What is FDI?
Foreign Direct Investment (FDI) is an investment in a foreign company or project by an investor, company, or government of another country.
Generally, the term is used to describe a corporate decision to acquire a substantial interest in, or outright purchase of, a foreign enterprise or to expand its operations into new territories. The term is not normally used to describe pure equity investment in foreign enterprises. Foreign direct investment is a key component of international economic integration as it creates stable and lasting links between economies. Global FDI flows declined by 24% year-on-year to US$1.286 trillion in 2022. Despite the slowdown in FDI inflows, the United States remained the top destination country globally with US$318 billion, followed by China with US$180 billion. In Europe, one of the largest FDI investors is China. Over the entire period from 2005 to June 2023, of China’s total FDI in Europe of around US$415 billion, companies in the transport sector accounted for the largest share at around US$77.9 billion.
Types of FDI
Generally, there are three types of FDI. The horizontal, vertical, and conglomerate FDI.
In horizontal FDI, a company sets up the same type of business in another country as it does in its home country. An example is the acquisition of a Chinese mobile phone shop chain by a US mobile phone provider.
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Vertical foreign direct investment occurs when a company acquires a complementary business in another country. For example, a US manufacturer may acquire shares in a foreign company that supplies the raw materials it needs.
In conglomerate FDI, a company invests in a foreign company that has nothing to do with its core business. Since holding companies have no experience in foreign business, they are often set up in the form of joint ventures.
Disadvantages and advantages of FDI
Foreign direct investment is highly controversial. Its effects in developing countries are particularly criticised. For developing countries, FDI can offer significant growth opportunities as it can transfer large amounts of knowledge and know-how to host countries. However, this will always depend on the extent to which the population of the concerned country is involved. This effect is called the ripple effect.
On the other hand, foreign direct investment benefits companies and investors. These include, for example, the relocation of production because direct production costs are reduced. Tax avoidance: Tax differences between countries as a cost advantage can be exploited. Increased liquidity can also occur, facilitating access to financial markets. Certain activities are carried out centrally if the framework conditions for this activity are optimal, which drives globalisation.
Thus, it is always a matter of individual judgement whether FDI is suitable for a company, state, or private investor and whether the advantages outweigh the disadvantages.
