Human Capital Formation and Foreign Direct Investment in Developing Countries

Abstract

This paper synthesises the existing literature on human capital formation and foreign direct investment (FDI) in developing countries. The aim is to take a bird's eye view of the complex linkages between the activities of multinational enterprises (MNEs) and policies of host developing countries. In doing so, general trends, best practices and policy experiences are extracted to evaluate the current state of knowledge. The literature indicates that a high level of human capital is no doubt one of the key ingredients for attracting FDI, as well as for host countries to gain maximum benefits from their activities. Most developing countries, however, underinvest in human capital, and the investment that is actually taking place is unevenly distributed across countries and regions that have adopted different human resource development (HRD) policies. To improve human capital formation and thus to attract more FDI would therefore require a more coherent approach that takes host country constraints such as limited budgetary resources into account. One such approach is to provide strong incentives for MNEs and Investment Promotion Agencies (IPAs) to participate in formal education and vocational training even for workers employed by domestic firms. This allows HRD to be flexible and demand-driven. Another policy option is to facilitate HRD for small- and medium-sized domestic enterprises which usually do not invest sufficiently in training of employees although these enterprises stand to gain most from education and training. In addition, FDI promotion policies can target high value-added MNEs that are more likely to bring new skills and knowledge to the economy that can be tapped by domestic enterprises. Lastly, it is important that key components of HRD policies, i.e. formal schooling and vocational education and training policies (post-formal schooling) are well co-ordinated so as to equip students with knowledge and skills that will later be complimentary to training opportunities provided in the labour market.