Foreign direct investment

Definition

Foreign direct investment (FDI) occurs when a company or individual invests directly in business operations in another country, typically by acquiring a substantial ownership stake in a foreign enterprise. This form of investment is a critical component of globalization as it fosters cross-border economic integration and can lead to significant changes in local economies and industries.

5 Must Know Facts For Your Next Test

1. FDI can significantly impact host countries by creating jobs, transferring technology, and fostering innovation in local industries.
2. Countries often create favorable policies to attract FDI, such as tax incentives, streamlined regulations, and improved infrastructure.
3. FDI flows are sensitive to economic conditions, political stability, and exchange rate fluctuations in both home and host countries.
4. Emerging markets tend to attract more FDI due to their growth potential and untapped markets compared to developed economies.
5. The United Nations Conference on Trade and Development (UNCTAD) regularly reports on global FDI trends and their implications for economic development.

Review Questions

• How does foreign direct investment contribute to globalization and what are its economic implications for both home and host countries?
  • Foreign direct investment plays a crucial role in globalization by facilitating the movement of capital, technology, and expertise across borders. For host countries, FDI can lead to economic growth through job creation, technology transfer, and improved infrastructure. Conversely, home countries may benefit from increased profits and the ability to access new markets. However, there can be drawbacks, such as potential job losses in the home country or over-dependence on foreign capital for the host country.
• Analyze how changes in exchange rates can affect foreign direct investment flows between countries.
  • Exchange rate fluctuations can have a significant impact on foreign direct investment flows. A stronger currency in the home country makes foreign investments more expensive, potentially discouraging companies from investing abroad. Conversely, if the host country's currency is weaker, it may appear cheaper for investors, thereby attracting more FDI. Moreover, companies often engage in hedging strategies to manage risks associated with exchange rate volatility, influencing their investment decisions.
• Evaluate the long-term effects of foreign direct investment on economic development in emerging markets compared to developed economies.
  • Foreign direct investment has profound long-term effects on economic development, particularly in emerging markets where it can drive industrialization, improve infrastructure, and enhance human capital through skill transfer. In contrast, developed economies may experience slower growth due to established industries but benefit from reinvestment and innovation spurred by FDI. The challenge for emerging markets lies in ensuring that FDI translates into sustainable development while avoiding over-reliance on foreign capital. An effective regulatory environment is crucial for maximizing the positive impacts of FDI.

Related terms

Portfolio Investment: A type of investment that involves purchasing financial assets, such as stocks or bonds, in another country without taking control of the business.

Multinational Corporation: A company that operates in multiple countries, often managing production or delivering services across international borders.

Exchange Rate: The value of one currency for the purpose of conversion to another, which can significantly influence the level of FDI due to the cost implications for investors.