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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. In other words, if nations are reliant on each other for their income, then the likelihood of war is also reduced. 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. What happens as a result is that useful techniques or ways of conducting business are transferred.
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.
Finally, the technology could be reverse-engineered or provide inspiration for domestic development. 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.
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. 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.
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. 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.
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. 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. 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. 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. Countries rely on the U. Foreign direct investments can be made in a variety of ways, including the opening of a subsidiary or associate company in a foreign country, acquiring a controlling interest in an existing foreign company, or by means of a merger or joint venture with a foreign company.
Foreign direct investments are commonly categorized as being horizontal, vertical or conglomerate. A horizontal direct investment refers to the investor establishing the same type of business operation in a foreign country as it operates in its home country, for example, a cell phone provider based in the United States opening stores in China.
A vertical investment is one in which different but related business activities from the investor's main business are established or acquired in a foreign country, such as when a manufacturing company acquires an interest in a foreign company that supplies parts or raw materials required for the manufacturing company to make its products. A conglomerate type of foreign direct investment is one where a company or individual makes a foreign investment in a business that is unrelated to its existing business in its home country.
Since this type of investment involves entering an industry in which the investor has no previous experience, it often takes the form of a joint venture with a foreign company already operating in the industry. Examples of foreign direct investments include mergers, acquisitions, retail, services, logistics, and manufacturing, among others.
Foreign direct investments and the laws governing them can be pivotal to a company's growth strategy. In , for example, U. China's economy has been fueled by an influx of FDI targeting the nation's high-tech manufacturing and services, which according to China's Ministry of Commerce, grew Thus far, the firm's iPhones have only been available through third-party physical and online retailers.
Ministry of Commerce People's Republic of China. Government of India Ministry of Commerce and Industry. International Markets. Business Essentials. Your Money. Personal Finance. Your Practice. Popular Courses. Markets International Markets. Key Takeaways Foreign direct investments FDI are investments made by one company into another located in another country.
FDIs are actively utilized in open markets rather than closed markets for investors. Horizontal is establishing the same type of business in another country, while vertical is related but different, and conglomerate is an unrelated business venture.
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