Foreign direct investment (FDI) is made into a business or a sector by an individual or a company from another country. It is different from portfolio investment, which is made more indirectly into another country’s economy by using financial instruments, such as bonds and stocks.
There are various levels and forms of foreign direct investment, depending on the type of companies involved and the reasons for investment. A foreign direct investor might purchase a company in the target country by means of a merger or acquisition, setting up a new venture or expanding the operations of an existing one. Other forms of FDI include the acquisition of shares in an associated enterprise, the incorporation of a wholly owned company or subsidiary and participation in an equity joint venture across international boundaries.
If you are planning to engage in this kind of venture, you should determine first if it provides you and the society with maximum benefits. One good way to do this is evaluating its advantages and disadvantages.
List of Advantages of Foreign Direct Investment
1. Economic Development Stimulation.
Foreign direct investment can stimulate the target country’s economic development, creating a more conducive environment for you as the investor and benefits for the local industry.
2. Easy International Trade.
Commonly, a country has its own import tariff, and this is one of the reasons why trading with it is quite difficult. Also, there are industries that usually require their presence in the international markets to ensure their sales and goals will be completely met. With FDI, all these will be made easier.
3. Employment and Economic Boost.
Foreign direct investment creates new jobs, as investors build new companies in the target country, create new opportunities. This leads to an increase in income and more buying power to the people, which in turn leads to an economic boost.
4. Development of Human Capital Resources.
One big advantage brought about by FDI is the development of human capital resources, which is also often understated as it is not immediately apparent. Human capital is the competence and knowledge of those able to perform labor, more known to us as the workforce. The attributes gained by training and sharing experience would increase the education and overall human capital of a country. Its resource is not a tangible asset that is owned by companies, but instead something that is on loan. With this in mind, a country with FDI can benefit greatly by developing its human resources while maintaining ownership.
5. Tax Incentives.
Parent enterprises would also provide foreign direct investment to get additional expertise, technology and products. As the foreign investor, you can receive tax incentives that will be highly useful in your selected field of business.
6. Resource Transfer.
Foreign direct investment will allow resource transfer and other exchanges of knowledge, where various countries are given access to new technologies and skills.
7. Reduced Disparity Between Revenues and Costs.
Foreign direct investment can reduce the disparity between revenues and costs. With such, countries will be able to make sure that production costs will be the same and can be sold easily.
8. Increased Productivity.
The facilities and equipment provided by foreign investors can increase a workforce’s productivity in the target country.
9. Increment in Income.
Another big advantage of foreign direct investment is the increase of the target country’s income. With more jobs and higher wages, the national income normally increases. As a result, economic growth is spurred. Take note that larger corporations would usually offer higher salary levels than what you would normally find in the target country, which can lead to increment in income.
List of Disadvantages of Foreign Direct Investment
1. Hindrance to Domestic Investment.
As it focuses its resources elsewhere other than the investor’s home country, foreign direct investment can sometimes hinder domestic investment.
2. Risk from Political Changes.
Because political issues in other countries can instantly change, foreign direct investment is very risky. Plus, most of the risk factors that you are going to experience are extremely high.
3. Negative Influence on Exchange Rates.
Foreign direct investments can occasionally affect exchange rates to the advantage of one country and the detriment of another.
4. Higher Costs.
If you invest in some foreign countries, you might notice that it is more expensive than when you export goods. So, it is very imperative to prepare sufficient money to set up your operations.
5. Economic Non-Viability.
Considering that foreign direct investments may be capital-intensive from the point of view of the investor, it can sometimes be very risky or economically non-viable.
Remember that political changes can also lead to expropriation, which is a scenario where the government will have control over your property and assets.
7. Negative Impact on the Country’s Investment.
The rules that govern foreign exchange rates and direct investments might negatively have an impact on the investing country. Investment may be banned in some foreign markets, which means that it is impossible to pursue an inviting opportunity.
8. Modern-Day Economic Colonialism.
Many third-world countries, or at least those with history of colonialism, worry that foreign direct investment would result in some kind of modern day economic colonialism, which exposes host countries and leave them vulnerable to foreign companies’ exploitations.
Investing into another country’s economy, buying into a foreign company or otherwise expanding your business abroad can be extremely financially rewarding and might provide you with the boost needed to jump to a new level of success. However, foreign direct investment also carries risks, and it is highly important for you to evaluate the economic climate thoroughly before doing it. Also, it is essential to hire a financial expert who is accustomed to working internationally, as he can give you a clear view of the prevailing economic landscape in your target country. He can even help you monitor market stability and predict future growth.
Remember that we live in an increasingly globalized economy, so foreign direct investment will become a more accessible option for you when it comes to business. However, you should weigh down its advantages and disadvantages first to know if it is the best road to take.
Natalie Regoli is a child of God, devoted wife, and mother of two boys. She has a Master's Degree in Law from The University of Texas. Natalie has been published in several national journals and has been practicing law for 18 years.