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Essay Foreign Direct Investment Intr

Ali, Fathi A. Ahmed (2010) Essays on foreign direct investment, institutions, and economic growth. PhD thesis, University of Glasgow.

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The aim of this thesis is to explore and study various dimensions of the interaction between one of the most important institutional quality aspects, namely property rights, and one important aspect of integration into the world economy: foreign direct investment (FDI), and links them to economic growth. In particular, this thesis explores whether the interaction between institutions and FDI has any implication for economic growth and whether there is any complementarity between the role of institutions and the role of FDI in fostering economic growth. To achieve this aim, the thesis was designed to include four empirical chapters in addition to two chapters: one for the introduction and the other for the conclusion. The first two empirical chapters studied the interrelationship between FDI and institutions. And the other two empirical chapters studied the implication of the interrelationship and the complementarity between FDI and institutions for economic growth. Chapter one motivated the thesis and set its aim and structure. The second chapter studies the role of institutions in determining FDI inflows and shows that institutional quality is one of the most important determinants of FDI. Based on this result, chapter three introduces a hypothesis that foreign investors will create a demand for better institutions in host countries, and that governments competing to attract more FDI will be induced to provide such institutions, leading to improvements in institutional quality in host countries. The empirical evidence reported in this chapter supports this hypothesis and shows that FDI inflows have a positive impact on property rights in host countries. Chapter four explores whether institutions play a role in determining the contribution of FDI to economic growth. The results presented in this chapter show that a host country needs to achieve a minimum level of institutional quality in order to be able to benefit from the positive externalities offered by FDI. Based on the results of chapter three, chapter five investigates whether the positive impact of FDI in institutional quality on host countries can be considered as a new growth-enhancing role for FDI. The results reported in chapter five show that the impact of FDI on economic growth that works via institutions, is a significant one, and is generally greater and more robust than the direct impact. Over all, the major contribution of this thesis is that it shows that a better understanding of the contribution of FDI to economic growth requires taking into account the interrelationship and the complementarity between FDI and institutions.

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The term FDI is an abbreviation for “Foreign Direct Investment” and refers to the direct investment that any foreign company makes in another country, by the act of buying that company or by expanding some existing business in the country.

The ways of making foreign investment include, setting up an associate of the company in the foreign country, acquiring shares of the company or via a merger etc. Unlike, the indirect investments where the institutions abroad invest in the equities listed on a nation’s stock exchange, direct investment allows entities a higher degree of control over the company wherein it invests. A larger amount of FDI is a characteristic of an open economy which has good prospects of growth.

From the view point of the accounts of a country, FDI also refers to the net incoming investment (incoming-outgoing investment) in acquisition of minimum management interest of 10% or more of voting stock in the economy where the investment is being done.

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Every country has its own set of FDI rules that decide the way he foreign country can conduct business. A foreign company interested in investing in an Indian company can take two routes-automatic and government route. In case of automatics route, no prior approval from Government of India or RBI is required to invest in sectors/ activities that are defined in consolidated FDI policy. Activities, other than those covered in FDI policy require government approval which involves decision by the Foreign Investment Promotion Board, Department of Economic Affairs, and Ministry of Finance.

The key benefit of FDI is the foreign capital and funds that it brings to the country where the investment is made. Besides, it enables the exchange of skill sets, information and expertise, job opportunities and also leads to an increase in the productivity levels. Many Asian progressive economies like China, South Korea have experienced booms in their economies due to higher proportion of foreign direct investment in their economies. From economic perspective, the FDI can be defined as the measure of foreign ownership of domestic productive assets including factories, organizations, land etc.

With internet having changed the rules of businesses across the world, FDI no longer demands huge capital and physical investment. Advent of small internet start-ups which require lesser investment and economies becoming knowledge oriented that lay emphasis on human capital instead of manual labor has altered the FDI operations largely. FDI has already captured the advanced economies of the developed nations like U.S. and is currently moving towards the developing nations where the FDI flows are growing better.

FDI is being looked upon as a way to internationalize and have global presence for many industries and companies. This also provides an excellent tool to the government to check the local production and also trade to be carried on freely without any barriers. With FDI coming, setting up of locally based sales offices ensures that companies are able to approach the customer directly.