Foreign Direct Investment
Foreign Direct Investment – A multinational or transnational corporation invests money to start, acquire, or expand one of their affiliates in a foreign country. FDI is generally seen as a long-term investment in that country.
Portfolio Investment – typically seen as a short run kind of investment. Sometimes considered speculative, is the purchase of stocks, bonds, or other financial investments in a foreign country by individuals, multinational corporations, or equity funds.
Example, of portfolio investment is the Norwegian Sovereign Wealth Fund. Norway has a lot of oil wealth. They were trying to avoid what is known as the Resource Curse. Norway wanted to avoid that problem, so all the oil revenues are used to invest in stocks of foreign countries, for example, the Norwegian Sovereign Wealth Fund owns at least 1% of every S&P 500 company. This is a lot of money. It is used for, of course over the long-run all of those stocks together will grow and it is used to grow their pension fund.
Where does FDI normally go to?
About 50% go into developing countries and a little more than 50% goes into developed countries.
There is a sort of argument for either one.
If you want to invest in a developing country, there are advantages to that, maybe tax advantages in that, maybe the developing country does not have a robust tax infrastructure so you can use that to invest there and save money that way, maybe they have natural resource endowments so you can get cheaper gold, oil, or whatever that country has that your country does not, and of course in developing countries wages are usually lower, and the bad side of this is the workers may not be as educated because of the lower wages, there may be political instability in those countries, there may be currency issues, the currency may not be stable, those are reasons not to invest in developing economies.
You can also invest in developed countries, the advantage to that of course is the labour costs are higher, the workers are more educated so they should be more productive, currency fluctuations should be less of an issue, the political side should be more stable, so you are basically paying more for labour and things like that but there may be less risk in investing in a developed country verses investing in a developing economy.
First, if you are a multinational corporation, you may wish to seek access to new markets, you may have a really cool new product and you may think that individuals in a foreign country might want to invest in that.
Think of Subway, when they expanded into places like France or Germany, they were catering to those European Markets and that was bringing revenue back to the States, so they were accessing a new market that was unfamiliar with the Subway Products, therefore there was some sort of a novelty and therefore a competitive advantage. So, seeking access to new markets is one reason to engage in foreign direct investment.
Furthermore, you may want to grow beyond a domestic market, you have become thoroughly saturated.
Another thing is to generate some sort of efficiency or to lower your overall costs, think of something like this, maybe you have some very simple tasks that you need to perfume within your country but we have high labour costs, so you can export those tasks overseas and have individuals in a developing economy or a different country do those same tasks for a lower labour cost. Maybe you do not have access to certain natural resources so we would start investing in developing facilities or moving production capacity overseas where some of those natural resources might be more abundant. So the idea is invest overseas in order to create efficiencies or to lower your cost of production.
There are some thing to keep in mind when investing in developed and developing countries.
First – multinationals do not invest in a foreign country just because they are doing it for the good of charity or anything like that. You invest in a foreign country because you are looking at it as a potential way to make more money than you had before. So it is an investment and you are expecting some sort of a return on capital.
Of course, when these investment come to any country, but particularly developing countries, there can be significant economic benefits or consequences, and generally for the benefits a lot of less developed countries have significantly altered their tax structure and their investment policies in order to encourage multinationals to invest in their country.
The problem is certain negative effects of foreign direct investment.
First of all, a foreign company can squash local competition.
Furthermore, multinational firms typically have their shareholders in their home country, and therefore the profit from multinational companies are repatriated back to their home country and so the local residents do not get the full benefit from the multinational company’s presence.