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If foreign direct investment (FDI) in a sector is not stable, for example, if it increases dramatically one year and then declines the following year. If the fluctuation continues over ten years, what can FDI say about that sector? Its development, its problem, etc.

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  • $\begingroup$ Natia. Did the answer provided help? $\endgroup$ – Mike J Mar 24 at 14:34
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If a respective sector’s foreign direct investment (FDI) is not stable then this will create uncertainty which is a general deterrent to international investment. Because a recipient country can affect investment decisions policies may need to change for a particular industry/sector.

Investment requires a stable economic environment and changes in the economic cycle, currency fluctuations, and changes in business confidence creates uncertainty, which is a general deterrent to international investment.

Possible Problems:

  1. Transport costs would be increased as less firms having factories (manufacturing plants) overseas within consuming industries. This is especially important for bulk increasing products, such as motor vehicles.

  2. Investors will have a difficult time accessing to a countries markets thereby spending less on FDI resulting in decrease in GDP for an industry resulting in decrease aggregate GDP.

  3. more trading blocks forcing firms to deal with more barriers to trade such as tariffs.

Developments:

Less production growth and less productivity for a sector.

In a working paper by Robert Lensink and Oliver Morrissey (2001) titled "FOREIGN DIRECT INVESTMENT: FLOWS, VOLATILITY AND GROWTH IN DEVELOPING COUNTRIES"

When unstable FDI is introduced into their model the results have a negative effect on growth.

They stated that there are a number of reasons why volatility of FDI inflows may be negatively associated with growth.

One of them are that the volatility of FDI undermines investment (R&D [ If FDI inflows are uncertain, costs of R&D are uncertain, which negatively affects incentives to innovate.]), and thus has an adverse effect on growth and productivity.

Another finding, stated in their paper, is that they found increases in the volatility of FDI negatively affects growth as it decreases the certainty equivalent value of FDI and consequently increases set-up costs and decreases the rate of return on assets (page 10).

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  • $\begingroup$ I like your answer, but I'm puzzled about the causality of your first sentence. Do you have rigorous evidence that when "FDI is not stable, this will create uncertainty"? It could be the other way around. $\endgroup$ – emeryville Aug 19 at 8:04

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