Putting it to Work in Developing Countries - Nathan Associates

EXECUTIVE SUMMARY
The most striking change in development
finance in the last 15 years has been the dramatic
expansion of external private capital flows to
the developing world, particularly in the form of
foreign direct investment. In 2005, $238 billion
in FDI, on a net basis, flowed to developing
countries—roughly one-half of net resource
flows. FDI is therefore the single largest external
source of resource flows to developing
economies, including other private sources, such
as portfolio equity and debt, and official sources,
such as loans and grants. FDI consists of investment
in wholly new facilities, also known as
greenfield investment, or the purchase of existing
facilities, also known as mergers and acquisitions.
Greenfield investments are the most common
type of FDI in the developing world.
Though FDI is now the most important and
most stable external source of funding in the
developing world, financing development
remains first and foremost an issue of domestic
investment. FDI as a share of gross fixed capital
formation (i.e., total investment) in developing
countries as a group has not risen above 15 percent
since 1990, and has fallen to as low as 2 to
3 percent. FDI’s full value, however, lies disproportionately
in its unique ability to stimulate
competition, spur innovation, introduce new
technologies and processes, and elevate the skills
of workers and managers in developing countries.
These positive effects can benefit not only
the foreign affiliates directly receiving FDI, but
also host-country firms that supply the affiliates,
distribute their products, or even compete with
them.
WHAT FDI OFFERS TO
DEVELOPING COUNTRIES
For developing countries, the motivations for
hosting FDI are compelling: economic growth
and development. By adding to domestic savings,
FDI makes it possible to raise rates of capital
accumulation in both physical and human
resources. In competitive environments, high
quality FDI projects elevate the rate of return to
investment in the economy as a whole. These
projects lead to new employment and wages,
and this, in turn, creates more jobs and income
in progressively wider circles of the economy.
The result is increased economic growth.
FDI’s greatest contribution to development,
however, lies in its unique productivity-enhancing
effects, including
• Improving export capacity and increasing
imports of foreign-invested firms—both of
which help local firms integrate into global
production networks.
• Stimulating technology transfer in
production and management processes.
• Advancing training and skill development
among workers.
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