Foreign direct investment

Definition

Foreign direct investment (FDI) refers to an investment made by a company or individual in one country in business interests in another country, typically by establishing business operations or acquiring business assets. FDI can significantly impact economies, influencing everything from exchange rates to international capital flows and shaping the globalization landscape.

5 Must Know Facts For Your Next Test

1. FDI is often preferred by companies seeking long-term growth opportunities, as it provides greater control over operations compared to other forms of investment.
2. Exchange rate fluctuations can affect the profitability of FDI, as changes in currency values may impact the returns on investments made in foreign markets.
3. Countries with favorable policies towards FDI often attract more foreign investors, which can lead to job creation and economic growth in those host countries.
4. Offshore banking and tax havens can influence the flow of FDI, as companies may seek to minimize their tax liabilities by routing investments through these jurisdictions.
5. The impact of FDI on home countries includes both potential capital outflows as firms invest abroad and the repatriation of profits, which can strengthen or weaken domestic economies.

Review Questions

• How does foreign direct investment interact with exchange rate volatility and what implications does this have for investors?
  • Foreign direct investment can be significantly impacted by exchange rate volatility because fluctuations in currency values can alter the cost of doing business abroad and affect profit margins. For instance, if an investor's home currency strengthens against the host country's currency, the value of returns may decrease when converted back home. This risk can deter potential investors or lead them to seek hedging strategies to protect their investments from unfavorable currency movements.
• Discuss the role of foreign direct investment as a driver of international capital flows and how it compares to other types of investments.
  • Foreign direct investment serves as a crucial component of international capital flows, reflecting long-term commitments by investors in foreign markets. Unlike portfolio investments, which are more speculative and can be easily liquidated, FDI represents a significant commitment to building infrastructure, creating jobs, and transferring technology. This makes FDI a more stable source of capital for host countries compared to other forms of international investment that may be more volatile and subject to rapid withdrawal.
• Evaluate the benefits and challenges faced by emerging markets in attracting foreign direct investment, considering their impact on global financial stability.
  • Emerging markets can benefit from foreign direct investment through increased capital inflows, technology transfer, and job creation, which can enhance economic growth and development. However, challenges such as political instability, regulatory barriers, and inadequate infrastructure may deter potential investors. The inflow of FDI into these markets also raises concerns about global financial stability; if emerging markets become overly reliant on foreign investments, sudden capital flight due to global economic shifts could lead to financial crises and undermine their economic progress.

Related terms

Portfolio Investment: Investment in financial assets, such as stocks and bonds, where the investor does not have significant control over the companies in which they invest.

Capital Account: A component of the balance of payments that records all transactions involving the transfer of ownership of fixed assets and investments across borders.

Global Supply Chain: A network of production and distribution processes that spans multiple countries, enabling companies to source materials and produce goods efficiently across borders.