FDI: advantages and disadvantages

Foreign Direct Investment
| The European | 2 December 2020

What is Foreign Direct Investment? 

A Foreign direct investment (FDI) is an investment made by a firm, business, corporation or individual from one country into the business interest of a company located in another country.  

Finance resource, Investopedia states: “Generally, FDI takes place when an investor establishes foreign business operations or acquires foreign business assets in a foreign company. However, FDIs are distinguished from portfolio investments in which an investor merely purchases equities of foreign-based companies.” 

A study into FDI by the United Nations found that “Besides bringing capital, it facilitates the transfer of technology, organizational and managerial practices and skills as well as access to international markets.” 

But is FDI for you and your business? Here is an outline of the Advantages and disadvantages to help you decide: 

Advantages 

Portfolio Diversification 

Investors can reap a whole host of benefits from foreign diversity in their investment portfolios. Investors have been found to potentially achieve higher return per unit of risk, as FDI diversifies their holdings outside of a specific industry, country or political standing. 

Tax incentives 

Multi-National Corporations (MNCs) and Parent enterprises can provide FDI to receive additional expertise, technology and products.  

“As a factor in attracting FDI, incentives are secondary to more fundamental determinants, such as market size, access to raw materials and availability of skilled labor” a study by the United Nations revealed, the report looked into the effect of tax incentives on FDI.  As the foreign investor, a business/firm can receive tax incentives that will be highly useful in their selected field of business. 

Increase in Capital 

Another big advantage of foreign direct investment is the increase of the target country’s income. Capital inflows help create more jobs, higher wages and higher output; in return the national income normally increases. As a result, national economic growth is stimulated and this can cause a ripple effect. 

Long-term capital inflows are more sustainable than short-term portfolio inflows, they reduce the volatile nature of “hot money” e.g Short-term lenders.  

FDI can help finance a current account deficit. During economic recession, banks can easily withdraw portfolio investment, but capital investment is less prone to sudden withdrawals, providing greater financial security. 

 Increased foreign aid 

Recipient countries can benefit from improved knowledge and expertise of foreign multinational company, as found with FDI. Financial investment from abroad could lead to higher wages and improved working conditions, and opportunities where various countries are given access to new technologies and skills. 

The Harvard business review says “Forward-thinking managers not only will be concerned with success in new markets, but, like good chess players, also will be thinking two or three moves ahead.” 

Disadvantages  

There is an opportunity for powerful MNCs to use their financial power to influence local politics and gain lenient laws and regulations. Especially in regards to Environmental and Social Governance (ESG) within foreign countries.  

FDI has also proven to be a convenient way to bypass local environmental laws. Less Economically Developing Countries (LEDC) may be tempted to compete on reducing environmental regulation to attract MNCs. 

Entry of large giants into delicate domestic markets can mean bad news for smaller business that risk displacement and insolvency. 

Foreign Direct Investment does not always guarantee benefits for the recipient countries. As it enables foreign MNCs to obtain from ownership of raw materials and goods, with little evidence of capital being redistributed throughout the domestic economy. 

For more Foreign Direct Investment news follow The European.


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