Last Updated on Apr 6, 2021 by Manonmayi
Foreign direct investment fuels economic growth. To capitalise on this, governments across the globe revise their foreign investment policies from time to time so as to attract more investors. This is especially true for developing economies that face a shortage of capital and lack of advanced technology.
Though FDI offers several benefits that are discussed later, it also has certain downsides. Cutting to the core, the impact of FDI is mostly felt on the extracting industry and environment at large. In fact, if analysed well, you will find that both FDI and environment impact each other. That is what we’ll discuss in this article.
The article covers:
Table of Contents
Environmental issues caused by economic activities
The earth’s surface temperature has been rising due to the widespread industrialisation that began in the 2nd half of the 18th century. Add other pressing environmental issues across the globe to this and you will have a near-to-perfect recipe for gradual destruction.
One area of concern is the emission of carbon dioxide. In 2018, 36.7 billion metric tons of carbon dioxide was emitted globally. China led the list of the top carbon emitters by contributing ~27.5% to the global figure that year. What’s worse, CO2 emissions related to energy are expected to increase to 43 billion metric tons in 2050 worldwide.
Where does India stand?
The impact of FDI on the country’s CO2 emission has been significant. To be precise, India was the 3rd largest carbon emitter after China and the US in 2018.
The inflow of funds from an international entity into a domestic entity, with an intention to acquire lasting interest, is called FDI or foreign direct investment. As per the Organisation for Economic Co-operation and Development (OECD), lasting interest means when an international business acquires at least 10% of the voting rights in a domestic organisation.
But FDI is not just restricted to the international movement of capital, it can also take the form of complementary elements such as processes, skills, management, and technology. In exchange for the lasting interest that an FDI offers a foreign entity, a domestic company can unlock several benefits as discussed below.
Advantages of FDI for a domestic company
FDI is known to fuel economic development by boosting the recipient sector of the economy and creating jobs, for both skilled and unskilled labour. This, in turn, translates into an increased income of citizens and enhances their buying power, which again, goes on to boost the national consumption and economic activities in the nation.
Foreign direct investment also gives the domestic company access to the latest technology and improved processes, together which help the entity to achieve greater effectiveness and economies of scale.
Advantages of FDI for a foreign company
For the investing company, FDI is a means to reduce its cost of production, access cheaper resources and labour, and enjoy attractive tax benefits and subsidies offered by the recipient country.
Still, FDIs can pose certain challenges to both the host and foreign country, one of which relates to the impact on the environment.
How do foreign direct investment and environment connect?
Thanks to globalisation and liberalisation, over the years, emerging economies have seen a significant rise in FDIs flowing from developed countries. Incentives such as tax deductions and subsidies offered by emerging economies have also supported the traction of FDIs. Challenges persist nevertheless.
Due to the scarcity of exhaustive resources such as coal, global companies look to invest in a domestic entity associated with the extraction of such minerals. More funds in the sector mean increased economic activities coupled with the emission of carbon and other harmful gas. Moreover, with growing concerns of global warming and climate change, economies across the globe have been putting out strict fiscal and environmental measures in place so businesses can operate without impacting the environment significantly. Implementing a carbon tax is one such fiscal measure.
While these policies favour environmental-friendly operations, they can end up discouraging foreign companies from investing in the domestic country thus depriving it the benefits of a foreign direct investment. Ergo, host countries offer fiscal incentives such as subsidies to attract FDIs. In other cases, both the countries end up compromising on certain terms to arrive at a common ground. What happens in the end is not surprising—the environment suffers. But this is not the only area of concern.
Natural disasters don’t impact the host country alone. They can cause serious damage to the investing company as well. In the face of a natural disaster and large-scale destruction of infrastructure that follows, the survival of the foreign company is crucial to the host country’s economic health. If capital is lost, investing companies can seek assistance from parent companies at home and recover quickly. This, in turn, would contribute to the recovery of the host country as well.
However, capital-rich companies are not free from issues either. Natural disasters can disrupt vertical and horizontal linkages between the investing and the recipient companies by hurting local suppliers’ production. This can tempt foreign companies to uproot their funds from the domestic company and move elsewhere.
What is the way forward?
One of the most conducive ways to move ahead is to promote sustainable innovations. These would enable policymakers in framing regulations that are feasible for both economy and environment, and as a result, attract eco-friendly foreign direct investments. Second, countries can consider swapping traditional sources of energy with renewable resources.
With natural disasters (whether caused by humans or otherwise), climate change, and global warming on the rise, it is quintessential for countries to be sensitive to environmental wellbeing while also achieving economic development. There is just no single way.