Foreign Direct Investment Assignment Help

Foreign direct investment or FDI is the investment which is in the form of controlling ownership in a business in a country by an entity that is based in another country. It is therefore different from a foreign portfolio investment as it exercises direct control. It is a subset of international factor movements. The foreign direct investment can be made either “inorganically”, that is, by buying a company in the target country or “organically, that is, by expanding the operations of a business that already exists in that country.

Broadly, foreign direct investment consists of mergers and acquisitions, building new facilities, reinventing profits earned from overseas operations, and intracompany loans. Narrowly, it refers to building a new facility, and lasting management interest in an enterprise that is operating in an economy other than that of the investor.

Foreign Direct Investment is the sum total of equity capital, long-term capital, as well as short-term capital as shown in the balance of payments. It generally involves participation in management, joint ventures, transfer of technology and expertise. Foreign Direct Investment stock is the net cumulative FDI (that is, outward FDI - inward FDI) for any provided period. It does not include investment that is done through the purchase of shares.

According to Hymer, foreign direct investment is not just about the investment of excess profits in other countries. But it can be financed through loans obtained in the host country, payments in exchange for equity-like patents, machinery, technology, etc. and other methods. Foreign direct investment’s main determinants are side as well as growth prospects of a country’s economy when the foreign direct investment is made. There are some more determinants that Hymer proposed assuming market and imperfections. They are given below:

  1. Firm-specific benefits: Once the domestic investment is exhausted, an organization can exploit its benefits that are linked to market imperfections, which can provide the organization with competitive benefit and market power. Further, the organizations can monetize these benefits in the form of license.
  2. Removal of conflicts: There may arise conflicts when an organization is already operating in the foreign market or considering to expand its operations within the same market. The solution for this hurdle can be in the form of collusion, sharing the market with rivals or attempting to have direct control of production. However, it should also be considered that a reduction in conflict by acquiring control on the operations may increase the market imperfections.
  3. The propensity to formulate an international strategy to mitigate risk: According to the position the organizations are characterized with three levels of decision making, they are- the day to day supervision, management decision coordination and long-term strategic planning and decision making. The extent to which an organization can take risk depends upon how well it can formulate an internationalization strategy, taking the levels of decision into account.

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Types of Foreign Direct Investment

There are majorly three types of Foreign Direct Investment. They are as follows:

  1. Horizontal Foreign Direct Investment

This type of FDI arises when an organization duplicates its home country-based activities at the same value chain stage in the host country.

  1. Platform Foreign Direct Investment

This investment refers to the investment from a source country to a destination country and is for the purpose of exporting to a third country.

  1. Vertical Foreign Direct Investment

When an organization moves upstream or downstream through FDI in different value chains, that is, when value-adding activities are performed by the organization stage by stage in a vertical fashion in a host country, it is known as Vertical Foreign Direct Investment.

Methods of Foreign Direct Investment

The foreign direct investors may have the voting power of an enterprise through any of the following methods in an economy:

  1. By incorporating a wholly owned subsidiary or a company anywhere.
  2. By having shares in an associated enterprise.
  3. By acquiring an unrelated enterprise or through a merger.
  4. By taking part in an equity joint venture with another investor or enterprise.

Forms of Foreign Direct Investment Incentives

The incentives of foreign direct investment may take the following forms:

  1. Low corporate tax and individual income tax rates
  2. Tax holidays
  3. Tax concessions of different types
  4. Preferential traffic
  5. Special economic zone
  6. Export processing zones
  7. Investment financial subsidies
  8. Bonded warehouse
  9. Research and Development support
  10. Infrastructure subsidies
  11. Free land or subsidies on land
  12. Derogation from regulation

Importance of Foreign Direct Investment

Foreign Direct Investment has contribution in several things, to expand the investor base in the country, as well in solving the problem associated with unemployment by creating new job opportunities, and the introduction of advanced technology, learning modern methods of management, communication and marketing, that helps in acquiring higher skills and experience, etc.

The importance of foreign direct investment always attracts foreign investment to it through creating an atmosphere that is conducive to foreign investment, and the facilities and incentives provided to the foreign investor. Some of the reasons why foreign direct investment is crucial are listed below:

  1. It is of great importance in the economies of the host countries, as it will help in raising the rates of investment through foreign direct investment flow and has several positive effects.
  2. It plays an important role in creating new job opportunities, hence targeting the problem of unemployment, which is a widespread problem in developing countries.
  3. Foreign Direct Investment has an effect on the balance of payments by the flow of foreign capital, this makes it a good source for hard currency and increasing the physical capital in the host countries.
  4. It also contributes to the transfer of advanced technology and modern management skills. This has a major role in the development of skilled human resources and it also results in raising the efficiency of production.
  5. It also contributes to the development of the export sector which is in urgent need by the developing countries, and also increases the attention towards research and development in the host countries.
  6. As it increases productivity and production, it leads to an increase in national income, hence increasing the average per capita income and affecting the level of luxury.

Limitations of Foreign Direct Investment

With many advantages, there are also some limitations associated with foreign direct investment. They are as follows:

  1. It may have a negative effect on the host countries where foreign direct investment is a means to drain out the wealth of the countries that are developing.
  2. It may happen that what foreign investors bring do not get well with the circumstances of the developing countries.
  3. The introduction of new technologies and methods may result in worsening the problem of unemployment in the targeted countries.
  4. It may also lead to a rise in the monopoly of local markets in the host countries, altogether increasing the dependence on the developed countries by developing countries.