Foreign Direct Investment (FDI) lies at the heart of globalization and serves as an important conduit for transferring capital, goods, services, and information across economies. Measuring FDI helps us better understand how countries are interconnected and integrated into today’s global economy.
Foreign direct investment is a stake in a company or project by a foreign entity. Companies or governments considering an FDI generally consider target firms or projects in open economies that offer a skilled workforce and above-average growth prospects for the investor.
Types of Foreign Direct Investment
Foreign direct investments are commonly categorized as vertical, or horizontal. and conglomerate.
- In a vertical FDI, a business acquires a complementary business in another country. For example, a foreign manufacturer might develop an interest in a foreign company that supplies it with the raw materials it needs.
- With a horizontal FDI, a company establishes the same type of business operation in a foreign country as it operates in its home country.
- In a conglomerate FDI, a company invests in a foreign business unrelated to its core business. Because the investing company has no prior experience in the foreign company’s area of expertise, this often takes the form of a joint venture.
FDI can foster and maintain economic growth, in both the recipient country and the country making the investment. On one hand, developing countries have encouraged FDI as a means of financing the construction of new infrastructure and the creation of jobs for their local workers.
Both economic theory and recent empirical evidence suggest that FDI has a beneficial impact on developing host countries. But recent work also points to some potential risks: it can be reversed through financial transactions; it can be excessive owing to adverse selection and fire sales; its benefits can be limited by leverage; and a high share of FDI in a country's total capital inflows may reflect its institutions' weakness rather than their strength.