Foreign Direct Investment

Foreign direct investment (FDI) involves establishing a direct business interest in

a foreign country, such as buying or establishing a manufacturing business,
building warehouses, or buying buildings. Foreign direct investment tends to
involve establishing more of a substantial, long-term interest in the economy of a
foreign country. Due to the significantly higher level of investment required,
foreign direct investment is usually undertaken by multinational companies, large
institutions, or venture capital firms. Foreign direct investment tends to be
viewed more favourably since they are considered long-term investments, as well
as investments in the well-being of the country itself.

At the same time, the nature of direct investment, such as creating or acquiring a
manufacturing facility, makes it much more difficult to liquidate or pull out of the
investment. For this reason, direct investment is usually undertaken with
essentially the same attitude as establishing a business in one's own country—
with the intention of making the business profitable and continuing its operation
indefinitely. Direct investment includes having control over the business invested
in and being able to manage it directly, but it also involves more risk, work, and
commitment

Foreign Portfolio Investment

Foreign portfolio investment (FPI) refers to investing in the financial assets of a

foreign country, such as stocks or bonds available on an exchange. This type of
investment is at times viewed less favourably than direct investment because
portfolio investments can be sold off quickly and are at times seen as short-term
attempts to make money, rather than a long-term investment in the economy.

Portfolio investment typically has a shorter time frame for investment return
than direct investment. As with any equity investment, foreign portfolio investors
usually expect to quickly realize a profit on their investments.

As securities are easily traded, the liquidity of portfolio investments makes them
much easier to sell than direct investments. Portfolio investments are more
accessible for the average investor than direct investments because they require
much less investment capital and research
Types and Examples of Foreign Direct Investment

Typically, there are two main types of FDI: horizontal and vertical FDI.

Horizontal:

a business expands its domestic operations to a foreign country. In this case, the business
conducts the same activities but in a foreign country. For example, McDonald’s opening
restaurants in Japan would be considered horizontal FDI.

Vertical:

a business expands into a foreign country by moving to a different level of the supply chain. In
other words, a firm conducts different activities abroad but these activities are still related to
the main business. Using the same example, McDonald’s could purchase a large-scale farm in
Canada to produce meat for their restaurants.

Conglomerate:

a business acquires an unrelated business in a foreign country. This is uncommon as it requires

overcoming two barriers to entry: entering a foreign country and entering a new industry or
market. An example of this would be if Virgin Group, which is based in the United Kingdom,
acquired a clothing line in France.

Platform:

a business expands into a foreign country but the output from the foreign operations is
exported to a third country. This is also referred to as export-platform FDI. Platform FDI
commonly happens in low-cost locations inside free-trade areas. For example, if Ford
purchased manufacturing plants in Ireland with the primary purpose of exporting cars to other
countries in the EU.

Costs and benefits of FDI to home and host countries

List of Advantages of Foreign Direct Investment

1. Economic Development Stimulation.

Foreign direct investment can stimulate the target country’s economic development, creating a
more conducive environment for you as the investor and benefits for the local industry.
2. Easy International Trade.

Commonly, a country has its own import tariff, and this is one of the reasons why trading with
it is quite difficult. Also, there are industries that usually require their presence in the
international markets to ensure their sales and goals will be completely met. With FDI, all these
will be made easier.

3. Employment and Economic Boost.

Foreign direct investment creates new jobs, as investors build new companies in the target
country, create new opportunities. This leads to an increase in income and more buying power
to the people, which in turn leads to an economic boost.

4. Development of Human Capital Resources.

One big advantage brought about by FDI is the development of human capital resources, which
is also often understated as it is not immediately apparent. Human capital is the competence
and knowledge of those able to perform labour, more known to us as the workforce. The
attributes gained by training and sharing experience would increase the education and overall
human capital of a country. Its resource is not a tangible asset that is owned by companies, but
instead something that is on loan. With this in mind, a country with FDI can benefit greatly by
developing its human resources while maintaining ownership.

5. Tax Incentives.

Parent enterprises would also provide foreign direct investment to get additional expertise,
technology and products. As the foreign investor, you can receive tax incentives that will be
highly useful in your selected field of business.

6. Resource Transfer.

Foreign direct investment will allow resource transfer and other exchanges of knowledge,
where various countries are given access to new technologies and skills.

7. Reduced Disparity Between Revenues and Costs.

Foreign direct investment can reduce the disparity between revenues and costs. With such,
countries will be able to make sure that production costs will be the same and can be sold
easily.
 8. Increased Productivity.

The facilities and equipment provided by foreign investors can increase a workforce’s
productivity in the target country.

9. Increment in Income.

Another big advantage of foreign direct investment is the increase of the target country’s
income. With more jobs and higher wages, the national income normally increases. As a result,
economic growth is spurred. Take note that larger corporations would usually offer higher
salary levels than what you would normally find in the target country, which can lead to
increment in income

List of Disadvantages of Foreign Direct Investment

1. Hindrance to Domestic Investment.

As it focuses its resources elsewhere other than the investor’s home country, foreign direct
investment can sometimes hinder domestic investment.

2. Risk from Political Changes.

Because political issues in other countries can instantly change, foreign direct investment is
very risky. Plus, most of the risk factors that you are going to experience are extremely high.

3. Negative Influence on Exchange Rates.

Foreign direct investments can occasionally affect exchange rates to the advantage of one
country and the detriment of another.

4. Higher Costs.

If you invest in some foreign countries, you might notice that it is more expensive than when
you export goods. So, it is very imperative to prepare sufficient money to set up your
operations.
5. Economic Non-Viability.

Considering that foreign direct investments may be capital-intensive from the point of view of
the investor, it can sometimes be very risky or economically non-viable.

6. Expropriation.

Remember that political changes can also lead to expropriation, which is a scenario where the
government will have control over your property and assets.

7. Negative Impact on the Country’s Investment.

The rules that govern foreign exchange rates and direct investments might negatively have an
impact on the investing country. Investment may be banned in some foreign markets, which
means that it is impossible to pursue an inviting opportunity
Balance of Payments

The Balance of Payments or BoP is a statement or record of all monetary and economic
transactions made between a country and the rest of the world within a defined period (every
quarter or year). These records include transactions made by individuals, companies and the
government. Keeping a record of these transactions helps the country to monitor the flow of
money and develop policies that would help in building a strong economy.

In a perfect scenario, the Balance of Payments (BoP) should be zero. That is, the money coming
in and the money going out should balance out. But that doesn’t happen in most cases. A
country’s BoP statement correctly indicates whether the country has a surplus or a deficit of
funds. A BoP surplus indicates that a country’s exports are more than its imports. A BoP deficit,
on the other hand, indicates that a country’s imports are more than exports. Both scenarios
have short-term and long-term effects on the country’s economy.

Components of BoP

Now let’s understand the different components of the BoP. The BoP consists of three main
components—current account, capital account, and financial account. As mentioned earlier,
the BoP should be zero. The current account must balance with the combined capital and
financial accounts.

Current Account

The current account monitors the flow of funds from goods and services trade (import and
export) between countries. Now this includes money received or spent on manufactured goods
and raw materials. It also includes revenue from tourism, transportation receipts, revenue
from specialized services (medicine, law, engineering), and royalties from patents and
copyrights. In addition, the current account includes revenue from stocks.

Capital Account

The capital account monitors the flow of international capital transactions. These transactions
include the purchase or disposal of non-financial assets (for example, land) and non-produced
assets. The capital account also includes money received from debt-forgiveness and gift taxes.
In addition, the capital account records the flow of the financial assets by migrants leaving or
entering a country and the transfer, sale, or purchase of fixed assets.
Financial Account

The financial account monitors the flow of funds pertaining to investments in businesses, real
estate, and stocks. It also includes government-owned assets such as gold and Special Drawing
Rights (SDRs) held with the International Monetary Fund (IMF). In addition, it includes foreign
investments and assets held abroad by nationals. Similarly, the financial account includes a
record of the assets owned by foreign nationals

The balance of Payment’s importance can be gauged from the following points:

 It analyses the business transactions of any economy into exports and imports of goods
and services for a particular financial year. Here, the government can identify the areas
that have the potential for export-oriented growth and can formulate policies
supporting those domestic industries.
 The government can adopt some protective measures such as higher tariff and duties
on imports so as to discourage imports of non-essential items and encourage the
domestic industries to be self-sufficient.
 If the economy needs support in the form of imports, the government can formulate
appropriate policies to divert the funds and technology imported to the critical sectors
of the economy that can drive future growth.
 If the country has a flourishing export trade, the government can adopt measures such
as devaluation of its currency to make its goods and services available in the
international market at cheaper rates and bolster exports.
 The government can also use the indications from Balance of Payments to discern the
state of the economy and formulate its policies of inflation control, monetary and fiscal
policies based on that
Regional economic Integration

Regional economic Integration refers to cooperation between various

countries of a particular region in order to develop that particular area. It
includes economic integration of various trading areas of different countries. It
is also known as Regional trade block, Regional economic forces and Regional
grouping. A regional trade block is a type of inter-governmental agreement, in
which barriers to trade are reduced or eliminated among participating
countries. Regional economic integration is a collaborative arrangement
between different countries in order to take advantage of market
opportunities and to promote economic growth and stability

Economic integration can be classified in five additive levels, each present in the global
landscape:

 Free trade.
Tariffs (a tax imposed on imported goods) between member countries are
significantly reduced, some abolished altogether. Each member country keeps its
own tariffs in regard to third countries. The general goal of free trade agreements is
to develop economies of scale and comparative advantages, which promotes
economic efficiency.

 Custom union.
Sets common external tariffs among member countries, implying that the same
tariffs are applied to third countries; a common trade regime is achieved. Custom
unions are particularly useful to level the competitive playing field and address the
problem of re-exports (using preferential tariffs in one country to enter another
country).

 Common market.
Services and capital are free to move within member countries, expanding scale
economies and comparative advantages. However, each national market has its own
regulations such as product standards.
 Economic union (single market).
All tariffs are removed for trade between member countries, creating an uniform
(single) market. There are also free movements of labour, enabling workers in a
member country is able to move and work in another member country. Monetary
and fiscal policies between member countries are harmonized, which implies a level
of political integration. A further step concerns a monetary union where a common
currency is used, such as with the European Union (Euro).

 Political union.
Represents the potentially most advanced form of integration with a common
government and were the sovereignty of member country is significantly reduced.
Only found within nation states, such as federations where there is a central
government and regions having a level of autonomy.
 World Trade Organisation (WTO)

World Trade Organisation (WTO) is a permanent international organisation dealing with

global rules of trade between nations. It came into existence in 1995. It is the successor of
General Agreement on Tariffs and Trade (GATT) established aftermath of Second World War.
The last round 1986-94 Uruguay round led to creation of WTO. At the heart of WTO is
multilateral trading system. It consists of WTO agreements negotiated and signed by majority
world’s trading nations and their parliaments. One of important functions of WTO is smooth
trade flow between nations.

The important objectives of WTO are:

1. To improve the standard of living of people in the member countries.

2. To ensure full employment and broad increase in effective demand.

3. To enlarge production and trade of goods.

4. To increase the trade of services.

5. To ensure optimum utilization of world resources.

6. To protect the environment.

7. To accept the concept of sustainable development.

Functions:
The main functions of WTO are discussed below:

1. To implement rules and provisions related to trade policy review mechanism.

2. To provide a platform to member countries to decide future strategies related to trade and
tariff.

3. To provide facilities for implementation, administration and operation of multilateral and

bilateral agreements of the world trade.

4. To administer the rules and processes related to dispute settlement.

5. To ensure the optimum use of world resources.

6. To assist international organizations such as, IMF and IBRD for establishing coherence in
Universal Economic Policy determination.