TOPIC: THEROTICAL FRAMEWORK OF

FDI
PRESENTED BY
SAURAV KALITA (M.A, MPHIL)
THEORIES OF FDI

There are a number of theories explaining FDI. FDI theories are primarily based on imperfect market
conditions. Some of them are as follows:
MacDougall-Kemp Hypothesis
This theory was first developed by G.D.A. MacDougall (1958) and subsequently elaborated by M.C. Kemp
(1964). This theory discusses the investment flow from a capital-abundant economy to a capital-scare
economy until the marginal productivity of capital in both of them is equal or till the returns from
investment is greater than the loss of output in the home country.
Industrial Organisation Theory
One of the earliest theories based on the assumptions of an imperfect market was propounded by Stephen
Hymer (1976). This theory discusses the firm specific advantages
which is technological and similar other advantages possessed by a firm that enable it to produce new,
differentiated products.
Location-specific Theory
Hood and Young (1979) stress upon the location specific-advantage refers to advantages like cheap labor,
abundantly available raw material, and so on for the production of a commodity to be established in a
particular location or country.
Product Cycle Theory
This theory was developed by Vernon (1966) who feels that most products follow a life cycle that is divided
into three stages. The first stage is known as innovation stage where the product is in demand because of
its new and improved quality irrespective of its price. The second stage is known as maturing stage where
the demand for the innovator’s product is price elastic in view of the availability of similar products in the
market. The third stage is known as standardized product stage when technology does not remain the
exclusive possession of the
innovator.
Internalization Approach
Buckley and Casson (1976) discuss about the internalization benefit that is cost free intra-firm flow of
technology developed by the parent unit.
Currency based Approaches
Here different theories discuss about the change in the exchange rate and how it influences the flow of FDI
between countries.

BENEFITS AND COSTS OF FDI

When direct investment flows from one country to another, it creates benefits both for the home country
and the host country. At the same time, it involves some costs too.
Benefits to the host country
Availability of Scarce Factors of Production: FDI brings in capital (scarce foreign exchange)
Improvement in the Balance of Payments: FDI helps improve the balance of payments through its
contribution both to current and capital account.
Crowding-in effect: FDI helps crowding-in effect where the increase in total amount of investment in the
host country by more than the amount of FDI on account of backward and forward linkages.
Benefits for Home Country
FDI benefits home country through the supply of necessary raw materials. The balance of payments
improves insofar as the parent company gets dividend, royalty, technical services fee etc. It also helps in
rising export of the parent company to the subsidiary abroad.
Cost to the host country
It is a fact that inflow of foreign investment helps improve the balance of payments, but the outflow on
account of imports and the payments of dividends, technical service fee etc. might deteriorate the balance
of payments. Beside this, raw materials are exploited by the
parent company. Sometimes MNCs do not abide by pollution control norms for the sake of their profit.
Foreign investors are generally more powerful. Domestic industrialists do not compete with them, with
the result that the domestic industry fails to grow.
Cost to Home Country
The cost accruing to the home country is only little. However, cost in terms of outsourcing of skilled
manpower, technology etc. cant be denied. Since the MNCs operate in different countries to maximize
their profits, therefore sometime they adopt some techniques which may not be in the interest of the
home country. This leads to a tussle between the host government and home government, leading to
deterioration of the bilateral relations.
THANK YOU