Foreign Direct Investment (FDI): Definition and Overview

Foreign direct investment (FDI) is a substantial, long-term investment by a company, institutional investor, or government into a business or project located in another country. Unlike passive purchases of foreign stocks or bonds, FDI typically involves acquiring a controlling stake or otherwise exercising significant influence over management, operations, technology, or production.

Key takeaways
* FDI creates enduring links between economies and often includes capital, management, technology, and equipment.
* A controlling interest is commonly defined (per OECD guidelines) as ownership of at least 10% of a foreign company’s voting shares, though influence can be effective at lower levels.
* FDI inflows are a useful indicator of a country’s appeal as a destination for long-term investment and can represent a significant share of GDP for smaller economies.

How FDI works

Investors consider factors such as market size, growth prospects, regulatory environment, workforce skills, and access to inputs when targeting countries for FDI. Common motives include:
* Gaining access to new markets and customers
* Securing sources of raw materials or suppliers
* Reducing production or transportation costs
* Transferring technology or managerial expertise

FDI often extends beyond capital to include transfer of technology, brand, and managerial practices. Global FDI flows can be large and cyclical — for example, global investment fell sharply during the COVID-19 pandemic and later rebounded.

Ways to structure FDI

FDI can be executed through multiple channels:
* Greenfield investments: building new facilities or operations from scratch in the host country.
* Mergers and acquisitions: buying an existing local firm outright or taking a controlling interest.
* Joint ventures and strategic alliances: partnering with local firms to share investment, risk, and expertise.
* Establishing subsidiaries, branches, or associate companies.

Types of FDI

FDI is often categorized by strategic relationship to the investor’s existing operations:
* Horizontal FDI: duplicating the same business activity abroad (e.g., a local retailer opening stores in another country).
* Vertical FDI: investing in a foreign firm that is part of the investor’s supply chain (upstream suppliers or downstream distributors).
* Conglomerate FDI: investing in an unrelated business area, often via joint ventures or acquisitions where the investor lacks prior experience.

Special considerations and examples

• Ownership threshold: The OECD commonly uses a 10% ownership threshold to distinguish FDI from portfolio investment, but effective control can sometimes be achieved with less.
• Regulation and political risk: Investments are subject to host-country laws, trade policies, and changing political conditions; strategic or sensitive industries may face heightened scrutiny.
• Country-specific policies: Some countries actively liberalize rules to attract FDI (for example, allowing full foreign ownership in certain sectors), while others impose restrictions.
• Notable examples:
• Large multinational acquisitions can trigger competition and national security reviews (e.g., cross-border takeovers in technology or critical infrastructure).
• Multinational infrastructure initiatives — such as large-scale state-led investment programs — channel significant FDI into transportation, energy, and construction across regions.

FDI in China and India

• China: FDI has been a major engine for growth, particularly in manufacturing and high-tech sectors.
• India: Policy changes in recent years have relaxed rules in some sectors, enabling higher foreign ownership in retail and other industries to attract investment.

Advantages and disadvantages

Advantages
* Promotes economic growth in the host country through capital investment, job creation, and technology transfer.
* Helps investors access new markets, diversify operations, and achieve economies of scale.
* Can improve productivity and integrate local firms into global supply chains.

Disadvantages and risks
* Greater exposure to political and regulatory risk across multiple jurisdictions.
* Potential concerns in host countries about foreign control of strategic assets, profit repatriation, or negative effects on local businesses.
* Cultural and managerial integration challenges in cross-border operations.

FDI versus foreign portfolio investment (FPI)

• FPI involves buying foreign securities (stocks, bonds) primarily for diversification and financial return without seeking management control.
• FDI involves direct ownership or effective control over a foreign enterprise and implies a longer-term commitment and operational involvement.
• Both forms of cross-border capital are important for emerging economies, but FDI typically carries greater regulatory obligations and strategic implications.

Conclusion

FDI is a core mechanism for international economic integration and corporate expansion. It combines capital with managerial, technological, and operational links between countries. While it can deliver substantial benefits to both investors and host economies, FDI also brings political, regulatory, and integration challenges that require careful assessment and strategic planning.