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CHAPTER ONE

INTRODUCTION

1. 1 BACKGROUND TO THE STUDY

In the 1990’s, Foreign Direct Investment (FDI) became the largest single source of external finance for developing countries. In 1997, FDI accounted for about half of all private capital and 40% of local capital flows to developing countries. Following the virtual disappearance of commercial bank lending in 1980’s, policy makers in emerging markets eased restrictions on incoming foreign investment. Many countries even tilted the balance by offering special incentives to foreign enterprises including lower income taxes or income tax holidays, import duty exemptions and subsidies for infrastructure. The rationale for these special treatments often stems from the belief that foreign investment generates externalities in the form of technology transfer. Apart from employment and capital inflows, which accompany foreign investment, multinational activities may lead to technology transfer for domestic firms. If foreign firms introduce new product or processes to the domestic market, domestic firms may benefit from the accelerated diffusion of new technology. In some cases, domestic firms may increase productivity simply by observing the business methods of the foreign firms and the mix of their supply and demand.

Foreign Direct Investment (FDI) has increased tenfold over the last 20 years in developing nations. This kind of investment brings private overseas funds into a country for investments in manufacturing or services. In the years after the Second World War, global FDI was dominated by the United States, as much of the world recovered from the destruction wrought by the conflict. The U.S. accounted for around three-quarters of new FDI (including reinvested profits) between 1945 and 1960. Since that time FDI has spread to become a truly global phenomenon, no longer the exclusive preserve of Organization for Economic Cooperation and Development