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Advantages and Disadvantages of FDI

Advantages and Disadvantages of FDI

Owning a business enterprise in a foreign land has many benefits, but there are many downsides to such an ownership as well. The article below explains the advantages and disadvantages of FDI.
Rahul Thadani
Last Updated: Mar 19, 2018
Globalization has led to rapid expansion of several industries across national borders, and the FDI is perhaps, the most important economical figure that arose from this process. Every country today is opening up its doors and borders to foreign investment, because all of them are beginning to realize the importance of being on the global map. Business opportunities have expanded to a massive extent, and it has become imperative for any venture to search for foreign investors in order to increase their capital budgets and enhance their technical expertise management practices as well. In the midst of all this, several debates about the FDI (Foreign Direct Investment) have plagued various governments and economical thinkers.

What is FDI?
  • FDI (Foreign Direct Investment) simply refers to the act of investing capital in a business enterprise that operates overseas and in a foreign country.
  • The party making the investment could be an individual, a business corporation, or maybe even a group of companies. The enterprise that receives the investment will definitely benefit from this.
  • What this ultimately means though, is that the party making the investment has a long-lasting interest in the other party, and they also get a say in matters regarding the functioning of that enterprise.
  • The minimum voting rights, or shares of an enterprise, that a foreign investor is supposed to control is 10%. This holds relevant in cases where a foreign investor opens up a whole new business operation in another country after collaborating with a local player (Green-Field investment), or it simply merges with a local enterprise for the same purpose.
  • In addition, FDI is also carried out either horizontally (with an enterprise in the same industry with market expansion as the sole purpose) or vertically (with the aim of sharing resources like capital and expertise).
  • In effect, this is like any regular enterprise that invites investments, and then grants the donor of that investment a certain degree of control in the enterprise, along with a share of profits as well, even though this depends on the policy of profit repatriation in that country.
  • The only difference here is that the investor is actually a foreign party. As a result, different rules, policies, and governing factors come into play in such a scenario. Both the parties involved derive many benefits from such an arrangement.
  • On the other hand, both parties also suffer some disadvantages due to this process, so they have to take a decision after carrying out a balanced analysis.
The Advantages of Foreign Direct Investment

The party making the investment is usually known as the parent enterprise, and the party invested in can be referred to as the foreign affiliate. Together, these enterprises form what is known as a Transnational Corporation (TNC).
  • Many countries still have several import tariffs in place, so reaching these countries through international trade is difficult. There are certain industries that require to be present in international markets in order to succeed, and they are the ones who then provide FDI to industries in such countries, so that they can increase their sales presence there.
  • Many parent enterprises provide FDI because of the tax incentives that they get. Governments of certain countries invite FDI because they get additional expertise, technology, and products. So, to avail these benefits, they provide great tax incentives for foreign investors, which ultimately suits all parties.
  • Foreign investment reduces the disparity that exists between costs and revenues, especially when they are calculated in different currencies. By controlling an enterprise in a foreign country, a company is ensuring that the costs of production are incurred in the same market where the goods will ultimately be sold.
  • Different international markets have different tastes, preferences, requirements. By investing in a company in such a country, an enterprise ensures that its business practices and products match the needs of the market in that country specifically.
  • Though this is not such a big factor, some markets prefer locally produced goods due to a strong sense of patriotism and nationalism, making it very hard for international enterprises to penetrate such a market. FDI helps enterprises enter such markets and gain a foothold there.
  • From the perspective of the foreign affiliate, FDI is beneficial, because they get advanced resources and additional capital at their disposal. Something like this is always welcome, and it also helps strengthen the political relationships between various nations.
The Disadvantages of Foreign Direct Investment

While all these advantages are well and good, the fact is that there are certain cons that come along with them as well. Every industry, and every country, deals with these cons differently, and are also affected in varying degrees, so they are not meant to discourage foreign investors in any way. But every parent enterprise should be aware of these points.
  • Foreign investments are always risky because the political situation in some countries can change in an instant. The investor could suddenly find his investment in serious jeopardy due to several different reasons, so the risk factor is always extremely high.
  • In certain cases, political changes could lead to a situation of 'Expropriation'. This refers to a scenario where the government can take control of a firm's property and assets, if it feels that the enterprise is a threat to national security.
  • Many times, the cultural differences between different countries prove insurmountable. Major differences in the philosophy of both the parties lead to several disagreements, and ultimately a failed business venture. So, it is necessary for both the parties to understand each other and compromise on certain principles. This point is directly related to globalization as well.
  • Investing in foreign countries is infinitely more expensive than exporting goods. So an investor should be prepared to spend a lot of money for the purpose of setting up a good base of operations. This is something that parent enterprises know and are well prepared for, in most cases.
  • From the point of view of foreign affiliates, FDI is ill-advised, because they lose their national identity. They have to deal with interference from a group of people who do not understand the history of the company. They have unreal expectations placed on them, and they have to handle several cultural clashes at the same time.
Enterprises go down this path after carefully studying the advantages and disadvantages of foreign direct investment, so they are always well prepared for the worst. When handled properly, FDI can prove to be beneficial to both the parties, and the economies of both the party's countries as well. But if it goes wrong, then things can get very ugly for everyone involved as well. So, this is a double-edged sword that needs to be handled with lots of caution.