Foreign direct investment (FDI) occurs when a company or investor acquires shares in a foreign enterprise with the intent of controlling or exerting significant influence over management. It differs from passive investments like stocks and bonds in that FDI presents both benefits and risks to both sides involved.
Taxes
Foreign Direct Investment (FDI) is one of the main sources of capital inflow for market economies in transition, providing essential technology and management expertise that enables these nations to compete effectively on world markets while simultaneously serving as an additional revenue stream.
Therefore, it is crucial for countries to offer attractive tax incentives to attract foreign investment, but this may have unintended repercussions.
High taxes may drive investors down indirect routes. A higher bilateral effective average tax rate (BEATR) leads to more indirect FDI by redirecting part of immediate FDI from home countries directly into host nations through conduit countries.
This effect is stronger for indirect foreign direct investment (FDI) than ultimate FDI, consistent with the idea that investors are more sensitive to tax rates when selecting investments.
Development of Human Capital Resources
Foreign direct investment provides many advantages to nations, one being its development of human capital. This occurs because FDI firms employ workers that contribute directly to economic development by providing income sources. Thus stimulating economic expansion.
FDI also provides training programs to local workers, which enhances the skillsets of national workforce. Such training programs can assist a country in industrializing more effectively, leading to an increase in production of goods and services within a nation.
Countries vie to attract FDI, offering incentives like lower taxes and tax breaks for exports as incentives to entice it. But such inducements come with risks; too much FDI might indicate weak domestic institutions rather than an economically vibrant national economy.
Resource Transfers
Foreign investments often bring advanced technology, equipment and facilities that contribute to an economy’s expansion. For instance, bringing production lines from another country can expand a plant locally while simultaneously creating more jobs.
Technology transfer increases a nation’s competitiveness and can help it catch up to more advanced economies. Economic theory and previous empirical research support this claim; one study even finds FDI to be an avenue of technological improvements within host nations.
However, certain investments can have national security ramifications and could fall into the hands of entities that threaten international peace and stability. Nations should carefully weigh both benefits and risks when permitting foreign investments, which may necessitate restricting certain types of investments to reduce security threats.
Lower Labor Costs
Foreign investment into manufacturing and services sectors increases employment, leading to more income sources for the population. This boost in purchasing power helps spur economic development.
Foreign investors may acquire lasting management interests of 10% or more voting stock of domestic enterprises or expand their operations by setting up new plants overseas. Acquisition of existing assets has become the predominant form of direct investment in industrialized countries in recent decades (Kester 1991 and Harris and Ravenscraft 1991).
There are various factors that influence foreign direct investment (FDI). Real exchange rate depreciation stimulates FDI by lowering domestic asset and labor costs for foreign investors. A decrease in FDI could also be related to protectionist pressures.
Economic Growth
Foreign Direct Investment (FDI) helps boost both service and manufacturing sectors, creating more jobs in both sectors and increasing local incomes, which leads to people spending their money and stimulating economic growth.
Additionally, a country can attract more foreign investment if they offer lower taxes and ensure the rights of foreign investors are safeguarded. They should also facilitate technology transfer and intellectual property transfers that help their companies compete more successfully in global economies.
Foreign direct investment brings many advantages, yet assessing risks is key to its success and growth. Understanding regulatory shifts, tax challenges and insurance requirements as part of an international expansion plan helps mitigate risk and protect assets while simultaneously enabling businesses to adapt their strategies in response to shifts.