A foreign direct investment (FDI) is an investment in the form of a controlling ownership in a

business in one country by an entity based in another country.[1] It is thus distinguished from a
foreign portfolio investment by a notion of direct control.

Foreign direct investment (FDI), investment in an enterprise that is resident in a country other
than that of the foreign direct investor. A long-term relationship is taken to be the crucial feature
of FDI. Thus, the investment is made to acquire lasting interest and control of the economic
entity, with an implied influence on the management of the enterprise. Some degree of equity
ownership is usually considered to be associated with an effective voice. Basic forms of FDI are
investment made to develop a production or manufacturing plant from the ground up
(“greenfield investments”), mergers and acquisitions, and joint ventures. Three components of
FDI are usually identified: equity capital, reinvested earnings, and intracompany loans. Other
than having an equity stake in an enterprise, foreign investors may acquire a substantial
influence in many other ways. Those include subcontracting, management contracts,
franchising, leasing, licensing, and production sharing.

Foreign direct investment (FDI) is an investment from a party in one country into a business
or corporation in another country with the intention of establishing a lasting interest. Lasting
interest differentiates FDI from foreign portfolio investments, where investors passively hold
securities from a foreign country. A foreign direct investment can be made by obtaining a lasting
interest or by expanding one’s business into a foreign country.

The origin of the investment does not impact the definition, as an FDI: the investment may be
made either "inorganically" by buying a company in the target country or "organically" by
expanding the operations of an existing business in that country.

Foreign direct investment is when an individual or business owns 10% or more of a foreign
company.1 If an investor owns less than 10%, the International Monetary Fund (IMF) defines it
as part of his or her stock portfolio.
Pros

Foreign direct investment benefits the global economy, as well as investors and recipients.
Capital goes to the businesses with the best growth prospects, anywhere in the world. Investors
seek the best return with the least risk. This profit motive is color-blind and doesn't care about
religion or politics.9

That gives well-run businesses, regardless of race, color, or creed, a competitive advantage. It
reduces the effects of politics, cronyism, and bribery. As a result, the smartest money rewards
the best businesses all over the world. Their goods and services go to market faster than
without unrestricted FDI.

Individual investors receive the extra benefits of lowered risk. FDI diversifies their holdings
outside of a specific country, industry, or political system. Diversification always increases return
without increasing risk.10

Recipient businesses receive "best practices" management, accounting, or legal guidance from
their investors. They can incorporate the latest technology, operational practices, and financing
tools. By adopting these practices, they enhance their employees' lifestyles. That raises the
standard of living for more people in the recipient country. FDI rewards the best companies in
any country. It reduces the influence of local governments over them.

Recipient countries see their standard of living rise. As the recipient company benefits from the
investment, it can pay higher taxes. Unfortunately, some nations offset this benefit by offering
tax incentives to attract FDI.2

Another advantage of FDI is that it offsets the volatility created by "hot money." That's when
short-term lenders and currency traders create an asset bubble. They invest lots of money all at
once, then sell their investments just as fast.

That can create a boom-bust cycle that ruins economies and ends political regimes. Foreign
direct investment takes longer to set up and has a more permanent footprint in a country. 11

Cons

Countries should not allow foreign ownership of companies in strategically important industries.
That could lower the comparative advantage of the nation, according to an IMF report.

Second, foreign investors might strip the business of its value without adding any. They could
sell unprofitable portions of the company to local, less sophisticated investors. They can use the
company's collateral to get low-cost, local loans. Instead of reinvesting it, they lend the funds
back to the parent company.

Methods of Foreign Direct Investment

As mentioned above, an investor can make a foreign direct investment by expanding their
business in a foreign country. Amazon opening a new headquarters in Vancouver, Canada
would be an example of this.

Reinvesting profits from overseas operations, as well as intracompany loans to overseas

subsidiaries, are also considered foreign direct investments.

Finally, there are multiple methods for a domestic investor to acquire voting power in a foreign
company. Below are some examples:

 Acquiring voting stock in a foreign company

  Mergers and acquisitions
 Joint ventures with foreign corporations
 Starting a subsidiary of a domestic firm in a foreign country

Benefits of Foreign Direct Investment

Foreign direct investment offers advantages to both the investor and the foreign host country.
These incentives encourage both parties to engage in and allow FDI.

Below are some of the benefits for businesses:

 Market diversification
 Tax incentives
 Lower labor costs
 Preferential tariffs
 Subsidies

Diversification is also covered in CFI’s corporate & business strategy course, make sure to
check it out!

The following are some of the benefits for the host country:

 Economic stimulation
 Development of human capital
 Increase in employment
 Access to management expertise, skills, and technology

For businesses, most of these benefits are based on cost-cutting and lowering risk. For host
countries, the benefits are mainly economic.

Advantages of FDI

In the context of foreign direct investment, advantages and disadvantages are often a matter of
perspective. An FDI may provide some great advantages for the MNE but not for the foreign
country where the investment is made. On the other hand, sometimes the deal can work out
better for the foreign country depending upon how the investment pans out. Ideally, there should
be numerous advantages for both the MNE and the foreign country, which is often a developing
country. We'll examine the advantages and disadvantages from both perspectives, starting with
the advantages for multinational enterprises (MNEs).

 Access to markets: FDI can be an effective way for you to enter into a foreign market.
Some countries may extremely limit foreign company access to their domestic markets.
Acquiring or starting a business in the market is a means for you to gain access.
 Access to resources: FDI is also an effective way for you to acquire important natural
resources, such as precious metals and fossil fuels. Oil companies, for example, often
make tremendous FDIs to develop oil fields.
 Reduces cost of production: FDI is a means for you to reduce your cost of production if
the labor market is cheaper and the regulations are less restrictive in the target foreign
market. For example, it's a well-known fact that the shoe and clothing industries have
been able to drastically reduce their costs of production by moving operations to
developing countries.

FDI also offers some advantages for foreign countries. For starters, FDI offers a source of
external capital and increased revenue. It can be a tremendous source of external capital for a
developing country, which can lead to economic development.

For example, if a large factory is constructed in a small developing country, the country will
typically have to utilize at least some local labor, equipment, and materials to construct it. This
will result in new jobs and foreign money being pumped into the economy. Once the factory is
constructed, the factory will have to hire local employees and will probably utilize at least some
local materials and services. This will create further jobs and maybe even some new
businesses. These new jobs mean that locals have more money to spend, thereby creating
even more jobs.

Disadvantages of Foreign Direct Investment

Despite many benefits, there are still two main disadvantages to FDI, such as:

 Displacement of local businesses

 Profit repatriation

The entry of large firms, such as Walmart, may displace local businesses. Walmart is often
criticized for driving out local businesses that cannot compete with its lower prices.
In the case of profit repatriation, the primary concern is that firms will not reinvest profits back
into the host country. This leads to large capital outflows from the host country.

As a result, many countries have regulations limiting foreign direct investment.

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.
However, two other forms of FDI have also been observed: conglomerate and platform FDI.

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.

What Are the Different Kinds of Foreign Investment?

International investment or capital flows fall into four principal categories: commercial loans, official
flows, foreign direct investment (FDI), and foreign portfolio investment (FPI).

Commercial loans, which primarily take the form of bank loans issued to foreign businesses or
governments.

Official flows, which refer generally to the forms of development assistance that developed nations give
to developing ones.

Foreign direct investment (FDI) pertains to international investment in which the investor obtains a
lasting interest in an enterprise in another country. Most concretely, it may take the form of buying or
constructing a factory in a foreign country or adding improvements to such a facility, in the form of
property, plants, or equipment.

FDI is calculated to include all kinds of capital contributions, such as the purchases of stocks, as well as
the reinvestment of earnings by a wholly owned company incorporated abroad (subsidiary), and the
lending of funds to a foreign subsidiary or branch. The reinvestment of earnings and transfer of assets
between a parent company and its subsidiary often constitutes a significant part of FDI calculations.
According to the United Nations Conference on Trade and Development (UNCTAD), the global expansion
of FDI is currently being driven by over 65,000 transnational corporations with more than 850,000
foreign affiliates.

An investor’s earnings on FDI take the form of profits such as dividends, retained earnings, management
fees and royalty payments.

Foreign portfolio investment (FPI), on the otherhand is a category of investment instruments that is
more easily traded, may be less permanent, and do not represent a controlling stake in an enterprise.
These include investments via equity instruments (stocks) or debt (bonds) of a foreign enterprise which
does not necessarily represent a long-term interest.
Stocks:

 dividend payments
 holder owns a part of a company
 possible voting rights
 open-ended holding period

Bonds:

 interest payments
 ownership of bond rights only
 no voting rights
 specific holding period

While FDI tends to be commonly undertaken by multinational corporations, FPI comes from my diverse
sources such as a small company’s pension or through mutual funds held by individuals.

The returns that an investor acquires on FPI usually take the form of interest payments or dividends.

Investments in FPI that are made for less than one year are distinguished as short-term portfolio flows.
FPI flows tend to be more difficult to calculate definitively, because they comprise so many different
instruments, and also because reporting is often poor. Estimates on FPI totals generally vary from levels
equaling half of FDI totals, to roughly one-third more than FDI totals.

The difference between FDI and FPI can sometimes be difficult to discern, given that they may overlap,
especially in regard to investment in stock. Ordinarily, the threshold for FDI is ownership of “10 percent
or more of the ordinary shares or voting power” of a business entity (IMF Balance of Payments Manual,
1993).

Calculating Investment: Calculations of FDI and FPI are typically measured as either a “flow,” referring to
the amount of investment made in one year, or as “stock,” measuring the total accumulated investment
at the end of that year.

Until the 1980s, commercial loans from banks were the largest source of foreign investment in
developing countries. However, since that time, the levels of lending through commercial loans have
remained relatively constant, while the levels of global FDI and FPI have increased dramatically. Over the
period 1991-1998, FDI and FPI comprised 90 percent of the total capital flows to developing countries.
Over the period of 1996-2006, FDI and FPI outflows from the United States more than doubled
(International Monetary Fund, 2007). Global FDI flows decreased significantly from 2007-2009 due to
the Financial Crisis and finally started rising again in 2010, though have still not reached pre-crisis levels.

Similarly, when viewed against the tremendous and growing volume of FDI and FPI, the funds provided
in the past by governments through official development assistance, or lending by commercial banks the
World Bank or IMF, are diminishing in importance with each passing year. Therefore, when one talks
about the recent phenomenon of globalization, one is referring in large part to the effects of FDI and FPI,
and these two instruments will therefore be the primary focus of this Issue in Depth.
A Look Into Foreign Direct Investment Trends

From countries just beginning to modernize, to the rich country club at the Organization for Economic
Cooperation and Development (OECD), the world is awash with opportunities for development. While
central bankers have control over an economy’s monetary levels and politicians control fiscal affairs,
these two groups often cannot jumpstart growth without outside help. Enter foreign direct investments
(FDI). In simple terms they are inflows or outflows of capital from one country to another, with common
examples including companies building factories abroad or investing in the development of an oil field.

Countries with the Most FDI

Each year more than $1 trillion in FDI flows into countries around the world, but the distribution is far
from equal. According to the UN Conference on Trade and Development (UNCTAD), the countries with
the greatest share of FDI to GDP in 2011 were:

1. Liberia
2. Mongolia
3. Hong Kong SAR (China)
4. Sierra Leone
5. Luxembourg
6. Singapore
7. Congo republic
8. Belgium
9. Chad
10. Guinea

What’s striking about this list is that the economies fall into two camps: countries known for natural
resource development and countries known for financial business services. Mongolia, Liberia, Guinea,
and Congo have significant mineral resources and have garnered the attention of big mining companies
such as ArcelorMittal (NYSE:MT). Others are known for the sort of offshore banking companies that
individuals use to avoid taxes elsewhere.

Economies by Total FDI

Viewing FDI as a percentage of GDP does not indicate the size of the economy being invested in. Some
of the economies listed above are much larger/smaller than others in terms of GDP alone, and when you
rank economies by total FDI dollars received the picture changes almost completely.

1. United States: $258 billion

2. China: $220 billion
3. Belgium: $102 billion
4. Hong Kong (China): $90 billion
5. Brazil: $72 billion
6. Australia: $66 billion
7. Singapore: $64 billion
8. Russia: $53 billion
 9. France: $45 billion
10. Canada: $40 billion

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