How benefitial is Foreign Investment: Theory and application

Nurturing entrepreneurial activity
3rd August 2016
“Self-employed” or Entrepreneur?
9th August 2016

How benefitial is Foreign Investment: Theory and application

It is quite common when politicians refer to "development policies", to actually talk about institutional changes and particularly tax legislation in order to attract the inflow of foreign investment.
Nothing is more misleading to the youth of a nation than to state the outcome immediately after the beginning as if nothing could have taken place in between.

Gustav Stresemann

As positive as "inflow" and "foreign investment" might sound for an economy, it is a complex and multidimensional issue. The citizens-voters have to understand the different mechanisms that could theoretically occur and the mechanisms that experience shows that typically are applied. I will not expand too greatly on the theoretical models of development through foreign capital because they are pretty much explained by common sense; the foreign investor believes that an economy has a faster growth prospect than that his country, or that a business (or business idea) will be quite profitable thus able to return the initial investment plus (lots of) profit. In the case of government own assets, it is a common belief that the profit will come from cost-effective management (which the host country's government was bad at). The usual method of application differs greatly, particularly in less advanced countries or countries in unstable political and economical environments (e.g. Greece).
Greece’s inward FDI stock exceeded its outward stock throughout the last decade, but in 2009 and 2010, its outward stock overtook inward stock due to the decline in the market value of assets in Greece.


In the previously mention type of countries, the typical method of application of the foreign investments is, unfortunately, different and it does not generate the expected development promoted in the "advertising", or at least not for the host country who is the recipient of foreign capital. Strange as it sounds the real gain is for the country investor.
In practice, the foreign capital does not simply target the enterprises of the country recipient, but businesses that are owned directly or indirectly by the same foreign investors. In this perspective, one can clearly see that the "foreign" investment is not so "foreign" in financial terms, but only in geographical terms. Such companies are not foreign to the investor and in essence it is an expansion of its domestic economy. Most of these investments tend to focus on meeting the consumption needs of the consumers of the country investor. So the investment is served by consumer consumption of the country investor.
When a country recipient absorbs a high volume of foreign investment its economy starts expanding based on the erroneous assumption of its continuous flow. Hence, when foreign investment flow slows down, a recession occurs. This has been most evident in Latin American countries.
Not unexpected, the reinvested earnings in the host country's businesses are limited, in contrast with norms of entrepreneurship, where most of the profits will be reinvested in the business to help it grow. In Greece for example, this can be exceedingly seen in foreign capital investment in the tourism industry, as well as in the management of ports and airports that are targeted by foreign investment. With this model in mind, one can understand that the gains of the investor avoid capital taxation, dividend and interest payments because the investor does not withdraw capital from the country's economy since the consumption takes place in the host country. In the tourist industry particularly, a significant amount of the money will not even enter the host country since the financial transactions take place in the country investor (or online) before the arrival of the customer in the host country. As a result, the few profits for the country recipient of such foreign capital is that there are jobs created, which is a common phenomenon to be low-level/low-cost jobs, while top-level and hence higher-cost jobs are exclusive to expatriates of the investor country.
Let's keep small basket when we hear a lot of cherries, and remember that not all that shines is gold.
It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.

Adam Smith

Comments are closed.