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Direct investment referred to as foreign direct investment is an investment in a foreign business enterprise. Direct investment is one of two categories of foreign investment. Direct investment refers to financial investments in a company in order to gain control or ownership, while portfolio investment refers to financial investment for the purpose of interest or dividends. Foreign direct investment is a measure of foreign ownership of productive assets. Growth in foreign investment can be used as one measure of growing economic globalization.
Foreign direct investment is distinguished from foreign portfolio investment, a passive investment in the securities of another country such as public stocks and bonds, by the element of "control". Foreign direct investment is defined as a company from one country making a physical investment in another country.
Horizontal Foreign Direct Investment 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 a US based tyre
manufacturing firm, may purchase a china based tyre manufacturing firm. They are
both in the industry of tyre manufacturing and therefore would be classified as
a form of horizontal Foreign Direct Investment.
Vertical Foreign Direct Investment 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. 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 chain. Forwards vertical integration is where a firm invests in a foreign company that is further along in the supply chain. A company may look to purchase a share where it sells its products.
Conglomerate Foreign Direct Investment is where an investment is made in a completely different industry. It is not linked in any direct way to the investors business. A US retailer may invest in a German automobile manufacturer.
Foreign direct investment promotes international trade as it allows production to flow to parts of the world which are more cost effective. Many of the components are also shipped in from elsewhere. The supply chain has become inter-connected between countries. This has created new jobs and boosted trade between the nations. Foreign direct investment reduces regional and global tensions as countries are all dependent on each other. Foreign direct investment allows the transfer of technology, knowledge, and culture. Foreign direct investment reduces risk through diversification. By investing in other nations, it spreads the companies exposure. Foreign direct investments can benefit from lower labor costs. Reduced levels of corporation tax can save big businesses billions each and every year. Countries with lower tax regimes are usually those that are favoured. There are also tax incentives by which the foreign government offers tax breaks to investors.
One of the main fears among developing nations is that they can essentially be bought and controlled by foreign powers. When significant sums of money are transferred to another, it is an investment that would have been used in the home market. Foreign direct investment may boost employment in foreign nations, but may also temporarily reduce it at home. Instead of the funds being invested in new factories and creating jobs, it is sent abroad. When investing abroad, particularly in developing nations, there is associated risk.
Multinational Enterprises (MNEs) or Multinational Corporations (MNCs) have become one of the key drivers of the world economy and their importance continues to grow around the world. Today, developing countries account for almost one-third of the global stock of inward foreign direct investment.
The increased role of foreign direct investment in developing and emerging economies has raised expectations about its potential contribution to their development. Foreign direct investment can bring significant benefits by creating high-quality jobs and introducing modern production and management practices.
However, the activities of multinational enterprises abroad have also aroused much controversy and social concerns. For example, multinational enterprises have been accused of practicing unfair competition when taking advantage of low wages and labour standards abroad. In some cases, multinational enterprises have also been accused of violating human and labour rights in developing countries where governments fail to enforce such rights effectively.