Factors Determining Foreign Direct Investment, and Its Role in Raising Living Standards

Answer

Part (a) — Determinants of FDI [10]

Foreign direct investment is long-term investment from abroad — typically by multinational corporations (MNCs) — either to establish a lasting interest in a domestic enterprise or to control assets and manage production in a host country (distinct from domestically funded investment). Its level is determined by:

Economic determinants — what the FDI seeks. Market-seeking FDI looks for a large market and high per-capita incomes, or access to regional and global markets, to raise revenue. Resource-seeking FDI looks for raw materials, low-cost or skilled labour, technology and brand assets, or physical infrastructure (ports, power, telecommunications). Efficiency-seeking FDI looks for the lowest input and transport costs, or for membership of regional agreements offering preferential tariffs. Each raises the MNC’s expected profit, drawing in the investment.

Government policies. Policies conducive to foreign investment raise FDI: economic, exchange-rate, political and social stability; liberalised, competitive markets and privatisation; favourable rules on foreign operators; trade policy (low tariffs); and tax incentives. All raise expected after-tax returns.

Other factors. Good business-facilitation and legal frameworks, administrative efficiency and the absence of corruption lower “hassle costs”, raising the attractiveness of a location.

Singapore has attracted a steady FDI flow precisely because it scores well across these — strong physical and regulatory infrastructure, global connectivity and a skilled manpower base.

Part (b) — Does FDI raise the standard of living? [15]

Standard of living has a material dimension (real income per capita) and a non-material dimension (health, education, environment, leisure). The thesis is that FDI generally raises living standards through growth and employment, but the net effect is conditional on policy.

Thesis: FDI raises material living standards. FDI is an injection that raises aggregate demand directly (higher I) and, where it builds export-oriented factories, indirectly (higher X); via the multiplier this raises real national income — actual growth.

FDI also raises aggregate supply: it brings newer technology that raises labour productivity (SRAS, actual growth) and, in the long run, productive capacity (potential growth). If population and inflation are contained, real income per capita rises, lifting purchasing power and material living standards. In Singapore, FDI into high-end manufacturing, pharmaceuticals, petrochemicals and finance raised value-added and built comparative advantage.

Non-material living standards. Stronger growth widens the tax base, funding government spending on infrastructure, education and healthcare; higher incomes also let households enjoy more leisure — raising non-material living standards.

Anti-thesis: FDI can lower living standards. FDI in extractive industries can cause pollution and environmental degradation (e.g. oil spills in the Niger Delta), a negative externality lowering non-material living standards. Domestic firms unable to withstand foreign competition may close, raising structural unemployment and lowering both dimensions of living standards if this outweighs the jobs FDI creates. Output produced by MNCs is often exported away, so high measured per-capita income may not translate into goods available to citizens — especially if FDI targets capital or military goods rather than consumer goods. And in the long run, profits are repatriated to the home country, lowering national income and worsening the balance of payments, while extractive FDI can deplete natural resources, undermining sustainability.

Judgement. FDI plays an important, generally positive role in raising living standards — through growth, employment and capacity-building — and is especially critical where domestic savings are low; even a developed economy like Singapore owes much of its growth and living standards to it. But the costs (pollution, structural unemployment, profit repatriation, resource depletion) mean the role is conditional on policy. Whether FDI’s net effect on living standards is positive depends on whether the government has measures to capture the gains — creating employment, raising competitiveness, building inter-sectoral linkages — while mitigating the harms (environmental regulation, retraining for displaced workers). With sound complementary policy, FDI raises living standards; without it, the costs can erode the gains.