The Benign Model of FDI and Development Perhaps the most prevalent version of the beneficial conceptualization begins

with a stylized description of how FDI may help the host country to break out of the vicious cycle of underdevelopment. Here, the potential host is mired in a poverty-laden equilibrium: low levels of productivity lead to low wages, which lead to low levels of saving, which lead to low levels of investment, which perpetuate low levels of productivity. FDI can break this cycle by complementing local savings and by supplying more effective management, marketing, and technology to improve productivity (Gillis et al. 1996; Cardoso and Dornbusch 1989). The gain in national income depends on the size of the capital inflow and the elasticity of the demand for capital. Furthermore, technological and managerial inputs, and transfers and spillovers to local firms may cause the national production function to shift outward. Thus, under reasonably competitive conditions- which the foreign presence may enhance FDI should raise efficiency, expand output, and lead to higher economic growth in the host country. Indeed, the interaction between economic and social development should be positive as well: the additional supply of capital should lower the relative return to capital while the additional demand for labour should bid up the wages of workers, thereby equalizing the distribution of income and improving (quite probably) health and education throughout the society. The emphasis on the new resources that foreign investors bring to relieve the bottlenecks that constrain development is a common theme among international business groups and multilateral agencies that urge faster greater acceptance of international corporations within the developing countries and economies in transition. It is the prevailing assumption in macroeconomic growth models that gaps in savings and in foreign exchange set the limits to long-term growth. Foreign Direct Investment and Development: the new policy agenda for developing countries and economies in transition, Theodore H. Moran, 1999, Institute for international economics

Theories of FDI Foreign direct investment currently plays an important role in global business. In the past decade, it had come to play a major role in the internationalization of business. Globalization and economic liberalization policies being followed by many countries have acted as significant catalysts for the expanding role of FDI in global business. The most profound effect has been observed in developing countries where foreign direct investment flows have increased manifold. There are both proponents and opponents for foreign direct investment. The proponents point out that the foreign investment flows benefit both the home country (the country from which the investment originates) and the host country (the destination of the investment). Opponents, on the other hand, note that multinational conglomerates are able to wield great power over smaller and weaker economies, and can drive out much of the local competition. The theories of FDI attempt to explain what factors have prompted the development and growth of FDI in the international economic system. Some of the important theories are now discussed. FDI benefits and costs There is much discussion, debate and research taking place on the consequences of FDI, namely, the benefits and costs of FDI to the host country as well as the home country. A question that is often debated is whether countries should promote FDI. One common view is that FDI helps accelerate the process of economic development in the host countries. Developing countries view FDI as a means of economic development, modernization, income growth and employment generation. Many emerging economies are developing a policy framework to attract FDI from MNCs. Standard practices to promote FDI include the extension of tax holidays, exemptions from import duties, and the offer of direct subsidies. In order to assess whether the policy of promoting FDI is economically justifiable or not, we need to understand the benefits and costs of FDI. Such benefits and costs accrue to both the host country and the home country. The host country perspective The overall benefits of FDI for the host country, especially a developing country, are well documented. FDI brings in capital, technology and managerial skills and techniques. It triggers technology diffusion or spillovers, assists human resource development, helps bring about a more competitive business environment, and enhances efficiency and productivity or local enterprises. The foreign exchange which flows to the host country economy through FDI may help improve the balance of payments position of the host country economy. All these factors contribute to higher economic growth of the host country. The important benefits of FDI to the host country are now discussed. 1. Brings in important factors of production: FDI brings to the host country important factors of production such as capital, foreign exchange, skilled labour, managerial competence and willingness to bear risk. These factors supplement the domestic resources and are helpful in promoting the economic development of the host country. 2. Impact of FDI on macroeconomic growth: macroeconomic growth is a potent source of poverty reduction in developing countries FDI has a positive impact on the macroeconomic

growth of the host country economy. It usually influences growth by raising total factor productivity in the host economy. This operates through two channels; The spillovers and other externalities absorbed by the host countrys business sector. And the direct impact on structural factors in the host country. FDI thus makes a positive contribution to income growth in the host country economy by raising productivity in the economy. The effect of FDI on domestic investment also needs to be observed. It may sometimes stimulate domestic investment or it may crowd out domestic investment in certain sectors where FDI is predominant. The overall impact of FDI on growth depends on its effect on domestic investment. Further, a developing economy can benefit fully from FDI only if the economy has achieved a threshold level of educational and infrastructural development. Imperfect or underdeveloped financial markets in the economy may prevent a country from reaping the full benefits of FDI. 3. Technology transfer: multinational corporations are important global players in developing and using innovative technologies. They generally possess a higher level of technical knowhow than is available in developing countries. A crucial benefit of a FDI is the transfer of technology from the parent company to the subsidiary or affiliate company in the host country through FDI. Technology transfer and diffusion operates through four interrelated channels: Vertical linkages with suppliers or purchasers in the host countries Horizontal linkages with competing or complementary companies in the same industry Migration of skilled labour from multinationals to local firms Internationalization of R&D with the help from multinationals. The vertical may be in the form of backward linkages with suppliers in the host country or forward linkages with clients in the host country. MNCs usually provide technical assistance, training and other support to raise the quality of products of local suppliers. In horizontal linkages, competing enterprises in the host country learn via demonstration or direct competition. The ability of the host country to absorb the foreign technology, however, depends on its current level of technology. When the technology gap between the host country enterprises and the MNCs is large, absorption of technology may not be effective. Further, the foreign technology being transferred through FDI may not be suitable for the host country in its present stage of development or for its available economic resources. 4. Human resources development: another benefit of FDI is the potential for enhancing the skills and knowledge of human resources of the host country. The superior managerial skills, knowledge and ability of personnel of the MNCs are passed on to host country personnel employed by them through training and on the job learning. As these persons move on to other firms, the enhancement of human capital in the host country gains momentum.

There is indeed an interaction between human resources development and technology diffusion. Each reinforces and supports the other. Transfer of technical knowledge accelerates human resources development. As the same time, without proper human resources development, technology diffusion may not be effective, especially where there are wide technology gaps. 5. Employment generation: FDI is helpful in providing employment in the host country, this leading to employment generation in the economy. Moreover, it is instrumental in raising labour standards in the host country towards the levels prevailing in the investors home countries. 6. Promotion of competitive environment: the entry of foreign competitors in the host country acts as a spur to competition in the host country economy. Local firms attempt to raise their productivity and enhance the quality of their products to face competition from foreign MNCs. FDI thus has a positive impact on competition by creating a better competitive environment in the host country. Such competition leads to increased efficiency and productivity, lower prices and more efficient resource allocation. 7. Boosting international trade: an important benefit of FDI for developing countries lies in its long-term contribution in integrating the host economy more closely with the world economy, leading to the growth of foreign trade of the host country. Foreign investment and foreign trade are mutually supportive. FDI thus provides a boost to the foreign trade of the host country. 8. Improvement in the balance of payments: FDI brings in valuable foreign exchange to the host country. The inward remittance of foreign exchange helps improve the balance of payments of the host country by enhancing the foreign exchange reserves of the country. FDI is also likely to result in import substitution and export promotion; both these measures would improve the position of the current account. 9. Social and environmental benefits: FDI has the potential to bring social and environmental benefits to the host economies through the dissemination of good social and environmental practices and techniques within the MNCs and through their subsequent spillovers to domestic enterprises. The economic benefits of FDI are real, but they do not accrue automatically. The extent of benefits varies according to the policies and environment of the host country. A minimum level of technological, educational and infrastructural achievement is necessary to reap the full benefits of FDI. When economic and legal structures create a healthy environment for business in the host country, the entry of foreign MNCs through FDI tends to stimulate the host country business sector, either through competition, vertical linkages or demonstration effects. Appropriate policy initiatives by the host country authorities are needed for maximizing the benefits of FDI. The host country authorities must undertake programmes to raise education levels, invest in the infrastructure and improve the health of domestic business sector. Foreign direct investment is, however, not an unmixed blessing. It has a lot of negative impacts on the host country and its economy, which may be called the cost of FDI. Some of the significant negative impacts of FDI are as follows:

Deterioration of the balance of payments of the host country as profits of MNCs are repatriated and dividends, royalty, technical service fees, etc., are paid to the parent company in the foreign country Lack of positive linkages with local communities Loss of political sovereignty on account of dependence on international corporate enterprises Inability to take full advantage of the technical know-how transferred through FDI due to a wide technology gap or low levels of education of workforce in the domestic business sector. Transfer of inappropriate technology leading to higher costs of production Higher prices charged by foreign enterprises which may occupy oligopolistic position in the market Inability of domestic enterprises to compete successfully with the foreign enterprises which have superior resources and competence. The suitable approach to be pursued by the host country towards FDI would be to maximise the benefit of FDI while trying to minimize the costs of FDI. Suitable policies have to be evolved to achieve these objectives. http://books.google.co.uk/books?id=GCbYWsfvyiIC&pg=PA232&dq=FDI+benefits&hl=en&sa=X&ei= WbRnT4ruAcm90QXJqITxCA&redir_esc=y#v=onepage&q=FDI%20benefits&f=false Fundamentals of international financial management, S. KEVIN, 2009, New Delhi, PHI learning private limited