Foreign Direct Investment and Human Development

Abstract

In this thesis, I examine the relationship between foreign direct investment (FDI) in a host country and human development. Human development comprises the education, health, and income opportunities available to people in a particular country. I assert that FDI can potentially enhance human development through economic growth and higher income in a host country. However, alongside these benefits, FDI can also have negative effects by worsening a host country’s income inequality. Given FDI’s counteracting positive and negative effects on human development, I propose that FDI’s net effect on human development takes the form of an inverted U-shaped relationship. I further predict that a host country’s institutional maturity, defined as the degree of institutional development within a country, plays an important role in understanding which national contexts strengthen or weaken this relationship. I contend that the inverted U-shaped relationship between FDI and human development is moderated by a host country’s institutions, and assess this moderation with respect to two dimensions: business sophistication and transparency. Business sophistication measures the extent to which a country possesses supplier networks, technology production, and advanced business practices (World Economic Forum, 2015). My results show that countries with low business sophistication have a pronounced inverted U-shaped relationship between FDI and human development, while countries with high business sophistication experience an attenuated effect (flattened inverted U-shaped). Similarly, transparency measures public-sector employees and executives’ accountability and performance, as well as civil society’s access to information about public affairs (World Bank, 2016). My results show that economies with low transparency have a steeper inverted U-shaped relationship between FDI and human development; by contrast, economies with high transparency exhibit a flatter inverted U-shaped curve. My study makes three core contributions to the field. First, it adds to development economics scholars’ analysis of human development by proposing that income inequality is a key FDI cost. Therefore, while FDI can indeed enhance human development (as past studies have shown), it can also have a negative effect by worsening a host country’s income inequality. Second, my study facilitates better knowledge of the relationship between FDI and human development by integrating the positive and negative effects of this relationship. Third, in line with studies that propose the contingent effects of FDI (Meyer & Sinani, 2009), my study contributes to understanding how a host country’s institutional maturity in the private and public sectors affects the strength of FDI’s curvilinear effect on human development.