Foreign direct investment
Foreign direct investment ( english foreign direct investment , short FDI or FDI ) are investments abroad by a domestic investor ( natural or legal persons ). In contrast to portfolio investments, the most important differentiating criteria for direct investment are the influence and control of business activities abroad and thus of generating income . So not only capital flows, but also knowledge and technology. Direct investments are therefore part of the international movement of capital (and thus of globalization).
According to the International Monetary Fund, a characteristic of a direct investment is a stake of at least 10% in the company abroad, whereby a stake of 25% and more is usually assumed, taking into account the control aspect.
Direct investment has a flow, a stock and an income component.
The analysis of transactions resulting from a direct investment relationship is most widespread . This flow-based view corresponds to the role of direct investment in the balance of payments , in which it forms part of the capital account .
The capital flows include the transactions necessary to establish a direct investment relationship and any subsequent transactions between the direct investor and the direct investment company. The former includes the acquisition of shares or other shares in existing companies abroad and their reserves as well as the transfer of capital for the establishment of companies abroad. Second, in addition to capital increases, there are internal company loans from the parent company to the subsidiary and the subsidiary's earnings reinvested abroad .
Another focus is the stock-based view, which looks at the capital stocks in direct investment companies at a specific point in time. This view corresponds to the role of direct investment in foreign assets . The capital stock comprises the equity capital held proportionally by a direct investor in a direct investment company as well as credit relationships between the two.
Although capital flows influence the capital stock, conclusions cannot be drawn directly from the change in the capital stock about the capital flows or vice versa. The change in the capital stock is subject to various influences that do not lead to capital movements. The capital stocks are also changed by changes in exchange rates, new valuation principles (e.g. adjustment to international accounting standards), etc.
Finally, the income-based perspective examines the direct investor's income earned in direct investment companies and their distribution. Direct investment income is composed of reinvested income and dividends transferred to the direct investor. This view corresponds to the role of direct investment in the current account , where it forms a component of investment income.
- Relocation of production - which can either lower the direct costs of production or achieve economies of scale .
- Tax reduction - taking advantage of the difference in taxation between different countries.
- Financial Markets - where simple and easy access to financial markets is offered to a company through improved liquidity or leverage.
- Information arbitrage - differences in knowledge and experience in the areas of production, marketing or organization can come into play through direct investments in various markets. A company that can identify such differences can thereby gain a direct competitive advantage in such markets.
- Global coordination - As certain activities are performed centrally where the framework conditions for these activities are optimal, the centralization of the activities can be achieved.
- Reduction of political risk - Different countries have different levels of risk of losing capital through government influence. In regions of relative political stability, high investments are more secure than in regions with high instability.
Growing competition in traditional home markets is driving companies to take advantage of these advantages. However, such factors can hardly achieve lasting advantages, since competing companies use the same means and paths.
In the case of foreign direct investments, the focus is on the choice of location. However, certain obstacles can lead to restrictions or the absence of foreign direct investment. Examples are:
- Political risks (e.g. actions by the foreign government)
- Economic risks (eg. As exchange rate risk , marketing risk , labor market problems )
- Social risks (e.g. language difficulties)
- Other risks (e.g. climatic conditions)
If the country can offer an investment-friendly environment in the form of few obstacles, then market and cost-oriented motives play a prominent role in the choice of location. Market-oriented motives are for example:
- Aquire new markets
- Use of the location as an export base
- Securing existing markets
The cost-oriented motives include:
- Labor cost advantages (= most important motive in this category)
- Tax benefits
- Purchasing and procurement advantages (especially in resource-rich countries)
- Government investment incentives
Dunning Eclectic Paradigm
Among the direct investment theories, John H. Dunning's eclectic paradigm is considered to be the most comprehensive, as it seeks as much as possible to encapsulate all the different approaches in one model; hence the term " eclectic ". Dunning's model is based on three main theories:
According to Dunning, there must be three conditions for a company to make direct investments:
- Ownership advantages : The company must have an exclusive competitive advantage over its competitors on the foreign market, e.g. B. management quality , degree of vertical integration or organizational synergies .
- Location advantages : The company must benefit from the differences between home and host country, for example through lower wage or factor costs .
- Internalization advantages : A company must use its specific competitive advantages itself and not pass them on to the companies already located there, e.g. B. in the form of licenses, sell.
The model is also referred to as the OLI paradigm after the respective first letter of the conditions.
A distinction must be made between direct foreign investments ( direct investments ) and indirect foreign investments ( portfolio investments ). In the case of the former, it is important for the investor to directly control the acquired means of production . In the case of indirect foreign investments, on the other hand, the only concern for the investor is to participate in the current profits of a production controlled by others .
Investing abroad can create problems for both the investor and the country in which the investment is made. For the investor, the main concern here is the security of his investment and the right to transfer profits back to his home country. On the other hand, developing countries in particular have problems with the fact that investors there sometimes encourage corruption and that international standards in environmental protection and occupational safety are often not observed (extreme case: sweatshops ) .
UNCTAD was the first to deal with the regulation of the international framework for foreign investments . In this context, the developing countries had some influence, but no agreement was reached with the industrialized countries . At the end of the nineties there was then a draft within the framework of the OECD for a multilateral agreement on investments (MAI). a. the French government raised concerns. A regulation is now being negotiated within the framework of the World Trade Organization .
The benefits of foreign investments and the approaches to regulating them are controversial in connection with the debate about globalization and neoliberalism . The debate about the Multilateral Agreement on Investment is seen by some as the point of origin of the criticism of globalization as an independent approach.
From a macroeconomic perspective, the sum of foreign investment ( net foreign investment ) is of interest , which by definition is identical to capital export. Investments flowing in from abroad, on the other hand, form the capital import; together these two items form the capital account .
A ( foreign ) direct investment is the financial participation of an investor ( direct investor , parent company ) in a company in another country ( direct investment company, subsidiary ), which is usually intended to circumvent possible barriers to market entry (e.g. trade barriers) and (also ) is intended in terms of type and scope to exert a permanent influence on the business policy of this company. According to international standards (see section), the required “permanent influence” can be assumed if the stake makes up at least 10% of the capital of the direct investment company.
From the domestic perspective, a distinction is made between active direct investment (direct investment abroad) and passive direct investment (foreign direct investment at home).
The effects can be divided into primary and secondary effects. Primary effects represent the type of financing, which essentially deals with the investment process of foreign companies. Two types are distinguished here; The already known Greenfield Investments (Green Meadows) also include the mergers and takeovers of foreign companies, the Mergers & Acquisitions .
If a company makes direct foreign investments in another country, it becomes transnational (TNK - transnational corporations). This property can be classified into three levels:
- Part of foreign assets in total assets
- Component of foreign sales in total sales
- Part of the employees abroad in the total number of employees.
Secondary effects are the consequences of the type of investment. While many are positive, negative aspects can also emerge from a direct investment.
In addition, it must be taken into account which sectors of the host countries are profitable in order to better assess the consequences of an FDI on the respective segments. Direct investment encompasses some areas such as:
- Employment and income effects
- Multiplier effects
- Trade and Payments Balance
- Competitive effects
Foreign direct investments in natural resources offer countries with the corresponding potential the chance of increased growth, but can also have negative economic, social and ecological consequences such as forced relocation , a lack of occupational safety , land grabbing , deforestation and soil degradation if legislators and supervisory authorities do not take adequate precautions to meet.
Positive effects Greenfield investments can lead to a significant increase in the total amount of investments in developing countries. This process is known as “crowding in”.
An important prerequisite for constant economic growth is the monetary situation. With these new jobs can be created, production and ultimately income can be increased. The standards of living can certainly be improved by investing the money in improving the infrastructure , both technical and social.
Furthermore, foreign direct investments make a positive contribution to the diversification of the production structure through the transfer of new management techniques and technology transfers.
Negative effects On the other hand, foreign direct investment also has negative effects. The “crowding out” effect describes the decline in investments after the TNC have invested.
If the majority of funds are invested in sectors that are already profitable, it is possible that local businesses will be affected by the new changes. The new competition from abroad displaces existing corporations, which in turn means that fewer profits are made and thus less can be produced. Due to limited capital, companies are forced to relocate or lay off employees. Falling incomes are the result. (It is important to pay attention to the mentality of the people in order to achieve a really positive development)
Direct Investment and Globalization
Direct investment is an important indicator of globalization . As a rule, they depict direct, stable and long-term interrelationships between economies and data that are comparable worldwide are available. Direct investment as a percentage of nominal gross domestic product (GDP) is the most frequently used measure of the globalization of an economy that can be derived from direct investment statistics. This indicator is created for inflows, stocks or direct investment income. The capital stock as a percentage of GDP is particularly suitable for longer-term considerations.
There are several reasons for foreign investment.
- Development of new sales markets
- Use of cheaper production locations ( low-wage country ) see also: Outsourcing
- Avoiding exchange rate risks by relocating production capacities to the sales countries ( natural hedging )
- Diversification of the investment portfolio
The basic manual for direct investment is the balance of payments manual of the International Monetary Fund (IMF) . It is supplemented and substantiated by an OECD manual, the so-called “benchmark”. These two handbooks are based on the direct investment data for most countries. According to regular studies by the OECD and IMF, there are still some considerable differences in implementation in the individual countries, but these have become smaller compared to before.
Investment protection and risk protection
Investments abroad are initially subject to the legal system of the host country. In addition, unlike portfolio investments, direct investments are also protected under customary international law.
Today, the risks do not represent so very obvious expropriations without compensation or measures equivalent to expropriation, as these are now generally viewed as contrary to international law.
At the beginning of the 20th century, according to the Calvo Doctrine , the view was still held that foreigners, for example in the case of nationalization in the host country, were only entitled to equal treatment with domestic citizens, i.e. there was also no diplomatic protection right . This was countered by the Hull formula that the expropriating state was obliged to provide immediate (no installment payment), adequate (value-appropriate) and effective ( convertibility of the payment currency) compensation.
Today there are various bilateral and multilateral investment protection agreements , investment protection through regional economic agreements ( European Communities , North American Free Trade Agreement , ASEAN and Mercosur ) and corresponding agreements within the framework of the OECD and WTO.
These contracts are concluded to give foreign investors fair competition, to guarantee the protection of investors' property and to assure foreign investors the opportunity to enforce their rights in the host country.
Most agreements offer four key guarantees:
1. Protection against discrimination,
2. Protection against expropriation without compensation ,
3. Protection against unfair and unfair treatment,
4. Guarantee of the free movement of capital.
As a result, certain forms of government risk protection are no longer permitted if they are seen as hidden export promotion. This is to prevent a race between export subsidies.
On the other hand, direct investment is also better protected against more subtle forms of property disruption, such as B. Subsequent disproportionate and discriminatory official requirements under the pretext of environmental protection. This protection exists for use cases outside of one's own regional economic agreement, in particular if the corresponding investment protection agreement offers protection according to ICSID ( International Center for the Settlement of Investment Disputes ).
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