One of the world’s biggest businesses, with outflows from one country to another totalling more than $805 billion worldwide during 2018, goes by the name of foreign direct investment (FDI). And as a subject, it is hard to avoid for anyone interested in finance or economics.
Governments boast about how much FDI they have managed to attract, while august international bodies compile statistics tracking FDI by country.
In the circumstances, it may seem prudent for anyone unclear as to the exact nature of FDI to keep quiet and nod along with the rest. But there’s no shame in being a little confused as to what is being discussed, not least because expert opinion is not always on the same page as to what constitutes FDI.
Stamp of approval
All agree, however, that FDI is distinct from foreign indirect investment, also known as portfolio investment – essentially, the purchase by foreign investors of paper assets such as shares. FDI refers to “real” assets, such as factories, infrastructure projects, buildings and so forth.
Disagreement can arise, however, over whether FDI refers to any type of cash investment in such assets, or whether it ought to be restricted to the establishment of new assets. In the broadest sense, FDI can involve a merger or takeover of a domestic business as well as the building of a new business facility in the country concerned.
However, politicians and commentators tend to focus on the latter, given this type of FDI creates new capacity in the economy and also is immune to accusations of asset stripping and to negative headlines of the type suggesting the country’s commercial crown jewels are being sold off to the highest bidder.
So why is foreign direct investment important? Well, for many years now, a high and sustained level of FDI has been seen as a vote of confidence in both the economy and in the wider society, given that indispensable features for a country seeking to become an FDI magnet include rule of law, enforceable contractual and property rights, a low level of public and private corruption, political stability and the absence of the sort of controls that would prevent the investors repatriating their profits.
Features for a country seeking to become an FDI magnet
rule of law
enforceable contractual and property rights
low level of public and private corruption
Politicians in particular have almost always stressed the importance of FDI, taking it as proof that international capital markets are backing a “winning” economy. In the corridors of power, to be an “FDI destination” is seen as a stamp of approval.
At its best, FDI allows capital to flow across national frontiers to where it can be used most fruitfully. During the high noon of globalisation, this was seen as evidence that untrammelled financial flows were inherently efficient. The impact of foreign direct investment was seen as almost entirely benign.
But there are foreign direct investment advantages and disadvantages.
Indeed, some aspects of FDI have proved problematic, even before the financial crisis.
One is the use of state aid to tempt investors to one location rather than another. On occasion, the financial packages have been so lavish that the jurisdiction in question has had trouble finding the money to meet its pledges to the investors.
For example, two US states in the Nineties encountered serious difficulties having lured multinational companies and, in one case, had to raid other parts of the budget to meet commitments.
Following from this, domestic companies can become aggrieved at their exclusion from such incentives, which can include non-financial items such as looser planning regulations and the provision of land and supporting infrastructure.
Finally, there is the "hot money" issue, when FDI goes into reverse in response to a change in economic circumstances, in effect upending the role of foreign direct investment.
Such capital flight can be particularly damaging for developing countries, for whom this is one of several FDI risks.
Presidential hostility blamed
More recently, FDI has encountered a rather more fundamental problem – the numbers involved have sharply declined. According to the Organisation for Economic Co-operation and Development (OECD), the 36-nation club of rich countries: “FDI creates stable and long-lasting links between economies.”
But by the OECD’s own FDI data, it is doing so less and less. In the peak year of 2007, FDI outflows for all countries in the world totalled $2.2 trillion, of which the OECD countries accounted for $1.9 trillion.
This plunged in the wake of the crisis to give a world figure of $1.1trillion in 2009, of which the OECD accounted for $0.9 trillion.
There was something of a rally by 2015, when the world figure was $1.7 trillion, of which the OECD accounted for $1.3 trillion. But a decline set in since then, and the current world level - $0.81 trillion and the OECD sub-total of $0.5 trillion is lower even that the modest totals seen in 2005 of $0.84 trillion and $0.71 trillion respectively.
While the crisis triggered the initial decline in FDI flows, more recent moves by President Donald Trump to discourage US firms from investing abroad instead of at home has had an impact, as has his “America first” attitude to trade.
In July last year, Foreign Affairs magazine claimed: “The President’s] hostility to globalisation is ruining the United States’ attractiveness as a place to do business…This year, net inward investment into the United States by multinational corporations—both foreign and American—has fallen almost to zero, an early indicator of the damage being done by the Trump administration’s trade conflicts and its arbitrary bullying of companies and governments.”
But history suggests FDI volumes will revive, reflecting shifting economic activity across the world. At the end of the day “foreign direct investment” is simply “investment”, the allocation of capital by people who have it to people who need it, and that process is as old as civilisation itself.