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