5.3 Foreign direct investment and technology transfer

Foreign_Direct_Investment_(FDI)_0### plays a crucial role in economic development. It involves companies or individuals investing in business interests abroad, establishing operations or acquiring tangible assets in host countries. FDI differs from portfolio investment and provides external capital, technology transfer, and employment opportunities.

Several factors attract FDI, including market size, economic growth, resources, labor costs, and infrastructure. Government policies also impact FDI, such as political stability, liberal trade policies, and investment incentives. The effects of FDI on host countries include technology transfer, increased competition, and productivity growth.

Foreign Direct Investment (FDI) and Economic Development

Concept of foreign direct investment

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• Investments made by a company or individual from one country into business interests in another country
• Establishes operations or acquires tangible assets in the host country (factories, machinery, land)
• Differs from portfolio investment which only involves purchasing securities and financial assets (stocks, bonds)
• Significant source of external capital for developing countries supplements domestic savings and investment
• Contributes to formation of physical capital like infrastructure and production facilities (roads, power plants, manufacturing sites)
• Facilitates technology transfer and knowledge spillovers from developed to developing countries
• Stimulates competition and productivity growth in the host country's domestic market
• Creates employment opportunities and enhances human capital through training and skill development

Attracting factors for FDI

• Large and growing domestic markets attract FDI seeking to capture market share (China, India)
• High GDP growth rates and increasing per capita incomes are more attractive to foreign investors
• Abundance of natural resources like oil, gas, and minerals attracts resource-seeking FDI (Nigeria, Brazil)
• Low labor costs in developing countries can attract efficiency-seeking FDI (Vietnam, Bangladesh)
• Availability of skilled labor is important for FDI in knowledge-intensive industries (software development, R&D)
• Well-developed transportation, communication, and energy infrastructure facilitates FDI
• Stable political environments and predictable economic policies reduce risk and encourage FDI
• Liberal trade policies and reduced barriers to foreign investment attract FDI (free trade agreements, investment treaties)
• Tax incentives, subsidies, and other promotional policies can attract FDI to specific sectors or regions (special economic zones)

Impact of FDI and Government Policies

FDI impact on technology transfer

• Multinational enterprises (MNEs) often possess advanced technologies and production methods
• Direct transfer of technology to subsidiaries or joint ventures in the host country
• Technology spillovers occur through imitation, reverse engineering, and labor mobility
• Introduction of new technologies and production processes increases efficiency
• Competition from foreign firms stimulates domestic firms to improve productivity
• Vertical linkages between foreign and domestic firms lead to productivity spillovers (supply chain integration)
• Absorptive capacity of the host country affects extent of technology transfer (human capital, technological capabilities)
• Larger technological gap between foreign and domestic firms enables more potential for catch-up
• Degree of linkages and interactions between foreign and domestic firms influences spillover effects
• Intellectual property rights protection and enforcement in the host country impacts willingness to transfer technology

Government policies for FDI benefits

1. Improve the investment climate
   • Ensure political and economic stability
   • Reduce bureaucratic barriers and streamline investment procedures (one-stop shop for investors)
   • Strengthen the rule of law and protect property rights
2. Provide investment incentives
   • Offer tax incentives like tax holidays or reduced corporate tax rates for foreign investors
   • Provide subsidies or grants for specific sectors or activities (renewable energy, high-tech industries)
   • Establish special economic zones or industrial parks with preferential policies (Shenzhen in China)
3. Promote linkages between foreign and domestic firms
   • Encourage joint ventures and partnerships between foreign and local companies
   • Implement local content requirements to increase the use of domestic inputs
   • Support the development of local supplier networks and value chains
4. Invest in human capital and technological capabilities
   • Improve education and training systems to develop a skilled workforce
   • Promote research and development (R&D) and innovation through public investment and incentives
   • Facilitate technology transfer and adaptation through science and technology policies
5. Ensure appropriate regulation and oversight
   • Implement competition policies to prevent market dominance and anti-competitive practices
   • Enforce intellectual property rights to encourage technology transfer and innovation
   • Monitor and evaluate the impact of FDI to ensure alignment with development objectives