Globalization, Growth and Poverty
brief on research results
Foreign Direct Investment
Can foreign firms benefit developing countries?
Globalization has meant that people, businesses and nations have become increasingly interconnected
in the past few decades through the greater movement of people, goods, services and information. An
important component of this interconnectedness has been the rise of foreign direct investment (FDI) –
overseas investments by private multinational corporations – into developed and developing countries
alike. This paper provides a snapshot of some of the research projects by Canada`s International
Development Research Centre (IDRC) and other researchers on the topic of FDI. It explores trends in
Asia, Latin America and Africa, as well as emerging South-South trends in FDI.
Trends and Debates new enterprise where no previous resources existed,
as opposed to changing ownership through mergers
World FDI inflows reached an all-time high in 2007, and acquisitions), which faced large declines in 2009
but dropped by almost 15% in 2008 due to the global after being more resilient when the crisis began in
economic crisis.1 Nevertheless, worldwide FDI flows 2008.
rose steadily from 2003 to 2007, reaching $1.979
trillion in 2007 from $600 billion in 2003. The crisis and previous boom in FDI have affected
Preliminary findings from UNCTAD reveal a sharp various regions and countries quite differently. Just
decline in foreign direct investment, with inflows as growth and globalization in general have
falling 44% as compared with the same period in benefited the poor unevenly, so too has FDI. It is
2008. Developing countries held a higher proportion particularly noteworthy that of the $1.7 trillion
of worldwide FDI inflows in 2008 than 2007, partly worldwide FDI flows in 2008, $620 billion of these
due to the large decline of flows to developed flows (around 37%) went to developing countries.
countries. Mergers and acquisitions have been However, FDI flows are still larger than migrants‟
declining consistently, but are expected to recover remittances (around $240 billion) or official
faster than greenfield investments (the creation of a development assistance (ODA).
FDI inflows in 2008
Developed Asia 23%
$1.7 trillion $620 billion
The intricacies of how FDI affects exports, economic Current and capital account deficits: The
growth, the transfer of technology, innovation and current account may deteriorate from foreign
poverty reduction in the developing world have been firms importing intermediate products and
discussed for decades. This debate is largely capital goods; the capital account may
between those who believe that FDI brings about deteriorate from foreign firms repatriating
mostly positive spillovers and those who believe FDI profits, royalties and management fees.
brings about very few positive, or even some
negative, spillovers. This paper focuses on Lack of skills acquisition and resource transfer:
theoretical reasons for how spillovers might occur, A low absorptive capacity may prevent the
and presents research from IDRC and other transfer of management and entrepreneurial
organizations on the evidence of spillovers. skills, ideas and technology in developing
Traditional arguments in favour of FDI point to a
number of benefits, particularly: a transfer of Lack of contribution to the domestic economy:
capital, the creation of employment and positive Foreign firms pay less in taxes than they should
spillovers. This last advantage is perhaps the most because of liberal tax concessions, investment
important because of the productivity and allowances and tariff protection.
technological strengths inherent in foreign
investment as opposed to domestic investment. Environmental degradation: Environmental
Spillovers can take a number of forms:2 damage has been driven by increased economic
activity, including FDI, which is often attracted
Promote competition: Domestic firms can to “pollution havens” (developing countries that
benefit from the presence of foreign firms when have lax environmental regulations). This can
they have an opportunity to adopt superior lead to an increase in greenhouse gas emissions,
technology or use existing technology more deforestation and a loss of biodiversity.
effectively to compete for the market.
The effects of FDI then, are not clear. With
Increase exports: Domestic firms can gain from increases in knowledge, technology and quality,
foreign firms by benefiting from the improvements can perhaps be made in the overall
improvements they make in distribution productivity and efficiency of domestic firms.
networks, logistics services and infrastructure, However, low absorptive capacity and a potential
all of which can help domestic firms penetrate unwillingness of foreign firms to contribute
export markets. positively to developing country economies,
environment and labour force may negatively affect
Skills acquisition: Domestic workers can gain domestic firms. What has the evidence been
new skills through higher quality training from regarding FDI and spillovers in Asia, Latin America
foreign firms which they can use for future and Africa?
employment in the domestic market.
Imitation: Domestic firms can profit by imitating In Asia
the products or processes of foreign firms. This
is also referred to as reverse engineering. Of developing countries, FDI outflows to Asia
(including South, South-East, East, West and
Linkages: Domestic firms may benefit from Oceania) have been the largest in absolute terms,
vertical linkages created with foreign firms since and represented 11% of the region‟s gross fixed
foreign firms often require high quality inputs capital formation in 2007. In 2008, FDI inflows to the
and often sell high quality outputs. region were at $300 billion, that is, 63% of the
developing world total. China alone received $171
Traditional arguments against FDI include a number billion (including $63 billion to Hong Kong, S.A.R.) in
of economic and some more political or philosophical FDI in 2008, followed by India a distant second at
reasons. Some of them directly opposed to FDI $42 billion and Singapore at $23 billion. Saudi
include:3 Arabia, Turkey and the United Arab Emirates were
the top attractors of FDI in West Asia.
Stifle competition: Foreign firms may lower
domestic savings and investment rates by In India, economic reforms opened up the country in
stifling competition. If they do not reinvest the early 1990s. Today, FDI is generally accepted as
much of their profits (and instead import a positive investment and the government continues
intermediate products from overseas affiliates), to attempt to attract foreign investment through
this inhibits the expansion of domestic firms favourable policies. For foreign firms, India is ranked
that might supply them with such goods. as the second most desirable location to invest
(sandwiched between first place China and third
GGP brief on research results 2 November 2009
place United States). India attracts investors in high spillovers or backward linkages in Latin America, and
value-added services, particularly financial services in some cases, crowded out domestic investment.6
and information technology, partly due to the large
pool of educated Indians. Some Indian firms are also In Latin America, Brazil had the highest inflows of
heeding the demand for environmentally friendly FDI, with a 30% increase in flows in 2008 over 2007.
products and are producing in line with EU IDRC-supported researchers Daniel Chudnovsky and
standards. These companies demonstrate that India Andrés Lopez investigate the role of FDI on
can continue to move toward Western standards of development in the Mercosur countries and find that
living without the environmental footprint required in the case of Brazil, there is evidence of vertical
by Western models. India is welcoming Japanese productivity spillovers from foreign firms to domestic
investment. With urbanization on the rise, Indian firms (Mercosur: Economic Research and Integration,
cities are finding new ways to improve infrastructure projects 101490 and 102922). However, there is
and many are looking at the possibilities of mass- little evidence of horizontal productivity spillovers
transit systems, all with the assistance of Japanese (which would occur between companies competing
engineering excellence, knowledge in urban-transit within the same sector). Within Argentina and Brazil
systems and capital. Japanese firms are also though, there was some evidence that domestic
providing foreign investment to India in the firms benefited from the presence of foreign firms.
chemicals, pharmaceuticals, food processing, IT In Argentina, the domestic firms that benefited the
software and textiles industries. Through foreign most from the transnational corporation presence
direct investment, Indian firms can potentially were those that had the greatest absorptive
increase their competitiveness by adopting cutting- capacity; while, in Brazil, it was those firms that had
edge technology and Indian workers can benefit from the largest productivity gap in relation to the foreign
the acquisition of new skills learned from foreign firms. What emerges from these findings is not a
firms.4 positive or negative picture of FDI spillovers, but a
recognition that the impact of FDI depends on
In Vietnam, as in other case studies, IDRC-supported prevailing conditions and policies in the recipient
researcher Hoang Thanh Huong finds that foreign countries.7
firms pay higher wages than domestic firms (Does
Foreign Direct Investment Lead or Follow Opponents of FDI criticize foreign firms for
Development? Differences in FDI behaviour in low- maximizing profits with little regard to the
and middle-income countries, project 103253). Also consequences for local populations and
these firms provide their employees with higher communities. Specifically, critics point to
levels of on-the-job training than those employed in unfavourable working conditions and labour
Vietnamese firms. By enhancing the level of human standards, disregard for the environment, low wages
capital through skills acquisition, foreign firms in and a decreased role for national sovereignty in the
Vietnam are opening up the possibility of domestic face of powerful international corporations.
industries benefiting from higher quality labour in Corporate social responsibility (CSR) programs
the future. 5 arguably address these criticisms, though some view
CSR more as an exercise in lip service rather than a
concrete solution to curbing the destructive
In Latin America practices of foreign firms, especially in mining and
other extractive industries. Julia Sagebien and other
Latin America and the Caribbean attracted $144 IDRC-supported researchers (Corporate Social
billion in FDI inflows in 2008 (23% of FDI flows to Responsibility in the Latin American Extractive
developing countries). Much FDI in the region comes Industry: Challenges and Best Practices, project
from investment in natural resources (mostly mining 104937) are examining the ways in which the CSR
investment rather than in the oil and gas sectors, as strategies of Canadian companies in the extractive
there are many strong domestic companies in these industries can contribute to the process of
areas). sustainable development in Latin America. 8 Also, the
International Finance Corporation (IFC) through the
Little evidence of positive spillovers has been found World Bank has a program in Latin America and the
in Latin America through the 1990s and 2000s. Caribbean intended to address the inequalities that
Foreign investment has fallen far short of stimulating can arise from the influx of FDI into an economy.
broad-based economic growth and environmental The rationale behind Enhancing Local Benefits is to
protection in the region, a recent study finds. This help local populations gain from investments in the
could be because of the heavy investment in the region. For instance, in Peru, the IFC helped train 30
extractive industries, which leaves less room for local potato producers in crop improvement, growing
spillovers than other industries. Though foreign firms practices, fertilizers and hygiene control. Staff of a
were found to have higher levels of productivity, pay local NGO were trained in food hygiene, trout
higher wages and were likely to increase trade handling, processing, maintaining fish ponds,
within the region, FDI still did not produce many standardization, finance and marketing. Now, IFC
GGP brief on research results 3 November 2009
has joined forces with Orient Express Hotels to help communities and organizations in five African
link the hotel restaurant buyers with local producers countries (Democratic Republic of Congo, Ghana,
of potatoes and trout. This example highlights the Kenya, Mali and Tanzania) and other lower-income
possibilities of the potential benefits from FDI for countries around the world that are dealing with the
local producers. effects of extractive industries.11
Within the services sector, however, there is much
In Africa room for spillovers into the community. As an
example, tourism is an industry that has a long value
FDI flows into Africa stood at $88 billion for 2008, a chain, which means that the positive effects, but
record for the region, but still accounting for only also any negative effects, of FDI will have a long
14% of FDI flows to developing countries. The largest reach and be felt widely (Foreign Direct Investment
recipients in Africa included Nigeria, Angola, Egypt in Tourism: the Development Dimension; project
and South Africa. Much of the investment in Africa 103030). IDRC-funded researchers Diana
comes from the United States and Europe (though Barrowclough and Francis Nsonzi find that the
China is stepping up investments), and is driven by impact of tourism FDI on development depends on
the extraction of natural resources. three main factors: the policy environment, the
level of development in any given country of the
One example of government policy working tourism industry itself, and the geography of the
extremely effectively with a transnational country.12 Tourism FDI in Botswana, Kenya,
corporation is the case of the diamond industry in Mauritius, Uganda and Tanzania has improved the
Botswana and the relationship with De Beers. service delivery and the supply capacity of these
Botswana was the fastest growing economy in 1970- countries. Evidence from East and Southern Africa
2000, largely because of the country‟s vast diamond also shows that the tourism industry is benefiting
wealth, and made the leap from least developed from spillovers from FDI inflows including the
country to upper middle-income country. In the transfer of technology, skills acquisition and
early 21st century, diamonds accounted for four- linkages. “Both policy and non-policy initiatives to
fifths of Botswana‟s total exports, making the make the tourism industry amenable to increased
country the largest producer and exporter of FDI are key to sustaining its development role,”13
diamonds in the world. “The contributions of conclude the researchers.
[foreign firms] to Botswana‟s economic development
have taken place in the context of an open and
transparent mineral licensing and taxation regime, From North-South to South-South
and a competent institutional structure,”9 says the
World Investment Report. The rise of FDI outflows from developing countries to
other developing countries (or South-South
The Botswana government has used its strong investments) must not be overlooked. South-South
bargaining position to negotiate favourable profit- flows have been increasing in recent years14, far
sharing arrangements with De Beers, making sure faster than North-South flows. In 2008, FDI from
profits stay in Botswana in the form of royalties and developing countries reached a record high of
taxes. Although the government has an ownership $292 billion, with $220 billion of this investment
stake of 15-50% in major mining projects, it has not coming from Asian-based foreign firms. The growth
assumed a direct operational role in the mining in FDI outflows from Asia was driven by the
ventures. extractive industries and services. IDRC recognizes
this new trend and currently supports many projects
Despite the success of Botswana, the forward and that are investigating the implications of this surge
backward linkages associated with investment in of outward FDI.
primary products are not often large. In many other
countries, tax concessions and other incentives in Why does an increase in South-South flows matter
the mining sector may mean that profits are often and what are the development implications? One
repatriated and little is left for developmental IDRC-supported researcher expects the following:
efforts, unlike the case of Botswana (Extractive
Industries and Sustainable Development in Africa: Foreign southern firms may be more likely to
Evaluating the Reforms and Recommendations of the promote backward and forward linkages with
World Bank, project 102787). Additionally, domestic firms.
employment has been limited in the sector due to
the increased use of surface mining technology, The technology gap between foreign southern
reducing the possibilities of knowledge spillovers.10 firms and domestic firms is likely to be smaller,
Because of these effects, IDRC is helping Mining which might increase the chance of transferring
Watch Canada to provide information, training, more appropriate technologies.
dissemination and networking support to
GGP brief on research results 4 November 2009
Southern foreign firms may also be more willing exports to Swaziland, Lesotho, Namibia and
than northern firms to enter into informal Mozambique.
governance arrangements; but, once there, they
may also push domestic governments to improve
infrastructure and governance to lower their risk Positive spillovers in manufacturing and tight
(South-South Links: Third World Multinationals regulations in services: FDI in Canada
and Development (South Africa, East Africa,
India), project 103254). In 2007, Canada received $109 billion in FDI
inflows, representing more than 30% of the
IDRC researchers are comparing North-South versus country’s gross fixed investment. Research at
South-South flows of FDI in Ghana (Impacts of Statistics Canada by John Baldwin and Wulong
Foreign Direct Investment (FDI) Flows on Poverty in Gu (2005) of Statistics Canada has found that
Ghana: Comparison of North-South and South-South “foreign-controlled plants are more productive,
Inflows into Ghana, project 105697). This project more innovative, more technology intensive,
will explore the critical factors that attract FDI, pay higher wages and use more skilled
investigate the channels through which FDI enhances workers.”15 Additionally, the authors find that
growth, and examine the extent to which enhanced productivity spillovers do occur in Canada from
economic growth from FDI flows affects employment foreign to domestic firms. This happens mostly
and poverty reduction. through two channels: increased competition
and technology transfer.
IDRC-supported researchers, Rajiv Kumar,
Ramkishen S. Rajan and Nicola Virgill, recently Even though, this record of FDI may appear
published a book on South-South investment entitled beneficial for Canadian manufacturing, tight
New Dimensions of Economic Globalization, Surge of regulations have kept foreign businesses out of
Outward FDI from Asia (Preferential Trading the Canadian services sector. Canada’s
Agreements in Asia: Towards an Asian Economic regulations on foreign investment in
Community, project 102566). In this work, the telecommunications, electricity and
editors point to four structural drivers of intra-Asian transportation are among the most restrictive,
FDI. First, because of poor domestic policies in according to the Organisation for Economic Co-
certain Asian economies, investment sought out operation and Development (OECD).16 The OECD
more favourable environments in other countries. and others have called for a relaxation in these
Second, some Asian governments pursued a „national regulations by arguing that Canadian services
champion‟ strategy to allow their firms to gain would benefit from more capital as well as
market share, achieve lower production costs and positive spillovers in technology-intensive
improve access to resources and raw materials. services.
Third, there has been an increase in investment
within Greater China (China, Hong Kong, Taiwan and
Chinese diaspora in other parts of Asia) since the
investment environment has been so favourable to AERC has also completed research on the impact of
foreign firms through various incentives. Finally, Chinese investments in Kenya. Chinese FDI is mainly
intra-Asian FDI has increased because of traditional in the manufacturing, services and mining sectors.
economic and strategic reasons.17 The findings indicate that the overall impact of
China‟s trade, FDI and aid to Kenya is mixed. While
Chinese investment is also taking a prominent role as a low cost of imports means that consumer and
a source of FDI in Africa. An IDRC project, being producer goods are relatively cheap, benefiting
carried out by the African Economic Research consumers, the competition has forced some local
Consortium (AERC) (Impact of China on Sub-Saharan businesses out of the market, hurting local
Africa: Country Case Studies, project 104442), is employees. The economic implications of Chinese
preparing country case studies in each of the areas FDI in Kenya are both direct and indirect. Some of
of primary impact: oil and gas, solid minerals, the indirect impacts relate to loss of regional
agriculture and forestry, and manufacturing. One markets or loss of opportunity to participate in
completed study examines China‟s relationship with international trade. However, Chinese FDI also
South Africa, including the impact of foreign presents an opportunity for technology transfer and
investment through mergers and acquisitions on the upgrading of local enterprise likely to make local
labour market and exports.18 Chinese companies firms competitive for the international markets.
operating in Africa have demonstrated a strong
preference for local labour, potentially increasing AERC identifies some policy implications stemming
the skills acquisition of local workers; however, from their work on Chinese FDI in Africa. First, the
South African companies have been negatively demand for African commodities, which is being
affected since they cannot compete with Chinese created by China (and India), need not come to an
end should demand from these two economies wane.
GGP brief on research results 5 November 2009
Rather, African countries should actively pursue However, in the new knowledge economies,
linkages and local partnerships with foreign developing countries need to find ways to leapfrog,
investors. Second, Africans need to develop dynamic following closely advanced, cutting-edge technology
capabilities to scan changing environments and leaders. There are many potential gains from
strategies to explore the possibilities of joint attracting FDI, but there remains today a lack of
ventures. Third, it is necessary to examine that what positive spillovers, especially in the extractive
is important for Africa may not relate to the static industries where FDI is largely concentrated in some
gain and loss from FDI today, but is instead the developing countries. What emerges from the
future industrialization of Africa. Africa should not research supported by IDRC and others on FDI is a
become locked in to activities that are low rent. clear message, despite the variety of regions and
topics examined: the impact of FDI depends on local
The South African Institute of International Affairs at circumstances, the policy environment and the type
the University of Witwatersrand in Johannesburg is of industry involved. More research is needed to
investigating China‟s role in Ghana, Gabon and the identify specific constructive policies that will help
Democratic Republic of Congo among others.19 The individual countries capture the potential benefits of
findings suggest that in Ghana, China is helping to these flows.
build productive infrastructure while expanding
access to new technologies and combating poverty in Some of the policy implications that stem from the
ways that humanitarian aid cannot. Also, research above relate to how governments can
investments in the services and industrial sectors by maximize the spillover effects from FDI. For
China, India, South Africa and Nigeria have instance,
contributed to strong growth in agriculture. The
ability to continue to attract Chinese investments Governments should continue improving the
may increasingly depend on the availability of overall investment climate governing both local
suitable local partners. Collaborations will and foreign firms. This can include everything
encourage the diffusion of technologies and from overcoming regulatory hurdles and a lack
management practices from more competitive of infrastructure to enforcing property rights
Chinese companies to Ghanaian firms. Despite the and contracts, and promoting competitive
findings of this study, there are also reports of markets. Improvements in the institutional
Chinese investors engaging in illegal labour practices framework provide a basis for further domestic
by ignoring safety rules and paying workers far below and foreign investments, but more importantly,
minimum wage in African countries.20 they should encourage greater innovation, and
facilitate the transfer, exchange, adaptation or
adoption of these new ideas and technologies.
Further Research Is Needed
Governments should also continue negotiating
Foreign firms enter countries and markets as profit- and monitoring bilateral investment treaties
seeking entities looking for environments where with foreign investors that emphasize
financial and regulation costs are low. Despite the sustainable development practices. Bilateral
clearly business (and not development) oriented investment treaties are largely responsible for
nature of foreign firms, it is still expected that the driving international investment forward at the
presence of FDI within a country will lead to rate seen in the past decade. Today there are
development results. FDI flows have been increasing almost 2,500 such treaties. Sustainable
substantially in the past decade (though the current development will only be possible with a
financial crisis highlights the danger of relying too significant change in the way we produce,
heavily on outside sources), but are still a small distribute and dispose of goods. This change will
proportion of developing country funds. North-South likely come from investments in new
flows have been rising, but so too have South-South technologies and FDI is one way that developing
flows and to an even greater degree. The smaller countries can gain access to new technology
technology gap inherent in South-South flows has that can mitigate or reverse unsustainable
long been lauded for fostering the adoption of more practices.
appropriate technologies in developing countries.
GGP brief on research results 6 November 2009
* Prepared by Katy Stockton and Edgard Rodriguez, July-August 2009.
Figures on FDI are taken from the United Nations Conference on Trade and Development‟s (UNCTAD), World Investment Report
2007 and 2008 unless otherwise indicated.
Görg, H., Greenaway, D. 2003. Much Ado About Nothing? Do Domestic Firms Really Benefit from Foreign Direct Investment?
Discussion Paper No. 944, IZA, Bonn.
Todaro, Michael P. and Smith, S. 2006. Economic Development Ninth Ed., Boston: Pearson Addison Wesley.
Ghosh, I. 2007. Japanese Investments in India, Centre for Studies in International Relations and Development, Discussion Paper
Hoang Thanh Huong. FDI and Wages: Evidence from Vietnam’s FDI Employee Survey; project 103253; March 2006-January 2009;
Responsible Officer: Andres Rius.
Working Group on Development and Environment in the Americas, “Foreign Investment and Sustainable Development: Lessons
from the Americas”, available at http://ase.tufts.edu/gdae/WorkingGroup_FDI.htm, Anthem Press: 2009.
Lopez A. and Chudnovsky, D. Foreign Direct Investment and development: the MERCOSUR experience; projects 101490 and
102922; 2002-2009; Responsible Officer: Andres Rius.
Royal Roads University and Sagebien, J. Corporate Social Responsibility in the Latin American Extractive Industry: Challenges
and Best Practices; project 104937; November 2008 – February 2010; $72,090; Responsible Officer: Loredana Marchetti.
UNCTAD. 2007. World Investment Report, page 144.
Akabzaa, T. “Mining in Ghana: Implications for National Economic Development and Poverty Reduction”, in Mining in Africa,
ed. Bonnie Campbell; project 102787; September 2004 – May 2008; $230,483; Responsible Officer: Gisèle Morin-Labatut.
Mining Watch Canada. Communities and Mining: Corporate Responsibility and Impacts; project 103313; July 2005 – April 2006;
$60,000; Responsible Officer: Gisèle Morin-Labatut.
UNCTAD. Foreign Direct Investment in Tourism: the Development Dimension; project 103030; November 2005 – July 2009;
$416,500; Responsible Officer: Basil Jones.
UNCTAD. 2008. FDI and Tourism: The development dimension, page 4. Available at
Under the project “South-South Links: Third World Multinationals and Development (South Africa, East Africa, India)”,
researcher Stephen Gelb examined the case of South-South FDI to Africa. From 1990-97, FDI flows from China to Africa
amounted to around $20 million; from 1998-2002, FDI flows jumped to $120 million. Indian-owned firms are increasing their
presence and are currently involved in projects in services (IT, banking) and manufacturing (automotive, steel and
pharmaceuticals). After Asian investment, the largest source of South-South FDI to Africa is South Africa, with the majority of
projects in services.
Baldwin, J. and Wulong Gu. “Global Links: Multinationals, Foreign Ownership and Productivity Growth in Canadian
Manufacturing”, Statistics Canada, 2005, page 6.
Department of Foreign Affairs and International Trade. “Canada‟s restrictions on FDI tightest of all G-7 countries”, February
19, 2007. Accessed at http://www.dfait-maeci.gc.ca/canadexport/articles/384870.aspx, Accessed on June 17, 2009.
Kumar, R. Preferential Trading Agreements in Asia: Towards an Asian Economic Community; project 102566; March 2005 – May
2008; $225,120; Responsible Officer: Evan Due.
African Economic Research Consortium. Impact of China on Sub-Saharan Africa: Country Case Studies; project 104442; July
2007- July 2009; $699,400; Responsible Officer: Basil Jones.
Idun-Arkhurst, I. 2008. “Ghana‟s Relations with China”, Braamfontein: The South Africa Institute of International Affairs at the
University of Witwatersrand.
Baah, Anthony Yaw and Herbert Jauch (eds). “Chinese Investments in Africa: A Labour Perspective”, African Labour Research
GGP brief on research results 7 November 2009