Fdi Theory Evidence and Practice

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Foreign Direct Investment
Theory, Evidence and Practice
Imad A. Moosa

1 Introduction and Overview
WHAT IS FOREIGN DIRECT INVESTMENT? Foreign direct investment (FDI) is the process whereby residents of one country (the source country) acquire ownership of assets for the purpose of controlling the production, distribution and other activities of a firm in another country (the host country).1 The International Monetary Fund's Balance of Payments Manual defines FDI as `an investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of the investor, the investor's purpose being to have an effective voice in the management of the enterprise'. The United Nations 1999 World Investment Report (UNCTAD, 1999) defines FDI as `an investment involving a longterm relationship and reflecting a lasting interest and control of a resident entity in one economy (foreign direct investor or parent enterprise) in an enterprise resident in an economy other than that of the foreign direct investor (FDI enterprise, affiliate enterprise or foreign affiliate)'.2 The term `long-term' is used in the last definition in order to distinguish FDI from portfolio investment, the latter characterized by being short-term in nature and involving a high turnover of securities.3 The common feature of these definitions lies in terms like `control' and `controlling interest', which represent the most important feature that distinguishes FDI from portfolio investment, since a portfolio investor does not seek control or lasting interest. There is no agreement, however, on what constitutes a controlling interest, but most commonly a minimum of 10 per cent shareholding is regarded as allowing the foreign firm to exert a significant influence (potentially or actually exercised) over the key policies of the underlying project. For example, the US Department of Commerce regards a foreign business enterprise as a US foreign `affiliate' if a single US investor owns at least 10 per cent of the voting securities or the equivalent. Both equity and debt-financed capital transfers to foreign affiliates are included in the US government's estimates of FDI. Sometimes, another qualification is used to pinpoint FDI, which involves transferring capital from a source country to a host country. For this purpose, 1

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Foreign Direct Investment

investment activities abroad are considered to be FDI when (i) there is control through substantial equity shareholding; and (ii) there is a shift of part of the company's assets, production or sales to the host country. However, this may not be the case, as a project may be financed totally by borrowing in the host country. Thus, the distinguishing feature of FDI, in comparison with other forms of international investment, is the element of control over management policy and decisions. Razin et al. (1999b) argue that the element of control gives direct investors an informational advantage over foreign portfolio investors and over domestic savers. Many firms are unwilling to carry out foreign investment unless they have one hundred per cent equity ownership and control. Others refuse to make such investments unless they have at least majority control (that is, a 51 per cent stake). In recent years, however, there has been a tendency for indulging in FDI co-operative arrangements, where several firms participate and no single party holds majority control (for example, joint ventures). But what exactly does `control' mean in the definition of FDI? The term `control' implies that some degree of discretionary decisionmaking by the investor is present in management policies and strategy. For example, this control may occur through the ability of the investor to elect or select one or more members on the board of directors of the foreign company or foreign subsidiary. It is even possible to distinguish between the control market for shares and the non-control or portfolio share market as...
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