Foreign direct investment, or FDI, occurs when an individual or a business entity owns a minimum of 10% capital in a foreign organization. FDI refers to the initial investment that is made to reach the 10% threshold. Any additional transactions that build a further capital stake in a foreign organization are listed as extra direct investments, or EDI.
At the 10% minimum, it is not possible to achieve a controlling interest in that foreign organization. It does give the investor a voice in the policies and procedures of that company, offering an opportunity to influence future decisions for the mutual benefit of everyone involved.
The advantage of FDI is that it allows the developed world to begin improving emerging market opportunities. The developing world can see improvements in wealth and opportunity, while the developed world can benefit from increased profits, developing relationships, and a greater level of market influence.
The disadvantage of a foreign direct investment is the risks that are involved. There is no guarantee that an investment will offer dividends in the future. The global political climate is inherently unstable as well, which means a company could lose its investment as soon as it is made should a seizure or takeover take place.
Here are some additional foreign direct investment advantages and disadvantages to take a look at today.
Top Advantages of Foreign Direct Investment
1. It provides local economic benefits in multiple locations.
The companies or individuals that participate in FDI can stimulate community economic growth on the local level for their headquarters or home. Profits are often reinvested into workers or increasing organizational opportunities, which can create new jobs, which then creates new FDI opportunities. The investments do the same for the home market of the foreign organization as well.
2. It makes international trade easier to complete.
Many countries have import tariffs that must be paid for goods and services. Import/Export businesses can struggle to keep products at affordable prices for customers because of these taxes. Through FDI, it becomes possible to limit or eliminate these tariffs since a minimum stake in a foreign organization occurs. That gives the local business more control over the market while maintaining price competition.
3. Foreign income can increase.
Many foreign markets have employees working at wages that would be considered poverty wages in the United States. A majority of the world earns less than $4 per hour. Some international markets offer less than $1 per hour. With FDI, foreign income levels can increase. Worker wages increase. That creates new resources that can help communities to begin growing.
4. It improves human resources.
Businesses are successful because humans have expertise. In the under-developed and developing world, human skills are limited to basic labor, agricultural work, and other entry-level skills. Foreign direct investment creates educational opportunities so that people can improve their personal skill base. With better skills, higher wages can be earned. Greater productivity levels are achieved. The company benefits, as does the individual, and that trickles down to each community.
5. It allows your money to work harder for you.
To encourage FDI, many governments have placed tax incentives on this type of investment. That makes more money available to work for a foreign company without disrupting the investing agency’s budget dramatically. These incentives make it easier to accomplish goals because the money involved can be directed toward resources instead of government coffers. At the same time, the gap between cost and revenue is reduced, providing more opportunities to find profit streams.
6. It provides a foreign company with needed experience.
Investors bring more than money to an FDI relationship. They can also bring their personal experiences within a specific industry. For the foreign company, such an investment can create an immediate surge in productivity. Investments can also provide better facilities for the foreign organization, better equipment assets, and improved vendor access if contact access from the investor is permitted in the relationship.
7. It creates new opportunities for workers.
Workers who are employed by the investing company can travel overseas and experience new cultures and ideas. That can make them more productive at home. Foreign workers have better access to the best practices that have been developed, which helps them to create new opportunities as well. This process helps both parties grow faster than if they were on their own.
Top Disadvantages of Foreign Direct Investment
1. It stops domestic investments from happening.
A 10% minimum investment into a foreign company is money that isn’t going into domestic companies. Although money comes back into local communities with FDI, a local investment’s value is almost another $1 for every dollar spent. That means a $10,000 domestic investment could be worth $20,000 or more in the future.
2. It isn’t without risk.
Political instability around the world means that the business environment can change at a moment’s notice. Although companies and individuals choose foreign organizations that have little risk, there can never be a complete elimination of risk from the transaction. In some countries, the political risk factors could be so high that a foreign direct investment doesn’t make sense.
3. It can be more expensive.
In the United States, the dollar is one of the strongest currencies in the world. For an investment into the developing world, the value of the currency can be stretched further than it would be domestically. That isn’t always the case, however, because the euro and the pound trade higher than the dollar. Investing into one of those markets through FDI would actually have higher costs for the individual or business compared to a domestic investment.
4. It can affect currency exchange rates.
A developing country with a struggling currency may see a surge of popularity after a foreign direct investment. People and companies see an investment as a sign of stability, creating additional interest in the market being examined. That higher level of interest can lead to a better monetary value for the foreign nation, which may destabilize exchange rates.
5. It can lead to exploitation.
Exploitation of FDI can happen on a number of levels. A foreign government might choose to seize the investment. Assets or proprietary information might be seized for political purposes. The foreign company might take the investment and squander it. Even if there is a well-constructed contract governing the terms and conditions of the investment, some foreign companies may decide to take the money and run. That can leave an investor with few, if any, options to recover their funds.
These foreign direct investment advantages and disadvantages provide a foundation for the decision-making process. Every key point must be carefully considered before completing a transaction. That way, the best possible outcome can be achieved for everyone involved in the investment.
Blog Post Author Credentials
Louise Gaille is the author of this post. She received her B.A. in Economics from the University of Washington. In addition to being a seasoned writer, Louise has almost a decade of experience in Banking and Finance. If you have any suggestions on how to make this post better, then go here to contact our team.