Trade and growth: d) Foreign direct investment (FDI) and link to growth

The idea

Foreign direct investment (FDI) occurs when a firm in one country makes a physical investment or acquires significant business interests in another, such as building a new factory or acquiring a foreign business. FDI is a crucial driver of economic growth for the host nation. It injects capital, creates jobs, and brings advanced technology and managerial expertise, which boosts productivity. For example, a multinational car manufacturer building a plant in a developing economy increases local employment and output, contributing directly to GDP growth. However, the link to growth can be complex; profits may be repatriated to the home country rather than reinvested, and domestic firms might be crowded out by powerful multinational competitors.

What earns the marks

• Define FDI as investment made by a firm or individual in one country into business interests located in another country.
• Explain how FDI contributes to economic growth through capital accumulation and direct job creation.
• Identify the transfer of technology, skills, and knowledge as a key long-term benefit of FDI for host countries.
• Evaluate the potential drawbacks of FDI, such as profit repatriation and the crowding out of domestic businesses.
• Distinguish between inward FDI (foreign firms investing in the domestic economy) and outward FDI (domestic firms investing abroad).

Common mistakes and how to put them right

• Confusing FDI with portfolio investment.

  Put it right: FDI involves acquiring a lasting management interest and physical assets, whereas portfolio investment is purely financial, such as buying shares without control.

• Assuming FDI only benefits the host country.

  Put it right: FDI can also benefit the home country through repatriated profits, though it may lead to job losses domestically.

• Believing FDI always leads to sustained economic growth.

  Put it right: The growth impact depends on how well integrated the multinational is with the local supply chain and whether profits are reinvested or repatriated.

Exam tips

• Use a specific example of a multinational corporation investing in a developing country to illustrate the tangible benefits of FDI.
• When evaluating the impact of FDI on growth, consider both the short-term effects, such as construction jobs, and long-term effects, such as technology transfer.
• Be prepared to discuss how government policies, such as tax incentives or infrastructure improvements, can be used to attract inward FDI.