Sulaimani Polytechnic University and the University of Garmian
Foreign Direct Investment (FDI) contributes?significantly to potential economic development by infusing foreign assets into domestic economies and incentivizing economic growth in many economic sectors. In the last 30 years, increased economic liberalisation and openness between countries have all contributed?to the rising flow of Foreign Direct Investment. FDI adds capital however; it also brings considerable spillovers, including increased exports?and new technologies that play a crucial role in GDP and growth. This is particularly true?with developing countries which aim at attracting FDI to spur growth. This paper examines the benefits and costs of?FDI, beginning with a description of its pattern across countries. The effects of FDI on employment, technology spillovers, and tax revenue will be analysed, finding FDI and local firms through external?linkages, exploring questions about FDI. You will also look at the inflow of finance and its function?for economic growth. Conversely, rapid industrialization in developing countries spurred by FDI often tends toward violations of environmental protection goals, as foreign investments?lead to pollution and increased carbon emissions, among other environmental hazards. As?a result, it is imperative that the investment process implements sustainable policies and practices that align economic development with environmental protection. The paper wraps up with a call for government policies?that encourage green, sustainable economic growth and draw foreign investments
Foreign direct investment (FDI) is the investment of foreign assets into a local economy, or the transporting of new assets to a host country, in order to increase the amount of output in different economic sectors. With an increased economic liberalization and economic openness between countries, foreign direct investment has been increasing during the last three decades. The inflow of foreign direct investment (FDI) is not only bringing capital inflow, but it also brings spillovers including, export, and advanced technology and so on. These are very significant to increasing GDP and to encouraging economic development. Developing countries are trying to attract FDI. In this essay the author is going to discuss, the benefit and cost of FDI. First, the distribution of FDI in the will be considered between countries. After that, it will be covered the impact of FDI on employment and then technological spillovers in the host country. The next step will look at tax revenue, followed by external linkage, and following this linkage FDI with local firms will be addressed. And then inflow of finance will be examined, last but not least is conclusion. Attracting foreign direct investment (FDI) is indeed a critical component of successful economic development, as it can bring innovation, technology, employment opportunities, and get to worldwide markets. However, balancing economic growth with environmental protection is a significant challenge, particularly in developing countries where they require for quick industrialization and increase employment opportunity often conflicts with sustainability goals (Nguyen 2020). Environmental protection is the process of protecting and keeping the environment clean from pollutant and needs to be repaired the damage (Nguyen 2020). However, countries attracting foreign investment, environmental quality have been harmed. Foreign investment brings such a technology that can affect the environment and led to increase carbon dioxide and greenhouse gas emissions (Sabir et al., 2020). Balancing economic development along with environmental protection requires a sustainable strategic approach that assimilates sustainability into every phase of the investment process. This dual effort is essential for achieving sustainable development in a gradually interconnected and environmentally conscious world.
The paper examines the impact of foreign direct investment and environmental pollution on economic growth in an emerging economy. Subsequently, the government needs to have policies to attract foreign investment to develop a green and sustainable economy.
The distribution of FDI flow is different between countries. During 1986 and 2000, the highest percentage of FDI inflow went to developed countries which reached 72% in total inflow globally, however, in 2008 the total inflow of FDI in the world was approximately $1.697 trillion, nearly $962 billion of which went to developed countries, while north America attracted 361$ billion (UNCTAD, 2009).
Chart (1) the distribution of FDI in the world
Source: UN Trade and Development (UNCTAD),
On the other hand, the inflow of FDI in developing countries was about $700 billion in 2008, The inflow of FDI between developing countries is different as well (UNCTAD, 2009). China, Mexico, Brazil, Indonesia and Singapore have attracted more than 55% of total FDI for developing nations during last two decades (Long, 2005). In East and South East Asia the FDI inflows totalled about $300 billion by 2008, the biggest proportion of FDI went to China; it was approximately $52 billion (UNCTAD, 2009). Fischer (2000) demonstrated that there are two reasons for the accumulation of FDI in China. First, China has a huge market to sell products. Second, it offers low labour costs. But FDI in India was $18 billion by 2008, and India is the second biggest country in the region, but in Latin America the inflow of FDI in 2008 was $63 billion, and the highest proportion of FDI inflow went to Brazil, standing at $18.55 billion. Mexico enjoys the second biggest FDI inflow of the Latin American countries, being nearly $8.350 billion, whereas, in East and South East Europe the FDI inflow in 2008 was about $114 billion, 84% going to the Russian Federation, Kazakhstan and Ukraine (UNCTAD, 2009). In the African continent the proportion of FDI in 2008 was about $88 billion, the largest inflow of FDI being concentrated in three countries, South Africa, Nigeria, and Angola, As a result of the presence of a large amount of natural resources, the inflow stood at $26 billion for those countries (UNCTAD, 2009).
FDI frequently leads to the founding of new businesses or the expansion of existing ones, creating new jobs and reducing unemployment. Increasing inflow of FDI leads to decrease the rate of unemployment in the host countries. FDI has a significant impact on the creation of job opportunities in the host countries (Muhammad et al; 2024). (Mirza and Giroud (2004) found that the impact of FDI on labour market in the host country depends on the type of investment. For example, the mining sector does not offer many job opportunities, as a result of using capital intensively in this sector if compared with the volume of capital. Crespo and Fonroura (2006) found that creation of jobs is not related to the amount of capital inflow. Below is a chart (2) shows the number of jobs created by Greenfield FDI projects in selected countries between 2003 and 2022:
Source: Overview of Greenfield Foreign Direct Investment
Some sectors like agriculture uses a huge number of workers in the process of production compared to the mining sector. For example, in Namibia, the volume of capital in the mining sector that was used in 2005 was about $1.45 billion but participation of local labour is very small, being only 5,000 workers, however, the volume of FDI inflow in agricultural sector was just $250 million but the number of 55.000 workers (UNCTAD, 2009).
However, Gelb and Black (2004) pointed out that FDI pays high wages to skilled labour and uses capital-intensively in the process of productions. Thus, foreign direct investment does not create jobs for unskilled labour which constitutes a large proportion of the labour market in developing countries (Yaqub 2024). Therefore, there is a small linkage between FDI and labour market. For instance, in Vietnam, the demand for skilled labour increased between 1996 and 2006, according to department of labour, invalids and social affairs of Ho Chi Minh City in Vietnam; by 2010 the demand for unskilled labour will decrease from 32% to 17%. Therefore, the impact of FDI of demand on unskilled labour is relatively weak.
Foreign investors often bring advanced technologies and management practices, which can develop productivity and novelty in the host country. Advanced technology and raising labour productivity are the most significant matters in process of production. Multinational Corporations (MNCs) control most of the advanced technology in the world. MNCs spend approximately 80% of Research and Development (R&D) (Correa and Kumar, 2003). FDI can transfer technology to host countries via foreign enterprises to local firms (joint venture), and Transfer technology occurs via three major paths, training local employees, backward & forward linkages and competition (Fischer, 2000). Setting up a new industry through FDI might create new jobs via linkage with domestic firm (Yaqub 2024)s. It may also transfer knowledge through FDI to local firms; in addition, foreign affiliates give more training for local labour (Caves (1996). For instance, an improvement of productivity in Indonesia was directly associated with training local workers, which was done by foreign enterprises. High productivity in local firms occurred in the US between 1987 and 1996 as a result of participation of FDI in the country (Lipsey and Sjoholm, 2005). Kokko el al (1996) found in Uruguayan industry that technology spillovers significantly changed only for those firms that have a small technology gap with foreign enterprises. Therefore, FDI has a big role in improving economic activity and encourage economic development.
However, Correa and Kumar (2003) found that knowledge spillovers from FDI to domestic firms might not happen, due to poor in capacity to absorb or the presence of a weak relationship between local and foreign investment. For example, Fischer (2000) indicated that transfer technology from FDI to domestic firms in China is fairly low, because the majority of FDI is not sophisticated and also many investors are poor to transfer sophisticated technology via FDI. In addition domestic investors cannot absorb high technology in a proper way.
It is thought that the presence of FDI in a country, cause an increase in government revenue, through paying tax. Zee et al. (2002) found that tax holiday can be positive for some economies or they can be negative, for example, in East Asian countries like South Korea, Taiwan and Singapore which are the most successful economic, offer tax breaks to attract FDI, although, they lost tax revenue as a result of tax holiday, but in another way, they improved their economics and became industrial countries as well as achieving economic development, on the other hand, countries like Indonesia, the Philippines, and Thailand are not successful to encourage foreign investors when they forgo tax holiday. In 2000 the Vietnamese government earned nearly 51.045 billion Dongs (Dong is Vietnam’s local currency) from foreign investors, this amount increased with increasing volume of FDI. In 2002 government revenue increased to 84.207 billion Dongs, this revenue was significantly useful to fund government budget (UNCTAD, 2008). However, although it costs for the host government a lot to forgo this revenue, it should be considered a benefit from FDI on domestic economy and the amount of losing tax breaks (Hanson. 2001). For example, The US government tax revenue decreased over the last four decades, as a result of tax holiday on FDI. In 1965 share of corporate tax in GDP was about 4.0% whereas, in 2000 the share of corporate tax in GDP was negative (-1.5%). This negatively impacts on government revenue (OCED, 2001 as summarised by Wolf, 2004, Table12.3 P. 256).
One of the potential benefits of FDI to host countries is the linkage of local products to international markets. This is very significant for economic development in the host country. Crespo and Fontoula (2006) pointed out that inflow of FDI to host countries, is a substitute for, and leads to an improved balance of payments, in addition to protecting the local currency from devaluation. FDI might expand the volume of export in a recipient country because it leads to pushing local firms to increase competition and produce high quality goods, because these firms face strong competition from the international market. Therefore, FDI can have a positive role in competition and in increasing the amount of export goods and service. For example, FDI in Zambia contributed to increasing amount the amount of export in cotton and tobacco (agriculture sector) from 8% in 2000 to 17% in 2004, after increasing productivity in this sector. In addition, the amount of revenue from the export sector sharply increased from $7 million in 1990 to $143 million in 2004 (UNCTAD, 2006). On the other hand, FDI can be a reason to trade imbalance for host country, because when FDI enters a host country, the volume of imports is bigger than the volume of export from the host country. This is as a result of importing equipments and sophisticated technology to the host country (Spratt, 2009). For instance, in 2000, in Bosnia and Herzegovina, the total of export by FDI stood at 24% of products whereas, the total of imported was about 33% which is done by FDI (Holzner, 2003).
The linkage between FDI and local supplier is divided into two types, backward and forward. Backward linkages, indicates increasing demand of domestic inputs, providing domestic supplier with advanced technology in order to produce high quality goods (Lall, 1980). The cost of transport affects FDI decision as to whether FDI uses input from the host country or import from the home country, he thinks that if the cost of transport from host country to home country high enough, FDI encourages using inputs to the recipient country, and vice versa (Yaqub 2024). As regards forward linkages, Multinational Enterprises (MNEs) provide cheap and superior quality of inputs (machine, advanced equipment) to local suppliers (Rudriguez-Clare, 1996). The presence of multinational companies are a major factor in increasing the demand of intermediate goods which local firms produce, that leads to a decrease in the cost of production and an increase in profit, and pushes new producers to enter the market in order to produce intermediate goods, and thereby eventually increases economic activity (Lipsey and Sjoholm, 2005). In terms of market structure, Hellar (2004) pointed out that FDI has a significant impact on structure of the market in a host country. However, he believes that this relationship is fairly complex. The number of domestic firms might increase the volume of competition in the host country’s market. Furthermore, the impact of FDI on market structure can take place, when employees who have already worked for MNEs leave their jobs to start their own business (Correa and Kumar, 2003). Improving market structure and the level of concentration might be influenced by FDI in a host country, through advertising or (R&D), This is significantly useful for selling more products in local and international markets, and also encouraging local enterprises to improve their volume of sales (Correa and Kumar, 2003). FDI improves local completion which is done via providing a higher quality of input. Therefore, local firms can make bigger output and use more employees (Sjoholm, 1999). Moreover, FDI increases competition with domestic firms. When FDI enters a host country, local firms might react against overseas investment by using the presence of technology in higher efficiency or using a new technology to maintain their market share. This leads to an increase in local firms’ ability to produce high quality goods and services (Correa and Kumar (2003).
However, FDI can have a negative impact on local firms. In some cases, FDI crowds out local firms in a host country. Caves (1996) argued that crowding out of domestic firms in developing countries can happen more easily than in developed countries, because the technology gap between developed countries and MNEs is smaller than the technology gap between MNCs and developing nations. Blonigen and Wang (2005) found in Morocco that access to credit for domestic investors was more difficult after the inflow of FDI led to problems for local firms in funding their enterprises as well as crowding out a number of local firms particularly small sized firms. Crowding out can be stronger, if the technology gap is very wide between domestic firms and FDI (Correa and Kumar, 2003). Aitken and Harrison (1999) argued that crowding out can be happen, when MNEs do not concentrate only on foreign market to sell their products, but also if they prefer to sell their products to local markets as well. Crespo and Fonroura (2006) pointed out that FDI can crowd out domestic firms through paying higher wages to skilled labour. This can leads to increasing marginal and average costs for local firms.
Inflows of finance are one of the most significant positive points which is achieved from FDI. Studies found that the impact of capital inflows on local investment was significant in 58 developing nations during 1978-1995, each US$1 inflow of capital led to an increase of US$0.50 in local investment (Bosworth & Collins, (1999) summarised by Spratt, (2009)). FDI in China has increased its share in domestic firms from 2% in 1983 to 28% in 1996. Inflow of finance has a positive role to improve production processes (Fischer, 2000). However, a large amount of inflow in finance can be negative for a host country and this is a weakness rather than a strength, the proportion of inflow of finance has a negative correlation with riskiness for the countries concerned (Hausman and Fernandez-Aris, (2000) as summarised by Spratt, (2009).
While attracting foreign direct investment (FDI) is often seen as a key driver of economic development, but in the meantime have some disadvantages such as environmental impact if not properly regulated (Salih at el., 2020). Foreign investors may prioritize profit over environmental sustainability, leading to environmental degradation. This is mostly concerning in developing countries where environmental regulations may be less strictly enforced (Ponce et al., 2020; Destek et al., 2022; Salih at el., 2019). Some FDI projects, especially in mining, oil, and gas sector, can lead to overexploitation of natural resources. Industries such as manufacturing and agricultures may affect the environment and contribute to air, water, and soil pollution (Mohammed et al., 2020; Salih et al., 2018). Therefor environmental standards and regulations have to enforce. Large-scale agricultural or infrastructure projects can lead to deforestation and loss of biodiversity too (Qiu et al., 2021). FDI in energy-intensive industries can increase greenhouse gas emissions particularly carbon dioxide emission and led to accelerating climate change impact (Qiu et al., 2021). To ensure that FDI contributes to sustainable development, governments and stakeholders must adopt policies and regulations that balance economic growth with environmental protection. Enforce severe environmental standards and require environmental impact assessments (EIAs) for FDI projects. Encourage investments in sustainable and green renewable energy, sustainable agriculture, and eco-friendly technologies. Country such as Costa Rica has involved FDI in eco-tourism and renewable energy, supporting economic growth with environmental conservation (Yaqub 2025). While Denmark has developed FDI in green technology, making it a global leader in renewable energy. The government in Rwanda has arranged sustainable FDI in sectors like agriculture and tourism, safeguarding environmental protection while driving economic growth (Mohammed et al., 2020; Salih et al., 2018). It is important to ensure that FDI projects are transparent and that companies are held, accountable for environmental damage.
CONCLUSION
This paper has examined, to what extent the inflow of FDI benefits economic development. Despite FDI having some negative points for local economics, it has been shown that FDI is a significant factor for encouraging economic development. Most developing countries have achieved a huge benefit from FDI. However, the ratio of benefit differs between countries; developed countries achieve more benefit from FDI than developing countries when FDI enters their economics, but developing countries can attain some benefit from FDI. It has been suggested that every country should encourage FDI via a liberal economy and free trade between countries, particularly in developing countries, because they suffer many economic problems, such as (unemployment, trade deficit, low productivity labour and so on). It is believed that those problems can be resolved by FDI (zia et al; 2025). However, attracting FDI is essential for economic development, but it must be done in a right way that reduces environmental damage and minimalize risks. Countries have to inspire foreign investors to implement CSR practices that prioritize environmental sustainability. Government can reach sustainable development that benefits both the economy and the environment. This can happen due to implementing strong environmental regulations, promoting green investments, and fostering cooperation between governments, businesses, and communities. Balancing these priorities is safe way to ensuring long-term prosperity and sustainable environmental health
REFERENCE
Ivan Kamal Hamasalih*, Ali Mohammed Salih, Burhan Ali Mohammed, Kamaran Qader Yaqub, Yaseen Abdulrahman Ahmed, Pakhshan M. R. Palani, Attracting Foreign Direct Investment Is Central to Successful Economic Development and Balance with Environmental Protection, Int. J. Sci. R. Tech., 2025, 2 (3), 25-32. https://doi.org/10.5281/zenodo.14953580
10.5281/zenodo.14953580
