What Is a Foreign Direct Investment (FDI)?
Foreign direct investment (FDI) is an ownership stake in a foreign company or project made by an investor, company, or government from another country.
Generally, the term is used to describe a business decision to acquire a substantial stake in a foreign business or to buy it outright to expand operations to a new region. The term is usually not used to describe a stock investment in a foreign company alone. FDI is a key element in international economic integration because it creates stable and long-lasting links between economies.
- Foreign direct investments (FDIs) are substantial, lasting investments made by a company or government into a foreign concern.
- FDI investors typically take controlling positions in domestic firms or joint ventures and are actively involved in their management.
- The investment may involve acquiring a source of materials, expanding a company’s footprint, or developing a multinational presence.
- The top recipients of FDI over the past several years have been the United States and China.
- The U.S. and other Organisation for Economic Co-operation and Development (OECD) countries have been the top contributors to FDI beyond their borders.
Foreign Direct Investment
How Does Foreign Direct Investment (FDI) Work?
Companies or governments considering a foreign direct investment (FDI) generally consider target firms or projects in open economies that offer a skilled workforce and above-average growth prospects for the investor. Light government regulation also tends to be prized. FDI frequently goes beyond mere capital investment. It may include the provision of management, technology, and equipment as well. A key feature of foreign direct investment is that it establishes effective control of the foreign business or at least substantial influence over its decision making.
The net amounts of money involved with FDI are substantial, with more than $1.8 trillion of foreign direct investments made in 2021. In that year, the United States was the top FDI destination worldwide, followed by China, Canada, Brazil, and India. In terms of FDI outflows, the U.S. was also the leader, followed by Germany, Japan, China, and the United Kingdom.
FDI inflows as a percentage of gross domestic product (GDP) is a good indicator of a nation’s appeal as a long-term investment destination. The Chinese economy is currently smaller than the U.S. economy in nominal terms, but FDI as a percentage of GDP was 1.7% for China as of 2020, compared with 1.0% for the U.S. For smaller, dynamic economies, FDI as a percentage of GDP is often significantly higher: e.g., 110% for the Cayman Islands, 109% for Hungary, and 34% for Hong Kong (also for 2020).
COVID’s Impact on FDI
In 2020, foreign direct investment tanked globally due to the COVID-19 pandemic, according to the United Nations Conference on Trade and Development. The total $859 billion global investment that year compared with $1.5 trillion the previous year. And China dislodged the U.S. in 2020 as the top draw for total investment, attracting $163 billion compared with investment in the U.S. of $134 billion. In 2021, global FDI bounced back by 88%.
Foreign direct investments can be made in a variety of ways, including opening 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 an FDI that establishes a controlling interest, per guidelines established by the Organisation for Economic Co-operation and Development (OECD), is a minimum 10% ownership stake in a foreign-based company. That definition is flexible. There are instances in which effective controlling interest in a firm can be established by acquiring less than 10% of the company’s voting shares.
Types of Foreign Direct Investment
Foreign direct investments are commonly categorized as horizontal, vertical, or conglomerate.
- With a horizontal FDI, a company establishes the same type of business operation in a foreign country as it operates in its home country. A U.S.-based cellphone provider buying a chain of phone stores in China is an example.
- In a vertical FDI, a business acquires a complementary business in another country. For example, a U.S. manufacturer might acquire an interest in a foreign company that supplies it with the raw materials it needs.
- In a conglomerate FDI, a company invests in a foreign business that is unrelated to its core business. Because the investing company has no prior experience in the foreign company’s area of expertise, this often takes the form of a joint venture.
Examples of Foreign Direct Investment
Foreign direct investments may involve mergers, acquisitions, or partnerships in retail, services, logistics, or manufacturing. They indicate a multinational strategy for company growth.
They also can run into regulatory concerns. For instance, in 2020, U.S. company Nvidia announced its planned acquisition of ARM, a U.K.-based chip designer. In August 2021, the U.K.’s competition watchdog announced an investigation into whether the $40 billion deal would reduce competition in industries reliant on semiconductor chips. The deal was called off in February 2022.
FDI in China and India
China’s economy has been fueled by an influx of FDI targeting the nation’s high-tech manufacturing and services. Meanwhile, more recently relaxed FDI regulations in India now allow 100% foreign direct investment in single-brand retail without government approval.
What is the difference between foreign direct investment (FDI) and foreign portfolio investment (FPI)?
Foreign portfolio investment (FPI) is the addition of international assets to the portfolio of a company, an institutional investor such as a pension fund, or an individual investor. It is a form of portfolio diversification, achieved by purchasing the stocks or bonds of a foreign company. Foreign direct investment (FDI) instead requires a substantial and direct investment in, or the outright acquisition of, a company based in another country, and not just their securities.
FDI is generally a larger commitment, made to enhance the growth of a company. But both FPI and FDI are generally welcome, particularly in emerging nations. Notably, FDI involves a greater responsibility to meet the regulations of the country that hosts the company receiving the investment.
What are the advantages and disadvantages of FDI?
FDI can foster and maintain economic growth, in both the recipient country and the country making the investment. On one hand, developing countries have encouraged FDI as a means of financing the construction of new infrastructure and the creation of jobs for their local workers. On the other hand, multinational companies benefit from FDI as a means of expanding their footprints into international markets. A disadvantage of FDI, however, is that it involves the regulation and oversight of multiple governments, leading to a higher level of political risk.
What are some examples of FDI?
One of the most sweeping examples of FDI in the world today is the Chinese initiative known as One Belt One Road (OBOR). This program, sometimes referred to as the Belt and Road Initiative, involves a commitment by China to substantial FDI in a range of infrastructure programs throughout Africa, Asia, and even parts of Europe. The program is typically funded by Chinese state-owned enterprises and organizations with deep ties to the Chinese government. Similar programs are undertaken by other nations and international bodies, including Japan, the United States, and the European Union.
The Bottom Line
FDI involves the direct investment by companies or governments into foreign firms or projects. This accounts for nearly $2 trillion in cash flows around the world, with the U.S. and China leading in the FDI inflow statistics. For smaller and developing countries, FDI funds can be a substantial part of overall GDP. Foreign portfolio investment (FPI) is related to FDI but instead involves owning the securities issued by firms (e.g., stock in foreign companies) rather than direct capital investments.