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 through the establishment of business operations or the acquisition of assets. This form of investment plays a crucial role in shaping international economic relationships, influencing balance of payments, capital flows, and monetary policy decisions across borders.

5 Must Know Facts For Your Next Test

1. FDI can take the form of establishing new business operations (greenfield investments) or acquiring existing businesses (brownfield investments).
2. Countries with favorable investment climates, such as stable governments and open markets, tend to attract more foreign direct investment.
3. FDI is often seen as a long-term investment compared to other types of capital flows, contributing to sustainable economic growth in host countries.
4. Foreign direct investment can significantly affect the balance of payments by creating income flows through dividends, interest payments, and reinvested earnings.
5. Government policies, including tax incentives and regulatory frameworks, play a critical role in attracting or deterring foreign direct investment.

Review Questions

• How does foreign direct investment impact a country's balance of payments?
  • Foreign direct investment directly influences a country's balance of payments by affecting both the capital and current accounts. When FDI occurs, it appears as an inflow in the capital account, reflecting the funds being invested in local businesses or assets. Additionally, subsequent income generated from these investments—like profits repatriated to the investor's home country—affects the current account. This interaction demonstrates how FDI can create significant economic activity while impacting financial reporting between nations.
• Analyze how government policies can either promote or hinder foreign direct investment within a country.
  • Government policies play a crucial role in shaping the landscape for foreign direct investment. Policies that promote FDI might include tax breaks for investors, streamlined regulations, and incentives for technology transfer. Conversely, restrictive policies such as high tariffs, stringent regulations, and nationalization fears can deter potential investors. By understanding these dynamics, policymakers can create an environment that encourages FDI, fostering economic growth and job creation.
• Evaluate the long-term effects of foreign direct investment on both host and home countries in terms of economic development and capital flows.
  • The long-term effects of foreign direct investment are complex and multifaceted for both host and home countries. For host countries, FDI can lead to technology transfer, job creation, and improved infrastructure, ultimately spurring economic development. However, it may also result in profit repatriation that could negatively affect local economies. For home countries, while FDI may lead to capital outflows initially, it can enhance competitiveness through access to new markets. Over time, the interplay between these factors highlights how FDI contributes to global capital flows and economic interdependence.

Related terms

portfolio investment:

Portfolio investment involves the purchase of financial assets, such as stocks and bonds, in a foreign country without significant control over the companies issuing those securities.

multinational corporation: A multinational corporation is a company that operates in multiple countries, often conducting FDI to establish production facilities or subsidiaries abroad.

capital account: The capital account is a component of a country's balance of payments that records all transactions involving the purchase and sale of assets, including foreign direct investment.