FDI or, Foreign Direct Investment: Concept and Types

FDI or, Foreign Direct Investment: Concept and Types

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A type of cross-border investment known as foreign direct investment (FDI) occurs when a resident investor in one economy acquires a significant amount of influence and a long-term interest in a business in another economy. Evidence of such a relationship can be found in the fact that an investor in a different economy owns 10% or more of the voting power in an enterprise in one economy. Because it establishes connections between economies that are stable and enduring, foreign direct investment (FDI) is an essential component of international economic integration. Foreign direct investment (FDI) can be an important vehicle for economic development, facilitates international trade by providing access to foreign markets, and is an important conduit for the transfer of technology between nations. This group covers inbound and outbound stock, flow, and income values by partner country, industry, and FDI restrictiveness indicators. If a long-term interest is established, an investment in a foreign company is an FDI. When an investor acquires at least 10% of a company's voting power, they have a lasting interest.

Control is essential for foreign direct investment. The intention to actively manage and influence the operations of a foreign company is referred to as control. The most important difference between FDI and a passive foreign portfolio investment is this. To define FDI, a 10% stake in the voting stock of the foreign company is required. However, this criterion is not always used in all situations. For instance, even if you only own a small amount of voting stock, you can still control more widely traded businesses.

Methods of Foreign Direct Investment

As previously stated, an investor can expand their business in a foreign nation to make a foreign direct investment. An illustration of this would be Amazon opening a new headquarters in Vancouver, Canada. Foreign direct investments also include intra-company loans to overseas subsidiaries and reinvesting profits from overseas operations. Lastly, a domestic investor can acquire voting rights in a foreign company in a variety of ways. Here are just a few examples:

1. Acquiring voting stock in an international business

2. Acquisitions and mergers

3. Partnerships with multinational corporations abroad

4. Establishing a foreign subsidiary of a domestic company

Benefits of Foreign Direct Investment - Foreign direct investment benefits both the investor and the host nation. Both parties are motivated to participate in and allow FDI by these incentives. The following are a few advantages for businesses:

1. Diversification of the market

2. Tax incentives

3. Reduce labor expenses

4. Prioritized tariffs

5. Subsidies

The benefits for the host nation include the following:

1. Stimulation to the economy

2. The growth of human capital

3. Access to technology, skills and expertise

Disadvantages of Foreign Direct Investment - Despite its many advantages, FDI still has two main drawbacks, which include:

1. The loss of local businesses

2. Repatriation of profits

For instance, the entry of large corporations like Walmart may force local businesses out of business. The main concern with profit repatriation is that businesses won't put profits back into the host nation. The host nation experiences significant capital outflows as a result. Consequently, regulations restricting foreign direct investment exist in many nations.

Types of Foreign Direct Investment

There are typically two primary types of FDI: FDI, both horizontal and vertical.

a) Horizontal - A company moves its domestic operations to a different nation. In this instance, the company carries out the same operations in another country. Horizontal foreign direct investment, for instance, would be McDonald's opening of restaurants in Japan.

b) Vertical - By moving up a level in the supply chain, a company moves into a new country. To put it another way, a company may engage in a variety of activities abroad, but these activities are still connected to the primary business. McDonald's could buy a large Canadian farm to produce meat for their restaurants, using the same example.

However, two additional types of FDI have been observed as well: FDI into platforms and conglomerates.

(c) Conglomerate - A company acquires a foreign business that is not related to it. This is uncommon because it necessitates overcoming two entry requirements: establishing oneself in a new country and sector or market. An illustration of this would be the acquisition of a clothing line in France by Virgin Group, which has its headquarters in the United Kingdom.

(d) Platform - A company expands into a new country, but the goods produced there are exported to a third nation. The term "export-platform FDI" is another name for this. Within free-trade zones, low-cost locations are frequently the location of platform FDI.