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Unit 7: Foreign Direct Investment

Balance-of-Payments effect notes

Given the concern about current account deficits, the balance-of-payments effects of FDI can be
an important consideration for a host government. There are three potential balance-of-payments
consequences of FDI. First, when an MNE establishes a foreign subsidiary, the capital account
of the host country benefits from the initial capital inflow (A debit will be recorded in the capital
account of the MNEs home country since capital is flowing out of the home country).
Second, if the FDI is a substitute for imports of goods or services, it can improve the current
account of the host country’s balance of payments. Much of the FDI by Japanese automobile
companies in the United States and United Kingdom, for example can be seen as substituting for
imports from Japan.
A third potential benefit to the host country’s balance-of-payments position arises when the MNE
uses a foreign subsidiary to export goods and services to other countries.

effect on competition and economic Growth

When FDI takes the form of a green-field investment, the result is to establish a new enterprise,
increasing the number of players in a market and thus consumer choice. In turn, this can
increase competition in a national market and thus consumer choice. In turn, this can increase
competition in a national market, thereby driving down prices and increasing the economic
welfare of consumers. Increased competition tends to stimulate capital investments by firms in
plant, equipment, and R&D as they struggle to gain an edge over their rivals. The long-term
results may include increased productivity growth, product and process innovations and greater
economic growth.

FDI’s impact on competition in domestic markets may be particularly important in the case of
services, such as telecommunications, retailing, and many financial services where exporting is
often not an option because the service has to be produced where it is delivered.
7.4.2 Benefits and Costs of FDI to Home Countries

Benefits of FDI to the Home Country

The benefits of FDI to the home country arise from three sources.
1. The capital account of the home country’s balance-of-payments benefits from the inward
flow of foreign earnings FDI can also benefit the current account of the home country’s
balance of payments if the foreign subsidiary created demands for home country exports
of capital equipment, intermediate goods, complementary products, and the like.
2. Benefits to the home country from outward FDI arise from employment effects. As with
the balance of payments, positive employment effects arise when the foreign subsidiary
creates demand for home-country exports of capital equipment, intermediate goods,
complementary products, and the like. Thus, Toyota’s investment in auto assembly
operations in Europe has benefited both the Japanese balance-of-payments position and
employment in Japan because Toyota imports some component parts for its European-
based auto assembly operations directly from Japan.
3. Benefits arise when the home-country MNE learns valuable skills from its exposure to
foreign markets that can be transferred back to home country. This amounts to a reverse
resource-transfer effect. Through its exposure to a foreign market, an MNE can learn about
superior management techniques and superior products and process techniques. These
resources can then be transferred back to the home country, contributing to the home
country’s economic growth rate.

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