Cosmopolitian’s

Valia C.L. College of Commerce & Arts.

NAME: ARYAN RAJESH JAISWAL

STD : TYBAF
ROLL NO: 61
DIV: A
SUBJECT: ECONOMICS - III
TOPIC: FOREIGN DIRECT INVESTMENT.
  INTRODUCTION

Foreign Direct Investment (FDI) is when an investor, company, or government from one
country acquires an ownership stake in a business in another country, typically amounting to
at least 10% of the voting power. This form of investment creates lasting and significant links
between economies and can take various forms, such as opening a subsidiary, acquiring a
controlling interest in a foreign company, or engaging in a merger or joint venture. FDI is
distinct from foreign portfolio investment, as it involves a more active and long-term role in
the foreign business. It can lead to the transfer of technology, promote international trade, and
contribute to economic development. FDI can be "outbound," where a domestic firm invests
in a foreign country, or "inbound," where a country receives investment from a foreign firm.
It is considered a key element in international economic integration and can have various
advantages for both the investing and host countries. However, it also presents challenges,
such as the need for regulatory oversight and the potential for negative impacts on local
businesses. FDI is a significant driver of global economic growth and development.
  TYPES OF FDI

 HORIZONTAL FDI:
Horizontal FDI is a type of foreign direct investment where a company invests in a foreign
company that operates in the same industry as the investing company. In other words, the
investing company invests in a foreign company that produces similar goods or services as
the investing company. For example, a Spanish clothing company investing in an Indian
clothing company. The primary aim of horizontal FDI is to improve market access and gain a
competitive advantage in the foreign market. Horizontal FDI can help companies to expand
their customer base, reduce production costs, and increase profits. The factors that influence
horizontal FDI include market size, growth potential, ease of doing business, political
stability, and the availability of skilled labor. Horizontal FDI is the most common type of FDI
and is often used by companies to enter new markets and expand their global presence.

 VERTICAL FDI:
Vertical FDI is a type of foreign direct investment where a company invests in a foreign
company that is part of its supply chain, either as a supplier or distributor. The investing
company acquires a controlling interest in the foreign company, which may or may not
belong to the same industry. Vertical FDI can be further categorized as backward or forward
vertical integration. Backward vertical integration occurs when a company invests in a
foreign company that supplies raw materials or components to the investing company. For
example, a coffee producer investing in coffee plantations in a foreign country. Forward
vertical integration occurs when a company invests in a foreign company that is higher up in
the supply chain, such as a distributor or retailer. For instance, a coffee company investing in
a foreign grocery brand. The primary aim of vertical FDI is to improve the efficiency and
quality of the supply chain, reduce costs, and increase profits. The factors that influence
vertical FDI include the availability of raw materials, transportation costs, and the quality of
the local workforce. Vertical FDI is common in industries such as automotive, oil, and
infrastructure.

 CONGLOMERATE FDI:
Conglomerate FDI occurs when a company invests in a foreign company belonging to an
entirely different industry, with no direct link to the investor's business. The primary purpose
of conglomerate FDI is to diversify business interests or start a completely new business in a
foreign country. An example of conglomerate FDI is a US-based retailer like Walmart
investing in Tata Motors, an Indian automobile manufacturer. This type of investment is not
directly related to the investor's core business and is aimed at expanding into new and
unrelated industries in foreign markets. Conglomerate FDI is one of the four primary types of
foreign direct investment, the others being horizontal, vertical, and platform FDI. Itrepresents
a strategic move to enter new business areas and expand the investor's global presence.
  PLATFORM FDI:
Platform FDI, also known as export-platform FDI, occurs when a business expands into a
foreign country, but the output from the foreign operations is exported to a third country. This
type of FDI commonly happens in low-cost locations inside free-trade areas. An example of
platform FDI is when a company, such as Ford, purchases manufacturing plants in a country
with the primary purpose of exporting cars to other countries. The investment is made to
manufacture goods in the foreign country and sell the finished product in a third country. This
type of FDI is unique and is aimed at taking advantage of cost efficiencies and market access.
It is often associated with companies seeking to optimize their production and distribution
processes by leveraging the comparative advantages of different countries. Platform FDI is a
strategic approach to international business expansion and market access, and it is an
important aspect of global trade and investment.
 Features of Foreign Direct Investment
Foreign Direct Investment (FDI) encompasses a variety of features that contribute to its
complexity and impact. Here are more points detailing the aspects of FDI:

 Method of Investment:
FDI can be made through various channels, such as acquiring a controlling stake in a foreign
company, setting up a subsidiary, or through mergers and acquisitions.

 Ownership and Stakes:

FDI allows the investing company to take ownership and stakes in more than one company
in different fields, enabling them to be part of the daily decision-making process of the
invested company.

 Impact on Economy:
FDI contributes to economic growth, technology transfer, and the development of local
businesses. It also fosters the expansion of multinational companies into international markets
and supports the local economy by creating jobs and boosting exports.

 Regulatory Changes and Government Policy:

Governments may make policy changes to attract FDI, such as amendments in investment
policies, production-linked incentive schemes, and easing the permission process for foreign
investors.

 Challenges and Risks:

FDI is associated with challenges such as political risk, regulatory changes, exchange rate
risk, and potential poor performance, which require careful consideration and risk assessment
before engaging in FDI.

 Liquidity Risks:
Liquidity risk is the risk of not being able to sell an investment quickly at any time without
risking substantial losses due to a lack of buyers in foreign markets, especially in emerging
markets.
  Currency Volatility:
Currency volatility is an additional layer of risk in making foreign transactions, as the value
of investments can fluctuate due to changes in exchange rates.

 Higher Transaction Costs:

The biggest barrier to investing in international markets is the added transaction cost, which
can be substantially higher than domestic transactions.

 Difficulty Accessing Information:

International investors may have difficulties accessing information on companies outside the
U.S., as some information may not be available in English.

 Working with Foreign Brokers:

Working with a foreign broker or investment adviser may be a challenge since they may not
be registered with the SEC.

 Legal Remedies:
It can be difficult to find legal remedies outside the U.S., as the legal system and protections
may differ from country to country.

 Different Operating Environments:

Foreign markets may operate differently than in the U.S., and investors must be aware of
these differences to make informed decisions.
These features highlight the diverse nature of FDI, its impact on the economy, and the
associated challenges and risks.

ADVANTAGES OF FDI
The advantages of Foreign Direct Investment (FDI) include:

 Economic Growth:
FDI can stimulate economic development, boost the manufacturing and services sector, and
create jobs, leading to reduced unemployment rates and increased incomes.
  Human Capital Development:
FDI can enhance the knowledge and skills of the workforce through training and technology
transfer, thereby boosting the education and human capital of a country

 Technology Transfer:
Targeted countries and businesses receive access to the latest technologies and operational
practices from around the world, leading to enhanced efficiency and effectiveness of the
industry

 Increase in Exports:
FDI can lead to an increase in exports, as many goods produced by FDI have global markets,
not solely domestic consumption

 Exchange Rate Stability:

The flow of FDI into a country can result in stable exchange rates due to a continuous flow of
foreign exchange

 Improved Capital Flow:

Inflow of capital through FDI is particularly beneficial for countries with limited domestic
resources and those with restricted opportunities to raise funds in global capital markets

 Creation of a Competitive Market:

FDI helps create a competitive environment, break domestic monopolies, and fosters
innovation and access to a wider range of competitively priced products.

 Resource Transfer:
FDI allows for the transfer of knowledge, technologies, and skills, leading to the
development of human capital resources and reduced production costs.

 Increased Productivity:
The facilities and equipment provided by foreign investors can increase a workforce’s
productivity in the target country.
  Increase in a Country’s Income:
FDI can lead to an increase in the target country’s income, with more jobs and higher wages,
promoting economic growth.

 Access to New Markets:

FDI can provide access to new markets, allowing companies to expand their customer base
and increase sales.

 Improved Infrastructure:
FDI can lead to the development of infrastructure, such as roads, ports, and airports, which
can benefit the local economy and improve the quality of life for residents.

 Increased Competition:
FDI can increase competition in the local market, leading to lower prices and better quality
products for consumers.

 Diversification of the Economy:

FDI can help diversify the economy by introducing new industries and technologies,
reducing dependence on a single industry or sector.

 Improved Balance of Payments:

FDI can improve a country's balance of payments by increasing exports and reducing
imports.

 Access to Capital:
FDI can provide access to capital, which can be used to finance new projects and expand
existing businesses.

 Improved Governance:
FDI can lead to improved governance and transparency, as foreign investors often demand
high standards of corporate governance and accountability.
These advantages highlight the positive impact of FDI on economic development, technology
transfer, and the overall competitiveness of the target country.
 DISADVANTAGES OF FDI
The disadvantages of Foreign Direct Investment (FDI) include:

 Hindrance of Domestic Investment:

FDI can lead to a decline in domestic investment as local companies may struggle to
compete with foreign firms, potentially leading to a loss of interest in investing in domestic
products.

 Political Risk:
FDI involves the regulation and oversight of multiple governments, leading to a higher level
of political risk, as changes in the political landscape of the host country can impact the
investment.

 Negative Exchange Rates:

FDI can affect exchange rates, potentially to the advantage of one country and the detriment
of another, leading to economic imbalances.

 Higher Costs:
Investing in foreign countries can be more expensive, with a greater portion of the investment
going into machinery and intellectual property rather than local employee wages.

 Economic Non-Viability:
FDI can sometimes be economically non-viable or risky, particularly for developing and
emerging market countries, and may not always lead to the expected economic benefits.

 Expropriation:
Political changes in the host country can lead to expropriation, where the government takes
control of the investor's property and assets.

 Modern-Day Economic Colonialism:

Some countries fear that FDI could lead to a form of modern-day economic colonialism,
leaving them vulnerable to exploitation by foreign companies.
  Poor Working Conditions:
Multinational companies have been criticized for poor working conditions in foreign
factories, raising concerns about the impact of FDI on labor standards.

 Environmental Impact:
FDI can lead to environmental degradation if not properly regulated, as foreign companies
may not adhere to the same environmental standards as local firms.

 Dependency on Foreign Investment:

Overreliance on FDI can lead to a country becoming overly dependent on foreign
investment, which can pose risks to its economy and sovereignty.

 Profit Repatriation:
Profits generated by foreign companies through FDI can be repatriated to their home
countries, leading to a potential loss of wealth for the host country.

 Market Domination:
FDI can lead to the domination of local markets by large foreign firms, potentially stifling
competition and innovation.

 Cultural Impact:
The influence of foreign companies through FDI can impact local culture and traditions,
leading to concerns about the preservation of national identity.

 Job Displacement:
In some cases, FDI can lead to the displacement of local workers as foreign companies may
bring in their own employees or use more advanced technologies, potentially leading to
unemployment.

 Inequality:
FDI can exacerbate income inequality within the host country, as the benefits of investment
may not be distributed evenly across the population.
These additional disadvantages highlight the complex and multifaceted nature of FDI,
including its potential impact on the environment, culture, and local labor markets.
 Challenges faced by Investors in Fdi.
The challenges faced by investors in Foreign Direct Investment (FDI) include:

 Political Risk:
Political risk refers to the risk of changes in government policies, political instability, and
other political factors that could affect the profitability of the investment.

 Cultural Differences:
Cultural differences between the investor's home country and the host country can create a
communication gap and make it difficult to conduct business.

 Legal and Regulatory Framework:

Investing in a foreign market requires compliance with local laws and regulations, which can
be complex and time-consuming.

 Infrastructure and Logistics:

Investing in a foreign market requires access to reliable infrastructure and logistics, which
may not be readily available in some countries.

 Currency Risk:
Fluctuations in currency exchange rates can affect the profitability of the investment.

 Dependency on Host Country:

Overreliance on the host country can lead to a loss of control over the investment and
potential risks to the investor's business.

 Market Competition:
FDI can lead to increased competition in the local market, potentially making it difficult for
local businesses to compete.

 Environmental and Social Impact:

FDI can have a negative impact on the environment and local communities if not properly
regulated.
  Expropriation:
Political changes in the host country can lead to expropriation, where the government takes
control of the investor's property and assets.

 Poor Working Conditions:

Multinational companies have been criticized for poor working conditions in foreign
factories, raising concerns about the impact of FDI on labor standards.

These challenges highlight the potential risks and complexities associated with FDI,
including political risk, cultural differences, and legal and regulatory compliance. Investors
must carefully assess these challenges and adopt appropriate strategies to mitigate risks and
maximize returns on their investment.

Impact of Fdi on Country Economy

Foreign Direct Investment (FDI) can have a significant impact on the economy, contributing
to economic growth, technology transfer, and various other welfare-enhancing processes. The
following points summarize the impact of FDI on the economy based on the provided
sources:

 Economic Growth:
FDI can contribute to economic growth by raising total factor productivity and the efficiency
of resource use in the recipient economy. It triggers technology spillovers, assists human
capital formation, contributes to international trade integration, and enhances enterprise
development, leading to higher economic growth.

 Technology Transfer and Productivity:

FDI can positively influence the growth rate by generating increasing returns in production
via externalities and production spillovers. It brings new technology, managerial and
marketing expertise, and international best practices, which can be diffused into indigenous
firms, creating more innovation and productivity growth.

 Employment Opportunities:
FDI can lead to the creation of employment opportunities in the host country, reducing
unemployment and boosting the gross domestic product, thus promoting economic growth.
  Poverty Reduction:
Studies have found that higher incomes in developing countries, generally resulting from
FDI, benefit the poorest segments of the population proportionately, thus contributing to
poverty reduction.

 Trade Integration:
FDI can broaden access to export markets, as transnational corporations often serve as
channels for the distribution of goods from one country to other markets located in another
country, thus contributing to trade integration.

 Human Capital Development:

FDI can benefit countries with better endowment of human capital, as they are believed to
benefit more from FDI-induced technology transfer and spillover-effects than others with less
human capital.

 Financial Development:
FDI plays an important role in contributing to economic growth, and the level of
development of local financial markets is crucial for the positive effects of FDI to be realized.

 Growth in GVC Activity:

FDI has a positive association with growth in countries that experience high global value
chain (GVC) activity growth, and strengthening human capital and improving financial
development.
In conclusion, FDI can have a substantial and multifaceted impact on the economy,
contributing to economic growth, technology transfer, poverty reduction, and trade
integration. However, the extent of these impacts can depend on various country-specific
factors and the level of development of the host country.

How do Cultural Differences Impact Fdi Policies.

Cultural differences can significantly impact FDI policies in various ways. Two primary
effects of cultural differences on FDI are the level effect and the distance effect.

 Level effect:
This refers to the differences in the level of cultural values between countries, which can
influence FDI flows. For example, FDI tends to flow from low uncertainty avoidance
countries to high uncertainty avoidance countries.
  Distance effect:
This refers to the differences in cultural values between countries, which can create barriers
to FDI. Cultural distance can lead to higher transaction costs, which can negatively affect FDI
flows.
Cultural differences can also lead to cultural spillover, where FDI can contribute to cultural
convergence across countries.
For instance, FDI can lead to the adoption of more productive employment structures and
gender equality practices in local firms.
However, cultural differences can also create challenges for FDI, such as communication
barriers, misunderstandings, and conflicts between local and foreign firms.
To overcome these challenges, host countries can put in place appropriate frameworks, such
as a healthy enabling environment for business, which encourages both domestic and foreign
investment, provides incentives for innovation, and contributes to a competitive corporate
climate.

How do Fdi Differ Between Developed and Developing Countries

Foreign Direct Investment (FDI) policies differ between developed and developing countries
in several ways. Developed countries, which are the source of most FDI flows, can contribute
to the growth of developing countries by facilitating their access to international markets and
technology. They can also use overseas development assistance to leverage public/private
investment projects and encourage non-OECD countries to attract FDI. Developing countries,
in turn, are strongly interested in attracting FDI to accelerate their growth and economic
transformation. They have been liberalizing their national policies to establish a hospitable
regulatory framework for FDI by relaxing rules regarding FDI flows. Developing countries
see FDI as a means of transferring production technology, skills, innovative capacity, and
organizational and managerial practices between locations, as well as of accessing
international marketing networks. They are taking steps to improve the principal determinants
influencing the locational choices of foreign direct investors. However, FDI in developing
countries can present several risks, including political risk, exchange rate risk, economic non-
viability, expropriation, poor performance, hindrance of domestic investment, and
environmental impact. To maximize the benefits of FDI while minimizing the risks, host
countries need to put in place appropriate frameworks, such as a healthy enabling
environment for business, which encourages both domestic and foreign investment, provides
incentives for innovation, and contributes to a competitive corporate climate.
 Conclusion
The growing importance of FDI in the world economy has placed the activities of direct
investors and direct investment enterprises under increasing scrutiny and raised demands for
more statistical work. Although countries are compiling and disseminating a greater amount
of data on FDI transactions and stocks and increasingly are adopting the recommendations of
the international statistical manuals, there remain important deficiencies in the coverage and
comparability of data in both industrial and developing countries. The data deficiencies
reflect the complexities of compiling FDI data, as well as the use by countries of different
methodological practices in compiling these data.
Various international and regional organizations are working with countries to improve FDI
statistics through the provision of methodological materials, technical assistance, and training
courses and workshops. In connection with the updating of the BPM5 and the OECD
Benchmark Definition, consideration will be given to possibly simplifying some of the
present international recommendations, which many countries have found difficult to apply
or explain to survey respondents (for example, the issue of indirectly owned enterprises). The
SIMSDI will be repeated in 2004, with respect to country practices in 2003, to monitor
countries’ efforts to implement the internationally agreed statistical recommendations for FDI
statistics. It is expected that information will be obtained on the practices of over 100
countries.

Refrences
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