Academic journal article
By Kovac, Oskar
Serbian Studies , Vol. 20, No. 2
What can a developing country reasonably expect from foreign direct investments? Do they promote economic growth and social development? Foreign direct investments are part of investment finance, alongside, mostly, domestic savings. Foreign direct investments (FDI) contribute to economic growth in their net amount: the amount that remains after repatriation of foreign capital and profits are taken into account. If FDI finance research and development or in some other way bring in the most recent technology, they can be an ingredient of another source of growth, called technical progress.
Countries with huge external (balance of payments) and domestic (budget) deficits are compelled to import foreign capital in all forms, including FDI. In that respect the USA and Serbia are similar. Domestic savings of companies and households in these countries are not sufficient to finance investments. (2)
Will foreign capital come to countries with obvious deficits to fulfill the gap in national savings and finance economic development? Such altruism does not exist in the world. Capital is invested abroad to earn maximum return (profit, dividends, interest) that is: only if it earns a higher return abroad than at home. In other words, FDI primarily help the development of the country of the investor. Without that, there would be no FDI. Another issue is whether they contribute to the development of the recipient country. They may and may not.
In the short term, outward direct investments can increase production and wealth in the country of origin if subsidiaries of transnational corporations (TNC's) in recipient countries increase the demand of goods and services of their country. In that case, the export multiplier works. In the long-term, subsidiaries of transnational corporations abroad transfer a part of their profits into their country of origin. That increases its gross national product and disposable income.
A country, expecting some gain and willing to attract FDI, must be aware of investors' motivation. If an investor comes, he will come because of his own profit. That is why foreign investments go mostly to countries that have large markets with high or growing purchasing power. So, it is more likely that economic growth attracts foreign capital than vice versa.
Relations between the countries of origin of transnational corporations and FDI host countries are in accordance with economic theory. In developed countries there is abundant capital compared to feasible projects, thus marginal return on capital will gradually decrease. In less developed countries, it is the other way round: capital is a scarce resource and feasible projects are numerous, return on capital will be higher in the long-term perspective than in developed countries. However, due to their market power and specific monopolistic advantages, TNC's earn not an average but a monopolistic return, a peculiar rent on specific resources that they manage, even on the market of developed countries.
It is not a coincidence that the best part of the eclectic theory of transnational corporations explains that the basis of their business operations and existence is some specific advantage that cannot be easily reproduced in other companies and is not exposed to normal competition.
Following Dunning's articles "International Production and the Multinational Enterprise" (3) and "The Globalization of Business," (4) the profession accepted three categories of such specific advantages: ownership advantages, location advantages and the advantage of internalization. The first advantage is ownership of some mobile resource (patent or trademark) that a company can locate in places where it will be used most efficiently and with the lowest costs. The advantage of internalization is the principle to exploit advantages in one's own subsidiary instead of letting it over to some independent company for some compensation. …