Understanding Foreign Direct Investment (FDI)

3.1.1 What is FDI?

To understand the meaning of Foreign Direct Investment (FDI), it is important to analyse the meaning of its various associated concepts.

Investment consists of applying resources (financial / technological / human) to generate value in terms of products / services. For that purpose, we can outline the following resources:

• Financial – consists of the money that is used to get the investment going.
• Technological – consists of having technology that supports the process of adding value
• Human – is the differentiating factor in the process of adding value. This consists of implementing the differentiating capacities of people in the development of innovation and creativity that sustain the capacity to be more efficient, in increasingly globalised environments.

Direct means a relocation, i.e. an investment made in another country.

However, the following must be borne in mind:

• The socio-cultural environment is different from the country of origin, and the rules and standards governing industrial / commercial / labour practices may be different.
• The management of investment processes is the responsibility of each country.
• The ‘displacement’ must be associated with an advantage assessed by the investor as potentially important for the development of their business (e.g. footwear business); this advantage may also be the implementation in a preferential economic space.
• Increasingly, there is a process of competition between countries in raising / attracting financial and technological resources.
• The rules of business control are those of the hosting country. In this context, each country/state has organisations that help companies with the internationalisation process.

In Portugal there is AICEP – http://www.diasporalusa.pt/instituicoes/aicep-agencia-investimento-comercio-externo-portugal/. AICEP Portugal Global, E.P.E., the Portuguese Agency for Investment and Foreign Trade, is a public entity of a business nature dedicated to the development of a competitive business environment that contributes to the globalisation of the Portuguese economy.

In Poland, there is the Polish Investment and Trade Agency (PAIH) which supports both the foreign expansion of Polish business and the inflow of FDI into Poland. https://www.paih.gov.pl/pl

In Italy, there is the Trade & Investment Agency, a Governmental agency that supports the business development of Italian companies abroad and promotes the attraction of foreign investment into Italy. https://www.ice.it/it/chi-siamo.

In Greece, the organisation that promotes International trade is the ‘Enterprise Greece S.A.’ It is designed to promote and support Greece’s substantial investment opportunities and to engage the global business community with (first-class) high end export products—goods and services made in Greece.www.enterprisegreece.gov.gr

In Spain, there are the following agencies:

ICEX, a national public business entity whose mission is to promote the internationalisation of Spanish companies and foreign investment https://www.icex.es/icex/es/index.html. Within the Catalunya Region, there is ACCIO – an agency to support companies’ competitiveness. This agency offers different kinds of services to companies aiming to internationalise through different instruments. They have several trade support offices in several countries around the world, they can facilitate direct contacts with local actors and companies, they support the definition and preparation of the internationalisation strategy, and provide funds for internationalisation. http://www.accio.gencat.cat/ca/serveis/internacionalitzacio/

Also, there is the Fondo para la Internacionalización (FIEM) whose purpose is to promote the export operations of Spanish companies, as well as Spanish direct investment abroad, by financing operations and projects of special interest for the internationalisation strategy of the Spanish economy. It also finances the technical assistance that these operations and projects require in both developed and developing countries.

In general, financing will be provided mainly in the form of loans, credit and credit lines, although non-refundable financing, technical assistance and consulting services may also be provided to firms, as well as projects and operations when required. https://www.ico.es/web/ico/fondo-para-la-internacionalizacion-de-la-empresa

In Ireland, Enterprise Ireland, is the government organisation responsible for the development and growth of Irish enterprises in world markets. https://www.enterprise-ireland.com/en/ . On the other hand, the Irish Development Authority (IDA), is the Irish semi-state body promoting Foreign Direct

Investment into Ireland through a wide range of services. They partner with potential and existing investors to help them establish or expand their operations in Ireland. https://www.idaireland.com/

Foreign means ‘the movement of investors of a specific nationality to another country’.

Therefore, Foreign Direct Investment (FDI) is an investment from a party in one country into a business or corporation in another country with the intention of establishing a lasting interest. The establishment of lasting interest differentiates FDI from foreign portfolio investments, whereby investors passively hold securities from a foreign country. A foreign direct investment can be made by obtaining a lasting interest or by expanding one’s business into a foreign country. An investment into a foreign firm is considered an FDI if it establishes a lasting interest. A lasting interest is established when an investor obtains at least 10 % of the voting power in a firm.  The FDI process is also always based on the idea that any business has to be competitive and contribute to the globalisation of the economy of a given country / state.  Within this process, the main challenge is to add value.

The key factors which increase the likelihood that an SME will export are:

• belonging to a group,
• being experienced,
• being large (in terms of turnover),
• having the ambition to grow,
• being active in the goods sector,
• selling to other businesses or organisations, and
• being innovative.

For hosting countries, relocation strategies are based on support at the following levels:

• Fiscal – there are incentives such as tax exemptions in the support of the facilities.
• Access to EU incentive programmes in that country, including operational programmes that encourage investment, whether for material goods or for training, etc.

3.1.2 Factors that promote relocation

Foreign Direct Investment is a key factor in the growth of economies. Not only for its contribution to economic growth, employment and exports, but also for the promotion of the country as a global, reputable and attractive brand. Foreign Direct Investment should be promoted and valued, especially in cases where it creates wealth and has a multiplying effect, boosting related sectors or companies. Direct investments in companies’ capital (incorporation of companies, capital increases or acquisition of shareholdings) are privileged vehicles for the realisation of Foreign Direct Investment, having allowed the countries concerned to become more and more integrated in global value chains, in the most varied sectors of activity.

While more and more multinational companies have established themselves in several countries (Google, Vestas, Natixis), there are also mergers & acquisitions (M&A), driven by a large number of cross border transactions.

One can point out motivations that put countries on the radar of Foreign Direct Investment, for example:

• climate of social stability,
• potential for increasing productivity, or
• competitive labour costs.

Nevertheless, it must be taken into account that Foreign Direct Investment, per se, does not guarantee prosperity. This becomes even more evident when sectors with lower added value are considered, which are established in some countries only due to their comparative advantages in terms of labour cost. The initials cost of undertaking an FDI project are fixed as they consist of a once-off cost incurred by the SME to assess its possibilities and understand the regulation surrounding the planned FDI project.  These costs include both the monetary and time costs associated with undertaking the investment, as well as the risk associated with the project, which needs to be covered by the return on it. The higher the risk associated with a given investment, the higher the costs. This implies that the costs of undertaking an FDI project are higher, the higher the uncertainty of the foreign relationship and the more complicated the bureaucracy surrounding the regulation. The latter impacts the costs of undertaking an FDI project by increasing the time and money required in preparation of the investment.

The larger the fixed costs of undertaking the FDI project, the larger the projects must be in order to generate a profit. Therefore, the decrease in the average deal size of the projects over time can be seen as an indication that the fixed costs are decreasing, allowing smaller projects to be profitable. The severe impact of the crisis on the European market some years ago, may also have pushed some SMEs to look for better market opportunities outside of their home market, and may thus have been a push factor for smaller FDI projects.

3.1.3 Methods of FDI

As already mentioned, an investor can make a foreign direct investment by expanding their business in a foreign country. An example of this would be Amazon opening a new headquarters in Vancouver, Canada. Reinvesting profits from overseas operations, as well as intra-company loans to overseas subsidiaries, are also considered foreign direct investments.  Finally, there are multiple methods for a domestic investor to acquire voting power in a foreign company which include the following:

• Acquiring voting stock in a foreign company,
• Mergers and acquisitions,
• Joint ventures with foreign corporations, or
• Starting a subsidiary of a domestic firm in a foreign country.

3.1.4 Advantages and Disadvantages of FDI

FDI offer advantages to both the investor and the foreign host country.

Here are some of the benefits for businesses:

• Market diversification.
• Tax incentives.
• Lower labour costs.
• Preferential tariffs.

The following are some of the benefits for the host country:

• Economic stimulation.
• Development of human capital.
• Increase in employment.
• Access to management expertise, skills and technology.

The disadvantages of FDI are as follows:

• Displacement of local businesses.
• Profit repatriation.

The entry of large firms, such as Walmart, Mercadona, Pingo Doce, etc. may displace local businesses. They are often criticised for driving out local businesses that cannot compete with their lower prices. In the case of profit repatriation, the primary concern is that firms will not reinvest profits back into the host country. This leads to large capital outflows from the host country. As a result, many countries have regulations limiting foreign direct investment.