Foreign Direct Investment (FDI)

Foreign direct investment (FDI) is the investment in an entity in one economy by an investor in another economy. Unlike foreign portfolio investment (FPI), in which the investment is in foreign financial instruments, FDI provides the investor with control over the [Page 928]acquired asset. Control of an asset has been defined (OECD Benchmark) as owning 10% or more of the ordinary shares or voting stock in an incorporated enterprise or the equivalent in an unincorporated enterprise. FDI can occur in various forms: greenfield investments in which there is an investment in a new facility; mergers in which the assets and operations of firms from two different countries are combined to form a new entity; and acquisitions in which there is a transfer of existing assets from a local entity to a foreign investor. There are also nonequity forms of FDI, which include types such as subcontracting, management contracts, turnkey arrangements, franchising, licensing, and product sharing. The amount of FDI is generally defined by two measures: the flow of FDI and the stock of FDI. The flow of FDI refers to the amount of investment over a given time period (typically one year), and it is made up of three components: equity capital (purchase of shares of the enterprise), reinvestment of retained earnings of the entity, and intracompany loans or transactions between the parent enterprises and its foreign affiliates. It is commonly tracked both inwardly (FDI recipient or host country) and outwardly (FDI source or home country). The stock of FDI refers to the total accumulated value of foreign-owned assets at a given time. Individuals or business entities may undertake FDI. Firms that source FDI are known as multinational or transnational corporations (MNCs or TNCs) or enterprises (MNEs or TNEs). These firms are generally large and have budgets that exceed those of many countries.

An investor's motivation for acquiring or establishing foreign assets fall into three primary categories: FDI may be an effective way of gaining access to a foreign market or to valuable foreign resources, or it may be an effective way of reducing the cost of operations. But these incentives may be mitigated by potential risks due to uncertainty in the political and economic environment of the host country or the openness of the country to FDI.

Worldwide FDI has grown tremendously since the late 1980s as the institutional structures have encouraged economic liberalization and globalization. FDI inflows peaked in 2000 at $1.4 trillion but have since fallen to $560 billion in 2003 as a result of a worldwide economic downturn and the events of September 11, 2001, in the United States.

Historically, the developed countries have accounted for the majority of FDI. In 2003, they were responsible for 90% of the FDI outflow and were the recipients of 66% of the inflow. That being said, FDI is a major source of external capital for developing countries and is thought to be a major contributor to economic growth and development. In 2003, FDI inflows accounted for 72% of all resource flows to developing countries.

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