Foreign Direct Investment, Its Pros, Cons and Importance to You

How FDI Affects Your Life

••• FDI increases economic growth and trade.

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

A 10 percent 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 who invests in their country's businesses.

 

In 2016, global FDI was $1.75 trillion, according to the United Nations. It had fallen 2 percent from 2015's record of $1.76 trillion. 

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 UN report warned that climate change would hit them the hardest.  

In 2016, developing countries received 37 percent of total global FDI. They had 43 percent in 2015. The downturn was due to slower growth in the developed world.  The United States economy only grew 1.5 percent, compared to 2.9 percent in 2015. The UN forecast that an improving economy in 2017 will increase world FDI to $1.8 trillion. 

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' investment is via mergers and acquisitions between mature companies. These global corporations' investments were for either restructuring or refocusing on core businesses.

Advantages

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. That's because 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. 

Disadvantages

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

Free Trade Agreements and FDI

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

Foreign Direct Investment Statistics

Four agencies keep track of FDI statistics.  

  1. The UN Conference on Trade and Development publishes the Global Investment Trends Monitor. It summarizes FDI trends around the world. For example, UNCTAD reported that FDI set a record in 2012 of $1.5 trillion. It surpassed that record in 2015.
  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, OECD, and UNCTAD.
  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.  

(Sources: "Definitions of Foreign Direct Investment: A Methodological Note," Banco de Espana, July 31, 2003.)