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Introduction: HUMAN CAPITAL FORMATION AND FOREIGN DIRECT INVESTMENT IN DEVELOPING COUNTRIES

Written by: OECD Development Centre

Article Overview: Human resource development (HRD) and foreign direct investment (FDI) are among the key drivers of growth in developed and developing countries.

Introduction: HUMAN CAPITAL FORMATION AND FOREIGN DIRECT INVESTMENT IN DEVELOPING COUNTRIES

Human resource development (HRD) and foreign direct investment (FDI) are
among the key drivers of growth in developed and developing countries1. While HRD and
FDI individually affect growth, they also reinforce each other through complementary
effects. In general, enhanced HRD increases incoming FDI by making the investment
climate attractive for foreign investors. This is done through a direct effect of upgraded
skill level of the workforce, as well as via indirect effects such as improved socio-political
stability and health (World Bank, 2003; UNESCO and OECD, 2003). On the other hand,
FDI contributes to HRD since multinational enterprises (MNEs)2 themselves can be
active providers of education and training, bringing new skills, information and
technology to host developing countries. Ultimately, this complementary effect leads to a
virtuous circle of HRD and FDI where host countries experience continuous inflow of FDI
over time by increasingly attracting higher value-added MNEs, while at the same time
upgrading the skill contents of preexisting MNEs and domestic enterprises.
Figure I.1 illustrates how this virtuous circle takes place. The first part of the cycle
(A: Determinants of Inward-FDI) shows that sound government policies are important
determinants of FDI3. Host investment climate such as market access and
availability/quality of factors of production are other key factors affecting inward-FDI.
Sound policies should also contribute to a better investment climate. After a host
developing country succeeds in attracting FDI, the next step of the cycle is to mobilise
MNEs so that the new technologies that they brought into the country are transmitted to
other firms and industries. This is usually achieved through MNEs’ links with domestic
firms as well as through their own HRD activities. Note that HRD is not limited to
enterprise training but extends further to MNE collaboration with governments,
investment promotion agencies (IPA), and domestic enterprises to design and coordinate
HRD activities of the country or of the industry. The final step of the circle is for
host countries to take advantage of the upgraded skill levels of the economy so that
more inward FDI takes place. This is not simply to increase the flow of inward FDI, but to
attract higher value-added MNEs, in which the key factor of production is the skilled
workforce. To this end, host country governments need to constantly fine-tune policies so
that the investment climate adapts in a way that higher value-added MNEs that utilise
new skills and information will be attracted.

The objective of this paper is to delve into the vast literature of HRD and FDI in
order to identify how this virtuous circle takes place and to seek ways to fine-tune polices
to promote it. In doing so, empirical regularities, best practices and numerous policy
experiences are extracted from the literature. Surprisingly, there has been a lack of
comprehensive survey done on this issue as yet in spite of the growing concern and
interest on this issue by policy makers, academics and other stakeholders. Since the
major aim of this paper is to capture common regularities in how host developing
countries mobilise human resources, it will not cover the whole literature exhaustively.
The paper is organised as follows. The rest of this section summarises questions
to be posed throughout the paper. Section II presents background of the issue by
summarising recent trends in FDI and HRD in developing countries. The next three
sections provide the meat of the paper including: i) attracting inward FDI; ii) human
capital formation by MNEs and technology transfers; and iii) the virtuous circle of human
capital formation, incoming FDI, and technology transfers. Section VI concludes by
revisiting the posed questions and providing directions for future research.

Related Articles
  Summary: HUMAN CAPITAL FORMATION AND FOREIGN DIRECT INVESTMENT IN DEVELOPING COUNTRIES
  Preface: HUMAN CAPITAL FORMATION AND FOREIGN DIRECT INVESTMENT IN DEVELOPING COUNTRIES
  Questions Posed: HUMAN CAPITAL FORMATION AND FOREIGN DIRECT INVESTMENT IN DEVELOPING COUNTRIES
  HUMAN CAPITAL FORMATION BY MNES AND TECHNOLOGY TRANSFERS
  THE VIRTUOUS CIRCLE OF HUMAN CAPITAL FORMATION, INWARD FDI, AND TECHNOLOGY TRANSFERS

Article Tags: continuous inflow, developing country, factors of production, fdi, foreign direct investment, foreign investors, health world, host countries, hrd, human resource development, indirect effects, information and technology, investment climate, investment promotion agencies, market access, multinational enterprises, socio political stability, sound government, sound policies, virtuous circle



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