Direct Foreign Investment: Costs and Benefits

By Richard D. Robinson | Go to book overview

Chapter Seven
The Financial Component of Foreign Direct Investment: Implications for Developing Countries
Donald R. LessardForeign direct investment (FDI) involves the transfer across national boundaries of resources, including such intangibles as know-how and access to a global production and marketing system as well as funds, in return for claims on all or part of the future profits of the foreign venture. Thus, it is both an industrial and a financial phenomenon, in contrast to much of the literature that insists it is one or the other. FDI is similar to licensing or contracting in terms of the resources transferred, but it also displays the characteristics of portfolio equity investment in terms of the character of the claims acquired in return for the transferred resources.This chapter focuses on the nature of the financial claims created through FDI and their effect on the welfare of the host country. These claims are viewed as "sharing rules," which allocate the financial rewards and risks of microlevel activities, typically specific enterprises or projects, between the foreign investor and the host country. Since these rules divide the expected financial returns of the investment between the investor and the host country, it is natural to view the negotiation of investment terms as a zero-sum activity. However, this is not always the case. Efficient sharing rules can provide gains to one party without reducing the benefits to the other in several ways. They can do so by
1. 1. creating incentives for the appropriate design and efficient management of the activities undertaken:
2. 2. allocating the rewards and risks of the project between the investor and the host country in line with their respective comparative advantage in bearing the risks involved; and
3. 3. reducing the "deadweight" contracting costs that result from conflicts of interest between the various parties coupled with the impossibility of creating completely enforceable contracts across national boundaries.

Of course, these microlevel sharing rules also can lead to economic inefficiency if they result in incentives for negative-sum behavior.

Various implications at the micro- and macroeconomic level are drawn from the "sharing rule" perspective of FDI. First, the financial contribution

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