Introduction
FDI is the initials for Foreign Direct Investment. FDI can be defined as an investment from an individual, business, or corporation in one economy or country into another enterprise in a different republic with the intention to establish lasting interests in it. The capacity to control, manage and influence constitutes an abiding interest. According to Amirova et al. (2022), Foreign Direct Investment is the net inflows of a venture in the acquisition of lasting management interest (ten percent or more of the voting stock) in an enterprise operating in an economy other than an economy than that of the investor. Over the years, FDI has broadened to capture shares and assets, giving foreign investors’ forms’ management interest. Direct control, ownership, or influence distinguishes foreign portfolio investment (FPI) from foreign direct investment. FPI lacks control and ownership of the foreign venture.
For a foreign direct investment to happen there must be a country willing to invest overseas (outflows) and another ready to offer a desirable environment for the foreign investors to encourage their ventures. This paper will provide an in-depth understanding of foreign direct investments, the emerging trends of FDI inflows and outflows in growing economies, alongside the associated benefits.
Methods of Establishing Foreign Direct Investments
- Equity capital is also called voting stock in a non-resident company- enterprise shares purchased by a foreign investor.
- Reinvested earnings in the form of income not remitted to the investor or proportionate direct investor’s shares
- Intra-company debts or loans are long-term or short-term lending and borrowing of funds between the parent and affiliate enterprises.
- Joint ventures with foreign enterprises
- Merger and acquisitions.
- It is opening an affiliate of the domestic corporation in a foreign jurisdiction.
Key Issues and Terms
FDI inflows are the inward overseas direct investments that the reporting or domestic economy’s enterprises receive from foreign businesses or individuals. On the other hand, FDI outflows are the outward overseas direct investments the domestic country’s residents make to companies based or operating in foreign economies.
Benefits of FDI Inflows and Outflows
Foreign direct investment accrues benefits to both the foreign host economy and the investor. Governments and states ease trading both involved parties to earn the incentives linked to FDI. Some of the benefits accruing to the Investing enterprises include:
Market diversification- is defined as the process of moving an enterprise or economy from one to multiple sources of income by spanning through other markets and sectors. In the case of FDI, the investing entity in one country diversifies its market by investing overseas. Economies or businesses that have globally succeeded are vigilant of new and potential markets to widen their sources of income. For instance, if a U.S.A.-based banking institution opens subsidiary branches in Canada, the U.K, Mexico, and other countries, it will increase its capital base and likely to record increased revenues in its income statements.
Tax Incentives- foreign direct investment spurs the economic growth of the country receiving FDI inflows. For instance, poor economies offer foreign manufacturing companies incentives to encourage them to invest. Investment in a developing country would imply employment opportunities, the market of local inputs, and increased revenue to the host government (Chopra & Sachdeva, 2014). In some countries, licensing fees to establish foreign enterprises are waved for the investors and offered friendly landing terms. After the company has invested heavily and established itself, the government re-introduces the taxes and other charges.
Lower labor costs- growing economies encourage developed economies to invest within their boundaries to spur economic growth. Due to high poverty levels and low per capita income, the citizens of growing economies are willing to work at lower pay than the residents of the investor’s country. Low wages and remuneration is a cost-saving strategy that encourages foreign firms to diversify their market.
Subsidies are the sum of money or resources a government grants to a specific industry to keep the commodity or service’s prices low. For instance, foreign investors are getting subsidized services and goods in the growing economies as an incentive to set up their enterprises. Reduced licensing fees and seamless immigration procedures of foreign investors are vital contributors to earning international traders’ trust.
Preferential tariffs- Most Favored Nation (MFN) tariff is the ordinary rate charged to imported goods entering a country. According to Chopra & Sachdeva (2014), a preferential tariff is a lower rate charged to goods imported after governments sign a preferential trade agreement. Preferential tariff is usually lower than MFN tariff. Countries that intend to grow their economies through FDI inflows enter into trade negotiations and agreements with developed states and enjoy preferential tariffs. These tariffs act as incentives for investors whose foreign investment would demand to import a lot of equipment into the host country.
Benefits of FDI Inflows Accruing to the Host Country
Below are some of the reported benefits of the FDI inflows as it relates to the host country:
- Development of human capital – among the irreducible minimums agreed between the host country, and the foreign investor is that the labor force will not be imported except for the skill not available in the market. Therefore, the host country is a developing economy that benefits from the capacity building of its human capital. The labor force engaged in a foreign enterprise acquires new technology and expertise that renders itself employable even when the investor exits the local market.
- Economic stimulation – according to Chopra & Sachdeva (2014), whenever an economy is in recession, the government pumps money into the market through government spending to spur economic growth. Since the growing economies are limited in resources, they take advantage of foreign direct investment for economic stimulation. As the investor pumps resources into the foreign country through equity transfer, reinvestment of earning, or lending subsidiary companies, the economy is charged and stimulated to grow.
- FDI inflows give host countries access to management skills, expertise, and technology – the imported human capital is generally assumed to be highly skilled to deal with managerial and technological issues that the resident labor force lacks. As the resident workforce interacts with the experienced staff, it learns new and advanced management skills and technology.
- Increase in employment – the operations of a foreign enterprise are run mainly by the resident workforce. Some subsidiary corporations set in growing economies require personnel from manufacturing, distribution, sales, administration, and management. This is the easiest way to stimulate employment with an educated labor force in a growing economy.
Disadvantages of Foreign Direct Investment
On the other hand, foreign direct investment has its share of shortcomings. The two main disadvantages of FDI to the growing economies include:
- Displacement of local business – when large organizations enter a growing economy, they displace small and medium enterprises that had begun gaining roots in the market. Large firms like Walmart, Coca-Cola, and Colgate enjoy economies of scale because of their size of operations and outputs. Large companies offer lower prices to substitute goods they produce together with a local business. They also provide better working conditions than their competitors, who have little capital.
- Profit repatriation – some foreign companies do not reinvest in the same economies. Where foreign investors take away the profit into their mother country or different jurisdictions, the host economy significantly loses large capital outflow.
Due to these challenges, growing economies enact strict protective regulations that limit foreign direct investment.
Current State Analysis
It is established that developing countries absorbed more foreign direct investment than developed economies. Research carried in 2012 demonstrated that developing states accounts for 52% of the total global FDI inflows (Abotsi, 2018). According to UNCTAD Investment Trends Monitor, it rebounded back, surpassing the pre-COVID-19 level (Abotsi, 2018). Investment flows to developing countries have recovered and are pretty impressive. However, the least developed economies have stagnated in new investment in essential industries critical for sustainable development goals (SDGs) and productive capacities sectors such as food, health, and electricity.
Before the occurrence of COVID-19, global FDI flows were intact and thriving. This occurred after the recession occasioned by COVID-19 to an estimated $1.65 trillion, up 77% from $929 billion in 2020 (Afesorgbor et al., 2022). On the other hand, the developing economies FDI inflows in 2021 hit a record $870 billion, a single-year increase of 30% from 2020 (Afesorgbor et al., 2022). The 2021 FDI level was three times the lowest record low level of 2020. As the COVID-19 ravaged powerful economies globally, developing and least developed countries were even awfully hit, and the foreign direct investment dropped significantly.
The manufacturing sector forms the largest share of FDI inflows, severely impacted by the pandemic. Nonetheless, all industries are recovering due to the increased mass vaccination and more significant populations’ boosted immunity after the four waves of COVID-19 variants. Many economies have also recorded a low COVID-19 infection rate over a period recommended to lift stringent measures (Afesorgbor, et al., 2021). As the developing countries recover, foreign direct investors are encouraged to step back to stimulate the economy.
In 2021, activities in emerging markets and developing economies were estimated to grow by 6.3%. The expansion of the developing economies depended on the external environment, especially foreign direct investment (World Bank, 2021). The growing economies are gaining momentum to incubate human capital through continuous capacity building. Chopra & Sachdeva (2014) found that some of the African best economies like South Africa and Egypt are equipping their workforce with infrastructural and technological skills to leverage the status quo in case foreign investors exit. As the Foreign Direct Investment inflows diminish from the western countries, the Asian countries like China and UAE are willing to trade with developing economies (Afesorgbor, et al., 2021). Nevertheless, Asian countries are entering trade agreements with predetermined conditions, such as a high controlling stake on their projects.
Future Directions
As the increasing interest to invest in growing economies rise, there are resultant consequences that the host countries should be preparing for. The future is for those who can perceive it and plan how to get there. For the developing countries to shift their ranking upward, they ought to take into consideration their factors:
The first is divestment projection. Soon divestment perspective is looming to the developing and emerging economies. Divestment refers to the sale of a subsidiary’s controlling or voting power. In other words, divestment is the opposite of foreign direct investment (Afesorgbor, et al., 2021). As the growing economies attract foreign investors, the workforce continues to learn and enhance their skills mix. In case of retrenchment, the employees who have gathered enough capital commence their similar competing enterprises.
In other circumstances, established companies invite the fired staff into their enterprise to offer skilled managerial expertise due to a foreign subsidiary’s experience. As a result, competing local businesses get more robust and rebound back into the market. Due to the home advantage, the local enterprises edge out the foreign investment. When the foreign direct investments are no longer, the management opts to sell the enterprises to foreigners or locals (Abotsi, 2018). The exit from the foreign market where a business or individual has substantial control or influence is called divestment. Therefore, for the local companies to take advantage of the foreign investors exiting their market, they should adequately prepare for divestment.
The second factor is the inevitable energy reforms. The energy sector will be highly affected as the driver sector in developing economies. According to Blondeel (2019), the energy sector is the most significant stimulator for economic growth. As the world prepares to come into terms with climate change effects, developing economies should brace for tough times and radical changes. The primary sources of energy are oil and coal in developing economies. The by-products from the usage of the two energy sources are the major causes of the greenhouse effect. Therefore, to avoid high temperatures, one of the greenhouse effects, countries have signed treaties that require them to transit to renewable energy sources such as wind power, solar and geothermal energy. As a result, growing economies ought to transition to the recommended and acceptable energy sources to avoid international sanctions and alter the fast growth.
Conclusion
Foreign direct investment is both a contributor and a limitation to the growth of developing economies. However, growing economies should create a favorable business environment attracting foreign investors since the benefits outweigh the disadvantages. Many developed countries have used the foreign direct investment to spur their economies into growth and awesomely succeeded. Consequently, developing economies should take advantage of the FDI to stimulate economic growth.
Inflows and outflows are different depending on the foreign investor and the host country. Inflows are the capital injected into a foreign economy, while outflow is funds invested into a diverse economy other than the investor. Some of the advantages of foreign direct investment to the host country include economic stimulation and human capital development. On the other hand, benefits to the foreign investment enterprise are market diversification, preferential tariffs, tax incentives, subsidies, and lower labor costs. The two critical shortcomings of FDI to the host country are displacement of the local business and profit repatriation. Indigenous firms lack required abilities to compete favorably, hence losing the necessary advantage in the industry. The current trends show that foreign direct investment in the growing economies nearly rebounded back in 2021 and tripled after the spread of COVID-19 slowed globally. The future directions for FDI in growing economies are divestment and transition from current energy sources such as oil and coal to renewable energy sources.
References
Abotsi, A. K. (2018). Tolerable level of corruption for foreign direct investment in Europe and Asia. Contemporary Economics, 12(3), 269-284.
Afesorgbor, S. K., van Bergeijk, P. A., & Demena, B. A. (2022). COVID-19 and the threat to globalization: An optimistic note. In COVID-19 and International Development, 29-44). Springer, Cham.
Amirova, Z., Shirinzada, N., & Abdulova, A. (2022). AN ANALYSIS OF CURRENT TRENDS IN FOREIGN DIRECT INVESTMENT INFLOWS TO AFRICA. Intercon. 21
Blondeel, M. (2019). Taking away a “social licence”: Neo-Gramscian perspectives on an international fossil fuel divestment norm. Global Transitions, 1, 200-209.
Chopra, S., & Sachdeva, S. K. (2014). Analysis of FDI inflows and outflows in India. Journal of Advanced Management Science, 2(4), 326-332.
World Bank. (2021). Global economic prospects, January 2021. The World Bank, 14.