What is Foreign Direct Investment (FDI)?

What is Foreign Direct Investment (FDI)?

Foreign direct investment (FDI) is a category of cross-border investment in which an investor resident in one economy establishes a lasting interest in and a significant degree of influence over an enterprise resident in another economy.

Ownership of 10 percent or more of the voting power in an enterprise in one economy by an investor in another economy is evidence of such a relationship. FDI is a key element in international economic integration because it creates stable and long-lasting links between economies.

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 intra-company 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

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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

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

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.