Understanding Foreign Direct Investment (FDI)

Jan 27, 2025

Foreign Direct Investment (FDI): What It Is, Types, and Examples

Definition

  • Foreign Direct Investment (FDI): An ownership stake in a foreign company or project by an investor, company, or government from another country.
  • FDI is used to describe acquiring a substantial stake in a foreign business or buying it outright to expand operations.

Key Takeaways

  • FDI is a substantial, lasting investment by a company or government into a foreign entity.
  • Investors typically take controlling positions in domestic firms or joint ventures, actively managing them.
  • Involves acquiring materials, expanding a footprint, or developing a multinational presence.
  • Top recipients: United States and China; top contributors: U.S. and OECD countries.

How FDI Works

  • Involves a stake in a company or project by a foreign entity.
  • Focused on target firms in open economies with skilled workforces and growth prospects.
  • Goes beyond capital investment to include management, technology, and equipment.
  • Establishes effective control or substantial influence over foreign business.
  • FDI totaled roughly $1.28 trillion in 2022.
  • United States, China, Brazil, Australia, and Canada were top FDI destinations.
  • U.S., Japan, China, Germany, and UK were top FDI outflow contributors.

Special Considerations

  • Made via subsidiaries, associate companies, mergers, or joint ventures.
  • OECD guidelines set a 10% ownership stake as FDI threshold.
  • Effective control can sometimes be established with less than 10% stake.
  • FDI in China fueled by high-tech manufacturing; India allows 100% FDI in single-brand retail.

Types of Foreign Direct Investment

  • Horizontal FDI: Establishes the same business operation in a foreign country.
  • Vertical FDI: Acquires complementary business in another country.
  • Conglomerate FDI: Invests in unrelated foreign businesses, often as joint ventures.

Examples of Foreign Direct Investment

  • Involves mergers, acquisitions, or partnerships across sectors.
  • Can face regulatory challenges, e.g., Nvidia's planned acquisition of ARM was investigated for competition concerns.

Difference Between FDI and Foreign Portfolio Investment (FPI)

  • FPI: Addition of international assets into a portfolio for diversification.
  • FDI: Substantial, direct investment or acquisition in another country.
  • FDI involves more regulation and responsibility than FPI.

Advantages and Disadvantages of FDI

  • Advantages: Promotes economic growth, job creation, international expansion.
  • Disadvantages: Involves multi-government regulation, increased political risk.

Examples of FDI

  • China's One Belt One Road initiative: large FDI in global infrastructure.
  • Similar programs by Japan, U.S., and the EU.

The Bottom Line

  • FDI entails direct investments by companies or governments into foreign entities.
  • Accounts for significant global cash flows, with U.S. and China leading.
  • FPI relates to securities ownership, not direct capital investments.