Foreign direct investment (FDI) is a direct investment into production or business in a country by an individual or company of another country, either by buying a company in the target country or by expanding operations of an existing business in that country. The accepted proportion for a foreign direct investment relationship, as defined by the OECD Organization for Economic Co-operation and Development, is 10%.
That is, the foreign investor must own at least 10% or more of the voting stock or ordinary shares of the investee company.
Example of foreign direct investment:
American company taking a majority stake in a company in China. Canadian company setting up a joint venture to develop a mineral deposit in Chile.
Foreign direct investment is in contrast to portfolio investment which is an Indirect (passive) investment in the securities of another country such as shares . Types of FDI
Strategically FDI comes in three types:
1) Horizontal: where the company carries out the same activities abroad as at home Example: Toyota assembling cars in both Japan and the UK.
2) Vertical: when different stages of activities are added abroad. Forward vertical FDI is where the FDI takes the firm nearer to the market. Example: Toyota acquiring a car distributorship in America
Backward Vertical FDI is where international integration moves back towards raw materials Example: Toyota acquiring a tire manufacturer or a rubber plantation). 3) Conglomerate: where an unrelated business is added abroad. This is the most unusual form of FDI as it involves attempting to overcome two barriers simultaneously: entering a foreign country and a new industry. This leads to the analytical solution that internationalization and diversification are often alternative strategies, not complements. Notice:
Horizontal FDI decreases international trade as the product of them is usually aimed at host country; the two other types generally act as a stimulus for it. Methods of FDI
The foreign direct investor may acquire voting power of an enterprise in an economy through any of the following methods like: 1) Incorporating a wholly owned subsidiary or company anywhere 2) Participating in an equity joint venture with another investor or enterprise. 3) Through a merger or an acquisition of an unrelated enterprise. 4) Franchising:
Arrangement where one party (the franchiser) grants another party (the franchisee) the right to use its trademark or trade-name as well as certain business systems and processes, to produce and market a good or service according to certain specifications. The franchisee usually pays a one-time franchise fee plus a percentage of sales revenue as royalty. Forms of FDI incentives
Foreign direct investment incentives may take the following forms: 1) Low corporate tax and individual income tax rates.
2) tax holidays
3) preferential tariffs
4) special economic zones
5) R&D support
6) derogation from regulations (usually for very large projects)
Importance of FDI
The local population may be able to benefit from the employment opportunities created by new businesses. An increase in FDI may be associated with improved economic growth due to the influx of capital and increased tax revenues for the host country. Host countries often try to channel FDI investment into new infrastructure and other projects to boost development. Greater competition from new companies can lead to productivity gains and greater efficiency in the host country It has been suggested that the application of a foreign entity’s policies to a domestic subsidiary may improve corporate governance standards. Foreign investment can result in the transfer of soft skills through training and job creation, the availability of more advanced technology for the domestic market and access to research and development resources.