Understanding Foreign Direct Investment and Intellectual Property Rights in the Context of CPEC [Part 2]
In the last article, the issues that were examined included the fundamentals of foreign direct investment (FDI), its definition, the definition of multinational enterprises (MNEs), some of the factors considered by MNEs when deciding to invest, as well as some literature dealing with these issues. In this article, the discussion will be taken further, analysing FDI’s impact on economic growth and its significance.
FDI and Economic Growth
The impact of FDI on the economy of the host state appears to resemble the ‘cause and effect’ phenomenon. However, neither the economy nor FDI is a singular and unblended item. Since they both are composite items, formed by the amalgamation of many constituent factors, variations in those constituents can alter the relationship between the two composites. Thus, both the economy of the host state and FDI have multiple components which have a cumulative effect.
a. Trade, Stock Market and Absorptive Capacity
Li, Woodward and Leatham (2013),[1] in a causal study on the relationship between FDI and economic growth, demonstrate trade to be a vital intermediary which facilitates and enables the interactions between FDI and other factors. They also show the stock market to behave as an intermediary which augments the influence of various causal variables of FDI on itself as far as developed countries are concerned. Balasubramanyam, Salisu, and Dapsoford (1996)[2] emphasise that trade openness plays a vital role in the manifestation of the growth-effects of FDI. It has been shown in various studies that FDI can accelerate the economic growth of a host state, provided the host state has absorptive capacity of ‘domestic firm, financial systems, physical infrastructure, technological, and institutional development.’[3]
b. Human Capital
E. Borensztein et al (1998)[4] find that FDI can positively impact the economic growth of the host state, provided the host country has to its avail a particular level or threshold of human capital. More recently, Esther & Folorunso (2011)[5] have confirmed this trait of FDI. Other studies have also shown that FDI positively influences economic growth, a proposition consistent with the endogenous growth theory (Carkovic and Levine, 2002)[6].
c. Adequate Financial Infrastructure
Besides human capital, other ‘prerequisites’ have also been identified by various empirical studies which, if present, enable FDI to boost the economy of the host state. Blomstrom, Lipsey, and Zejan (1994)[7] propose in their study that FDI can have a positive growth-effect if the host country is adequately wealthy. Alfaro, Chandra, Kalemli-Ozcan, and Sayek (2000)[8] find that FDI promotes economic growth in countries that have sufficiently developed financial markets.
d. Sector-specific FDI
The foregoing may give the impression that all FDI, irrespective of which sector it is going towards, contributes to economic growth, provided the conditions mentioned above are present in the host state. However, there are studies which negate that. All FDI cannot have such a causal relationship with the economy of the country. Miao Wang (2009)[9] has been able to demonstrate that FDI can have a significant effect on the economy, provided that investment has been carried out in the manufacturing sector. This finding is consistent with the endogenous growth theory. Hansen and Rand (2006)[10] have proposed that FDI can impact the gross domestic product (GDP) through the adoption of new technology and knowledge transfers. Toulaboe, Terry and Johansen (2007)[11] have postulated the following in their research:
- FDI directly and beneficially affects the recipient/host country;
- This direct effect is stronger in comparatively developed (middle-income) countries;
- FDI can have a beneficial indirect effect on the host countries because of the interactions between human capital and FDI and the combined effect which results therefrom;
- Indirect effect is stronger in case of developed (more advanced) economies. They added further that the absorptive capacity of the host country plays the decisive role in determining the complete effect of FDI on the country’s economy.
FDI – Knowledge Transfer and Spillover
Among other things, there are two additional effects of FDI which are relevant:
- One is technology transfer that can result because of FDI. The investing MNE has the disadvantage of not having access to the host state’s market and consequently possessing inadequate knowledge of the host state’s market. This distortion of knowledge symmetry is compensated by factors such as advanced technology and special tax concessions afforded to the foreign investor by the host state. The chief advantage that the MNEs have is the possession of advanced technologies and capabilities. The relocation also results in a transfer of technology to the host state.
- The second relevant and important effect of FDI is the spillover effect. Technology transfer and diffusion of knowledge and technical know-how often occur simultaneously. Both effects will be discussed in a later article.
The primary concern of MNEs while deciding the mode of entry is profitability. MNEs are oligopolistic in their approach and mainly concerned about the returns they would get on their investment. Nobility of purpose does not usually cloud the judgment of MNEs – they are not motivated to alleviate poverty, create employment opportunities or eradicate inequality (Todaro and Smith, 2003)[12].
Significance of FDI
As demonstrated above, FDI depends on many factors. The decision to invest requires an examination of the overall climate of the host country. The primary concern of MNEs is the potential return that they can get on their investment. Besides this, the sector they choose to invest in plays a vital role. Mr. Kofi Annan, former Secretary General of the United Nations, spoke about the importance of FDI and emphasized that it played a cardinal role in the economic development of developing countries as it was inherently capable of creating new jobs, raising overall productivity and transferring technology (United Nations, 2003).
To attract FDI, the host country should ideally have an overall positive outlook so that investors can comfortably invest there. In this way, the need for FDI pushes countries to reform and improve their business environment along with areas that play a determining role in attracting FDI (Mallampally and Sauvant 1999)[13]. Incentives minus a good business environment might not attract as much FDI. Hence, there is a need for increasing the ease of doing business so that MNEs can encouraged to bring in investment.
Trevino et al. (2008)[14] have argued that FDI exerts pressure on the host country’s government and/or domestic firms to develop new technologies and innovate. Such pressure often manifests into policies or regulations. It increases competition between domestic and foreign investors, which can be considered a positive contribution.
Adams (2009)[15] finds that the theoretical relationship between FDI and economic growth is founded on ‘modernisation and dependency theories.’ Briefly put, according to the modernisation theory, since investment of capital is required for economic growth, FDI can serve as the ‘engine to economic growth’ (Saqib, Masnoon et al. 2013)[16]. The dependency theory suggests that FDI creates monopolies for foreign investors in the manufacturing sector and such dependence of the country on FDI can have a negative impact on its economy (Adams, 2009)[17]. The lack of symmetry results from activities and operations of MNEs which can dislocate local firms unable to compete with the foreign firms, resulting in reduced growth of the local firms (Jones, 1996)[18].
Although there is no consensus on the effect that FDI has on the economy of the host country, there is an overwhelming amount of data and literature which favours the proposition that FDI has a positive effect on the economy of the host country and can lead to economic growth and development. A host country, which would have a significant gap between savings and investment, would be more willing to attract FDI to bridge that gap. On the other hand, Jones (1996)[19] has found that the flow of capital can contribute to domestic savings and chime in with domestic capital formation in countries which suffer from constrained capital, thus increasing domestic investment.
The next article will further explore the benefits of FDI and examine some of its effects related to the intellectual property (IP) environment of the host nation.
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References
[1] Li, Y., et al. (2013). “Causality among foreign direct investment and economic growth: A directed acyclic graph approach.” Journal of Agricultural and Applied Economics 45(4): 617-637.
[2] Balasubramanyam, V. N., et al. (1996). “Foreign direct investment and growth in EP and IS countries.” The economic journal: 92-105.
[3] Nguyen, Hoang & Duysters, Geert & Patterson, James & Sander, Harald. (2019). Foreign Direct Investment Absorptive Capacity Theory.
[4] Borensztein, E., J. De Gregorio and J. W. Lee. “How Does Foreign Direct Investment Affect Economic Growth?,” Journal of International Economics, 1998, v45(1,Jun), 115-135.
[5] Adegbite, Esther & Ayadi, Folorunso. (2011). The role of foreign direct investment in economic development: A study of Nigeria. World Journal of Entrepreneurship, Management and Sustainable Development. 6. 133-147. 10.1108/20425961201000011.
[6] Carkovic, M. V. and R. Levine (2002). “Does foreign direct investment accelerate economic growth?”.
[7] Blomstrom, M., et al. (1994). “What explains the growth of developing countries?” Convergence of productivity: Cross-national studies and historical evidence: 243-259.
[8] Alfaro, L., et al. (2004). “FDI and economic growth: the role of local financial markets.” Journal of international Economics 64(1): 89-112.
[9] Wang, M. (2009). “Manufacturing FDI and economic growth: evidence from Asian economies.” Applied Economics 41(8): 991-1002.
[10] Hansen, H. and J. Rand (2006). “On the causal links between FDI and growth in developing countries.” The World Economy 29(1): 21-41.
[11] Toulaboe, D., et al. (2011). “Foreign direct investment and economic growth in developing countries.” Southwestern Economic Review 36: 167-170.
[12] Todaro, M., & Smith, (2003)). ” Economic development 8th ed.” Boston: Addison Wesley.
[13] Mallampally, P. and K. P. Sauvant (1999). “Foreign direct investment in developing countries.” Finance and Development 36(1): 34.
[14] Trevino, L. J., et al. (2008). “The three pillars of institutional theory and FDI in Latin America: An institutionalization process.” International Business Review 17(1): 118-133.
[15] Adams, S. (2009). “Can foreign direct investment (FDI) help to promote growth in Africa?” African Journal of Business Management 3(5): 178.
[16] Saqib, D., et al. (2013). “Impact of foreign direct investment on economic growth of Pakistan.”
[17] Ibid 14
[18] Jones, G. (1996). “Jones, G. The Evolution of International Business. London.”
[19] ibid 17
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