M4L2: FDI good or bad?

Why do the developing countries want FDI?

Because they want to make a sustained attack on poverty, unemployment and socio-economic problems. They believe that FDI will act as a catalyst to generate greater output and income and complement local capability building.

1.    FDI can be of two types. One that is used by MNCs primarily as a base for exports to third countries. This is usually found in small economies with abundant labor. Other that is market seeking and wants to sell its product in domestic markets. This is usually found in large economies like India, which gives these governments more bargaining power and capacity.

In the former case, this results in thin industrialization. This is due to the fact that MNCs prefer to concentrate their maximum amount of resources on the development of high value-added technology and little on low value-added technology. These product lines that require low value-added technologies are then transferred and outsourced to developing countries. This means that FDI does not cover large areas of manufacturing as it develops very limited linkages with local firms and local markets.  Thus, the core for industrial growth in such countries is formed by ordinary skills, with a very narrow technological base due to specialization in a very narrow range of production activities. This creates very little externalities (spillover effects) in horizontal (backward and forward linkages with other manufacturing firms) and vertical chains (downstream and upstream linkages with non-manufacturers (producers and consumers)

In most of the cases, it has been found that MNCs have incentives to prevent information flows of their core technologies to other firms.  In order to protect their core knowledge, they prefer to keep their R&D centers in the developed countries. This may prove detrimental for the developing nation, that is the recipient of FDI in a long run.

A strong foreign presence with advanced technology can create natural monopolies that may prevent local competitors from investing in deepening their own capabilities. It becomes more difficult for the newcomers to break in and eventually, may lead to crowding out effect of MSMEs. They may withdraw altogether leading to opportunity loss which could have accrued by encouraging these SMEs and MSMEs. Their small sizes make them flexible, which makes these new entrants as driving force for innovation.