FDI Impacts on UK Economy

Sample Essay: Discuss The Effect of Foreign Direct Investment on UK Economy?

Firstly, for an open ended question on UK economy, consider the main macro economic objectives.

• Economic Growth
• Inflation
• Unemployment
• Balance of Payments on Current Account
• Exchange Rate
• Government borrowing
• Also, Always consider how AD and AS will be affected.

Definition FDI – Foreign Direct investment is investment from foreign firms (e.g. Japanese firm building a car factory like Toyota). Don’t forget in economics investment is an increase in the capital stock (not to be confused with savings)

Therefore foreign direct investment will be an injection into the economy. Investment is a component of AD. Therefore, the investment will help to increase AD and create a faster rate of economic growth. The investment will also create jobs directly, and also indirectly through faster economic growth. This jobs bonus is likely to be concentrated on the local area of investment.

Also in the longer term, investment will help increase the productive capacity of the economy and shift AS to the right. Therefore this will enable low inflationary growth.

Effect of Investment on Economy

The investment may also help to boost the skills and technological capacity of the economy. e.g. the Japanese firm may introduce new working practises which boost labour productivity. There is evidence that foreign investment in the 1980s and 1990s did achieve this to some extent.

Foreign Investment counts as a credit item on the financial account of the balance of payments (used to be called capital account). This capital inflow helps finance the UK current account deficit.

If the firm exports cars to Europe this will be a credit on the current account. But, if they send profit back to japan, this flow will be a debit on the current account.

Evaluation
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Firstly foreign direct investment is a relatively small % of AD. The biggest component of AD is domestic consumption. The impact of foreign direct investment may not really be felt beyond the local region where it occurs.

Also it depends on other factors in the economy. For example, if FDI increased during the current recession, it would probably be insufficient to create positive economic growth because other factors are reducing AD and these are more powerful.

The impact of FDI may also depend on the extent to which there is a multiplier effect. E.g. does the investment stimulate the creation of new industries to support the new factory?