What is Foreign Direct Investment? Advantages, Disadvantages

What is Foreign Direct Investment (FDI)?

Foreign direct investment (FDI) is the direct ownership of facilities in the target country. It involves the transfer of resources including capital, technology, and personnel. Direct foreign investment may be made through the acquisition of an existing entity or the establishment of a new enterprise.

Direct ownership provides a high degree of control in the operations and the ability to better know the consumers and competitive environment.

However, it requires a high level of resources and a high degree of commitment.

As increased globalization in business has occurred, it’s become very common for big companies to branch out and invest money in companies located in other countries. These companies may be opening up new manufacturing plants and attracted to cheaper labor, production, and fewer taxes in another country.

For example General Motors and Volkswagen have invested billions in China, starting more than a decade ago. Ford is rushing to catch up by adding production capacity and expanding its dealer network in China. Ford and its joint-venture partner, Chang’an Ford Mazda Automobile, plan to start producing next-generation Ford Focus models at a new, $490 million plant in Chongqingin 2012.

Advantages of Foreign Direct Investment

• Capital inflows create higher output and jobs.
  
• Capital inflows can help finance a current account deficit.
  
  
• Long term capital inflows are more sustainable than short term portfolio inflows. e.g. in a credit crunch, banks can easily withdraw portfolio investment, but capital investment is less prone to sudden withdrawals.
  
  
• Recipient country can benefit from improved knowledge and expertise of foreign multinational.
  
  
• Investment from abroad could lead to higher wages and improved working conditions, especially if the MNCs are conscious of their public image of working conditions in developing economies.

Disadvantages of Foreign Direct Investment

• Gives multinationals controlling rights within foreign countries. Critics argue powerful MNCs can use their financial clout to influence local politics to gain favourable laws and regulations.
  
  
• FDI may be a convenient way to bypass local environmental laws. Developing countries may be tempted to compete on reducing environmental regulation to attract the necessary FDI.
  
  
  
• FDI does not always benefit recipient countries as it enables foreign multinationals to gain from ownership of raw materials, with little evidence of wealth being distributed throughout society.
  
  
• Multinationals have been criticised for poor working conditions in foreign factories (e.g. Apple’s factories in China)