Topic 11.5 – Relationship Between Countries at Different Levels of Development (Cambridge 9708)
11.5.1 Foreign Direct Investment (FDI)
Definition (Cambridge 9708 11.5)
FDI is an investment made by a resident entity of a source country into a business located in a host country with the intention of obtaining a lasting interest and a degree of control over the foreign enterprise.
Key elements of the definition
- Cross‑border flow: Capital moves from the investor’s (source) country to the host country.
- Ownership threshold: The investor must hold ≥ 10 % of the voting rights in the foreign enterprise – this distinguishes FDI from portfolio investment.
- Control: Ability to influence management, technology or strategic direction (e.g., board representation, voting rights, contractual rights).
- Lasting interest: The stake is intended to be retained for the medium‑ to long‑term, not a short‑term speculative purchase.
- Long‑term perspective: The investment aims at sustained operations rather than a one‑off financial transaction.
Forms of FDI
| Form |
Typical characteristics |
| Greenfield investment |
Establishing a new subsidiary or production facility from scratch in the host country. |
| Brownfield investment |
Acquiring or merging with an existing firm (e.g., takeover, joint venture that becomes a merger). |
| Joint venture (JV) |
Partnering with a local firm; ownership and control are shared according to the partnership agreement. |
Why Multinational Enterprises (MNEs) Choose FDI
- Market‑seeking motive: Proximity to new customers and reduction of transport costs.
- Efficiency‑seeking motive: Access to cheaper labour, specialised skills or factor endowments.
- Resource‑seeking motive: Direct access to natural resources, raw materials or strategic inputs.
- Strategic‑seeking motive: Presence in politically or economically important locations; hedging against trade barriers.
- Policy‑seeking motive: Exploiting favourable tax regimes, investment incentives or regulatory environments.
- Technology‑seeking motive: Acquiring patents, brand reputation or managerial know‑how.
FDI vs Portfolio Investment
| Aspect |
FDI |
Portfolio investment |
| Ownership stake |
≥ 10 % voting rights – implies control |
< 10 % – no control |
| Purpose |
Long‑term strategic interest |
Short‑term financial return |
| Risk exposure |
Higher – operational, political, exchange‑rate risk |
Lower – mainly market risk |
| Typical instruments |
Equity, reinvested earnings, intra‑company loans |
Stocks, bonds, other securities |
Economic impact of FDI on the host country
- Technology transfer: Introduction of advanced production techniques and managerial know‑how.
- Employment creation: Direct jobs in foreign‑owned firms; indirect jobs in supporting industries.
- Balance of payments (BOP):
- FDI inflows are recorded in the capital account (as “Inward direct investment”).
- Repatriated profits appear in the “Net income” component of the current account.
- Productivity & spill‑over effects: Domestic firms may adopt superior practices, raising overall efficiency.
- Fiscal effects: Host governments receive tax revenues; source countries gain income from profit repatriation.
Key formulae (assessment focus)
When analysing the impact of FDI on a host country’s BOP, use the identity:
\[
\text{Current Account} = \text{Net Exports} + \text{Net Income} + \text{Net Transfers}
\]
– Inward FDI appears in the capital account; the “Net Income” term captures profit repatriation (outward flow).
Suggested diagrams for exam answers
- Balance‑of‑payments diagram showing the capital account (inward FDI) and the current‑account “Net income” line.
- Flow‑chart of a Greenfield investment – from source‑country capital → construction → production → profit → repatriation.
- Comparative bar chart of FDI inflows (by region) versus portfolio inflows – useful for “FDI vs portfolio” questions.
11.5.2 International Aid
Definition (Cambridge 9708 11.5)
International aid is a flow of resources—financial, technical, or material—provided by one country (or an international organisation) to another country to support its economic development, humanitarian relief, or other specific objectives.
Forms of aid (Cambridge 9708 11.5)
- Official Development Assistance (ODA) – government‑to‑government aid aimed at economic development and welfare.
- Multilateral aid – delivered through organisations such as the World Bank, IMF, UN agencies.
- Private (non‑governmental) aid – donations from NGOs, charities, private foundations or corporations.
- Humanitarian aid – emergency assistance (food, shelter, medical care) in response to crises.
- South‑South cooperation – assistance exchanged between developing (often emerging) economies.
- Technical assistance & capacity‑building – training, expertise and technology transfer without direct cash flows.
Reasons for giving aid
- Humanitarian motives: Alleviate suffering, respond to natural disasters or conflicts.
- Political motives: Strengthen diplomatic ties, gain influence, support allies.
- Economic motives: Open new markets, secure access to resources, promote stability that benefits trade.
- Strategic/security motives: Prevent the spread of conflict, terrorism or disease.
- Ideological/moral motives: Promote human rights, democracy, or the Sustainable Development Goals (SDGs).
Effects of aid
Positive effects
- Improved health, education and infrastructure → higher human‑capital formation.
- Fiscal relief when aid is concessional (low‑interest or grant).
- Facilitates technology transfer and institutional development.
- Can reduce poverty and accelerate progress towards the SDGs.
Negative effects / criticisms
- Dependency: Recipient economies may become reliant on external funding.
- Crowding‑out: Aid can displace private domestic investment or savings.
- Conditionality: Policy prescriptions may undermine sovereignty or be ill‑suited to local conditions.
- Misallocation / corruption: Poor governance can divert aid away from intended projects.
Illustrative example
In 2022 ODA to Sub‑Saharan Africa was ≈ $50 bn. The inflow helped raise primary‑school enrolment from 71 % to 78 % (2015‑2022) but also sparked debate about “aid dependency” and the need for greater “aid effectiveness”.
Scale and trends (2023 data)
- Top five donors – United States, Germany, United Kingdom, Japan and France – together supplied around $150 bn in ODA.
- This represents roughly 0.3 % of global GDP**.
- Aid flows have risen modestly over the past decade, reflecting commitments to the 2030 Agenda for Sustainable Development.
Linkages to other syllabus points
- Balance of payments: Aid inflows are recorded in the capital account (as “Transfers”) and can improve the current‑account balance when used for productive investment.
- Exchange rates: Large aid inflows can cause currency appreciation, affecting export competitiveness.
- Economic development: Aid interacts with growth models, structural change and the determinants of long‑run productivity.
- International trade & investment: Aid can complement or substitute for FDI, influencing the overall pattern of foreign capital flows.
Suggested diagram for exam answers
Two‑column flow chart:
- Left column – FDI: capital, technology, employment → impacts on host‑country BOP, growth and productivity.
- Right column – Aid: financial transfers, technical assistance, humanitarian relief → impacts on host‑country BOP, fiscal balance and human‑capital formation.
- Arrows illustrate feedback effects on the source country (profit repatriation, diplomatic influence, etc.).