How important is FDI for developing economies?

Is the quantum FDI very important? Is it the cause or the effect of economic development? Intuitively we know that it is important. The question is how important. The decision to invest in a particular country depends on several factors, including political situations, economic conditions, infrastructure, business growth, etc. Governments also play a significant role in attracting foreign investors by offering subsidies or tax concessions.

• FDI allows the transfer of technology—particularly in the form of new varieties of capital inputs—that cannot be achieved through financial investments or trade in goods and services. FDI can also promote competition in the domestic input market.
• Recipients of FDI often gain employee training while operating the new businesses, which contributes to human capital development in the host country.
• Profits generated by FDI contribute to corporate tax revenues in the host country

However, if we look at two comparable economies (in terms of size), Bangladesh and Vietnam, they make you question the conventional wisdom. Both economies have been growing at a fast clip during the last 10 years. In 2022, Bangladesh's economy had grown to USD 460 billion whereas the Vietnamese economy had grown to USD 408 billion. Their recent trajectories compel a deeper dive.

The Bangladeshi economy overtook the Vietnamese economy in 2016 and has been powering ahead since then. It has been growing faster since 2012. Vietnam received USD 17.9 billion FDI in 2022 whereas Bangladesh received only USD 1.56 billion. That’s 8 times. Vietnam has consistently attracted FDI of the order of 4-5% of its GDP whereas Bangladesh gets barely 1-1.5% of its GDP, often less than 1%

The trends are as shown –

The one major difference is the population difference. Bangladesh is home to 170 million people whereas Vietnam has a population of 98 million. While this is significant, it will be odd to assume that this alone makes up for the difference in FDI. What are the other factors at play here?

Is FDI the cause or the effect of economic performance?

The extraordinary thing about Vietnam is its participation in international trade. Both exports and imports are over 80% of the GDP. Bangladesh on the other hand, is at a more normal level - Exports at about 15% of GDP and Imports at about 20% of GDP

As an economy, Bangladesh makes up somewhat for its lack of FDI with personal remittances. Although remittances to Vietnam are considerable, Bangladesh is higher by 60%.