Foreign Direct Investment
The term foreign direct investment (FDI) refers to the purchase of an interest in a company from an investor or company that is located outside of the borders of the company in which the investment is made. In other words, we can define foreign direct investment as a foreign investor or company purchasing interest in a company from the USA or the other way around.
Simple stock investment in a foreign company does not equate with foreign direct investment. Usually, this term is used when we describe the decision of a company or investor to purchase a generous share in a business that is outside their jurisdiction. At the same time, foreign direct investment can mean simply buying a company intending to expand the business to new regions.
How does Foreign Direct Investment Work?
In general, companies that consider foreign direct investment in a business look at companies that share the following characteristics: the company is in an open economy, the environment of that economy offers a skilled workforce, and the company has above-average growth prospects. If the country also provides light regulation, this is a plus for potential investors.
Investors don’t limit themselves to only capital investments when it comes to foreign direct investment. For instance, the investor may also provide technology, management, and equipment to ensure a profitable future for the company.
The way in which foreign direct investment differs from stock investment in a foreign company is by establishing control over the foreign business or, at least, the possibility to influence the company’s decision-makers substantially.
Due to COVID-19, in 2020, the global market faced a sudden drop in foreign direct investments. From the previous year, when global investment had been at $1.5 trillion, in 2020, this fell to $859 billion. This also happened as China dislodged the US as a top investor, attracting over $163 billion in investment, while the US only managed to attract $134 billion.
Foreign direct investments can result from various practices. The most common are opening an associate or subsidiary company, purchasing a controlling interest in a company, or mergers or joint ventures with a foreign company.
While the definition of foreign direct investment is flexible, the Organization of Economic Cooperation and Development (OECD) established that a minimum of 10% ownership stake is required. In some instances, investors can achieve effective control with less than 10% of a company's voting shares.
Types of Foreign Direct Investment
There are three categories of foreign direct investments:
- Horizontal Direct Investment: company A establishes the same type of business in another country as they have in their own country by buying interest in providers of those services in the foreign country. For example, a US cell phone provider buys phone store chains in China.
- Vertical Direct Investment: company A buys a business in another country that’s complementary to their business in their country. For example, a US fashion brand acquires interest in a leather-making factory in India.
- Conglomerate Direct Investment: company A invests in a company from another country that is unrelated to their core business.
Advantages and Disadvantages of Foreign Direct Investment
In many ways, both parties involved in this economic practice benefit from it. While foreign direct investment fosters and maintains economic growth, infrastructure development, and new jobs for both of them, it is also a way for the company that invests to expand its footprint into international markets.
The downside of foreign direct investment, however, is that it deals with regulations from multiple governments and oversight. This can lead to a higher political risk. Also, regarding vertical direct investment, it’s important to note that manufacturing is regulated differently in the US than in other countries. The above example can further underline why this is problematic from an environmental perspective. To follow the example, India doesn’t have the laws and regulations imposed in the US. That means that while the labor and materials are cheaper there, the resulting pollution is much higher, impacting the sustainability of those products.
Popular Real Estate Terms
Generally, a turnaround means a performance improvement. The term applies to various economic fields and real estate too. What does turnaround mean? After a prolonged recession, a ...
The term developer’s profit is the actual profit generated by a developer’s project after the costs of the development have been covered. This profit can come from the sale of ...
Economic or physical life of a fixed asset. The property is depreciated over the period benefited. ...
Standard precut lumber sizes for lumber industry needs. The typical sizes are 2 to 5 inches thick by 5 to 12 inches wide. ...
People often need help understanding the difference between offeror vs offeree in real estate. A rhythm sets the stage from the first step in real estate transactions. It's the interaction ...
Oral defamation of the character or reputation of another. It is the basis for a lawsuit. ...
The person identified to receive the benefit of property held in trust. ...
Right of an individual to be offered something before it is offered to others. For example, a tenant whose apartment is going to be converted to a cooperative has the first right of ...
The Exclusive Agency Listing is regularly confused with the Exclusive Right to Sell Listing, but they are not the same. True: on both Listings, only 1 Broker or Agent has the right to sell ...
Have a question or comment?
We're here to help.