Foreign Direct Investment

How FDI Affects Your Life

Foreign direct investment is when an individual or business owns 10% or more of a foreign company. If an investor owns less than 10%, the International Monetary Fund defines it as part of his or her stock portfolio.

A 10% ownership doesn't give the investor a controlling interest. It does allow influence over the company's management, operations, and policies. For this reason, governments track investments in their country's businesses. 

In 2018, global foreign direct investment was $1.2 trillion, according to the United Nations Conference on Trade and Development. FDI is down 20% from 2017's $1.47 trillion. The record was $1.8 trillion in 2016.

The decline was due to President Donald Trump's tax cut. Since 2017, U.S multinational corporations have repatriated accumulated foreign earnings. Many of those investments were in Europe.

The Act allows companies to repatriate the $2.6 trillion they held in foreign cash stockpiles. They pay a one-time tax rate of 15.5% on cash and 8% on equipment. The Congressional Research Service found that a similar 2004 tax holiday didn't do much to boost the economy. Companies distributed repatriated cash to shareholders, not employees.

Importance of FDI

Foreign direct investment is critical for developing and emerging market countries. Their companies need the multinationals' funding and expertise to expand their international sales. Their countries need private investment in infrastructure, energy, and water to increase jobs and wages. The U.N. report warned that climate change would hit them the hardest.  

In 2017, developing countries received $694 billion, or 58% of total global FDI. They received 43% of worldwide investment. Investments rose 8% in developing Asia, which received $502 billion.

The developed economies, such as the European Union and the United States, also need FDI. Their companies do it for different reasons. Most of these countries' investments are via mergers and acquisitions between mature companies. These global corporations' investments were for either restructuring or refocusing on core businesses.

Pros and Cons of FDI

© The Balance 2018

Pros

Foreign direct investment benefits the global economy, as well as investors and recipients. Capital goes to the businesses with the best growth prospects, anywhere in the world. Investors seek the best return with the least risk. This profit motive is color-blind and doesn't care about religion or politics.

That gives well-run businesses, regardless of race, color, or creed, a competitive advantage. It reduces the effects of politics, cronyism, and bribery. As a result, the smartest money rewards the best businesses all over the world. Their goods and services go to market faster than without unrestricted FDI.

Individual investors receive the extra benefits of lowered risk. FDI diversifies their holdings outside of a specific country, industry, or political system. Diversification always increases return without increasing risk.

Recipient businesses receive "best practices" management, accounting, or legal guidance from their investors. They can incorporate the latest technology, operational practices, and financing tools. By adopting these practices, they enhance their employees' lifestyles. That raises the standard of living for more people in the recipient country. FDI rewards the best companies in any country. It reduces the influence of local governments over them.

Recipient countries see their standard of living rise. As the recipient company benefits from the investment, it can pay higher taxes. Unfortunately, some nations offset this benefit by offering tax incentives to attract FDI.

Another advantage of FDI is that it offsets the volatility created by "hot money." That's when short-term lenders and currency traders create an asset bubble. They invest lots of money all at once, then sell their investments just as fast.

That can create a boom-bust cycle that ruins economies and ends political regimes. Foreign direct investment takes longer to set up and has a more permanent footprint in a country. 

Cons

Countries should not allow foreign ownership of companies in strategically important industries. That could lower the comparative advantage of the nation, according to an IMF report.

Second, foreign investors might strip the business of its value without adding any. They could sell unprofitable portions of the company to local, less sophisticated investors. They can use the company's collateral to get low-cost, local loans. Instead of reinvesting it, they lend the funds back to the parent company

Example

Trade agreements are a powerful way for countries to encourage more FDI. A great example of this is the North Atlantic Free Trade Agreement, the world's largest free trade agreement. It increased FDI between the United States, Canada, and Mexico to $452 billion in 2012. That was just one of NAFTA's advantages.

Foreign Direct Investment Statistics

Four agencies keep track of FDI statistics.  

  1. The U.N. Conference on Trade and Development publishes the Global Investment Trends Monitor. It summarizes FDI trends around the world. 
  2. The Organization for Economic Cooperation and Development publishes quarterly FDI statistics for its member countries. It reports on both inflows and outflows. The only statistics it doesn't capture are those between the emerging markets themselves.
  3. The IMF published its first Worldwide Survey of Foreign Direct Investment Positions in 2010. This annual worldwide survey is available as an online database. It covers investment positions for 72 countries. The IMF received help from the European Central Bank, Eurostat, the Organization for Economic Cooperation and Development, and the United Nations Conference on Trade and Development.
  4. The Bureau of Economic Analysis reports on the FDI activities of foreign affiliates of U.S. companies. It provides the financial and operating data of these affiliates. It says which U.S. companies were acquired or created by foreign ones. It also describes how much U.S. companies have invested overseas.  

The Bottom Line

A foreign direct investment happens when a corporation or individual invests and owns at least ten percent of a foreign company. When an American tech company opens a data center in India, it makes an FDI. The BEA tracks U.S. FDIs. 

Many developing countries need FDI to facilitate economic growth or repair. International trade agreements have paved the way for increasing FDI flows. FDI has benefited countries through:

  • Raised living standards in emerging markets.
  • Competitive global capital allocation.
  • Dampening of market volatility caused by asset bubbles. 

But FDI can become a disadvantage when:

  • Comparative advantage is lowered by foreign investment in strategic industries.
  • It strips or adds no value to businesses.

In an increasingly globalized economy, the opportunities for foreign direct investment is growing. Investing abroad may be very financially rewarding, but also consider that such investment carries weighty risks.

Article Sources

  1. Third World Network. “United Nations: Global FDI Flows Fell by 19% Last Year, Published in SUNS #8830 dated 23 January 2019,” Accessed Dec. 10, 2019.

  2. The Wall Street Journal. “Report: Repatriation Tax Holiday a ‘Failed’ Policy,” Accessed Dec. 10, 2019.

  3. UN News. “Climate Crisis Could See ‘Collapse’ of Some Economies Without Diversification, Warns UN Trade Chief,” Accessed Dec. 10, 2019.

  4. Bank for International Settlements. “Definitions of Foreign Direct Investment (FDI): A Methodological Note,” Accessed Dec. 10, 2019.

  5. International Monetary Fund. “How Beneficial is Foreign Direct Investment for Developing Countries?” Accessed Dec. 10, 2019.

  6. The World Bank. “Pop the Champagne: Developing-Country Outbound Investment Hits Record High,” Accessed Dec. 10, 2019.

  7. International Monetary Fund. “Press Release: IMF Publishes First Worldwide Survey of Foreign Direct Investment Positions,” Accessed Dec. 10, 2019.

  8. Bureau of Economic Analysis. “Foreign Direct Investment in the United States (FDIUS),” Accessed Dec. 10, 2019.