etc back to their place state, haltering the capital history of the state.


Multinationals normally tend to be in close propinquity to each other. It is seen that MNCs have a inclination to concentrate in the certain sectors taking advantage of the location, labor and resources. Thus the economic system becomes highly reliant on the MNC. A backdown of MNC from such countries could earnestly halter the economic system and this is seen as a really terrible job in the backward countries.


This research paper was carried out to analyze the negative effects of FDI on the host economic system and we have come to a decision that even though FDI helps in the development and growing of assorted states all over the universe, these benefits do non come free of charge. FDI can hold several harmful effects on the host state. To get the better of these harmful effects some recommendations gave been proposed

To get the better of the negative impact of environmental jeopardies, the host states can utilize a assortment of channels. One such channel is the technique consequence where the local houses of the host state could larn from MNEs who frequently use superior engineering or these houses may besides go out from the market if the foreign houses seize the market portion every bit good as labour supply. Therefore straightness to merchandise will assist in bettering the quality of the environment. Another channel is the income consequence whereby the local electorate may demand better environment criterions every bit good as more rigorous ordinances which are more enforceable by the authorities when the multinationals increase the income in the economic system by making occupations and therefore increasing employment ( Liang,2006 ) .

To get the better of the competitory barriers in developing states, the domestic houses could utilize assorted protective corporate understandings. They could either unite local houses or get down concerted ventures with the foreign houses.
Government of the host company should go more rigorous with their policies. They should follow policies which encourage proper societal and environmental rules by the foreign companies. Multinationals should be penalised if they do non adhere by the policies of the state

Measures should be taken to control consumer and labour development and at the same clip competition should be created in the labor and merchandise market, taking all entry barriers from the domestic markets.
Encourage instruction, train laborers and advance substructure to increase the local capacity to absorb and circulate the superior new traditions pioneered by abroad companies.
By taking a few precautional steps and by amending the authorities policies, the harmful effects of FDI can be avoided. Therefore, these policies should be such that they are able to maximize the benefits of FDI and curtail their negative effects.

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