Understanding Foreign Direct Investment (FDI)

Definition

Foreign direct investment (FDI) plays an extraordinary and growing role in global business. It can provide a firm with new markets and marketing channels, cheaper production facilities, access to new technology, products, skills and financing. For a host country or the foreign firm which receives the investment, it can provide a source of new technologies, capital, processes, products, organisational technologies and management skills, and as such can provide a strong impetus to economic development.    Foreign direct investment, in its classic definition,  is defined as a company from one country making a physical investment into building a factory in another country.  The direct investment in buildings, machinery and equipment is in contrast with making a portfolio investment, which is considered an indirect investment. In recent years, given rapid growth and change in global investment patterns, the definition has been broadened to include the acquisition of a lasting management interest  in a company or enterprise outside the investing firm’s home country. As such, it may take many forms, such as a direct acquisition of a foreign firm, construction of a  facility, or investment in a joint venture or strategic alliance with a local firm with attendant input of technology, licensing of intellectual property,   In the past decade, FDI has come to play a major role in the internationalisation of business. Reacting to changes in technology, growing liberalisation of the national regulatory framework governing investment in enterprises, and changes in capital markets profound changes have occurred in the size, scope and methods of FDI. New information technology systems, decline in global communication costs have made management of foreign investments far easier than in the past. The sea change in trade and investment policies and the regulatory environment globally in the past decade, including trade policy and tariff liberalisation, easing of restrictions on foreign investment and acquisition in many nations, and the deregulation and privatisation of many industries, has probably been been the most significant catalyst for FDI’s expanded role.

 

The most profound effect has been seen in developing countries, where yearly foreign direct investment flows have increased from an average of less than $10 billion in the 1970’s to a yearly average of less than $20 billion in the 1980’s, to explode in the 1990s from $26.7billion in 1990 to $179 billion in 1998 and $208 billion in 1999 and now comprise a large portion of global FDI..   Driven by mergers and acquisitions and internationalisation of production in a range of industries, FDI into developed countries last year rose to $636 billion, from $481 billion in 1998 (Source: UNCTAD)

Proponents of foreign investment point out that the exchange of investment flows benefits both the home country (the country from which the investment originates) and the host country (the destination of the investment).  Opponents of FDI note that multinational conglomerates are able to wield great power over smaller and weaker economies and can drive out much local competition.  The truth lies somewhere in the middle.

For small and medium sized companies, FDI represents an opportunity to become more actively involved in international business activities.  In the past 15 years, the classic definition of FDI as noted above has changed considerably.  This notion of a change in the classic definition, however, must be kept in the proper context. Very clearly, over 2/3 of direct foreign investment is still made in the form of fixtures, machinery, equipment and buildings. Moreover, larger multinational corporations and conglomerates still make the overwhelming percentage of FDI. But, with the advent of the Internet, the increasing role of technology, loosening of  direct investment restrictions in many markets and decreasing communication costs means that newer, non-traditional forms of investment will play an important role in the future.   Many governments, especially in industrialised and developed nations, pay very close attention to foreign direct investment because the investment flows into and out of their economies can and does have a significant impact.  In the United States, the Bureau of Economic Analysis, a section of the U.S. Department of Commerce, is responsible for collecting economic data about the economy including information about foreign direct investment flows.  Monitoring this data is very helpful in trying to determine the impact of such investments on the overall economy, but is especially helpful in evaluating industry segments. State and local governments watch closely because they want to track their foreign investment attraction programs for successful outcomes.