Foreign direct investment Study Guide

📖 Core Concepts Foreign Direct Investment (FDI) – Ownership stake by a foreign entity that gives control (usually ≥10 % voting rights) over an asset in another country. Control vs. Portfolio – FDI = controlling ownership; Foreign Portfolio Investment (FPI) = passive ownership of ≤10 % of voting shares. Components of FDI – Mergers & acquisitions, greenfield (new‑facility) builds, reinvested earnings, intracompany loans. Balance‑of‑Payments (BoP) measurement – Stock of FDI = net cumulative equity + long‑term + short‑term capital (outward − inward). Firm‑Specific Advantages (FSAs) – Unique assets/know‑how that give a firm a competitive edge abroad; key driver of why firms go abroad. OLI Paradigm – Ownership (FSAs), Location (host‑country advantages), Internationalisation (internalisation of transactions). FDI Types – Horizontal (same product abroad), Vertical (backward / forward), Conglomerate, Import‑substituting, Export‑increasing, Government‑initiated, Platform. Incentives – Tax holidays, accelerated depreciation, preferential tariffs, SEZ/EPZ benefits, subsidies, land grants, infrastructure/R&D support, regulatory/IP perks. Effects – Generally raises local productivity; relationship with democracy depends on natural‑resource export share. --- 📌 Must Remember Control threshold: ≥10 % voting shares → FDI (vs. <10 % → portfolio). FDI stock formula (BoP): FDI stock = (Equity + Long‑term + Short‑term capital)ₒᵤₜ − (inward). Hymer’s insight: Degree of control distinguishes FDI from portfolio investment. Horizontal FDI: Replicates home‑country value chain abroad. Vertical FDI: Backward = acquire input sources; Forward = acquire distribution/outlet. Import‑substituting vs. Export‑increasing: First replaces imports, second boosts exports. Tax holiday: Temporary corporate‑income‑tax exemption for foreign investors. SEZ benefit: Regulatory/fiscal incentives concentrated in a defined zone. Productivity impact: Meta‑analysis (2010) → robust positive effect in developing/transition economies. --- 🔄 Key Processes FDI Measurement (BoP): Tally equity capital inflows/outflows. Add long‑term capital (e.g., debt > 1 yr). Add short‑term capital (e.g., intra‑company loans < 1 yr). Compute net: outward − inward → FDI stock. Decision to Pursue Horizontal vs. Vertical FDI: Assess market demand for the same product abroad → Horizontal. Identify input cost advantages or distribution bottlenecks → Vertical (backward or forward). Applying Incentives: Locate SEZ/EPZ → apply for tax holiday & tariff reductions. Submit project proposal → qualify for subsidies, land grants, R&D credits. Secure regulatory derogation if project size justifies. --- 🔍 Key Comparisons FDI vs. Portfolio Investment Control: ≥10 % voting rights vs. <10 % Goal: Long‑term strategic presence vs. Passive financial return Horizontal vs. Vertical FDI Horizontal: Same industry/ product in host country Vertical: Different stage of supply chain (backward = inputs; forward = distribution) Import‑Substituting vs. Export‑Increasing FDI Import‑Substituting: Produces goods previously imported → boosts domestic supply. Export‑Increasing: Aims to sell abroad → raises host‑country export volume. Tax Holiday vs. Accelerated Depreciation Tax Holiday: Complete temporary exemption from corporate tax. Accelerated Depreciation: Faster write‑off of asset costs → reduces taxable income each year. --- ⚠️ Common Misunderstandings “Any foreign equity is FDI.” – Only when the investor has control (≥10 % voting shares). “FDI always benefits host economies." – Benefits depend on sector, governance, and whether incentives create net fiscal loss. “Vertical FDI is only about resources.” – Backward can also target cheaper components; forward can target distribution efficiency, not just raw materials. “Tax holidays are free money.” – They are time‑limited and often offset by other obligations (e.g., local employment quotas). --- 🧠 Mental Models / Intuition Control = Influence: Think of FDI as “moving the steering wheel” in a foreign firm; portfolio investment is just “riding in the passenger seat.” OLI Triangle: Visualize a three‑sided pyramid – Ownership (FSAs) at the top, Location at one base corner, Internationalisation at the other. The stronger each side, the more likely FDI occurs. Incentive Cost‑Benefit Scale: Imagine a balance – Fiscal cost (tax loss, subsidies) vs. Economic gain (jobs, tech spillovers). Only invest when the gain outweighs the cost. --- 🚩 Exceptions & Edge Cases Control without 10 %: Some jurisdictions grant de‑facto control through board seats or voting agreements even with <10 % share – still counted as FDI in practice. Hybrid Incentives: A project may qualify for both a tax holiday and accelerated depreciation; apply the one that yields the larger present‑value tax saving. Resource‑Rich Democracies: In high‑resource export countries, rising democracy can reduce FDI (political stability may favor state‑controlled extraction over foreign entry). --- 📍 When to Use Which Choose Horizontal FDI when the host market has similar consumer preferences and the firm wants to replicate its brand/technology locally. Choose Backward Vertical FDI if the host country offers cheaper or unique inputs that improve cost structure. Choose Forward Vertical FDI when distribution channels in the host are inefficient or when the firm wants direct market access. Apply Tax Holiday for projects with high upfront capital and long payback periods; Accelerated Depreciation suits capital‑intensive assets with shorter returns. Select SEZ/EPZ when the project can be geographically concentrated and benefits from combined regulatory and fiscal incentives. --- 👀 Patterns to Recognize “Control + ≥10 %” → automatically flags an investment as FDI in BoP tables. “Host‑country factor abundance” (labour vs. capital) → likely triggers horizontal (labour‑intensive) or vertical (capital‑intensive) FDI patterns. “Democracy index ↑ & low resource share → FDI ↑” – a recurring trend in empirical studies. Incentive clusters (tax holiday + SEZ) → often appear together in large‑scale manufacturing projects. --- 🗂️ Exam Traps Distractor: “FDI includes any foreign purchase of stocks.” – Wrong; only purchases that give control qualify. Trap: “Vertical FDI only refers to backward integration.” – Incorrect; vertical includes both backward and forward integration. Misleading choice: “Tax holidays are permanent.” – They are temporary exemptions. Near‑miss: “Import‑substituting FDI always raises domestic employment.” – May raise employment, but can also displace local firms if not managed properly. Confusing OLI with Dunning’s “Eclectic Paradigm.” – OLI is the eclectic paradigm; a choice that separates them is a distractor.