fdi in india and its growth linkages - Department Of Industrial Policy ...

Chapter 1: Introduction
1.1 Backdrop
Capital formation is an important determinant of economic growth. While domestic investments add to the capital
stock in an economy, foreign direct investment (FDI) plays a complementary role in overall capital formation by filling
the gap between domestic savings and investment.
FDI has played an important role in the process of globalisation during the past two decades. The rapid expansion of
FDI by multinational enterprises (MNEs 1 ) since the mid-eighties may be attributed to significant changes in
technologies, liberalisation of trade and investment regimes, and deregulation and privatisation of markets in many
countries including developing countries like India. Fresh investments, as well as mergers and acquisitions, (M&A) play
an important role in the cross-country movement of FDI. However, various qualitative differences have been identified
between fresh FDI (greenfield FDI) and M&A.
An important question that arises is whether FDI merely acts as filler between domestic savings and investment or
whether it serves other purposes as well. At the macro–level, FDI is a non-debt-creating source of additional external
finances. This might boost the overall output, employment and exports of an economy. At the micro-level, the effects of
FDI need to be analysed for changes that might occur at the sector-level output, employment and forward and backward
linkages with other sectors of the economy. There are fears that foreign firms might displace domestic monopolies, and
replace these with foreign monopolies which may, in fact, create worse conditions for consumers. Thus, it is important
to have an efficient competition policy along with sector regulators in place.
While the quantity of FDI is important, equally important is the quality of FDI. The major factors that might provide
growth impetus to the host economy include the extent of localisation of the output of the foreign firm’s plant, its export
orientation, the vintage of technology used, the research and development (R&D) best suited for the host economy,
employment generation, inclusion of the poor and rural population in the resulting benefits, and productivity
enhancement.
1.2 Literature Survey
FDI plays a multidimensional role in the overall development of host economies. It is widely discussed in the literature
that, besides capital flows, FDI generates considerable benefits. These include employment generation, the acquisition
of new technology and knowledge, human capital development, contribution to international trade integration, creation
of a more competitive business environment and enhanced local/domestic enterprise development, flows of ideas and
global best practice standards and increased tax revenues from corporate profits generated by FDI (Klein et al., 2001;
Tambunan, 2005). While FDI is expected to create positive outcomes, it may also generate negative effects on the host
economy. The costs to the host economy can arise from the market power of large firms and their associated ability to
generate very high profits or by domestic political interference by multinational corporations. But the empirical evidence
shows that the negative effects from FDI are inconclusive, while the evidence of positive effects is overwhelming, i.e.,
its net positive effect on economic welfare (Graham, 1995).
1. MNEs, MNCs, and TNCs are used synonymously. They are corporations or enterprises that manage production or deliver services in more than one
country.