You are on page 1of 12




DEFINITION  FOREIGN INVESTMENT that establishes a lasting interest in or effective management control over an enterprise. Foreign direct investment can include buying shares of an enterprise in another country, reinvesting earnings of a foreign- owned enterprise in the country where it is located, and parent firms extending loans to their foreign affiliates.  INTERNATIONAL MONETARY FUND guidelines consider an investment to be a foreign direct investment if it accounts for at least 10 percent of the foreign firm's voting stock of shares. However, many countries set a higher threshold because 10 percent is often not enough to establish effective management control of a company or demonstrate an investor's lasting interest.


Direct investment in new facilities/ expansion of existing facilities Objective to create new production capacity and jobs, transfer technology and know-how and form linkages to the global marketplace Leads to crowding out of local industry due to production of goods more cheaply (due to advanced technology and efficient processes) and uses up resources (labor, intermediate goods, etc) Profits from production do not feed back into the local economy but to the multinational's home economy Primary type of FDI involving transfer of existing assets from local firms to foreign firms Assets and operation of firms from different countries are combined to establish a new legal entity (Cross-border merger) Control of assets and operations is transferred to foreign company by its local affiliate company (Cross-border acquisition).


No long term benefits to the local economy, unlike Greenfield investment, as mostly the owners of the local firm are paid in stock from the acquiring firm HORIZONTAL FOREIGN DIRECT INVESTMENT  Investment in the same industry abroad as a firm operates in at home VERTICAL FOREIGN DIRECT INVESTMENT  Backward vertical: Industry abroad provides inputs for a firm's domestic production processes  Forward vertical: Industry abroad sells the outputs of a firm's domestic production processes


Both FDI and FII is related to investment in a foreign country. FDI or Foreign Direct Investment is an investment that a parent company makes in a foreign country. On the contrary, FII or Foreign Institutional Investor is an investment made by an investor in the markets of a foreign nation. In FII, the companies only need to get registered in the stock exchange to make investments. But FDI is quite different from it as they invest in a foreign nation. The Foreign Institutional Investor is also known as hot money as the investors have the liberty to sell it and take it back. But in Foreign Direct Investment, this is not possible. In simple words, FII can enter the stock market easily and also withdraw from it easily. But FDI cannot enter and exit that easily. This difference is what makes nations to choose FDI’s more than then FIIs. FDI is more preferred to the FII as they are considered to be the most beneficial kind of foreign investment for the whole economy.

Foreign Direct Investment only targets a specific enterprise. It aims to increase the enterprises capacity or productivity or change its management control. In an FDI, the capital inflow is translated into additional production. The FII investment flows only into the secondary market. It helps in increasing capital availability in general rather than enhancing the capital of a specific enterprise. The Foreign Direct Investment is considered to be more stable than Foreign Institutional Investor. FDI not only brings in capital but also helps in good governance practices and better management skills and even technology transfer. Though the Foreign Institutional Investor helps in promoting good governance and improving accounting, it does not come out with any other benefits of the FDI. While the FDI flows into the primary market, the FII flows into secondary market. While FIIs are short-term investments, the FDI’s are long term.

Flow and stock increased in the last 20 years In spite of decline of trade barriers, FDI has grown more rapidly than world trade because
• Businesses fear protectionist pressures • FDI is seen a a way of circumventing trade barriers • Dramatic political and economic changes in many parts of the world • Globalization of the world economy has raised the vision of firms who now see the entire world as their market

Capital market theory
•One of the oldest theories of FDI (60s) •FDI is determined by interest rates

Dynamic macroeconomic FDI theory
•FDI are a long term function of TNC strategies •The timing of the investment depends on the changes in the macroeconomic environment •„hysteresis effect“

 FDI theory based on exchange rates
•Analyses the relationship of FDI flows and exchange rate changes FDI as a tool of exchange rate risk reduction

FDI theory based on economic geography
Explores the factors influencing the creation of international production clusters  Innovation as a determinant of FDI – „Greta Garbo effect“

Gravity approach to FDI

The closer two countries are (geographically, economically, culturally ...) the higher will be the FDI flows between these countries Explores the importance of the institutional framework on the FDI flows Political stability – key factor

FDI theories based on istitutional analysis
 

 Existence of firm specific advantages (Hymer)
 Access to raw materials  Economies of scale  Intangible assets such as trade names, patents, superior management etc  Reduced transaction costs when replacing an arm's length transaction in the market by an internal firm transaction

 FDI and oligopolistic markets
 In oligopolistic markets the companies follow the actions of the market leader  Mutual threats – game theory

Theory of internalisation

 

Due to market imperfections, there may be several reasons why a firm wants to make use of its monopolistic advantage itself (or organise an activity itself) Buckley and Casson (influenced by Coase), suggested that a firm overcomes market imperfections by creating its own market internalisation he theory of internalisation was long regarded as a theory of why FDI occurs By internalising across national boundaries, a firm becomes multinational