Foreign direct investment is when an investor has a controlling interest in a business in a foreign country. The term is different than foreign portfolio investment, which does not require controlling ownership of an entity. However, it does require a certain notion of direct control of the business. The notion of direct control is crucial in determining whether a foreign direct investment is a good idea.
Foreign direct investment can come in two forms: horizontal FDI and vertical FDI. Horizontal FDI occurs when a company expands its operation in a foreign country, such as opening a retail store in Mexico. Vertical FDI, on the other hand, involves a company taking control of more parts of a country’s supply chain. For instance, a large US retailer could establish a plant to manufacture clothes or a cotton farm in a foreign country.
While many companies in the US assemble their cars in the United States, many parts are purchased from other countries. For example, Ford Motors has assembly plants in Mexico and China. By sourcing these low-cost car parts from other countries, the company can keep its production costs low. Ford Motors has made substantial investments in these foreign operations. For example, in 2012, it invested $760M in a plant in Hangzhou, China. This expansion helped the company avoid tariffs while also increasing production.
FDI is not without risk. Some studies show that FDI is not necessarily beneficial for a host country. For example, foreign investors may have inside information about the productivity of a firm and may have a competitive advantage over domestic savers. In addition, FDI may lead to excessive over-investment.
Foreign direct investment can strengthen a country’s economy and contribute to political stability. It creates jobs and generates taxes. Manufacturing plants, for example, require land, materials, and labor. These investments benefit suppliers and construction workers in the country, which in turn helps the economy. Furthermore, the tax revenues that are generated by these workers are used by the government to support economic development in the country.
The United States and the United Kingdom are important markets for foreign direct investment. The United States received nearly $403.3 billion in FDI in 2016 and expects to double that amount by the end of 2021. European countries were the top FDI recipient for U.S. companies, and FDI from these countries was the largest percentage of all foreign direct investment.
In addition to direct investment, foreign direct investment can be made through various methods, including opening a subsidiary in a foreign country, buying control of a foreign company, or merging with another company. FDI is often categorized as horizontal, vertical, or conglomerate. Horizontal FDI means that a company owns more than one company in another country.
Foreign direct investment in India has been increasing steadily since 1991. Since economic liberalisation began, FDI has increased substantially. India is among the top 100 countries in the world when it comes to ease of doing business, and it ranks number one in greenfield FDI. To facilitate FDI, the government has enacted several policies, including the BUILD Act, which established the International Development Finance Corporation (IDFC).