Why Foreign Direct Investment Is Plummeting (2024)

Foreign direct investmenthappens when an individual or business owns 10% or more of a foreign company. If an investor owns less than 10%, theInternational Monetary Fund defines it aspart of their stock portfolio.

A 10% ownership doesn't give the individual investor a controlling interest in the foreign company. However, it does allow influence over the company's management, operations, and policies. For this reason, governments track investments in their country's businesses.

Recent Foreign Direct Investment Trends

In 2020,global foreign direct investment fell by one-third to $1 trillion due to the effects of the global COVID-19 pandemic, according to theUnited Nations Conference on Trade and Development. That's far below 2016's peak level of foreign direct investment, which nearly hit $2 trillion.

Importance of FDI

Foreign direct investment is critical fordevelopingandemerging marketcountries. Their companies need multinationalfunding and expertise to expand their international sales. Their countries need private investment in infrastructure, energy, and water to increase jobs and wages. TheUNhas also promoted the use of FDI to combatthe impacts ofclimate change.

Note

In 2020, developing countries received over half of the total global FDI.Most of those investments went to less-developed countries in Asia and Oceania.

Trade agreementsare a powerful way for countries to encourage more FDI. One great example of this is theNorth Atlantic Free Trade Agreement (NAFTA), the world's largestfree trade agreement. It increased FDI among the United States,Canada, andMexicoto $731billion in 2015. That was just one ofNAFTA's advantages.

Pros and Cons of FDI

Why Foreign Direct Investment Is Plummeting (1)

Pros Explained

Diversifies investor portfolios: Individual investors have the potential to achieve greater portfolio efficiency (return per unit of risk), as FDI diversifies their holdings outside of a specific country, industry, or political system. Generally, a broader base of investments will dampen overall portfolio volatility and provide for stronger long-term returns.
Provides technology to developing countries: Recipient businesses receive "best practices" management, accounting, or legal guidance from their investors. They can incorporate the latest technology, operational practices, and financing tools. By adopting these practices, they enhance their employees' lifestyles. That raises the standard of living for more people in the recipient country. FDI rewards the best companies in any country. It reduces the influence of local governments over them.
Provides financing to developing countries: Recipient countries see theirstandard of livingrise. As the recipient company benefits from the investment, it can pay higher taxes. Unfortunately, some nations offset this benefit by offering tax incentives to attract FDI.

Promotes stable, long-term lending: Another advantage of FDI is that it offsets thevolatilitycreated by "hot money." That's when short-term lenders andcurrency traderscreate anasset bubble. They invest lots of money all at once, then sell their investments just as fast. That can create aboom-bust cyclethat ruins economies and ends political regimes. Foreign direct investment takes longer to set up and has a more permanent footprint in a country.

Cons Explained

Not suitable for strategically important industries: Countries should not allow foreign ownership of companies in strategically important industries. That could lower thecomparative advantageof the nation,according to an IMF report.
Investors have less moral attachment: Foreign investors might strip the business of its value without adding any. They could sell unprofitable portions of the company to local, less sophisticated investors.
Unethical access to local markets: They can use the company's collateral to get low-cost,local loans. Instead of reinvesting it, they lend the funds back to theparent company.

Tracking Foreign Direct Investment

Four agencies keep track of FDI statistics.

The U.N. Conference on Trade and Development publishes theGlobal Investment Trends Monitor. It summarizes FDI trends around the world.
TheOrganization for Economic Cooperation and Developmentpublishes quarterly FDIstatistics for its member countries. It reports on both inflows and outflows. The only statistics it doesn't capture are those between the emerging markets themselves.
The IMF published its firstWorldwide Survey of Foreign Direct Investment Positionsin 2010.This annual worldwide survey is available as an online database. It covers investment positions for 72 countries. The IMF received help from theEuropean Central Bank, Eurostat, the Organization for Economic Cooperation and Development,and the United Nations Conference on Trade and Development.
TheBureau of Economic Analysisreports on the FDI activities ofU.S. affiliates of foreign companies. It provides the financial and operating data of these affiliates. It says which U.S. companies were acquired or created by foreign ones. It also describes how much U.S. companies have invested overseas.

The Bottom Line

A foreign direct investment happens when a corporation or individual invests and owns at least ten percent of a foreign company. When an American tech company opens a data center in India, it makes an FDI. The BEA tracks U.S. FDI.

Many developing countries need FDI to facilitate economic growth or repair. International trade agreements have paved the way for increasing FDI flows. FDI has benefited countries through:

Raised living standards in emerging markets
Competitive global capital allocation
Dampening of market volatility caused by asset bubbles

But FDI can become a disadvantage when:

Comparative advantage is lowered by foreign investment in strategic industries.
It strips or adds no value to businesses.

In an increasingly globalized economy, the opportunities for foreign direct investment are growing. Investing abroad may be very financially rewarding, but also consider that such investment carries weighty risks.

Frequently Asked Questions (FAQs)

What is horizontal foreign direct investment, and how does it compare to vertical FDI?

Horizontal foreign direct investment refers to a business and production model that can be replicated across multiple countries. These businesses can conduct their operations within a single country, and when they invest abroad, those investments are entirely contained within that country.

Vertical FDI involves breaking up the production and distribution processes. By fragmenting the process, vertical FDI allows a company to do each step of its process in the cheapest country for that specific step.

What kind of reserves does FDI help maintain?

FDI can help maintain stable foreign exchange reserve levels. The same factors that make FDI effective at promoting stable, long-term lending in equity markets can also apply to currency and bond markets.

As an expert in the field of foreign direct investment (FDI), I bring to the table a wealth of knowledge and firsthand expertise on the intricacies of this critical aspect of the global economy. Having delved deep into the dynamics of FDI, I can offer insights into its nuances, trends, and the impact it has on both developed and developing nations.

Now, let's break down the key concepts presented in the article:

Foreign Direct Investment (FDI) Definition:

Foreign direct investment occurs when an individual or business owns 10% or more of a foreign company. The International Monetary Fund (IMF) defines ownership below 10% as part of a stock portfolio.

Impact of 10% Ownership:

A 10% ownership doesn't grant a controlling interest but allows influence over the foreign company's management, operations, and policies. Governments monitor such investments for various reasons.

Recent FDI Trends:

In 2020, global FDI fell by one-third to $1 trillion due to the COVID-19 pandemic. Developing countries received over half of the total global FDI in 2020, with most investments going to less-developed countries in Asia and Oceania.

Importance of FDI:

FDI is crucial for developing and emerging market countries. It provides multinational funding and expertise for international sales expansion, private investment in infrastructure, energy, and water, leading to job and wage increases. FDI is also promoted by the UN to combat the impacts of climate change.

Trade Agreements:

Trade agreements, such as NAFTA, play a significant role in encouraging FDI. NAFTA increased FDI among the United States, Canada, and Mexico to $731 billion in 2015.

Pros and Cons of FDI:

Pros:

Diversifies investor portfolios.
Provides technology and best practices to recipient businesses.
Boosts financing in developing countries.
Promotes stable, long-term lending, offsetting volatility.

Cons:

Not suitable for strategically important industries.
Investors may lack moral attachment.
Unethical access to local markets using collateral.

Tracking FDI:

Four agencies track FDI statistics, including the UN, OECD, IMF, and the Bureau of Economic Analysis (BEA). They provide global investment trends, quarterly FDI statistics for member countries, worldwide surveys, and data on U.S. affiliates of foreign companies.

Bottom Line:

FDI is crucial for economic growth and repair in developing countries. It has positive impacts on living standards, global capital allocation, and market stability. However, strategic industry foreign investments and value-stripping can pose disadvantages.

FAQs:

Horizontal FDI: Business and production model across multiple countries.
Vertical FDI: Breaks up production and distribution processes.
FDI Reserves: Helps maintain stable foreign exchange reserve levels.

In an increasingly globalized economy, foreign direct investment presents opportunities for financial rewards but also carries substantial risks that should be carefully considered.