Foreign direct investment

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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.


[edit] History

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.

[edit] 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.
1) backward vertical FDI: where an industry abroad provides inputs for a firm's domestic production process
2) forward vertical FDI: in which an industry abroad sells the outputs of a firm's domestic production

[edit] Types of FDI based on the motives of the investing firm

FDI can also be categorized based on the motive behind the investment from the perspective of the investing firm:

  • Resource Seeking: Investments which seek to acquire factors of production that are more efficient than those obtainable in the home economy of the firm. In some cases, these resources may not be available in the home economy at all (e.g. cheap labor and natural resources). This typifies FDI into developing countries, for example seeking natural resources in the Middle East and Africa, or cheap labor in Southeast Asia and Eastern Europe.
  • Market Seeking: Investments which aim at either penetrating new markets or maintaining existing ones. FDI of this kind may also be employed as defensive strategy;<ref> Knickerbocker identified this phenomenon in his ‘follow-my-leader’ hypothesis in: Knickerbocker, F. T. (1973). Oligopolistic reaction and multinational enterprise. Boston(Mass.), Division of Research Graduate School of Business Administration Harvard University.</ref> it is argued that businesses are more likely to be pushed towards this type of investment out of fear of losing a market rather than discovering a new one.<ref name=Dunning (1993)> Dunning, J. H. (1993). Multinational enterprises and the global economy. Wokingham, England ; Reading, Mass, Addison-Wesley</ref> This type of FDI can be characterized by the foreign Mergers and Acquisitions in the 1980’s by Accounting, Advertising and Law firms.<ref> Dunning, J. H., B. Kogut and M. Blomstrom (1990). Globalization of firms and the competitiveness of nations. Lund, Institute of Economic Research Lund University ; Bromley : Chartwell-Bratt c1990</ref>
  • Efficiency Seeking: Investments which firms hope will increase their efficiency by exploiting the benefits of economies of scale and scope, and also those of common ownership. It is suggested that this type of FDI comes after either resource or market seeking investments have been realized, with the expectation that it further increases the profitability of the firm.<ref name=Dunning (1993)> Dunning, J. H. (1993). Multinational enterprises and the global economy. Wokingham, England ; Reading, Mass, Addison-Wesley.

</ref> Typically, this type of FDI is mostly widely practiced between developed economies; especially those within closely integrated markets (e.g. the EU).<ref name=Dunning (1993)> Dunning, J. H. (1993). Multinational enterprises and the global economy. Wokingham, England ; Reading, Mass, Addison-Wesley.</ref>

[edit] 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

[edit] See also

[edit] External links

el:Άμεση ξένη επένδυση es:Inversión extranjera directa fr:Investissement direct à l'étranger fi:Ulkomaaninvestointi vi:Đầu tư trực tiếp nước ngoài

Foreign direct investment

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