What Is a Foreign Direct Investment (FDI)?
A foreign direct investment (FDI) is an investment made by a firm or individual in one country into business interests located in another country. Generally, FDI takes place when an investor establishes foreign business operations or acquires foreign business assets in a foreign company. However, FDIs are distinguished from portfolio investments in which an investor merely purchases equities of foreign-based companies.
Foreign Direct Investment
- Foreign direct investments (FDI) are investments made by one company into another located in another country.
- FDIs are actively utilized in open markets rather than closed markets for investors.
- Horizontal, vertical, and conglomerate are types of FDI’s. Horizontal is establishing the same type of business in another country, while vertical is related but different, and conglomerate is an unrelated business venture.
- The Bureau of Economic Analysis continuously tracks FDIs into the U.S.
- Apple’s investment in China is an example of an FDI.
How a Foreign Direct Investment Works
Foreign direct investments are commonly made in open economies that offer a skilled workforce and above-average growth prospects for the investor, as opposed to tightly regulated economies. Foreign direct investment frequently involves more than just a capital investment. It may include provisions of management or technology as well. The key feature of foreign direct investment is that it establishes either effective control of or at least substantial influence over the decision-making of a foreign business.
The Bureau of Economic Analysis (BEA), which tracks expenditures by foreign direct investors into U.S. businesses, reported total FDI into U.S. businesses of $4.46 trillion at the end of 2019. Manufacturing represented the top industry, with just over 40% of FDI for 2019.
Countries rely on the U.S. using their manufacturing capabilities, where the U.S. provides a large benefit to their economy when utilized.
Foreign direct investments can be made in a variety of ways, including the opening of a subsidiary or associate company in a foreign country, acquiring a controlling interest in an existing foreign company, or by means of a merger or joint venture with a foreign company.
The threshold for a foreign direct investment that establishes a controlling interest, per guidelines established by the Organisation of Economic Co-operation and Development (OECD), is a minimum 10% ownership stake in a foreign-based company. However, that definition is flexible, as there are instances where effective controlling interest in a firm can be established with less than 10% of the company's voting shares.
Types of Foreign Direct Investment
Foreign direct investments are commonly categorized as being horizontal, vertical or conglomerate. A horizontal direct investment refers to the investor establishing the same type of business operation in a foreign country as it operates in its home country, for example, a cell phone provider based in the United States opening stores in China.
A vertical investment is one in which different but related business activities from the investor's main business are established or acquired in a foreign country, such as when a manufacturing company acquires an interest in a foreign company that supplies parts or raw materials required for the manufacturing company to make its products.
A conglomerate type of foreign direct investment is one where a company or individual makes a foreign investment in a business that is unrelated to its existing business in its home country. Since this type of investment involves entering an industry in which the investor has no previous experience, it often takes the form of a joint venture with a foreign company already operating in the industry.
Example of Foreign Direct Investments
Examples of foreign direct investments include mergers, acquisitions, retail, services, logistics, and manufacturing, among others. Foreign direct investments and the laws governing them can be pivotal to a company's growth strategy.
In 2017, for example, U.S.-based Apple announced a $507.1 million investment to boost its research and development work in China, Apple's third-largest market behind the Americas and Europe. The announced investment relayed CEO Tim Cook's bullishness toward the Chinese market despite a 12% year-over-year decline in Apple's Greater China revenue in the quarter preceding the announcement.
China's economy has been fueled by an influx of FDI targeting the nation's high-tech manufacturing and services, which according to China's Ministry of Commerce, grew 11.1% and 20.4% year over year, respectively, in the first half of 2017. Meanwhile, relaxed FDI regulations in India now allows 100% foreign direct investment in single-brand retail without government approval. The regulatory decision reportedly facilitates Apple's desire to open a physical store in the Indian market. Thus far, the firm's iPhones have only been available through third-party physical and online retailers.
Frequently Asked Questions
What is Foreign Direct Investment (FDI)?
Foreign Direct Investment (FDI) is the practice of starting or investing in businesses in foreign countries. For example, if an American multinational firm opens up operations in China or India, either by opening up its own premises or by partnering with a local firm, that investment would be considered part of FDI. Economists track the flows of FDI between countries as this is seen as an important contributor to economic growth.
What are the advantages and disadvantages of Foreign Direct Investment (FDI)?
FDI can help foster and maintain economic growth, both for the recipient country and for the country making the investment. For example, a developing country might benefit from incoming FDI as a way of financing the construction of new infrastructure or providing employment for its local workforce. On the other hand, multinational companies can benefit from FDI as a way to expand their footprint into international markets. One of the main disadvantages of FDI, however, are that it tends to rely on the involvement or oversight of multiple governments, leading to higher levels of political risk.
What are some examples of Foreign Direct Investment (FDI)?
One of the largest examples of Foreign Direct Investment (FDI) today is the Chinese initiative known as One Belt One Road (OBOR). This program, sometimes referred to as the “Belt and Road” initiative, involves contributing substantial FDI toward a range of infrastructure programs throughout Africa, Asia, and even parts of Europe. The FDI is typically funded by Chinese state-owned enterprises or other organizations associated with the Chinese government. Similar programs are also undertaken by other nations and international bodies, such as Japan, the United States, and the European Union (EU).