FDI Affects On The Economic Growth

Tuesday, July 3, 2012
Foreign direct investment (FDI) is known as movement of capital across national frontiers in a way that grants the investor control over the acquired asset. That is how it is distinct from portfolio investment which may cross borders, but does not offer such control over the business. Firms which supply for FDI are known as multinational enterprises and in this case control is defined as owning 10% or greater of the common shares of an incorporated firm. In the years after the Second World War FDI in general was dominated by the United States, as much of the world recovered from the destruction formed by the conflict of the war. The U.S. was quick at realizing that Foreign Direct Investment is to become a real gold mine. It accounted for around three-quarters of new FDI between 1945 and 1960. Since that time FDI has become a truly global phenomenon; countries with different economic development can enjoy its benefits now, not only well industrialized ones. Currently the importance of FDI can be measured by its share in the global GDP, which comprises of 20% brought in by FDI capital.

Economic growth is actually the increase in the value of goods and services generated by a particular economy. It is usually measured as the percentage of increase in real gross domestic product, or GDP. The growth is normally calculated in terms of adjusted inflation in order to net out the effect of inflation on the price of the goods and services produced. In economics, "economic growth" typically refers to growth of potential output, for instance, production at full employment rate rather than growth of aggregate demand.

It’s not a surprise that major portion of the FDI supply comes from the highly industrialized and economically developed countries. For example in 1988-1992 about 92% of all world’s FDI was between those countries, although it dropped to 85% after year 1997. The reason for such movement of funds is the desire of the developed countries to support themselves while establishing successful routes for their trade and generating growth in their own economies. The picture changed in the recent twenty years however, when huge emerging economies such as India, China and Eastern Europe began to attract investors. The distribution of funds however among those developing countries is quite unequal. The third of all capital was granted to China, mainly because of the size of the potential market, which is the biggest in the world. The biggest investor in China’s economy is Japan, the reason being that it’s closer to China that the rest of the world and distance is one of the major factors in determining the affiliates’ location. Those partners operating for instance in China nowadays sells more of the generated product in their host countries.

With FDI entering developing economies a lot of changes are taking place in the invested economy as well as in global trade. The entering of foreign capital in the Chinese economy first of all generated the development of various industries. Formerly this country was primary operating in the agricultural sector with lack of industrial growth. With money coming in and much of Japanese technology, China became on of the world leader in manufacturing automobiles, home appliances and other technical equipment. Consequently this mirrored positively on the labor market, providing millions of jobs. It’s a known fact that labor in China is one of the cheapest in the world, although the quality of work performed is decent, the fact that also attracted money to this country.

Growth and development of new industries caused GDP growth which is the indicator of overall economic growth of the country. Expanding industrial growth initiates demand for raw materials, thus causing more imports coming in which again are taking into consideration when calculating GDP. The fact of huge investments into Chinese economy and the number of people occupied currently in various manufacturing leads to increased competition. This in turn brings about lower prices in fight for the customer, which actually decreases profits in some instances. This is one of the reasons why too much of FDI can lead China to a "bubble burst" effect when too much of foreign money comes but they are not efficiently used, because it takes more time for the economy to develop. So the Chinese government has to watch closely for the signs and undertake measure to avoid another "American depression". This is a major disadvantage of FDI in the countries who receive the money. There is also a negative impact on those parties who lend money, as the fierce competition coming from developing countries can drive them out from the market, because countries such as China and Brazil offer much lower prices than say Germany. There has to be a balance of the FDI settings in order to prevent the overload in one countries and lack of capital in others.