Foreign Direct Investment (FDI)

A foreign direct investment (FDI) is made by an individual or an organization, into a business located in a foreign country. The host nation receives job creation prospects, advanced technology, a higher standard of living, infrastructural development, and overall economic growth.

According to the Organization for Economic Co-operation and Development (OECD), any foreign investor possessing 10% or more ownership in a foreign organization is labeled a 'lasting interest.' Lasting interest status helps foreign individuals or organizations exercise a meaningful influence on the company's management.

• Foreign direct investment (FDI) is a strategy for contributing funds and resources—to establish business units in foreign countries.
• In addition to the funds, the investment includes technology, equipment, raw materials, knowledge, and management skills.
• The investing companies get favorable deals—resources, workforce, facilities, land concessions, tax concessions, and subsidies. It gives investors an opportunity to expand their business into a new market.

Foreign direct investment (FDI) is a method of business expansion—it involves international mergers, acquisitions, and the development of new facilities outside geographical boundaries. It is important for both—the investor nation and the host nation. The former gets tax benefits and relaxed regulations. The latter receives capital which can lead to growth.

Investing nations look for host nations possessing natural resources, human resources, technology, and ease of establishment. Host nations with a struggling economy openly welcome investment.

The foreign direct investment regulation aims at gaining a controlling interest in foreign companies. According to The Organization for Economic Co-operation and Development (OECD), any foreign investor with 10% or more ownership in business located in another country is labeled a 'lasting interest. Foreign direct investment is different from foreign portfolio investment (FPI). The former is a company's contribution towards a foreign business—for expansion. The latter refers to the purchase of securities belonging to a foreign company.

Depending on the type of company(recipient), there are four different kinds of foreign direct investments (FDI):

• Horizontal FDI: Here, investors put their money on foreign companies that operate in the same industry—niche in which the investor operates domestically. This way, firms expand their existing business into different nations.
• Vertical FDI: When a company acquires or merges with a foreign company to add more value to its supply chain, it is called a vertical FDI. For example, if an automobile company invests in a foreign company manufacturing semi-conductor chips, the vertical integration would improve supply chain.
• Conglomerate FDI: Here, investors invest in completely different segments—unrelated to their existing operations. 
• Platform FDI: It is a unique form of FDI—businesses invest in a foreign company to manufacture goods. They then sell the finished product in a third country. 

Following are favorable factors in foreign direct investment regulation that a foreign investor looks for:

• Open Economy: Foreign direct investments are made when a host nation possesses an open economy—welcoming investments from developed countries. Investors avoid capital investment in a closed economy.
• Above-Average Growth: Usually, foreign investors are less interested in established markets. If a country is still developing with room for above-average growth, investments are more likely.
• Environmental Stability: Investors prefer sound political environments and geographically well-positioned nations.
• Skilled and Cheap Labour: Investors intend to employ affordable human resources with basic skills like communication and technical know-how.
• Exchange Rate Stability: The exchange rates between the investor and host nations should not fluctuate too much.
• Government Support: Investing companies often look for concessions—tax policies lenient towards the FDI.
• Return on Investment: Investors anticipate high returns—there should be sufficient scope for profitability, as per the foreign direct investment data.
• Good Infrastructure: Investors prefer countries that provide better infrastructure —networks, transportation, and other facilities that can further ease business operations.

Prominent FDI routes are as follows:

#1 – Greenfield Investments

As per the foreign direct investment statistics, many companies start everything from scratch when operating in a foreign country. They build new factories and train the workforce.

McDonald's and Starbucks India are examples of that. Both started from scratch and became prominent in a foreign nation. These are called greenfield investments.

#2 – Brownfield Investments

It can be viewed as a shortcut. Some foreign businesses decide not to start from scratch—they save time and effort. Instead, they expand their business by going for cross-border mergers. As a result, they can operate right away. Tata Motors' acquisition of Jaguar is one such example. Tata did not need to build a new factory in the UK. Instead, they picked up where Jaguar left; from the existing factory.

Let us understand the concept of foreign direct investment statistics with the help of some suitable examples.

Example #1

Many American companies and European companies invested in Ukraine—Nestlé, ArcelorMittal, BASF, Bayer, and 1000 other businesses. However, amidst the 2022 Russian attacks on the host country, an evacuation was recommended. But, the businesses relied on their contingency plans to deal with the adversities—postponing evacuation.

Example #2

In 2020. during the Covid pandemic, popular companies invested in India—Google, Facebook, and Walmart. Moreover, Facebook made an FDI of $5.7 billion into Reliance Jio.

There are various important reasons why the foreign investments are necessary in an economy. Let us study the points which highlight the main objectives of such an investment.

• Market expansion – These kinds of investments help broaden an economy's market, as per the foreign direct investment data. If foreign companies invest in the domestic economy and vice versa, there is an exchange of products and services within these two countries, leading to expansion of customer base, demand, and opportunity to sell.
• Increase in profits – Due to increase in area and number of customers the profitability increases. A country can now sell its goods not only domestically, but also internationally. Investors get opportunities to access foreign markets and increase their potential for better returns.
• Better resource – Each country getting the facility of FDI will also have access to better quality and more amount of resources in the form of funds, labor, raw materials, etc. Such resources may not always be available within the domestic economy.
• Reduce cost – Many companies look for investment in the foreign markets in order to reduce the cost of production and take advantage of low cost of labor, easily available raw materials, low cost of technology, etc. This makes production profitable because the overall cost and comes down and goods become more competitive in the global markets.
• Better technology – Corporation often get better access to technology, innovation and development and research opportunities due to investments in other international economies. They get the chance of exposure to advanced level of technologies.
• Brand building – Many organizations try to get access to foreign markets in order to promote their brands in global markets and increase their sales. It helps in enhancing their reputation and image internationally.
• Competition - It helps in increasing the competition of organizations at global level, access to international distribution and supply chain networks, through patnerships and strategic alliances. It also improves skill, expertise and customer relations.  

Let us look at some of the advantages and disadvantages of the concept.

Advantages:

• Foreign Direct Investment (FDI) is an opportunity for emerging economies. At the same time, it paves the way for investors who want to expand into new geographical regions.
• The above opportunities help them to reduce their cost of production since they get access to better resources at reduced cost.
• The profitability increases due to foreign direct investment policy, because of lowering of cost and increase in sales. These profits can be further invested in the organization for better infrastructure, development and expansion.
• Investors avail themselves affordable workforce, rare natural resources, cheaper setups, available land, tax benefits, and subsidies.
• Investors can tap into uncaptured market potential by investing in developing countries.
• For the host nation, more investment means better infrastructure, flooding job opportunities, new technology, new machinery, and trained labor. Also, FDI stabilizes the host nation's exchange rate, increases imports, improves exports, and encourages innovation.
• Due to FDI, there is an improvement in strategic alliances, better supply chain management and betterment of investment opportunities both in the host country as well as the economy where the investment is taking place.

Disadvantages

However, there are a couple of drawbacks in the foreign direct investment policy.

• FDI discourages domestic businesses; they can't always compete with global players. Due to entry of foreign investments, very often the domestic companies lose their market and end up running at a loss, and close down in the long run.
• It is a capital-intensive decision; natural calamities or political unrest occurring in a host nation can cause significant losses. Cultural differences also offer a challenge—many FDIs fail due to inefficient management and local protests.
• Many foreign companies enter economies for better and cheaper access to markets, labor, raw materials, and other resources. This sometimes leads to exploitation and overuse of such resources. Therefore, the foreign company makes money at the cost of the domestic market, which may ultimately not benefit the domestic economy.

Both the above concepts are related to investment in foreign countries. However, there are some differences between the two concepts.

• The former involves a direct investment in a company of any other country, but the latter involves investment in foreign assets or portfolios of other foreign companies.
• In case of the former, the company investing in any foreign company get significant ownership and control of the entity being invested in whereas in case of the latter, there is no transfer to control or ownership.
• The former refers to a long-term concept whereas the latter refers to a medium- or short-term concept.
• The former is mainly associated with processes like joint venture, establishing subsidiaries, etc, but the latter mainly involves transactions in financial instruments, with the objective of earning capital gains or investment returns.
• There is always a huge amount of risk involved in case of the former because the process leads to entering a foreign market and establish business over there, which means lots of challenges and financial commitment.  

Thus, the above are some key differences between the two types of investments in the global markets, which mainly lead to strategic control and ownership.

This has been a guide to what is Foreign Direct Investment (FDI). We explain it with examples, advantages & disadvantages & methods. You may learn more about economics from the following articles -

• Full-Form of FDI
• Real GDP Meaning
• What is Hyperinflation?