Foreign Direct Investment (FDI) is by far the largest and most stable source of capital for developing countries. However, the distribution of FDI has been uneven across different regions and countries.
Since 1992, China has attracted the largest proportion of FDI, the impact of which cannot be underestimated despite some of it being round trip. The impact of FDI on host economies is both beneficial and distortionary. FDI led growth has been seen to break host countries out of the vicious cycle of poverty, of underdevelopment by complementing local savings and supplying more effective management, marketing and technology to improve productivity. In most cases the gain to national income depends on the size of the capital flow and the elasticity of the demand for capital.
It is imperative that technological and managerial inputs should spill over to local firms to ensure maximum benefit. FDI joint ventures have been highlighted as one of the essential tools in which host countries and multinational enterprises (MNEs) mutually benefit. The rationale for joint ventures is to achieve more backward linkages into the domestic economy and to expand access into external markets. This cuts into building a business class and promotes self-reliance for host countries. Local partners become crucial in providing location specific knowledge regarding host country markets, local tastes, local labour practices, local suppliers and local business-government relations. This kind of strategy has been employed previously by the Chinese. For instance, in 1979 China began to cautiously welcome FDI with preference for joint ventures where foreign investors contributed 49 % of the capital with 51 % contributed by the government.
Therefore, FDI should raise efficiency and effectively expand output; this should surely incorporate local firms to ensure sustainability of economic growth and eliminating episodes of unsustained growth. Host countries need also to be aware of the disadvantages of interacting with MNEs. These include the possibility of encouraging the passing of laws that encourage socially undesirable practices such as pollution, health, minimum wage requirements and the repatriation of profits which might drain capital from host countries and the creation if oligopolistic markets which are theoretically exploitative.
To attract FDI in host countries, it is essential for host countries to improve beyond the macro and microeconomic fundamentals and provide the institutional infrastructure in terms of rules rather than deals to guide investment. These should be supported by an active policy towards FDI and the need to articulate where the authorities should focus their attention as they design policies to maximise their benefits. Host countries such as Malawi can utilise industrial policy as a tool of development strategy; not for trade protection but rather FDI facilitation which meets the need to upgrade and diversify the production and export base. Developing countries such as Malawi have a well-articulated National Export Strategy (NES) on which the industrial policy can be based. If not there is need to develop these export strategies in order to establish strategic and focused interaction with FDI. Empirical findings indicate that domestic content regulations are ineffective and inefficient, leading to domestic prices which are higher than those of neighbouring countries.
Distortions such as there are not conducive to export growth and consumer welfare. It is therefore imperative for developing countries to provide the right incentives for FDI facilitation, not restriction. Export bans for instance have been proven to discourage investment in the agricultural sector which is highly unproductive despite the sector catering for the majority of the population and also has high risk factors which discourage bank capital finance. As such, alternatives such as FDI need to be well incentivised across all the priority sectors.