There is an extensive literature on impact of FDI, with different explanations of various theories that were developed in different studies. However, these literatures have generated a lot of controversy due to differences in the framework for analysis.
3.1.1 Export Theory
The export theory can be classified under the neoclassical growth models. The underlying argument of the export theory is that "countries need to export goods and services in arder to generate revenue to finance imports which cannat be produced indigenously" (Coutts and Godley, 1992; McCombie and Thirlwall, 1994). Normally, Gross Domestic Product (GDP) is used as a proxy of a country's economie potency and it provides an estimate of the value of goods and services produced in a country in a specified period (Tayeb, 1992). Studies that have been undertaken to ascertain whether international trade influences GDP assume that as exports increase, centrus paribas, the GDP of a country rises and spur economie growth. The export theory can be interpreted in a way that the performance of exports has a stimulating effect to a country's economy especially in form of technology spillovers (Marin, 1992). Temple (1994) indicates that because of the demands of international markets such as coritinuous innovation and improved efficiency, there is increased specialisation which encourages utilisation of economies of scale. The export theory thus predicts that growth in exports causes economy wide productivity gains which amounts to enhanced gross domestic product. In addition, exports can
also be linked to sustainable economie growth through the balance of payments. The constraints on the balance of payments arise when a country's level of imports exceeds that of exports. In such a situation, the deficit can only be financed either through government borrowing or use of the country' s reserves.
3.1.2 Market Imperfection Theory
This theory explains that FDI is based on the idea that foreign firms follow their domestic competitors overseas. According to Hymer (1970), firms only invest overseas if they can capitalise on those capabilities that their competitors in the foreign country do not have with the hope of making high returns. According to this theory, firms invest overseas such that they can control more markets, increase their profitability and create oligopolies.
3.1.3 International Production Theory
This theory states that the tendency of firms to invest overseas is dependent on a cost - benefit analysis of particular factors in both its home country and the receiving country. This theory explicitly states that the decision to invest in a country is dependent not only on the anticipated retums but could also on country specifie factors like barriers to entry, political stability, cast of capital and production, economies of scale and demand for products (Dunning, 1980). According to Carbaugh (2000), firms may invest in countries where labour and raw materials are comparative! y cheaper in arder to minimise costs. This partly explains the movement of foreign direct investment to Asia; specifically China and India where the cast of labour is relatively cheaper than the rest of the world.
3.1.4 Modernisation Theory
This theory originated from the classical evolutionary explanation of social change (Giddens, 1991 and Smith, 2003). According to Rostow (1960) societies can modernise only if they have access to technology through industrial investment which is a pre-condition for economie take-off. In other words this theory stipulate that foreign direct investment can promote economie growth by providing extemal capital which then spills over to the entire economy. The spillover may be through technology advancement, increased efficiency or improved productivity. Findlay
(1978) suggests that foreign direct investment may result in technology advancement in the host country through the "contagion" effect.
3.1.5 Dependency Theory
This theory is a cri tic of the modernisation theory. Dependency theory first emerged as a reaction to liberal free trade theories in the 1950s, advocated by Raul Prebisch. This theory argues that decreases in the wealth of poor nations coincided with increases in the wealth of rich nations (Prebisch, 1959). It also hypothesises that whereas foreign direct investment may show a positive impact in the short run, it has an adverse negative effect on economie growth in the long run. The short run effect is attributed to perceived increase in savings, investments and consumption, which create immediate economie impact while in the long run; the effect of accumulation of foreign direct investments is due to intervening mechanisms of dependency such as decapitalisation and lack of linkages leading to higher negative account balances (Bomschier, 1980 and O'heam, 1990).
3.1.6 Foreign Direct Investment and Human Capital Formation/Enhancement
Increasing the lev el of literacy of a work force is one of the vital aspects that co un tries seeking to attract foreign direct investment should aspire to achieve. This is because literacy is a key business consideration by multinational enterprises looking to invest in foreign countries. In addition, not only does a literate work force attract foreign direct investment but it also ensures maximisation of human capital spillovers that could arise from the presence of foreign enterprises. The obvious benefit from foreign direct investment in relation to human capital formation and enhancement is that multinational firms tend to offer more training to their employees compared to domestic firms. Studies in developing countries have found spill overs of both managerial and technical skills. Gerschenberg (1987) using a comprehensive career data survey for 72 middle and top level managers in 41 manufacturing firms found that multinational firms offer more training than domestic firms2. The training provided by the multinational enterprises normally supplements the existing skills set of the work forçe and also provides a useful demonstration effect of the type of skills that are required for a given business sector. In
2 Study cited by Blomstrom and Kokko (1997), "How Foreign Investrnents affect Host Countries"; page 16
other instances, employees may move from the multinational firms to other firms further contributing to knowledge diffusion.
3.1.7 Foreign Direct Investment and Technology Transfer
When parent companies establish international subsidiaries, they normally put in place modem technology, machinery and infrastructure that distinguish them from the already existing firms.
This new technology enables the foreign firms to effectively compete with the domestic firms and create an identity for themselves. This is quite visible when foreign firms set up greenfield investments where they bring with them experts, skills and financial resources necessary to exploit the new technology. Over a period of time, the new technology is diffused to the wider business environment. Sorne studies such as Lall (1977) show that the most important channel of technology transfer is through "vertical linkages."Verticallinkage refers to assistance extended to local suppliers by the multinational company in order to enhance the quality of its products and services. The assistance may involve; training of the supplier's staff in the use of the new technology, sharing of information or it could be technical and or operational in nature like upgrading their production facilities.
3.1.8 Foreign Direct Investment and Business Competition
The desire to create, maintain and consolidate market share, profitability and growth has resulted in both a revision of and change in business strategies and industry structure. In the last two decades, there has been an avalanche of mergers and acquisitions especially as a result of privatisation of state enterprises and alliances across borders, all of which are geared at growth and sustainability of business firms. Inevitably, the dynamics in the business environment have led to increased investment in research and development which by itself stimulates innovation and competition in the domestic economy. The observable effects of competition are either
"crowding in" or "crowding out." "Crowding in" is a situation where the foreign firms are able to stimulate growth and efficiency in the host country' s business environment through vertical and horizontal linkages. Henderson (1989) cited an exarnple of South
E~st
Asia where foreign investment in the electronics industry was responsible for the activation of indigenous production through subcontracting; while "crowding out" is a situation where the domestic firms arehindering competition. The adverse effects of crowding out may be mitigated by establishing legislation that protects consumers against exploitation by the market players. Sometimes the introduction of a foreign player may lead to disentanglement of existing monopolies and an improvement in efficiency of service delivery by suppliers. Markusen and Venables (1999) found that foreign direct investment has positive impact on the productivity performance by domestic firms. They argue that increase in competition as a result of entry of a multinational firm enhances efficiency and improves product quality while also opening up avenues for export.
3.1.9 Foreign Direct Investment and Enterprise Development
Norrnally, foreign direct investment that is orchestrated as a result of a takeover of a domestic enterprise by a multinational finn leads to alterations in the management team and corporate govemance. The new managers impose their own policies, reporting systems, work ethos and organisational structure. The changes in organisational management are generally designed to ensure that the acquired business operates in line with the principles of the investor or parent firm while at the same time improving its efficiency. In the case of greenfield investments, employment opportunities may be created and or lead to increase in salary wages. Empirical evidence from the manufacturing industry in OECD countries indicates that foreign affiliates of multinational firms pay higher wages than domestic firms, which is reflected by the higher labour productivity.
Dunning (1971), who expounded the Eclectic Paradigm, location specifie advantages is the centrepiece in explaining motives behind FDI. Location specifie advantages imply advantages that arise from utilising resource endowments or assets that multinational firms find valuable to combine with their own assets. The ownership, location and intemalization advantages of multinational firms provide a ground on which foreign firms could compete with local firms.
Vernon (1971), analyzed FDI based on the product life cycle hypothesis. According to rms hypothesis which he propounded, initially a product is invented in the home country of a foreign investor with comparative advantage in technology and innovatory capabiljties, and produced for the home market in the home country near to both its investors and markets. At a latter stage of the product cycle, because of a favourable combination of innovation and production advantages offered by the home country, the product is exported to other countries most similar to the home
country m demand patterns and supply capabilities. Gradually, as the product becomes standardized or mature and labour becomes a more important ingredient of production cost, the attraction of locating value-adding activities in a foreign, rather than in a domestic location increases.
Casson (1990), sees the theory of FDI as a logical intersection of three distinct theories: The theory of international capital markets, which explains the financial and risk-sharing arrangements; the theory of the firm, which describes the location of headquarters, and input utilization; and trade theory, which describes location of production and destination of sales. In actual fact, he has acknowledged the need to integrate location specifie variables with intemalization variables to explain the multinational corporation's activities.