Foreign Direct Investment in Developing Countries - Policy Considerations for sustainable Growth

Term Paper, 2006

20 Pages, Grade: 1,3



1. Introduction

2. Definitions
2.1 Developing Countries
2.2 Foreign Direct Investment

3. Impact of FDI on Developing Countries
3.1 Theory
3.1.1 The Benign-Model
3.1.2 The Malign-Model
3.2 Empirical Evidence

4 Policies regarding FDI in Developing Countries
4.1 National and International Policies
4.1.1 Maximising the Positive Effects Political Stability and Corruption Liberalisation Infrastructure Human Resources Development Export Production Diversification Banking System
4.1.2 Minimising the Negative Effects Environment International Institutions The North-South Equity Divide
4.2 International Investment Agreements

5 Conclusion

1. Introduction

Developing countries today have to deal with the question of how to increase economic growth. This phenomenon depends on a variety of factors: political, economic and social ones. Due to globalisation, foreign direct investment (FDI) has become an often discussed issue in literature and is seen as a key factor for economic growth by many developing countries by now. But the effects of FDI are not necessarily positive. In this written assignment, the author would like to introduce policies to be conducted in order to maximise the positive effects and to minimise the negative ones.

This paper will start with a definition of the terms developing country and foreign direct investment. In the second part, a short introduction in the controversial theories about the impact on economies of developing countries will be presented. In the following, several national and international policy considerations will be introduced. The paper will end with a conclusion.

2. Definitions

2.1. Developing Countries

Definitions of the term developing country vary in literature. Generally, it is tried to find criteria enabling the separation between poor and rich countries.[1] The usage of the following criteria for the classification of countries is common:[2]

- economical,
- ecological,
- demographic,
- health-related,
- socio-cultural,
- political features and
- scarcity of capital or other resources.

The World Trade Organization (WTO) does not define the term at all. Member countries can decide by themselves, whether they want to be grouped into one of the two relevant groups called developed countries and developing countries. Countries classified as developing ones, can, but not necessarily will, benefit from assistance by developed countries. The decision about the qualification for one or the other group can be challenged by other member states.[3]

The classification used by the World Bank reduces the criteria to one: the income per capita of a country. Still it separates between low income countries and middle income countries, as well as between severely indebted low income countries and severely indebted middle income countries.[4]

The United Nations Organization (UNO) uses the terms less developed countries and least developed countries. In order to qualify for one of these groups, countries are checked using not only financial economic data, but also by different indexes concerning the vulnerability of the economy and social aspects.[5]

Summing up, one can state, that the term developing country is not defined concordantly by international organisations. But while putting different emphasises on the topic, they agree, that a developing country does in some way have a disadvantage compared to other economies.

2.2. Foreign Direct Investment

The Organisation for Economic Co-operation and Development (OECD) published a benchmark definition of foreign direct investment. This benchmark has been revised several times and is currently being revised, too. The definition given in this paper is according to its third edition published in 1999.

“Foreign direct investment reflects the objective of obtaining a lasting interest of a resident entity in one economy (…) in an entity resident in an economy other than that of the investor (…). The lasting interest implies the existence of a long-term relationship between the direct investor and the enterprise and a significant degree of influence on the management of the enterprise. Direct investment involves both the initial transaction between the two entities and all subsequent capital transactions between them and among affiliated enterprises, both incorporated and unincorporated.”[6]

3. Impact of FDI on Developing Countries

There are various theories, schools and researches dealing with the question of why FDI is undertaken. Due to the restriction of the extend of this paper, the author decided to limit the illustration of theories and evidence to the ones dealing with the impact of FDI on developing countries.

3.1 Theory

There are two main concepts regarding the contribution of FDI on the economic development of a country. In his book Foreign Direct Investment and Development, Theodore Moran calls them the Benign- and the Malign-Model.[7] In the following both conceptualisations will be introduced.

3.1.1 The Benign-Model

The Benign-Model expresses the beneficial character of FDI. Due to the poverty of the host country, there is low productivity and low wages. This leads to a lack in savings and investment and thus to underdevelopment. According to the model, FDI can break this circle by rising local savings as well as productivity (e.g. by submitting technology).[8]

The amount of the capital inflow as well as the local elasticity of the demand for capital define the potential gain in national income. Other inputs or spillovers can originate an improve of the production function of the host economy. The higher efficiency will cause a rise in output and thus create a higher economic growth.[9]

Regarding social aspects, the economical development can be the basis of a positive impact, too. Due to the higher supply the return on capital will decrease, while wages will rise due to the higher demand caused by the increased production. The advocates of this model claim the higher equalisation of income distribution to lead to better education and health in relevant societies.[10]

3.1.2 The Malign-Model

A long list of people is criticising FDI regarding multinational corporations. Most of them take offence at the possibility that these multinationals could influence the politics in the host countries, especially concerning health, safety, environment and minimum wages.[11]

The point of origin of the Malign-Model is another one: Being the alternative theory to the Benign-Model, it claims, that FDI can have negative effects on the economic growth of the host country. Advocates of this model argue, that foreign companies in imperfectly competitive international industries will harm the economic growth of a host country with an imperfectly competitive domestic market.[12]

These foreign companies benefit from the market concentration as their field of operation bears high entry barriers. Having a preferred access to the local capital market, they are able to evacuate capital, that otherwise would have been open to local economy. This function can become even worse, if these companies are in the position to pull-off rents.[13]

Companies acting this way are actively decreasing domestic savings and investment and deepening the vicious circle of underdevelopment. They can oust local companies of the economy and displace their products by imports. The preferred position in economy will even expand, if the company reinvests in the same industry within the economy of the host country. Finally money can be taken out of the economy of the host country by the affiliation of profits.[14]

In this scenario, the beneficial effects explained in the Benign-Model are not existent. The only group, benefiting from the FDI is the partners and suppliers of the company. As the activity of companies acting this way are mostly very technology-intensive, they produce a small management elite, while other workers will become or stay unemployed or underemployed. As a result, income distribution and social development will even degrade due to the FDI.[15]


[1] cp. Wezel, T., p.5

[2] cp. ibid

[3] cp. WTO: Development: Definition, online publication:

[4] cp. Moran, T.: Beyond Sweatshops, p.15

[5] cp. ibid, p.16 / UN: FDI in Least Developed Countries, p.iii

[6] OECD, p.7

[7] cp. Moran, T.: FDI and Development, p.19

[8] cp. Moran, T.: FDI and Development, p.20

[9] cp. ibid

[10] cp. ibid

[11] cp. ibid

[12] cp. Moran, T.: FDI and Development, p.20

[13] cp. Ibid, p.21

[14] cp. Ibid

[15] cp. Ibid

Excerpt out of 20 pages


Foreign Direct Investment in Developing Countries - Policy Considerations for sustainable Growth
Berlin School of Economics
Development Economics
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ISBN (eBook)
ISBN (Book)
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The paper examines effects of different qualities of FDI on the economies of developing countries and suggests policies for sustainable growth.
Foreign, Direct, Investment, Developing, Countries, Policy, Considerations, Growth, Development, Economics
Quote paper
Yasmin Shoaib (Author), 2006, Foreign Direct Investment in Developing Countries - Policy Considerations for sustainable Growth, Munich, GRIN Verlag,


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