Financing for development series: Foreign direct investment - a means to foster sustainable development?

Foreign direct investment (FDI) represents an increasingly important source of external finance for developing countries. However, its developmental effects arestill debated. This paper provides an overview of the possible effects of FDI and stresses the importance of host country characteristics and the type of FDI for a beneficial impact to the host country. Potential benefits from FDI include its contribution to increasing the domestic capital stock, creating employment and raising incomes, and promoting technology and skill transfer. Yet FDI may also lack positive impacts or even carry negative consequences, such as crowding out local firms, reinforcing domestic inequalities, or contributing to an outflow of foreign exchange. Rather than attracting as much FDI as possible host country governments would be well advised to focus their efforts in inviting the “right” kind of FDI. Most importantly, foreign investments should be wellintegrated into the local economy. The international community should work to strengthen the capacity of host countries to enact policies which facilitate a beneficial economic impact of multinational enterprises. In light of these challenges and the unequal global distribution of FDI, increasing private investment alone cannot be considered a cure for poverty in the world’s least favored economies in the foreseeable future.