Foreign Direct Investment—Impact and Analysis

Foreign direct investment (FDI) refers to the investment made by an entity, a business venture, or an individual, located in one country into a business venture located in another country. For that purpose, the investor – generally, creates foreign business operations, acquires business assets, or takes the  ownership or controlling interest in an existing company.

There is one distinction that need clarification: the Foreign Direct Investment doesn’t refer to portfolio investments in which an investor merely purchases equities (stocks) of a foreign-based companies.

According to the IMF and OECD, Foreign Direct Investment reflects the idea of obtaining a lasting interest by a resident entity of one economy (direct investor) in an enterprise that is resident in another economy (the direct investment enterprise). The “lasting interest” implies the existence of a long-term relationship between the direct investor and the direct investment enterprise and a significant degree of influence on the management of the latter. The direct or indirect ownership of 10% or more of the voting power of an enterprise resident in one economy by an investor resident in another economy is evidence of such a relationship.

This type of investment involves both the initial transaction establishing the relationship between the investor and the enterprise and all subsequent capital transactions between them and among affiliated enterprises.

Thus, the Foreign direct investments naturally flow into the countries that are open economies/open market with a large pool of skilled workforce and attractive growth prospects for the investor.

In an open market, it is assumed that the pricing of goods or services is driven predominantly by the principles of supply-and-demand with little interference from governmental agencies.

Developed economy are generally considered to be more ‘open’ economies. It is therefore understandable that such market economies were attracting the largest pool of inward FDI.

But, that trend is changing as increasingly more FDI is moving into the developing economies, including those of China and India. That trend is, in most part, due to the potential for higher rate of return on investment (ROI) and access to a larger and growing market of the host country.

The two charts below present the FDI inflow in top ten economies—and by regions.

{ Source: UNCTAD}

As per the “World Investment Report 2018” published by the United Nations Conference on Trade and Development, between 2013 and 2017 foreign direct investment accounted for 39 per cent of external finance for developing economies.

The Economic and Social Impact of Foreign Direct Investment

Foreign direct investment (FDI) plays an important role in the development and growth of any country’s economy – especially in those of the developing countries’. Properly directed foreign direct investment – with clearly defined and recognized objectives, benefits of both the investing entity and the host economy.

FDI is a two sided business arrangement. On the one side is the host country that receives the foreign direct investment, and on the other side is the investing entity that invest its capital and brings in the knowledge and management skills to run the venture. Both of these two sides must get positive outcomes from this arrangement to make it worth entering into such ventures.

With the investing business’ (outward Foreign Direct Investment) perspective, investment in an accommodating foreign country provides the benefits of relatively cheap labor and local talent that prefers to work for a foreign owned entity in anticipation of better conditions and higher wages. Also, Foreign Direct Investment opens the market of the host country to the products and services of the investing entity.

For the host country, inward Foreign Direct Investment must help in the economic development, creation of jobs, and, more importantly, resource transfer to the host country in terms of capital and technical knowhow.

But, in actual practice, as the Organization for Economic Co-operation and Development (OECD) also pointed out in its research report (‘The Social Impact of Foreign Direct Investment’), FDI – especially by the multinational enterprises (MNEs), may end up inflicting more harm to a developing country’s socio-economic structure than the benefit it brings in.

“The increased role of FDI in developing and emerging economies has raised expectations about its potential contribution to their development. . . . One way that FDI can be beneficial for host economies is by creating high-quality jobs that are associated with higher pay and better working conditions. . .

“However, the activities of multinational enterprises (MNEs) abroad have also aroused much controversy and social concerns. For example, MNEs have been accused of practicing unfair competition when taking advantage of low wages and labour standards abroad. In some cases, MNEs have also been accused of violating human and labour rights in developing countries where governments fail to enforce such rights effectively. In many OECD countries, civil society has appealed to MNEs to ensure that internationally-recognized labour norms are respected throughout their foreign operations.”

{ Source: Organization for Economic Co-operation and Development}

A well thought foreign direct investment is a way to reap the benefits of having preferred access to the destination country’s market, and, at the same time, enjoy the benefits of cheaper labor. It certainly makes sense for a progressive company/entity to see the entire global economy as the market for its products and service.

Among the successful examples of foreign direct investments are those made by the likes of Volkswagen, Ford, General Motors, and Apple in China. All these companies have made Billion of US Dollars of profit from their investments there.

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