Foreign Direct Investment (FDI)

Definition

Foreign Direct Investment (FDI) refers to an investment made by a company or individual in one country in business interests or assets in another country, typically by acquiring a significant degree of control or influence over the foreign enterprise. This type of investment often involves establishing operations or expanding existing ones, and it plays a crucial role in the economic integration of countries, affecting exchange rates and capital flows between nations.

5 Must Know Facts For Your Next Test

1. FDI can take various forms, including establishing new facilities (greenfield investments), merging with or acquiring existing businesses (brownfield investments), or reinvesting profits from existing operations.
2. Countries with stable political environments and strong legal frameworks tend to attract more FDI because they offer a lower risk for investors.
3. The flow of FDI can impact exchange rates, as increased investments in a country can lead to appreciation of that country's currency due to higher demand.
4. Developing countries often seek FDI to stimulate economic growth, create jobs, and gain access to advanced technologies and management skills.
5. Government policies and regulations regarding foreign investment play a significant role in either encouraging or deterring FDI, influencing how and where investments occur.

Review Questions

• How does foreign direct investment influence exchange rates and capital flows between countries?
  • Foreign direct investment affects exchange rates by changing the demand for currencies involved in the transaction. When foreign investors put money into a country, it increases demand for that country's currency, leading to potential appreciation. Additionally, FDI contributes to capital flows by moving funds across borders for business expansion, impacting both the host and home countries' economies.
• Discuss the factors that make certain countries more attractive for foreign direct investment compared to others.
  • Countries that are politically stable, have transparent legal systems, and offer incentives like tax breaks or infrastructure support tend to attract more foreign direct investment. Investors look for environments where their investments are secure and can generate profitable returns. Conversely, countries with high political risk, corruption, or restrictive regulations may deter FDI as companies seek safer options for their capital.
• Evaluate the long-term implications of foreign direct investment on economic development in host countries.
  • The long-term implications of foreign direct investment on economic development can be profound. FDI can lead to job creation, transfer of technology, and increased productivity within host countries. However, it can also create dependencies on foreign entities, impact local businesses negatively, and potentially lead to profit repatriation instead of reinvestment in the local economy. Balancing these outcomes is crucial for sustainable economic growth.

Related terms

Portfolio Investment: Investment in financial assets such as stocks and bonds in a foreign country that does not provide the investor with significant control over the companies.

Multinational Corporation (MNC): A company that has facilities and other assets in at least one country other than its home country, often engaging in FDI to establish or expand operations.

Exchange Rate: The value of one currency for the purpose of conversion to another, which can be significantly influenced by FDI inflows and outflows.