Foreign Direct Investment

Definition

Foreign direct investment (FDI) refers to the investment made by an entity or individual in one country into business interests located in another country. This can involve establishing new operations, acquiring or merging with an existing company, or expanding the operations of an existing foreign-owned business.

5 Must Know Facts For Your Next Test

1. Foreign direct investment can contribute to economic growth and development by bringing in new technologies, management expertise, and access to global markets.
2. Governments often offer incentives, such as tax breaks or subsidies, to attract foreign direct investment as a means of boosting domestic employment and economic activity.
3. The flow of foreign direct investment can be influenced by factors such as political and economic stability, the size and growth potential of the host country's market, and the availability of skilled labor.
4. Concerns around foreign direct investment include the potential for job displacement, the transfer of wealth and profits to the home country of the investing entity, and the impact on local businesses and industries.
5. The level of foreign direct investment can be an indicator of a country's economic competitiveness and its ability to attract and retain global capital.

Review Questions

• Explain how foreign direct investment can contribute to the components of economic growth, as discussed in Topic 7.3.
  • Foreign direct investment can contribute to the components of economic growth in several ways. By bringing in new technologies, management expertise, and access to global markets, FDI can help increase productivity and efficiency, which are key drivers of economic growth. Additionally, the influx of foreign capital and the establishment of new businesses can lead to the creation of new jobs and the expansion of the domestic workforce, thereby increasing the labor input to the economy. Furthermore, the increased competition and knowledge spillovers from foreign firms can stimulate innovation and the adoption of best practices, further enhancing the economy's growth potential.
• Discuss how foreign direct investment relates to the concept of economic convergence, as covered in Topic 7.4.
  • The relationship between foreign direct investment and economic convergence is complex. On one hand, FDI can contribute to the convergence of living standards and productivity levels between developed and developing countries. By bringing in new technologies, management expertise, and access to global markets, FDI can help boost the productivity and competitiveness of the host country, potentially leading to faster economic growth and a narrowing of the development gap. However, FDI can also exacerbate economic disparities if the benefits are concentrated in certain regions or industries, or if the foreign firms displace local businesses and capture a disproportionate share of the market. The ultimate impact of FDI on economic convergence depends on the specific policies and institutional frameworks in place to ensure that the benefits of FDI are widely shared across the population.
• Analyze how the flow of foreign direct investment can influence a country's trade balances and the overall flows of financial capital, as discussed in Topic 10.3.
  • The flow of foreign direct investment can have a significant impact on a country's trade balances and the overall flows of financial capital. When a foreign entity invests in a domestic business, it often brings in capital, technology, and expertise that can enhance the productivity and competitiveness of the host country's exports. This can lead to an improvement in the trade balance, as the host country's exports may increase relative to its imports. However, the repatriation of profits and dividends by the foreign investor can also result in outflows of financial capital, potentially offsetting some of the trade benefits. Additionally, the presence of foreign-owned businesses can affect the exchange rate dynamics, as the demand for the host country's currency may increase to facilitate the FDI transactions. These complex interactions between FDI, trade balances, and financial capital flows highlight the need for policymakers to carefully manage the costs and benefits of foreign direct investment to ensure sustainable economic development.

Related terms

Multinational Corporation (MNC): A large company that has operations and assets in multiple countries, often engaging in foreign direct investment to expand its global reach.

Portfolio Investment: Investments made in foreign financial assets, such as stocks or bonds, without the intent of gaining managerial control over the underlying business.

Economic Globalization: The process of increased integration and interdependence of national economies and markets, driven in part by the growth of foreign direct investment across borders.