4.

(b) Evaluate the effectiveness of Foreign Direct Investment (FDI) as a

means of achieving economic growth and economic development in a less
developed country. [15 marks]-2 minutes 24 seconds a mark
2006 November P1
definition of FDI
understanding of difference between economic growth and economic development
Candidates may include any of the following possible advantages of FDI:
fills savings gaps
fills foreign exchange gap resulting from deficit on current account of the balance of
payments
fills revenue gap by taxing MNC activities
transfer of technology from MDC to LDC
increased demand for local labour resources
training opportunities for local workers
reduced unemployment in LDC
extra goods for consumption and for export will be produced
local suppliers will be used by MDC to source supplies
source of capital for LDC which stimulates growth
Candidates may include any of the following possible disadvantages of FDI:
loss of sovereignty by host nation
dependence of host nation on activities of MNC
repatriation of profits by MNC
exploitation of local labour force low wages and poor working conditions
may drive out local businesses
dual economies result
income inequalities due to widening wage differentials in urban and rural areas
capital intensive technology rather than labour-intensive technology limits benefits to host
country
MNCs exert political control to influence government policy
environmental degradation
Advantages and disadvantages of FDI should be related to growth and development.
Examiners should be aware that candidates may take a different approach, which if
appropriate should be rewarded.
Effective evaluation may be to:
consider short run versus long run consequences
examine the impact on different stakeholders
discuss advantages and disadvantages
prioritize the arguments

Foreign direct investment refers to investment by multinational companies into

foreign countries that builds productive capacity (usually associated with the
building of factories/ offices). Less developed countries adopting an outward
looking export led approach to economic growth and development will try to
attract FDI to achieve their aims. Economic growth refers to increases in GDP,
however development is multifaceted including a broad range of welfare
measures related to health, education, poverty and income distribution. It can be
said that increases in GDP are a necessary, but in themselves, not sufficient
condition for development. Less developed countries are characterised by
having low GDP per capita, high levels of poverty and poor provision of
health care, education and infrastructure.
Clearly FDI into a LDC could be seen in many ways as making a positive
contribution to economic growth. Investment is a component of AD and as such
any FDI would increase real output and employment. Furthermore there will be
a stream of production that will create further increases in AD over time. Many
multinational companies look to export their production and so there will also be
an increase in eXports (and perhaps less reliance on imports if the goods are also
sold in the domestic economy improving the current account). The rise in AD is
shown below where AD1 moves to AD2. The outcome is shown by an increase in
real output from Y1 to Y2 (and employment and living standards). There is also a
rise in the price level (PL1 to PL2) , however, given that developing countries have
a large proportion of unemployed or under-employed resources this is unlikely to
be significant. (You could draw the AS / AD diagram.)
FDI plays an important role in filling gaps that exist in the finances of a LDC.
Firstly, due to lack of incomes LDCs suffer from a savings gap which limits the
levels of domestic investment. This creates a poverty cycle as without sufficient
investment productivity cannot rise to enable an economy to sustain higher
wages. FDI, to some extent, plugs that savings gap by bringing more investment

Starts off with

clear definitions
of all key terms

Nicely into a
bit of AS/ AD
you cannot go
wrong!

Make sure
there are no
gaps in your
knowledge.

capital into the country. It also fills the foreign exchange gap that exists as
LDCs struggle to earn foreign currency with which they can import capacity
creating capital goods. FDI, thus helps bridge both of those gaps and expands the
capacity of the economy thus shifting the production possibility curve of the
economy out to the right. (You could draw this)
However, FDI can also be a threat to local producers who are not able to produce
a product as efficiently as the multinational. Multinationals can also spend vast
sums on advertising, driving out of business local producers by developing brand
loyalty. Local companies may learn from multinationals how to improve efficiency
and thereby compete but, to some extent, it is probably inevitable that some local
jobs will be lost when the multinational is producing a product that is already
manufactured locally. The net effect is still likely to be positive in terms of job
creation.

Some good
analysis here
about the
potential gains
both for growth
and
development.
Evaluative
points being
made.
Nice.

Overall, employment and incomes are likely to rise. However, the nature of the jobs may be
low skilled and low wage. Poor health and safety, employment protection and
environmental laws can make employment dangerous and unreliable. The multinational is
there for this reason and is serving its own ends it is not in a less developed country to
help it meet its development goals. Economic research suggests that wages paid by
multinationals tend to be higher than those paid by local firms but instances of sweatshops
and child labour challenge the view that fdi is always a win-win situation. It is difficult to
see how 12 hour shifts in hot factories with child labour contributes to development. It
could be argued that the child is better off earning some money for his / her family to
overcome the pressing problem of poverty but it does not help to develop the health and
education of that child and therefore neither does it broaden the opportunities for that child
as they get older.
Foreign direct investment would be more beneficial to developing countries if the profits
earned were reinvested in the domestic economy. However, they are often repatriated back
to the multinationals home country. This represents a lost opportunity for the domestic
economy to gain from further investment and the creation of more jobs and a future output
and export stream.
Nevertheless, some countries such as Korea have managed to steer multinationals towards
broader development aims by requiring them to promote nationals into management
positions (thus adding to the human capital of the country) and by insisting they use a
given percentage of local suppliers. This amplifies the benefits of FDI as these
backward linkages create additional employment and output and tax revenues. The
more the multinational is reliant upon domestic suppliers the less raw materials /
components that need to be imported and a higher amount of the value added created
during the production process stays in the country. However, many LDCs have created
economic development zones that are attractive to multinationals due to low tax rates and
even low utility costs. In this model, multinationals import raw materials and export
finished products with limited connectivity to the domestic economy. They often rely on
relatively few cheap low skilled workers to carry out capital intensive production without
any prospects of promotion. This model of development is clearly not going to lead to a
significant increase in employment, living standards or development.
FDI may well increase GDP in developing countries but its role in promoting development is
less certain. Often FDI enters a country because it has won the race to the bottom in terms
of providing cheap labour and weak laws that help keep costs low at least the private
costs of production low. External costs such as pollution can be overlooked by governments
eager to be investment friendly. Nevertheless, FDI can create jobs, brings new technology
and perhaps training and new ways of working. FDI can spread ideas and work habits that
foster increases in productivity and provide employment in LDCs that may not otherwise be
available. Many MNCs may provide healthcare and education for their workers and their
families and build roads so that their goods can be transported to main artery roads. Ofcourse MNCs and their workers will also pay taxes which the government can use to spend
on healthcare, education and infrastructure projects. These can boost development in a
direct and tangible way.

Notes: OK, not perfect. Could be organised better, but I am writing under test conditions
examiners are forgiving as long as you actually do the basics define all key terms, ensure
you analyse your points do not provide a list, and include some evaluation.

Building on the
last paragraph
this part looks
more closely at
the extent to
which FDI is
beneficial for
GDP growth.

Well, I still had

6 minutes left
so out came
these
contributory
observations.
Some good
analysis.