Foreign direct investment

Foreign direct investment (FDI) is defined as a long term investment by a foreign direct investor in an enterprise resident in an economy other than that in which the foreign direct investor is based. The FDI relationship, consists of a parent enterprise and a foreign affiliate which together form a Transnational Corporation (TNC). In order to qualify as FDI the investment must afford the parent enterprise control over its foreign affiliate. The UN defines control in this case as owning 10% or more of the ordinary shares or voting power of an incorporated firm or its equivalent for an unincorporated firm.

In the years after the Second World War global FDI was dominated by the United States, as much of the world recovered from the destruction wrought by the conflict. The U.S. accounted for around three-quarters of new FDI (including reinvested profits) between 1945 and 1960. Since that time FDI has spread to become a truly global phenomenon, no longer the exclusive preserve of OECD countries. FDI has grown in importance in the global economy with FDI stocks now constituting over 20% of global GDP. In the last few years, the emerging market countries such as China and India have become the most favoured destinations for FDI and investor confidence in these countries has soared. As per the FDI Confidence Index compiled by A.T. Kearney for 2005, China and India hold the first and second position respectively, whereas United States has slipped to the third position.

Types of FDI

• Greenfield investment: direct investment in new facilities or the expansion of existing facilities. Greenfield investments are the primary target of a host nation’s promotional efforts because they create new production capacity and jobs, transfer technology and know-how, and can lead to linkages to the global marketplace. However, it often does this by crowding out local industry; multinationals are able to produce goods more cheaply (because of advanced technology and efficient processes) and uses up resources (labor, intermediate goods, etc). Another downside of greenfield investment is that profits from production do not feed back into the local economy, but instead to the multinational's home economy. This is in contrast to local industries whose profits flow back into the domestic economy to promote growth.

• Mergers and Acquisitions: occur when a transfer of existing assets from local firms to foreign firms takes place, this is the primary type of FDI. Cross-border mergers occur when the assets and operation of firms from different countries are combined to establish a new legal entity. Cross-border acquisitions occur when the control of assets and operations is transferred from a local to a foreign company, with the local company becoming an affiliate of the foreign company. Unlike greenfield investment, acquisitions provide no long term benefits to the local economy-- even in most deals the owners of the local firm are paid in stock from the acquiring firm, meaning that the money from the sale could never reach the local economy. Nevertheless, mergers and acquisitions are a significant form of FDI and until around 1997, accounted for nearly 90% of the FDI flow into the United States.

• Horizontal Foreign Direct Investment: is investment in the same industry abroad as a firm operates in at home.

• Vertical Foreign Direct Investment: Takes two forms:

1) backward vertical FDI: where an industry abroad provides inputs for a firm's domestic production process

2) forward verticle FDI: in which an industry abroad sells the outputs of a firm's domestic production processes.

References

• IMF (1993) Balance of Payments Manual, Fifth edition, Washington D.C.
• OECD (1996) Benchmark Definition of Foreign Direct Investment, Third edition, Paris.
• IMF (2003) Foreign Direct Investment Statistics - How Countries Measure FDI 2001, 2003, Washington D.C.
• Hill (2005), "International Business: Competing in the global marketplace", 5th Edn., McGraw-Hill, p.223, 229
• Bishop Matthew, Essential Economics
• UNCTAD World Investment Report

See also

• International investment position
• Bilateral Investment Treaty
• Multilateral Investment Guarantee Agency
• International Services Trade Information Agency

External links

• The Investment Promotion Network (IPAnet), a portal site providing access to information and analysis for companies seeking to invest in developing countries (Operated by the Multilateral Investment Guarantee Agency of the World Bank Group)
• OECD work on international investment
• Foreign Market Watch
• World Investment Report (UNCTAD)
• FDI: A lead driver for Sustainable Development? (Earth Summit 2002)
• World Bank archived online discussion: "Do Changing FDI Trends Require Governments to Adopt New Promotion Strategies?"
• The International Services Trade Information Agency (ISTIA) (Geneva, Switzerland) provides FDI statistical capacity building services to developing country governments, as a part of greater services trade-related statistics work.