FOREIGN DIRECT INVESTMENT

Foreign Direct Investment



Foreign Direct Investment

Introduction

Foreign direct investment (FDI) occurs when a foreign investor exerts direct control over domestic assets. It mainly consists of an international capital flow from the home country to a host country for the purpose of acquiring partial or whole ownership of substantial business activity. Technically, it is the book value of the equity held by the foreign investor that is attached to the asset. In most cases, the asset is a firm in a developed country, such as the United States, and the equity consists of two components: ordinary (common stock) and retained earnings. If both foreign and domestic investors own the common stock, then only a portion held by foreign investors is considered to be FDI, and if only a threshold percentage is attained, that is deemed to give the foreign investor control of the business. In the United States, this threshold is 10%, but some countries establish a higher minimum level of stock ownership, usually 25% (Yeung, 2007, 25).

Foreign investment can take place in two ways: Foreign investors can establish new firms overseas, which they control, or foreign investors can acquire controlling interests in the previously established domestic firms, or spin-offs of such firms. FDI as a vehicle of transnationalization is a significant contributor of economic development.

Transnational corporations (TNCs) act as significant transmitters of economic, social, cultural, and political change into different countries, sectors, and motivations. TNCs take advantage of geographical differences in the distribution of factors of production (natural resources, capital, labor, etc.) and local policies (taxes, trade incentives, subsidies, etc.). Other than FDI, TNCs engage in various kinds of collaborative ventures by which they coordinate and control transactions within geographically dispersed production networks. Resulting from these ventures, the global economy is envisaged as linking two sets of networks: (1) organizational (in the form of production circuits and networks) and (2) geographical (which include localized clusters of economic activity).

Theories of Foreign Direct Investment

There are several theories that attempt to account for foreign aid. The existing ones include Dunning's eclectic approach and the product cycle. John Dunning's eclectic paradigm emphasizes the critical role of geographical location in understanding the complex nature of TNC behavior. The location aspect, as encapsulated in this theory, suggests three primary motivations: (1) foreign-market-seeking FDI, (2) efficiency (cost reduction)-seeking FDI, and (3) resource-seeking or strategic-asset-seeking FDI. In general, a firm's motivations to be transnational can be classified into two categories: (1) market orientation, which pertains to marketing, sales, or production designed to serve a specific geographical market, and (2) asset orientation, when most of the assets required by a firm to produce and sell specific goods and services have an uneven geographic distribution, especially in the natural resources industry (Trevino, 2003, 45).

For a TNC to invest successfully abroad, it must possess advantages that no other firm has, the country it wishes to invest in should offer location advantages, and it must be capable of internalizing operations. Internalization tends to become synonymous with the ability of firms ...