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 establishing business operations or acquiring business assets. FDI is a critical element of global economic integration, influencing the balance of payments, facilitating the flow of capital, and enabling companies to expand their reach into foreign markets while also creating potential challenges and opportunities for local businesses and economies.

5 Must Know Facts For Your Next Test

1. FDI can take many forms, including establishing new operations (greenfield investments), acquiring existing businesses (brownfield investments), or forming joint ventures.
2. FDI is a major component of the balance of payments account, recorded as an inflow when foreign entities invest domestically and as an outflow when domestic entities invest abroad.
3. Countries with favorable regulatory environments, infrastructure, and market potential typically attract higher levels of foreign direct investment.
4. FDI can lead to technology transfer and skill development in host countries, potentially boosting local economies and productivity.
5. While FDI brings benefits like job creation and economic growth, it can also pose challenges such as market dominance by foreign firms and potential negative impacts on local businesses.

Review Questions

• How does foreign direct investment impact a country's balance of payments?
  • Foreign direct investment significantly impacts a country's balance of payments by recording both inflows and outflows of capital. When foreign companies invest in domestic operations, it leads to capital inflows, positively contributing to the current account. Conversely, when domestic companies invest abroad, it results in capital outflows that can affect the financial account. Understanding these dynamics helps gauge the overall economic health and international competitiveness of a country.
• Discuss the relationship between foreign direct investment and economic globalization. What factors drive FDI in an increasingly interconnected world?
  • Foreign direct investment is both a product and a driver of economic globalization. Factors such as technological advancements, trade liberalization, and market expansion encourage companies to invest abroad to access new markets and resources. As businesses seek to capitalize on global opportunities, they engage in FDI to enhance their competitiveness while fostering international economic ties that can lead to increased trade and cooperation among nations.
• Evaluate the challenges that foreign direct investment presents for local businesses in host countries and suggest strategies for addressing these challenges.
  • Foreign direct investment can create challenges for local businesses, including increased competition from well-established multinational corporations that may dominate market share. This can stifle the growth of domestic firms and lead to potential job losses. To address these challenges, local businesses should focus on building competitive advantages through innovation, forming strategic alliances with foreign investors, and advocating for supportive government policies that promote fair competition while protecting local interests.

Related terms

Portfolio Investment: Investment in financial assets such as stocks and bonds in a foreign country, typically not involving direct control over the businesses.

Multinational Corporation: A corporation that operates in multiple countries beyond its home country, often engaging in foreign direct investment to establish a local presence.

Joint Venture: A business arrangement where two or more parties agree to pool their resources for a specific project or business activity, often seen in the context of FDI.