Impact Of Foreign Direct Investment In Nation Development Economics Essay

The growing of international production is chiefly driven by economic and technological forces. It is besides driven by the on-going liberalisation of Foreign Direct Investments ( FDI ) and trade policies. Foreign Direct Investments ( FDI ) refers to an international investing made by a resident entity in one economic system ( Direct Investor ) with the aim of set uping a permanent involvement in an endeavor.

Globalization offers exceeding chances for developing states to accomplish a rapid economic growing through trade and investing. Foreign Direct Investment is considered as a major inducement to economic growing in developing states, as it contributes to host state economic growing, by heightening the state ‘s capital stock, presenting complementary inputs, bring oning engineering transportation and skill acquisition, or increasing competition among local industries. But merely a few states have been successful in pulling important FDI influxs to their state owing to so many grounds.

FDI bring away much needed resources to developing states such as capital, engineering, managerial accomplishments, entrepreneurial accomplishments, trade names and entree to new markets etc. These are indispensable for a underdeveloped state to industrialise, develop and make occupations assailing the poorness state of affairs in their states. As such most underdeveloped states recognize the possible value of FDI and have liberalized their investing governments and engaged in investing publicity. Globalization and regional integrating agreements can alter the degree and form of FDI and besides it reduces the trade costs. However, FDI flows to developing states started to pick-up in the mid 1990s mostly as a consequence of systematic addition in liberalisation of FDI policies in these states and the acceptance of by and large more outward orientated policies.

This study attempts to turn to the impact of FDIs towards the development of a state, deciding factors of pulling FDIs and issues faced by the host states in pulling FDIs. At the latter portion of this study include recommendations to host state authorities to follow towards foreign investors, in order to advance economic development. For the intent of designation of issues and turn toing of recommendations Sri Lanka, a underdeveloped state that keeps rely on FDIs is taken in to consideration.

2.0 Host state determiners that influences the influx of FDI ‘s

FDI determinations depend on a assortment of features of the host economic system,

Size of the Market

There can be seen a good well-known relationship between FDI and the size of the market and every bit good as with some of its features ( e.g. mean income degrees and growing rates ) . When the GDP of a state is comparatively little, it is an index of low degree of national income. As such investors prefer to put in states where there is a high growing potency and where there is a big market for their merchandises and services.


Even though the investors pay attending on the size and the growing of the market as of import, all the other domestic market factors are predictably much less relevant in export oriented foreign houses. Wide spread penetration is that unfastened economic systems encourage more foreign investing. One index of openness is the comparative size of the export sector. Particularly fabrication exports are a important determiner of FDI influxs. Investors prefer states where there are indulgent regulations and ordinances in relation to foreign trade.

Labor costs and productiveness

Labour cost is a important factor for foreign investors specially when doing their investings in labour intensive industries and for export oriented subordinates. ( For an illustration opening up garment mills, export processing houses where larger figure of employees is required ) Low pay rates to a great extent stimulate investors to do their investing determinations in a peculiar state. However when the cost of labor is comparatively undistinguished ( when pay rates vary somewhat from state to state ) the accomplishments of the labour force are expected to hold an impact on determinations about FDI location

Political Hazard

High returns in the extractive industries seem to counterbalance for political instability. In general, every bit long as the foreign company is confident of being able to run productively without undue hazard to its capital and forces, it will go on to put. Large companies overcome some of the political hazards by puting in their ain substructure care and their ain security forces. But these companies are restrained by little local markets and exchange rate hazards since they tend to sell entirely on the international market. If a state is vulnerable to a higher grade of public violences, labor differences, and corruptness and if it possesses greater condemnable degree, those will be the determiners that restrain foreign investings.

Infrastructure Facilities

Infrastructure covers many dimensions runing from roads, ports, railroads and telecommunication systems required to institutional development ( e.g. Legal services, accounting etc. ) The extent of conveyance installations and the propinquity to major ports has a important positive consequence on the location of FDI within the state. Poor substructure can be seen both as an obstruction and every bit good as an chance for foreign investing.

Incentives and operating conditions

Removal of boundaries and proviso of a healthy environment for concerns that consists of better operating conditions, lower revenue enhancement rates or revenue enhancement vacations are by and large believed to hold a positive impact on exciting FDI. Further inducements such as the granting of equal intervention to foreign investors in relation to local opposite numbers and the gap up of new markets ( e.g. air conveyance, retailing, banking ) have been reported as of import factors of promoting FDI flows to a peculiar state.


Through denationalization it has attracted some foreign investing influxs in recent old ages. But when traveling on to most of the development, low income states advancement is still low due to divestments of province assets. This has become political issues that demotivate investors. For an illustration employee opposition and their aggressive actions over denationalization or other moves which threaten their bing occupations and worker rights may move as a discouraging factor of FDI.

3.0 Issues to pull FDI

Majority of the low income states including Sri Lanka fail to pull big FDI flows in to their states as domestic markets are little in size. Investors are loath to put in their mills if they are unable to pull a critical mass for their merchandises.

Impossibility of pulling FDI due to miss of openness in the economic system as the export fabrication sector is governed by stiff regulations and the issues faced by the industry due to miss of or get rid ofing of quota.

Labour market rigidnesss and high pay rates in the formal sector with comparing to other states like China, Vietnam is frequently viewed as a discouraging factor in order to pull important in flows in to the export sector in peculiar. Lower productiveness with comparing to states like China and states in bomber Saharan Africa and deficiency of applied scientists and proficient staff is reported as keeping back possible foreign investing, particularly in fabricating exports sector. Further it lessens the attraction of puting in productive sectors.

Higher degree of labour differences, work stoppages, public violences, corruptness in the state and every bit good as some of authorities stiff policies inefficiency in the populace sector are the causal factors that prevent investors from puting in Sri Lanka.

Poor substructure can be seen as an obstruction to pull FDI to take down income states like Sri Lanka. Host authorities can pull important FDI by allowing more significant foreign engagement in the substructure sector. In Sri Lanka even tough there is a important addition in FDI in telecommunication and air lines. Other more basic substructure such as roads, edifices remain unattractive reflecting both he low returns and higher political hazards of such investings.

Even though the authorities has removed certain limitations late, which has been imposed earlier on FDI, the deficiency of transparence, inordinate hold in investing blessing processs, deficiency of clear cut policy for investing blessing and extended bureaucratic systems are still act as discouraging factors of foreign investings.

Due to employee perceptual experience sing foreign employers and their aggressive actions against denationalization and inclination towards province ain endeavors act as a barrier to pull foreign investors. Further a figure of structural jobs are restraining the procedure of denationalization. Slow growing and lower degree of competition in fiscal markets which has been characterized by inefficiencies, deficiency of deepness and transparence and the absence of regulative processs as those are still continued to be dominated by authorities activity and are frequently protected from competition.

Even though the attitudes of the civil society on the impact of FDI on chances for domestic concern and economic activities is positive and the net attitude of foreign houses toward FDI reveals that the investing clime has non improved in Sri Lanka as a consequence of deficiency of good administration, corruptness, political instability and perturbation, bureaucratic inactiveness and hapless low and order state of affairs.

4.0 Overall limitations in FDI

Most South Asiatic states have liberalized equity limitations on FDI in the services sector to promote trade under Mode 3, i.e. Trade through commercial presence. Taking stock of the liberalisation of services that has taken topographic point in different states in the part, in different sectors, significant one-sided liberalisation has taken topographic point under Mode 3 in Sri Lanka.

Though states are trying to pull FDI in many of their services, by liberalising services, the portion of the part in planetary FDI in services is still really low. One of the grounds for this is the being of barriers to FDI in South Asiatic states. There are so many barriers and limitations at assorted degrees get downing from the point of entry that deter investors. Even though there are no limitations on equity ownership, so many other limitations are available at the point of entry, stretching from mere presentment demands to straight-out prohibition of FDI ; others may aim the operations of houses ; while yet another class may curtail the country of ownership and control.

Sri Lanka has opened its services sector to foreign investing. Foreign ownership of 100 % equity is allowed in scope of services sectors such as banking, insurance, telecommunications, touristry, stock securities firm, building of residential edifices and roads, H2O supply, mass transit, production and distribution of energy, professional services and the constitution of affair offices or local subdivisions of foreign companies. However some of the limitations still exists, curtailing FDI in services even when 100 % equity is allowed are, foreign commercial Bankss are allowed to open subdivision offices in Sri Lanka topic to an economic demands trial and blessing by the Central Bank of Sri Lanka. Foreign investors are allowed to keep 100 % equity in local Bankss topics to bounds on single portion ownership. Even though the authorities has late privatized province ain insurance companies, nevertheless resident Sri Lankans are prohibited from obtaining foreign insurance policies except for wellness and travel.

The limitations may besides change with the nature of the industry. For an illustration distribution services, limitations may include public presentation demands, districting ordinances, advertisement limitations etc. In professional services limitations used are by and large of the nature of nationality and residence demands and deficiency of acknowledgment of foreign makings. Therefore even if the equity limitations are removed, there may be other limitations that may non let the influx of FDI in to the services sector. Please mention Annexure 1 for some bing barriers to FDI in different states in South Asiatic part.

5.0 Reasons for Caution of FDI

Even though it is said that FDI has a heavy impact on heightening the growing and development of a state, there are several grounds for developing states to stay with mean limitations in services or to hold other barriers to investings in services. Apart from the sensitiveness of services with cultural, societal, distributional or strategic significance, there are economic concerns excessively. Among them,

To avoid the hazard of foreign investors out viing domestic investors.

Sale of public public-service corporations to foreign houses raises complex issues related to denationalization and the ordinance of natural monopolies.

Entry by big multinational corporations involves competition policy considerations and many host states may non experience to cover with proficient or legal issues involved.

It is hard to measure the impact of liberalisation in a peculiar sector, particularly if it employees a big figure of unskilled people. As such it is of import to set about an in deepness survey prior to the determination to let foreign houses. But many states lack the will or expertise to set about such analysis.

Most of the foreign investors are monopolies and in any event demand to be regulated ; domestic ordinances are frequently hard to set in topographic point.

6.0 Recommendations

Government should concentrate its attending on obtaining foreign investor engagement in developing substructure. So far Sri Lankan authorities acts the function of substructure facilitator. But it should see on pulling FDIs to develop substructure sector as good, non merely in attractive and most profitable few countries like telecommunication and air hoses, but besides in building of roads, main roads, overpasss, rail roads, edifices etc. BOO ( Built, Operating, Ownership ) , BOT ( Built, Operating, Transfer ) , BTO/Turnkey Projects ( Built, Transfer, Operate ) , BLT ( Built, Lease, Transfer ) and assorted other mechanisms to heighten the foreign investor engagement in this respect.

Government should concentrate its attending on implementing an unfastened door policy where it encourages foreign investors. It should heighten the quality of the bing Export Processing Zones ( EPZ ‘s ) and Free Trade Zones ( FTZs ) in order to excite investors to come and open up their fabrication or processing workss in Sri Lanka.

Government intervention and domination on fiscal sector should be minimized unless to exert a control over such establishments to guarantee the transparence and proper operation of them. Existing stock market should be popularized among the general populace and should be opened up for foreign investors.

Even though there are no limitations on equity ownership there are several barriers at the point of entry, stretching from mere presentment demands to straight-out prohibition of FDI etc. These may discourage foreign investors from puting within the state. Thus this fact should be taken in to Account during the policy devising procedure.

It is frequently criticized the quality of the end product of Sri Lankan instruction system. It is said that there is a mismatch between the employer demands and the instruction provided to the pupils or undergraduates. Therefore Higher instruction policies particularly in relation to secondary, third and university instruction course of study should be changed in order to run into employer outlooks. Adequate preparation chances provided to them in order to acknowledge and unleash their potencies and accomplishments. Therefore more accent should be given towards the importance of industry preparation when representing higher instruction policies.

As FDI in services has grown, a figure of issues have come to the head of policy devising. One of the of import issues is that pulling FDI in services where it is most coveted. i.e. services sectors where domestic capablenesss are limited to provide to the turning demand or where the domestic service suppliers do non hold the ability or capacity to supply the needed quality of services, as for an illustration telecommunication, and conveyance services. As such more grants to be given for the investors those who are willing to put in those countries in order to promote them.

Regulatory frame work to be strengthened in order to pull investors and besides to avoid monopolistic state of affairss. States without necessary regulative frame work may free by hotfooting in to liberalisation. Particularly when a reversal of liberalisation is difficult to accomplish or when liberalisation has systemic deductions as in the instance of fiscal industry.

By and large, the positive growing effects of FDI have been more likely when FDI is drawn into competitory markets, whereas negative effects on growing have been more likely when FDI is drawn into to a great extent protected industries ( Encarnation and Wells, 1986 ) . As such domestic industries should be strengthened to a grade in order to supply them the ability to vie with foreign investings.

7.0 Decision

This study has examined the factors that stimulate the flow of FDI and the issues that limits or restrains a state from pulling FDIs based on Sri Lanka, a underdeveloped state that entertains FDI. It is doubtless accepted that there is a positive nexus between FDI and growing. Particularly when Sri Lanka concerns a direct and positive growing impact of FDI on the Sri Lankan economic system and its growing has non reflected during the past and every bit good as in the present.

Attitude of the civil society and foreign house towards FDI in the state is positive. But the investing clime has non improved in Sri Lanka as a consequence of political instability and perturbation, hapless jurisprudence and order state of affairs, direct and indirect regulative barriers, political instability and the implied policy instability, ill developed substructure installations, lower degree of human capital, deficiency of transparence in the trade policy etc. Consequently the protectionist trade policies, direct and indirect regulative barriers ( that raise the cost of investing to foreign houses, for illustration it has found that in Sri Lanka about 13 per centum of capital costs and 30 per centum of net incomes are lost due to hindrances in the regulative model ) , political instability and the implied stableness, ill develop substructure installations, lower degree of literacy and investing in human capital excessively discourage investors. Lack of transparence in the trade policy, favoritism against non-export orientated sectors like plantations and high loaning rates are excessively act as restraints to FDI flows in Sri Lanka.

The importance of FDI can non be overstated, as consequence, that investing clime in the state must be improved through appropriate steps such as de-regulation in economic activity, increase domestic economy, developing port web, route web, railroads and telecommunication installations etc, making more transparence in the trade policy and more flexible labor markets and puting a suited regulative frame work and duty construction. Currently Sri Lanka provides an attractive investing government but the response from the investor has non been really encouraging. If the ultimate aim of the authorities is to pull FDI for development, poorness decrease and growing, so an appropriate policy mix is necessary to accomplish these.

8.0 Annexure

Annexure 1

Table 1: Extent of Liberalisation in Mode 3 in Selected Services


Well Liberalised

( 100 % equity )

Reasonably Liberalised

Less than Reasonably Liberalised/


Sri Lanka

Banking, Insurance, Telecommunications,

Tourism, Construction,

Transport ( Road ) ,

Professional services.

Transporting and travel

bureaus, Freight forwarding, Higher instruction, Mass


Non Bank Money Lending,

Retail trade with capital

investing of less than $ 1mn, Secondary instruction, Air transit,

Coastal transportation.


Computer and

information services,

Transport ( Road ) .


Banking, Insurance,

Air Transport, Construction.

Retail trading,

Railwaies, Real estate,

Professional services like Postal, Accountancy etc.



Banking services,

Legal and technology consultancy services,

Transport, Construction,

Computer and information services.





Construction, Computer

and information services,

Banking and Insurance services.



Banking, Insurance,


Computer and information

services, Tourism.

Personal Business Services,

Advisory services.