What is Foreign Direct Investment

Foreign direct investment (FDI) is where an individual or business from one nation, invests in
another. This could be to start a new business or invest in an existing foreign owned business.
For instance, Mr Bloggs from the US has $1 million and wants to start a new company in
Germany. He invests this, creating a new clothing manufacturing firm in the country. This would
classify as a FDI.
However, the definition is slightly different when it comes to investing in a foreign companies
assets. According to the IMF, a foreign direct investment is where the investor purchases over a
10 percent stake in the company.
Anything under this amount is classed as part of a ‘stock portfolio’. For instance, this covers the
small amount of stocks that the average citizen may have invested. Essentially, anything too
small to influence any level of control of the firm.

Types of Foreign Direct Investment (FDI)

Horizontal FDI
Horizontal FDI is where funds are invested abroad in the same industry. In other words, a
business invests in a foreign firm that produces similar goods. For instance Nike, a US based
firm, may purchase Puma, a Germany based firm. They are both in the industry of sportswear
and therefore would be classified as a form of horizontal FDI.
Vertical FDI
Vertical FDI is where an investment is made within the supply chain, but not directly in the same
industry. In other words, a business invests in a foreign firm that it may supply or sell too.
For instance, Hersheys, a US chocolate manufacturer, may look to invest in cocoa producers in
Brazil. This is known as backwards vertical integration because the firm is purchasing a supplier,
or potential supplier, in the supply chainWe then have forwards vertical integration. So this is
where a firm invests in a foreign company that is further along in the supply chain. For instance,
Hersheys may look to purchase a share in Alibaba; where it sells its products.
Conglomerate FDI
Conglomerate FDI is where an investment is made in a completely different industry. In other
words, it is not linked in any direct way to the investors business. For instance, Walmart, a US
retailer, may invest in BMW, a German automobile manufacturer.
This may seem strange to some but offers big businesses an opportunity to expand and diversify
into new areas. To explain, some big businesses come to a point where the demand for its
fundamental business starts to decline. In order to survive, it must invest in new ventures. Even
big businesses with strong demand may look to new industries where growth and return on
investment are significantly larger.

Benefits of Foreign Direct Investment

1. Boost to International Trade

Foreign direct investment promotes international trade as it allows production to flow to parts of
the world which are more cost effective. For instance, Apple was able to conduct FDI into China
to assist with the manufacturing of its products.
However, many of the components are also shipped in from elsewhere, generally from the region
of Asia. For instance, the camera is made by Sony, which sources its manufacturing in Taiwan.
There is also the case of the flash memory, which is sourced by Toshiba in Japan. We also have
the touch ID sensor which is made in Taiwan, and the chipsets and processors, which are made
by Samsung in South Korea and Taiwan.

These are but a small handful of the components, but demonstrate how inter-connected the
supply chain has become between countries. Both Samsung And Song have conducted
investment in the likes of Taiwan, China, and Japan. As a result, it has created new jobs in the
region and boosted trade between the nations.

2. Reduced Regional and Global Tensions

As we have seen with the Apple example, a supply chain is created between countries. In part,
this is created by the division of labor. For instance, South Korea may make the batteries,
Taiwan the ID sensors, and Japan the cameras. As a result, they are all dependent on each other.
If there is a revolt in Taiwan, the whole process could fall apart. Without the ID sensors, the final
product cannot be made, so the need for other components is also reduced. This means workers
in Japan and South Korea are also affected.

As a result of this interconnected supply chain, it is in the interest of all parties to ensure the
stability of its trading partners. So FDI can create a level of dependency between countries,
which in turn can create a level of peace.

To use a famous metaphor, you don’t bite the hand that feeds you. In other words, if nations are
reliant on each other for their income, then the likelihood of war is also reduced.

3. Sharing of Technology, Knowledge, and Culture

Foreign direct investment allows the transfer of technology, knowledge, and culture. For
instance, when a firm from the US invests in another from India, it has a say in how the firm is
run. It is in its interest to ensure the most efficient use of its resources.
By coming in from a different cultural background and perspective, often, efficiencies can be
achieved. Furthermore, there is the case of technology. It can transfer over in a number of ways.
First of all, employees benefit from having first-hand access to the new technology. They may
then be able to use this to start their own ventures.

Second of all, the technology could be outright purchased from a foreign nation. For instance,
copyright technology could be sold from Company A in the US to Company B in India. Finally,
the technology could be reverse-engineered or provide inspiration for domestic development.

4. Diversification
From the businesses perspective, foreign direct investment reduces risk through diversification.
By investing in other nations, it spreads the companies exposure. In other words, it is not so
reliant on Country A. For instance, Target derives its entire revenues from the US. Should an
economic recession hit Stateside, it’s almost guaranteed to harm its profits.
By diversifying and investing in foreign markets, it allows businesses to reduce domestic
exposure. So if a US firm invests in new stores in Germany, the level of risk is reduced. This is
because it is not reliant on one market. Whilst there may be a decline in demand for one, there
may be growth in another. To use an analogy, it’s similar to placing a bet in roulette on both red
and black.

5. Lower Costs and Increased Efficiency

Foreign direct investments can benefit from lower labor costs. Often, businesses will off-shore
production to nations abroad that offer cheaper labor. Now there is an ethical element to this than
is often debated, but we will leave that aside for now. Whether it is ethical or not is irrelevant as
it is a benefit to the business.

Although labor costs are lower, we must also consider productivity. For instance, one person in
China may produce one unit for $1 an hour. However, an employee in the US may be able to
produce 20 units for $10 an hour. So whilst a Chinese employee is cheaper, they only make 1
unit per $1, compared to 2 units per $1 in the US.

With that said, foreign direct investors will take such factors into account. And in most cases, the
labor is so much cheaper than most of the productivity differentials are eliminated. This means
the investment is cost-effective. In other words, more employees will be needed to make the
same number of goods, but the total cost to produce is lower.

On most occasions, foreign direct investment will result in a net gain for the company. After all,
it is in their interest to ensure the investment pays off. However, there are exceptions, where FDI
can in fact go the other way.

Nevertheless, on the whole, FDI is generally associated with lower costs and increased cost-
effectiveness.

6. Tax Incentives
Reduced levels of corporation tax can save big businesses billions each and every year. This is
why big firms such as Apple use sophisticated techniques to off-shore money in international
subsidiaries.

Countries with lower tax regimes are usually those that are favoured. Examples include
Switzerland, Monaco, and Ireland, among others.

Furthermore, there are also tax incentives by which the foreign government offers tax breaks to
investors in a bid to encourage FDI.

7. Employment and Economic Boost

When money is invested in another country, it creates jobs, new companies, and new
factories/buildings. This brings about new opportunities for local residents and can stimulate
further growth.

With greater levels of employment being made available, it creates a greater level of purchasing
power in the wider economy. If we couple this with the fact that big corporations often pay
above the average to attract the best workers, we can see a spill-over effect.

With employees earning more money, they also create demand for other goods in the economy.
In turn, this stimulates employment in other markets and industries.

Disadvantages of Foreign Direct Investment

1. Foreign Control
One of the main fears, particularly among developing nations, is that they can essentially be
brought and controlled by foreign powers. Land, labor, and capital are relatively cheap in
countries such as Vietnam or Taiwan. Therefore the US or other developed nations can come in
with significant sums and buy up vast sums of the country.
This is why some countries place strict restrictions on FDI. Often, investors must join a
partnership with a local business in order to enter. This way there is still a level of domestic
control

2. Loss of Domestic Jobs

When significant sums of money are transferred to another, it is an investment that would have
been used in the home market. Consequently, FDI may boost employment in foreign nations, but
may temporarily reduce it at home.

Instead of the funds being invested in new factories and creating jobs, it is sent abroad instead.

As we have seen in the US, manufacturing jobs have been lost to the likes of Mexico, which can
manufacture motor vehicles at a lower cost. Whilst this provides cheaper goods for the
consumer, it can come at the cost of domestic jobs.

3. Risk of Political or Economic Change

When investing abroad, particularly in developing nations, there is huge risk that is associated.
For instance, there may be huge political upheaval, or a regional war. This may consist of a new
government that is not so favourable to investors.

Consequently, there is an element of significant risk. With that said, those countries and regions
that have been marred with instability are usually the last to be considered for investment. We
only need to look at the Middle East and Africa as examples.

Nevertheless, even in many Asian countries, there is a possibility of the unknown. With rising
tensions between China and Japan, there are risks of conflict as well as political uncertainty.
Methods of Foreign Direct Investment
As mentioned above, an investor can make a foreign direct investment by expanding their
business in a foreign country. Amazon opening a new headquarters in Vancouver, Canada would
be an example of this.
Reinvesting profits from overseas operations, as well as intra-company loans to overseas
subsidiaries, are also considered foreign direct investments.
Finally, there are multiple methods for a domestic investor to acquire voting power in a foreign
company. Below are some examples:
 Acquiring voting stock in a foreign company
 Mergers and acquisitions
 Joint ventures with foreign corporations
 Starting a subsidiary of a domestic firm in a foreign country

INFLUENCING FACTORS OF FDI

A) Supply Factors:
1) Production Cost 2) Logistics 3) Availability of Natural resources 3) Access to key
technology
B) Demand Factor:
1) Customer Access 2) Marketing Advantages 3) development of Competitive Advantages 4)
Customer Mobility
C )Political Factors:
1) Avoidance of Trade Barriers 2) Economic development Incentives

Factors affecting choice of FDI for sales expansion:

The factors affecting the FDI for sales expansion are:
1) Transportation
2) Excess Capacity
3) Trade restriction
4) Country of origin effects
5) Changes in comparative cost
FOREIGN DIRECT INVESTMENT IN BANGLADESH
1. Records of the Board of Investment (BOI) ,the only available source of information on
FDI in Bangladesh, suggest that FDI flows in the country are not very encouraging. The
Garments Industry has attracted the highest number of Joint Ventures and hundred percent
foreign ownership enterprises. Consumer products top the list based on volume of invested
capital. Tea is the oldest sector to involve FDI while the Karnafuli Fertilizer Company (KAFCO)
is the largest individual FDI in the country. The total number of FDI units established during the
period between 1947-1971 was only 22, and was dominated largely by units in sectors such as
drugs and pharmaceuticals, and electric goods.
2. Bangladesh initially adopted a policy of nationalization of all large and medium
industries. Consequently, there was no new inflow of FDI in the country until 1977. Subsequent
governments experimented with various industrial polices, but because of very uncertain political
situation in the country, the FDI flows remained negligible until 1993. Only 220 FDI units were
registered in Bangladesh between 1977 and 1993, but subsequently, FDI has experienced a fairly
high annual growth. The number of FDI units registered in the country during the period from
July 1996 to May 1999 was 425. The Expected volume of total investment in these enterprises
accounted for Tk.288.8 billions. These created employment for more than 94,000 persons. This
expansion is attributable largely to the relative stability of economic policies and the
establishment of an improved political, social and economic environment. Sectors that now
attract FDI are readymade garments, Textiles and Fabrics, Chemicals Paper and Paper Products ,
equipment and spares ,Printing & Packaging , Plastic Products , metal industries , food
processing, electrical goods, Pharmaceuticals etc. Of late, oil and Natural Gas, Electricity,
Telecommunication Cement, Hotels & Restaurants, and hospitals and clinics have become
sectors favored by many foreign investors. The choice of FDI in initial years was limited in low
investment, quick yield projects, while recent years show same diversification in lines of high-
tech, capital intensive projects as well as of preferential distribution within the traditional sectors
and sub-sectors. The share of Agriculture, construction, storage and communication, however,
remains historically low and account for less than 3% of the total FDI.
3. Significant changes have taken place over time in the geographic origin of FDI flows in
Bangladesh. Source leaders during the pre-independence period were developed market
economies such as UK, North America and Japan, Hong Kong, Malaysia, Pakistan and South
Korea began to invest in a relatively big scale in the 1990s. Nevertheless industrially developed
countries still dominate in FDI in Bangladesh, and other than UK, USA and Japan, notable
sources of FDI in the country are Netherlands, Germany and Canada.
4. FDI in Bangladesh consists primarily of three elements: cash capital and capital
equipment brought in and reinvested earnings .These components have fluctuated considerably
in the last two decades. In the beginning of this reference period, these three components were in
the ratio of 24:4:70, which, towards the end, changed to 8:2; 90. The difference implies that the
net transfer of resources into Bangladesh from abroad is fairly negligible, and that FDI
contributes very little in terms of transfer of hardware technology.
5. FDI apparently does not have significant long-term impact on the technological base of
the country because of concentration of FDI in relatively low technology industries. Even in the
case of industries where technological diffusion is possible, such as pharmaceutical, operation
have been confined mainly to bottling and packaging , only rarely has manufacturing come into
the scene .A shift of FDI related pharmaceutical industries from production of drugs to that of
cosmetics , toiletries , Pesticides , insecticides etc. allowed some transfer of technology through
licensing , introduction of a new processes , and training of local production and management
staff . In other FDI related sectors such as the electrical and engineering industries, investment
have been predominantly in imports of components for assembling rather than in real
manufacturing. External aid and donor agencies and foreign experts of local agents of
multinational companies traditionally play a significant role in decisions on choice of
technology.
6. The investment plans in Bangladesh do not have appropriate built in mechanism for
progressive development of technology capability in terms of research, engineering design, and
local manufacture of the various components of plants, machinery and infrastructure.
7. Bangladesh invites FDI in Joint Ventures as well as well as in arrangement like technical
licensing , counter trade, co-production arrangements, management agreements, marketing
assistance, turnkey operations , and combined turnkey and management contracts. Incidences of
technical collaboration are in evidence in sectors like cigarette, chemical and pharmaceuticals
(with UK firms), electric goods (with South Korean firms) standard paints (with Thai firms) etc.
Marketing collaboration has occurred with genuine zone companies in the tea industry and in
readymade garments industry. Licensing agreements is predominant in chemicals and in
pharmaceuticals sectors.
8. FDI in Bangladesh makes a direct contribution in terms of addition in terms of local
resources for investments in manufacturing, trade and the services sectors. New investments ,
including FDI , generate additional employment, train local executives and workers, make trusts
into the export market, introduce improved technologies, open up new horizon for R&D
expenditures , and above all, create new sources of tax revenue for the government. The
contribution of FDI in employment generation in the country however, is quite insignificant. FDI
provides employment to about 1.5% of the total industrial employment and less than 0.20% of
the total working population of the country.
9. Bangladesh is a signatory to the Multilateral Investment Guarantee Agency (MIGA) and
the overseas Private Investment Corporation (OPIC). This provides a guarantee to foreign
investors against loss occurred by non-commercial risks, the risks of currency transfer, war and
civil disturbances. The foreign Private Investment (Promotion & Protection) Act 1980 ensures
legal protection to FDI in the country against nationalization and expropriation and guarantees
repatriation of capital and dividend. Also, the various types of insurance facilities offered by
nationalized and private companies seem to provide adequate facilities for coverage of
operational risks.
10. The Industrial policy of the government provides extensive incentives and facilities to
attract FDI in Bangladesh. These include tax holidays , concession in import duty on machinery ,
repatriation profits & dividends, invested capital and capital gain, and salaries of foreign
personnel and exemption of tax on these incomes, exemption of export oriented industries from
playing local taxes , up to 90% financing of the LC value of export products . The government
has liberalized the trade regime and significantly reduced non-tariff restrictions. Foreign
investors in Bangladesh have access to domestic capital markets for working capital in the form
of loans from commercial banks and development financial institutions. They also have access to
the services of the country’s Stock Exchanges. Export oriented industries of the trust sector (toys,
luggage, and fashion articles, leather goods, diamond cutting and polishing , stationery goods,
Silk cloth, gift items ,cut and artificial flowers and orchid, vegetable processing , and engineering
consultancy services) are provided cash incentives ,Venture capital , and other facilities . The
establishment of EPZ proved to be effective steps in attracting FDI in Bangladesh and
government permission to allow creation of private EPZs in the country has been a welcome
decision.
11. The cultural environment in Bangladesh has a number of elements that can be identified
as favorable for FDI. The population has a high degree of cultural and communal harmony.
Conservatism on religious ground is not extreme and foreigners are exempted from restrictions
on this count. Major political parties of the country have almost identical economic
programmers. All of these favor liberalization, which will enable the country to fit in the
globalization process.
12. Despite The FDI friendly policies of the government and a culture of hospitality to
foreigners, FDI records in the country in terms of the number of projects implemented as
compared to those officially registered is frustrating. Of the 365 FDI projects registered during
1996-1998, only 72 went into production in end 1999 and 27 in process of implementation, while
the remaining 266 languished as the file –cases.
13. Problems that restricted FDI potentials in the country include excessive bureaucratic
interference, alleged irregularities in processing papers , lack of commitment on the part of local
investors, excessive de delays in selecting projects for feasibility studies, and frequent changes in
polices on import duties for raw materials , machinery and equipment. Overlapping
administrative procedures and absence of transparent system of formalities often confuse not
only investors proposing projects , but also staff and personnel assigned for discharging
procedurals responsibilities . Frequent transfers of top and mid level officials in various
ministries, directorates and departments affect continuity and prevent timely implementation of
strategic, procedural , and even routine duties . Many foreign companies feel disturbed and
ultimately are discouraged by disruptions in the production process in the country because of
frequent power failures, poor infrastructure support, and labor and political unrest. An additional
problem is the lack of professional personnel .i.e. the technical, managerial and innovative skills
in the country needed to efficiently handle entrepreneurial function including risk taking,
planning and coordination and control.
14. The standardized set of procedures required to be followed for FDI in a new venture in
Bangladesh starts with meeting of the foreign investor with BOI member to communicate the
investment proposals and submission of an application for registration. The BOI issues the
registration letter after scrutiny and collection of clearance from the department of Environment.
The company is then asked to submit a Memo and Articles of Association for incorporation with
SEC and registration with Registrar of the Joint Stock Companies and also with the chief
Inspector of Factories and Establishment. Upon Completion of registration formalities, the
company can purchase and acquire land, construct factory and office premises, open letter of
credit in any commercial bank for import of machinery and equipment and release of
consignment at customs point. This apparently easy looking process however, is often difficult to
put into practice. Foreign investors often find problems in infrastructure, law and order, and
enforcement of contracts.
15. Bangladesh has an advantage in labor costs, which can be converted into an exportable
product, but the advantage has many difficulties. The factories in the country have to deal with
constraints beyond their control, such as, power failures, poor communications or increased
transaction costs and cumbersome procedures in customs in many government offices. The
political instability, including frequent haratals, etc. is real hazards. However, the situation is
expected to improve if the political commitment of the government to promote and protect FDI
in the country can be increased and the policy environment can be changed from one that is
regulatory to one that is supportive/ complementary in nature.
DETERMINANTS OF FDI
1) Natural resources – securing type: Availability of natural resources is undoubtedly the
most important determinant of FDI. Some examples are iron ore mining in Australia and oil
exploration in Indonesia
2) Market securing type: A major determinant of this type of FDI is the presence of sizable
market, which is reflected in large population size or population with high income. In recent
years market securing FDI, which is motivated by rapid increase in purchasing power of the
Asian population.
3) Cost saving type: Cost saving FDI is undertaken by export oriented foreign firms. To
maintain international price competitiveness, export oriented firms need to set up a production
base where production can be performed at low cost. Cost saving type of FDI is noticeable in
electric and electronic industry.

POLICIES OF FDI
The foreign direct investment policies are the various rules and regulations that have been laid
down by the various countries in order to regulate the overseas investment that is being made in
a country.
The FDI policies are reviewed on a regular basis. The FDI policies are made mainly by entities
that are responsible for looking after the matters related to foreign direct investment in a country.
The policies also have various proposals that are made in order to improve the policies that are in
place for administrating the FDI policies.
TRENDS IN GLOBAL FOREIGN DIRECT INVESTMENT
Most of the developing and least developed countries worldwide equally participated in the
process of direct investment activities.
→ FDI inflows to Latin American and Crabian region increased by 11 percent on an average in
comparison to previous year.
→ In African region FDI inflows made a record in the year 2006
→ Flow of FDI to South, East and South East Asia and Oceania maintained an upward trend.

→ Both Turkey and Oil rich Gulf States continued to attract maximum FDI inflows.
→ United States Economy, being world’s largest economy also attracted largest FDI inflows
from Euro Zone and Japan.

Over recent years most of the countries over the world have made their business environment
investment friendly for absorbing global opportunities by attracting more invest able funds to the
country.