The Major Disadvantages of Foreign Direct Investment to Host Country

The Major Disadvantages of Foreign Direct Investment to Host Country


What is foreign direct investment?

Foreign direct investment is a means through which countries get capital flows from other countries. Basically multinational corporations set up shop in foreign markets and this can be done in three ways:

  • Horizontal foreign direct investment. This occurs when the foreign investors duplicate the methods and activities of production in the host companies.
  • Vertical foreign direct investment. This is when foreign investors fragment the production processes in accordance with production costs. The processes of production occur in different host countries with the lowest costs of production before assembly of the final product.
  • Platform foreign direct investment. Platform foreign direct investment occurs when foreign investors manufacture products in the local market then transport them to a host country in order to export them to different destinations.

Why do host countries desire foreign direct investment?

Foreign direct investment is greatly desired by most countries because of the potential benefits it offers in terms of economic growth. Foreign direct investment facilitates capital flows in the host countries and also provides consumers with a wide variety of products that are otherwise not produced locally.

Additionally, foreign direct investment can also encourage healthy competition in the host countries leading to high quality production and increasing consumer welfare. Through foreign direct investment, locals can get employment opportunities.

What are the disadvantages of foreign direct investment to host countries?

Despite the many advantages that foreign direct investment portends for the host countries, many economists have criticized it as a measurement of economic growth. This is because the foreign direct investment is only beneficial in the short term. After firms obtain their initial investments and begin making profits, their original countries benefit more than the host countries. The following are some of the disadvantageous effects that foreign direct investment may have on the host countries:

  • Loss of taxes and revenues. Most host countries especially the developing ones tend to implement policies that favor foreign investors including tax holidays. This is usually done to incentivize the foreign investors and can result in loss of revenue for the host countries. Additionally, in the long run the multinational corporations also benefit more from their ventures in the host countries as opposed to the governments and economies.
  • Employment issues. Most multinational corporations tend to change the dynamics of the labor sector in order to lower costs of production. This is often evident in measures such automation which lead to loss of employment.
  • Kills local manufacturing industry. Since multinational corporations often have more muscle and experience as compared to the local manufacturers, they often end up edging out the nascent local companies. This hinders development of local manufacturers.
  • Exploitation of local raw materials and laborers. Local raw materials are usually over exploited by the foreign direct investors. This can lead to disadvantages for the host countries as their resources can be fast depleted. Many multinational corporations have also been accused of being exploitative towards local laborers. This reduces benefits for the domestic workers.

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