Foreign direct investment

Definition

Foreign direct investment (FDI) refers to the investment made by a company or individual in one country in business interests in another country, typically through establishing business operations or acquiring assets. FDI is crucial as it involves not just financial investments but also the transfer of technology, skills, and management expertise. This investment plays a vital role in shaping exchange rates, influencing the balance of payments, fostering international trade agreements, and driving economic growth through capital accumulation and job creation.

5 Must Know Facts For Your Next Test

1. FDI can lead to technology transfer from developed to developing countries, enhancing productivity and competitiveness.
2. Countries with favorable regulatory environments and economic stability tend to attract more foreign direct investment.
3. Foreign direct investment can influence exchange rates by increasing demand for local currency as foreign firms invest.
4. FDI is often associated with job creation in the host country, providing new employment opportunities and skills development.
5. Many countries offer incentives such as tax breaks or subsidies to attract foreign direct investment as part of their economic strategy.

Review Questions

• How does foreign direct investment impact the balance of payments of a host country?
  • Foreign direct investment impacts the balance of payments by providing capital inflows into the host country, which are recorded as credits in the financial account. This influx can improve the overall balance of payments position by offsetting trade deficits. Additionally, FDI leads to increased exports due to enhanced production capabilities, which further strengthens the balance of payments over time.
• Evaluate the role of international economic organizations in promoting foreign direct investment among member countries.
  • International economic organizations play a critical role in promoting foreign direct investment by creating frameworks that facilitate trade and investment flows among member countries. These organizations often negotiate trade agreements that reduce barriers to FDI, establish dispute resolution mechanisms, and encourage transparency and fair treatment for investors. By fostering an environment conducive to FDI, these organizations help stimulate economic growth and development within member nations.
• Assess how foreign direct investment contributes to long-term economic growth in developing countries, considering both benefits and potential drawbacks.
  • Foreign direct investment contributes to long-term economic growth in developing countries by bringing in capital, creating jobs, and transferring technology and skills that enhance productivity. However, it can also lead to drawbacks such as profit repatriation, where profits generated are sent back to the investor's home country instead of being reinvested locally. Additionally, excessive reliance on FDI might hinder domestic entrepreneurship if local businesses struggle to compete with larger multinational corporations. Thus, while FDI can be a catalyst for growth, it is essential for developing countries to manage it strategically to maximize benefits and minimize negative impacts.

Related terms

Portfolio Investment: A type of investment that involves purchasing financial assets like stocks and bonds, rather than establishing physical business operations in a foreign country.

Multinational Corporation: A corporation that operates in multiple countries, often through foreign direct investment to manage production or deliver services across different regions.

Balance of Payments: A financial statement that summarizes a country's transactions with the rest of the world, including trade, services, and capital flows like foreign direct investment.