Determinants of Foreign Direct Investment
The volume of FDI in a country depends on the following factors:
- Natural Resources: Availability of natural resources in the host country is a major determinant of FDI. Most foreign investors seek an adequate, reliable and economical source of minerals and other materials. FDI tends to flow in countries which are rich in resources but lack capital, technical skills and infrastructure required for the exploitation of natural resources. Though their relative importance has declined, the availability of natural resources still countries to be an important determinant of FDI.
- National Markets. The market size of a host country in absolute terms as well as in relation to the size and income of its population and market growth is another major determinant of FDI. Large markets can accommodate more firms and can help firms to achieve economies of large scale operations. Market access has been the main motive for investment by American companies in Europe and Asia.
- Availability of Cheap Labour: The availability of low cost unskilled labour has been a major cause of FDI in countries like China and India. Low3 cost labour together with availability of cheap raw materials enable foreign investors to minimise costs of production and thereby increase profits.
- Rate of Interest: Differences in the rate of interest prevailing in different countries stimulate foreign investment. Capital tends to move from a country with a low rate of interest to a country with a low rate of interest to a country where it is higher. Foreign investment is also inspired by foreign exchanges rates. Foreign capital is attracted to countries countries where the return on investment is higher.
- Socio-Economic Conditions: Size of the population, infrastructural facilities and income level of a country influence indirect foreign investment.
- Political Situation: Political stability, legal framework, judicial system, relations with other countries and other political factors influence movements of capital from one country to another.
- Government Policies: Policy towards foreign investment, foreign collaborations, foreign exchange control, remittances, and incentives (monetary, fiscal and others) offered to foreign investors exercise a significant influence on FDI in a country.
