Foreign direct investment

Definition

Foreign direct investment (FDI) is 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 significant as it involves not just capital transfer but also the establishment of a lasting interest in a foreign entity, which can lead to increased economic activity, technology transfer, and job creation in the host country.

5 Must Know Facts For Your Next Test

1. FDI can take various forms, including mergers, acquisitions, joint ventures, and establishing new operations.
2. Countries often attract FDI by offering incentives such as tax breaks, favorable regulations, and access to local markets.
3. FDI can contribute significantly to economic growth in host countries by increasing capital inflows and creating jobs.
4. The motivations behind FDI often include market access, resource acquisition, and seeking competitive advantages.
5. While FDI can lead to positive outcomes, it may also raise concerns about foreign control over domestic industries and impacts on local economies.

Review Questions

• How does foreign direct investment differ from portfolio investment, and what implications does this have for host countries?
  • Foreign direct investment differs from portfolio investment in that FDI involves a lasting interest and control over business operations in the host country, while portfolio investment refers to financial investments without control. This distinction has significant implications for host countries, as FDI often leads to job creation, technology transfer, and economic growth, whereas portfolio investments might not result in substantial local economic impacts. Host countries benefit more from FDI because it fosters long-term relationships and stability.
• Evaluate the factors that influence a company's decision to pursue foreign direct investment and how these factors impact the host country’s economy.
  • Several factors influence a company's decision to pursue foreign direct investment, including the desire for market expansion, resource acquisition, and cost efficiencies. These decisions can significantly impact the host country's economy by introducing capital inflows, creating jobs, and enhancing technological capabilities. However, they can also lead to challenges such as foreign control over key industries and potential negative effects on local businesses if not managed properly.
• Assess the role of exchange rates in shaping foreign direct investment decisions and their potential effects on international economic relations.
  • Exchange rates play a crucial role in shaping foreign direct investment decisions as they affect the cost of investing abroad and the profitability of overseas operations. When a country's currency is strong relative to others, it may deter FDI because local investments become more expensive. Conversely, favorable exchange rates can encourage investments. This dynamic influences international economic relations by affecting capital flows between countries, impacting trade balances, and shaping competitive advantages on a global scale.

Related terms

Portfolio Investment: Investment in financial assets like stocks and bonds in a foreign country without seeking control over the companies.

Multinational Corporation: A company that operates in multiple countries, often engaging in foreign direct investment to establish local operations.

Exchange Rate Risk: The potential for losses due to fluctuations in exchange rates when conducting international business transactions.