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