International Investment Law Notes - III (Theories of Foreign Investment)

Theories of Foreign Investment

1. Classical Theory – This theory believes that foreign investment leads to economic development. It also believes that the benefits of such foreign will be uniform for all the sectors of the economy. It assumes that there will not be any problem relating to distribution of assets in the public at large. The World Bank Guidelines on the treatment of FDI provides the philosophy of the Classical Theory:

“that a greater flow of Foreign Direct Investment brings substantial benefits to bear on the world economy and on the economies of developing countries in particular, in terms of improving the long term efficient of the host country through greater competition, transfer of capital, technology and managerial skills and enhancement of market access and in terms of the expansion of international trade.”

Thus, this theory is supported by institutions like IBRD and IMF. The development of the classical theory of foreign investment law is supported by all the laws that are in force now such as TRIMS, TRIPS, GATS, GATT, UNCTAD etc. This theory is usually supported by the capitalist countries. It is said that it will continue to maintain its force in international law due to the support it receives from powerful countries and organizations.

2. Dependency Theory – This theory is opposite to the classical theory and it firmly believes that foreign investment does not bring any good to the economy of any nation. This theory abhors MNCs and believes that subsidiary companies of MNCs devise their policies in the interests of its parent companies and its shareholders in the home state. Since most of the MNCs are based in developed countries, they serve the interests of the developed states in which they have their centre of operations.

This theory further believes that the resources which flow into any state as a result of foreign investment benefit only the upper and elite classes in the developing states. These elite classes enter into alliances with foreign capitalists and provides conditions favourable for MNCs to nurture in the developing countries. Thus, dependency theory refutes the claim of the classical theory and holds that foreign investment is uniformly injurious. Rather than promoting developing, foreign investment makes developing countries dependent on the whims and fancies of the developed states. And unless a developing country breaks free, it is impossible to carry on economic development in that state. This theory was mainly popularized by Latin American Countries and Communist economies.

3. Middle Path Theory – This group of theorists have realized that both classical theory and dependency theory have their advantages and disadvantages. However, this group of theorists also believe that Foreign Investment is a necessary evil.

Sornarajah states that:

“Once it is conceded that multinational corporations can both benefit and harm economic development, it is easy to adopt the position that foreign investment should be harnesses to the objective of economic development and must be carefully regulated to achieve this end. The influence of this view, which strikes a middle course, has been significant.”

A good example is that of the nuclear liability law of India. The foreign investment in the nuclear sector is welcome. However, the entity that enters the nuclear sector must follow the strict standards and rules and regulations of our country.

4. Stand of UNCTC (UN Commission on Transnational Corporations) – This commission believes that MNCs are needed by every country and foreign investment is also needed in the form of FDI and FII. But, such MNCs can be regulated by enacting laws relating to them. Thus it believes in the stand taken by the middle path theory that states that neither the FI has to be rejected in totality nor the FI has to be accepted in totality. FI is beneficial but the benefits have to be distributed by the state.

International Trade Law Notes