Foreign direct investment Totally Explained

Everything about Foreign Investment totally explained

Foreign direct investment (FDI) is defined as "investment made to acquire lasting interest in enterprises operating outside of the economy of the investor." The FDI relationship consists of a parent enterprise and a foreign affiliate which together form a Multinational corporation (MNC). In order to qualify as FDI the investment must afford the parent enterprise control over its foreign affiliate. The UN defines control in this case as owning 10% or more of the ordinary shares or voting power of an incorporated firm or its equivalent for an unincorporated firm; lower ownership shares are known as portfolio investment.

History

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 brought by the conflict. The US 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 OECD countries. FDI has grown in importance in the global economy with FDI stocks now constituting over 20 percent of global GDP.

Types of FDI

By Direction

Inward

Inward foreign direct investment is a particular form of inward investment when foreign capital is invested in local resources. Inward FDI is encouraged by:

Tax breaks, subsidies, low interest loans, grants, lifting of certain restrictions
The thought is that the long term gain is worth more than the short term loss of income

Inward FDI is restricted by:

Ownership restraints or limits

Differential performance requirements

Outward

Outward foreign direct investment, sometimes called "direct investment abroad", is when local capital is invested in foreign resources. Yet it can also be used to invest in imports and exports from a foreign commodity country. Outward FDI is encouraged by:

Government-backed insurance to cover risk Outward FDI is restricted by:

Tax incentives or disincentives on firms that invest outside of the home country or on repatriated profits

Subsidies for local businesses

Government policies that support the nationalization of industries (or at least a modicum of government control)

Self-interested lobby groups and societal sectors who are supported by inward FDI or state investment, for example labour markets and agriculture.

Security industries are often kept safe from outwards FDI to ensure localised state control of the military industrial complex

By Target

Greenfield investment

Direct investment in new facilities or the expansion of existing facilities. Greenfield investments are the primary target of a host nation’s promotional efforts because they create new production capacity and jobs, transfer technology and know-how, and can lead to linkages to the global marketplace. The Organization for International Investment cites the benefits of greenfield investment (or insourcing) for regional and national economies to include increased employment (often at higher wages than domestic firms); investments in research and development; and additional capital investments. Criticism of the efficiencies obtained from greenfield investments include the loss of market share for competing domestic firms. Another criticism of greenfield investment is that profits are perceived to bypass local economies, and instead flow back entirely to the multinational's home economy. Critics contrast this to local industries whose profits are seen to flow back entirely into the domestic economy.

Horizontal FDI

Horizontal FDI occurs when the multinational undertakes the same production to activities in multiple countries.

Vertical FDI

Vertical FDI occurs when the multinational acquires a stake in a foreign firm that either uses its output or provides its input. The primary activity of the foreign firm usually precedes or succeeds that of the parent company.

Backward Vertical FDI

Investment in a firm whose industry output provides the input for the parent company's operations.

Forward Vertical FDI

Where an industry abroad sells the outputs of a firm's domestic production, or uses the firm's output as input.

By Motive

FDI can also be categorized based on the motive behind the investment from the perspective of the investing firm:

Resource-Seeking

Investments which seek to acquire factors of production that are more efficient than those obtainable in the home economy of the firm. In some cases, these resources may not be available in the home economy at all (for example cheap labor and natural resources). This typifies FDI into developing countries, for example seeking natural resources in the Middle East and Africa, or cheap labor in Southeast Asia and Eastern Europe.

Market-Seeking

Investments which aim at either penetrating new markets or maintaining existing ones. FDI of this kind may also be employed as defensive strategy; it's argued that businesses are more likely to be pushed towards this type of investment out of fear of losing a market rather than discovering a new one. This type of FDI can be characterized by the foreign Mergers and Acquisitions in the 1980’s by Accounting, Advertising and Law firms.

Efficiency-Seeking

Investments which firms hope will increase their efficiency by exploiting the benefits of economies of scale and scope, and also those of common ownership. It is suggested that this type of FDI comes after either resource or market seeking investments have been realized, with the expectation that it further increases the profitability of the firm..

Strategic-Asset-Seeking

A tactical investment to prevent the gain of resource to a competitor. Easily compared to that of the oil producers, whom may not need the oil at present, but look to prevent their competitors from having it.

Opposition

In the US, in the late 1960s and early 1970s, foreign direct investment became increasingly politicized. Organized labor, convinced that foreign investment exported jobs, undertook a major campaign to reform the tax provisions which affected foreign direct investment. The Foreign Trade and Investment Act of 1973 (or the Burke-Hartke Bill) would have eliminated both the tax credit and tax deferral. The Nixon Administration, influential members of Congress of both parties, and well-financed lobbying organizations came to the defense of the multinational. The massive counterattack of the multinational corporations and their allies defeated this first major challenge to their interests.

Further Information

Get more info on 'Foreign Investment'.

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