| FDI stands for Foreign Direct Investment, a | | | | earlier. An additional benefit is that FDI is thought |
| component of a country's national financial | | | | to be "bolted down and cannot leave so easily at |
| accounts. Foreign direct investment is investment | | | | the first sign of trouble." Unlike short-term debt, |
| of foreign assets into domestic structures, | | | | direct investments in a country are immediately |
| equipment, and organizations. Foreign direct | | | | repriced in the event of a crisis. |
| investment is thought to be more useful to a | | | | Recent evidence |
| country than investments in the equity of its | | | | To what extent is there empirical support for |
| companies because equity investments are | | | | such claims of the beneficial impact of Foreign |
| potentially "hot money" which can leave at the | | | | Direct Investment? |
| first sign of trouble, whereas FDI is durable and | | | | A comprehensive study by Bosworth and Collins |
| generally useful whether things go well or badly | | | | (1999) provides evidence on the effect of capital |
| The resilience of foreign direct investment during | | | | inflows on domestic investment for 58 developing |
| financial crises may lead many developing | | | | countries during 1978-95. The sample covers |
| countries to regard it as the private capital inflow | | | | nearly all of Latin America and Asia, as well as |
| of choice. Although there is substantial evidence | | | | many countries in Africa. The authors distinguish |
| that such investment benefits host countries, | | | | among three types of inflows: Foreign Direct |
| they should assess its potential impact carefully | | | | Investment, portfolio investment, and other |
| and realistically | | | | financial flows (primarily bank loans). |
| Economists tend to favor the free flow of capital | | | | Countries should concentrate on improving the |
| across national borders because it allows capital to | | | | environment for investment and the functioning |
| seek out the highest rate of return. Unrestricted | | | | of markets. They are likely to be rewarded with |
| capital flows may also offer several other | | | | increasingly efficient overall investment as well as |
| advantages. First, international flows of capital | | | | with more capital inflows." Although it is very likely |
| reduce the risk faced by owners of capital by | | | | that FDI is higher, as a share of capital inflows, |
| allowing them to diversify their lending and | | | | where domestic policies and institutions are weak, |
| investment. Second, the global integration of | | | | this cannot be regarded as a criticism of Foreign |
| capital markets can contribute to the spread of | | | | Direct Investment per se. Indeed, without it, the |
| best practices in corporate governance, | | | | host countries could well be much poorer. |
| accounting rules, and legal traditions. Third, the | | | | Fire sales, adverse selection, and leverage. Foreign |
| global mobility of capital limits the ability of | | | | Direct Investment is not only a transfer of |
| governments to pursue bad policies. | | | | ownership from domestic to foreign residents but |
| In addition to these advantages, which in principle | | | | also a mechanism that makes it possible for |
| apply to all kinds of private capital inflows,the | | | | foreign investors to exercise management and |
| gains to host countries from Foreign Direct | | | | control over host country firms—that is, it is a |
| Investment (FDI) can take several other forms: | | | | corporate governance mechanism. The transfer |
| • FDI allows the transfer of | | | | of control may not always benefit the host |
| technology—particularly in the form of new | | | | country because of the circumstances under |
| varieties of capital inputs—that cannot be | | | | which it occurs, problems of adverse selection, or |
| achieved through financial investments or trade in | | | | excessive leverage. |
| goods and services. FDI can also promote | | | | Both economic theory and recent empirical |
| competition in the domestic input market. | | | | evidence suggest that Foreign Direct Investment |
| • Recipients of FDI often gain employee | | | | has a beneficial impact on developing host |
| training in the course of operating the new | | | | countries. But recent work also points to some |
| businesses, which contributes to human capital | | | | potential risks: it can be reversed through financial |
| development in the host country. | | | | transactions; it can be excessive owing to |
| • Profits generated by FDI contribute to | | | | adverse selection and fire sales; its benefits can |
| corporate tax revenues in the host country. | | | | be limited by leverage; and a high share of Foreign |
| Foreign Direct Investment ( FDI) versus other | | | | Direct Investment in a country's total capital |
| flows | | | | inflows may reflect its institutions' weakness |
| Despite the strong theoretical case for the | | | | rather than their strength. Though the empirical |
| advantages of free capital flows, the conventional | | | | relevance of some of these sources of risk |
| wisdom now seems to be that many private | | | | remains to be demonstrated, the potential risks |
| capital flows pose countervailing risks. many host | | | | do appear to make a case for taking a nuanced |
| countries, even when they are in favor of capital | | | | view of the likely effects of Foreign Direct |
| inflows, view international debt flows, especially of | | | | Investment. Policy recommendations for |
| the short-term variety, as "bad cholestero. | | | | developing countries should focus on improving |
| In contrast, FDI is viewed as "good cholesterol" | | | | the investment climate for all kinds of capital, |
| because it can confer the benefits enumerated | | | | domestic as well as foreign. |