What is Foreign Investment?
Foreign investment or foreign direct investment is able to be defined in several different ways. The International Monetary Fund (IMF) describes it as an investment in a foreign corporation of 10% or more. Foreign investment is also described as a foreign company or individual having an active role in the management of that foreign business.
Even though 10% of a foreign company does grant that investor a controlling interest it the foreign firm, it does have the ability to vote and influence the foreign company’s operations.
The International Monetary Fund (IMF) considers ownership of less than 10% of a foreign firm as merely a holding in the company’s stock portfolio. This is the difference between foreign direct investment and a foreign passive portfolio investment.
How Foreign Investment Works?
Foreign investment is usually made by firms who are interested in expanding their company’s footprint and shows a company is bullish on economic growth into the future.
It is very common for larger companies to have presences in many countries around the world. In the era of globalization, companies opening new branches and production facilities in different countries is very appealing because of new market reach but mainly the ability to source less expensive labor and production costs.
Taxes are another large motivator for multinational corporations. It is normal for these companies to operate in more tax efficient country than their home county. These tax havens typically have more advantageous tax laws designed to target foreign companies.
Types of Foreign Direct Investment
Foreign direct investment could be; acquiring voting stock in a foreign corporation, merging with or acquiring a new company, creating a joint venture with a foreign corporation or launching a subsidiary of a domestic firm in a foreign country.
Foreign indirect investment or foreign portfolio investing involves individuals and entities purchasing stakes in foreign corporations. These positions do not have any voting rights and are more of a passive investment. These investments could be equity investments or debt investments.
Foreign direct investment by a corporation is usually conducted in one of two different approaches; horizonal or vertical foreign direct investment.
The horizontal approach would be the case if a business was to conduct the same business activities in the foreign country. For example; Wal-Mart opens a traditional store in a foreign country.
The vertical approach would be the case if the business was moving to a different stage of their supply chain. For example; Wal-Mart purchases a factory in a foreign country to manufacture goods at a lower cost.
Advantages of Foreign Investment
Foreign investment advances the global economy, in addition to investors and capital recipients. Investors seek out companies with the best chances of growth (highest return), coupled with the least amount of risk, all throughout the world.
In this scenario, smart money rewards great companies and management teams with capital; regardless of race, color or creed. Any business with a competitive advantage is a possible recipient of foreign investment.
Host countries see their standard of living rise and countries will also see an increase in their tax base (unless they have created a tax incentive to attract the investment in the first place).
Possible advantages for the investor include; market diversification, tax incentives, lower labor costs, preferential tariffs and subsidies.
Possible advantages for the foreign company and country include; economic stimulation, increase in employment, growth of human capital and access to management expertise, skills and technology that were previously unavailable.
Disadvantages of Foreign Investment
There are two key disadvantages that are possible with direct foreign investment; negative affects on local businesses and capital repatriation.
Local businesses that are already operating in a foreign country maybe displaced because of foreign investment. Jobs could also be temporarily lost as the foreign business introduces new technology and processes.
Capital and profit repatriation are also a possible outcome of foreign direct investment. Where will the profits go? Will there be further investment in the community and host country or will the majority of the profits flow back to the home country?
These disadvantages are why many countries heavily regulate foreign direct investment.