Despite being an export of capital, OFDI has the potential to raise the level of investment in the home country. This can be domestic investment undertaken by companies or individuals, or inward foreign direct investments made by foreign MNEs.
There are multiple channels through which OFDI can enhance the financial resources available for investment in the home country. Investment funds could become available from the repatriated financial earnings generated by the OFDI itself (see A1) Financial earnings), or from the export earnings associated with OFDI accruing to firms in the home country (see A2) Exports and production). MNEs with successful international businesses are also more capable of assuming the risks associated with further investments in their home country operations. Moreover, the enhanced economic integration with other countries resulting from OFDI could induce inward investment by foreign firms into the home country, especially if part of a process of cross-border specialisation within value chains and regional cooperation. Over time, greater domestic and inward investments will promote economic activity and industrialisation in the home country (UNESCAP 2020).
Additional domestic investment resulting from OFDI can support SDG 17.2 aimed at mobilising additional financial resources. Over time, greater investments in the home economy resulting from OFDI can promote domestic economic activity and industrialisation, thus contributing to SDG 9.2 (“promote inclusive and sustainable industrialisation”).
Key insights
- More studies find a positive relationship between OFDI and domestic investment (Ali et al. 2019, Gondim, Ogasavara, and Masiero 2018, Ameer, Xu, and Alotaish 2017, You and Solomon 2015, Desai, Foley, and Hines 2005, 2009), compared to those detecting a negative relationship (Al-Sadiq 2013, Goh, Wong, and Tham 2013, Feldstein 1995). Some studies report mixed results (Ameer et al. 2020, Liu, Tsai, and Tsay 2015, Herzer and Schrooten 2008).
- OFDI might also induce subsequent increases in inward FDI as a result of growing economic interdependencies.
- Policy aimed at nurturing positive home-country effects should focus on companies that concurrently invest both at home and abroad.
Interactions
B2) Industrial sector: In the manufacturing sector, a few studies find a positive impact of OFDI on domestic investment (You and Solomon 2015, Desai, Foley, and Hines 2009).
B9) Time since investment: The positive impact of OFDI on domestic investment tends to happen in the long term (Ameer, Xu, and Alotaish 2017, Huang 2013, Herzer and Schrooten 2008).
E1) Financial losses: Sometimes, capital outflows associated with OFDI subsequently crowd out domestic investment (Al-Sadiq 2013, Goh, Wong, and Tham 2013, Feldstein 1995), especially in the initial stages after the investment before OFDI starts to yield financial returns (UNESCAP 2020). Yet overall, more studies find a positive relationship between OFDI and domestic investment (Ali et al. 2019, Gondim, Ogasavara, and Masiero 2018, Ameer, Xu, and Alotaish 2017, You and Solomon 2015, Desai, Foley, and Hines 2005, 2009), and some report mixed results (Ameer et al. 2020, Liu, Tsai, and Tsay 2015, Herzer and Schrooten 2008).
Available Research Findings
Ameer et al. (2020): OFDI from 1996 to 2017 from developed countries augments domestic private capital formation but has a negative association with public capital formation. No effect is found in emerging economies.
UNESCAP (2020, 24-33): The effect of OFDI between 1960 and 2018 from ESCAP member states inducing inward FDI is positive for ASEAN member states and for greenfield OFDI from ESCAP developing countries.
Ali et al. (2019): Chinese OFDI from 1982 to 2016 complemented domestic investment in China.
Gondim, Ogasavara, and Masiero (2018): There is a positive association between Brazilian and Chinese OFDI and domestic investment during the period from 1975 to 2013. The crowding-in effect is more pronounced for Chinese investments.
Ameer, Xu, and Alotaish (2017): There is a positive relationship running from Chinese OFDI to domestic investment in the long run, but not in the short term.
Liu, Tsai, and Tsay (2015): OFDI by a sample of 1084 Taiwanese manufacturing firms between 2000 and 2010 had a favourable impact on domestic investment when it was made in high-wage countries but tended to result in ‘hollowing out’ when made in low-wage economies.
Al-Sadiq (2013): An examination of 121 developing and transition economies found that OFDI between 1990 and 2010 had a negative impact on domestic investment.
Goh, Wong, and Tham (2013): The long-run effect of Malaysian OFDI flows on domestic gross fixed capital formation is negative and inelastic, meaning that a decrease in gross fixed capital formation is proportionally less to the capital outflow.
Herzer and Schrooten (2008): United States OFDI has a positive long-run effect on domestic investment. German OFDI has a complementary relationship with domestic investment in the short run but substitutes domestic investment in the long run.
You and Solomon (2015): Domestic investment responds positively to Chinese OFDI, especially in industries with a heavy state presence and when supported by the government.
Desai, Foley, and Hines (2009): OFDI made by United States manufacturing firms between 1982 and 2004 increased domestic investment.
Feldstein (1995): OFDI reduces domestic investment.