Foreign investment occurs when capital is invested in another country by acquiring ownership stakes in businesses or purchasing financial assets. It plays a key role in global capital flows, drives economic growth, creates jobs, and brings in new technologies. But it can raise concerns about national sovereignty and economic independence. There are two forms: foreign direct investment (FDI), which involves the control or ownership of a company, and foreign portfolio investment (FPI), which involves purchasing financial assets without a controlling interest. Foreign investment has evolved from early trade to a regulated system.
Key Takeaways
- Foreign investment involves capital flowing from one country to another, often for ownership stakes in domestic assets.
- Foreign Direct Investment (FDI) involves substantial, long-term investments with control over the foreign enterprise.
- Foreign Portfolio Investment (FPI) refers to buying financial assets in foreign companies without active management.
- Controversies around foreign investment include concerns over national sovereignty, economic independence, and cultural integrity.
- Tax havens often attract foreign investment due to favorable tax laws, offering reduced financial burdens for investors.
$1.5 trillion
The amount of global FDI flows in 2024.
Understanding the Mechanics of Foreign Investment
Foreign investment refers to the allocation of capital by individuals, companies, or governments from one country into the assets or businesses of another country. This movement of capital can take various forms and serves many purposes, including the pursuit of higher returns, diversification of investment portfolios, fostering economic growth in the host country, and solidifying cross-border alliances.
Most notably, it’s rarely, if ever, without controversy. The influx of foreign capital often sparks debates about national sovereignty, cultural integrity, and economic independence. Examples abound, from the anxiety over Japanese investments in iconic American properties during the 1980s to contemporary concerns about American teenagers whiling away their days on Chinese-owned TikTok. In the United Kingdom, foreign ownership of prime real estate, particularly in London, has led to discussions about housing affordability and the changing character of neighborhoods.
These controversies often stem from fears of losing control over national assets, concerns about wealth inequality, and suspicions about the motives of foreign investors. Critics argue that foreign investment can lead to the exploitation of local resources, the displacement of domestic businesses, or even pose national security risks. Supporters of particular foreign investment projects, meanwhile, tend to emphasize the benefits of job creation, technology transfer, and economic stimulation that foreign investment can bring.
Foreign investment operates through two primary mechanisms: FDI and FPI. Each serves different purposes and has distinct characteristics.
Fast Fact
The United States, China, and India are among the top destinations for FDI, attracting billions of dollars in foreign capital annually.
Exploring Foreign Direct Investment (FDI)
FDI involves an investor establishing foreign business operations or acquiring foreign business assets, typically by controlling ownership in a foreign company. This form of investment is characterized by significant control over the foreign enterprise, often defined as owning 10% or more of the voting stock. FDI is usually part of a long-term commitment. It can take various forms, such as building new operational facilities from the ground up (Greenfield Investments), buying or merging with an existing foreign company, or partnering with a foreign company to establish a new enterprise (joint ventures).
Beyond capital, FDI often involves the transfer of technology, expertise, and management practices. FDI is usually grouped into three types:
- Horizontal FDI: A company establishes the same type of business operation in a foreign country as it operates in its home country. For example, a U.S.-based smartphone provider purchasing a chain of phone stores in China illustrates horizontal FDI.
- Vertical FDI: A business acquires a complementary business in another country. For instance, a U.S. manufacturer might acquire an interest in a foreign company that supplies it with the raw materials it requires.
- Conglomerate FDI: A company invests in a foreign business that is unrelated to its core operations. Since the investing company has no experience in the foreign company’s field, this often takes the form of a joint venture.
Delving into Foreign Portfolio Investment (FPI)
FPI refers to individuals, corporations, or institutions investing in foreign financial assets such as stocks, bonds, or other securities. Unlike FDI, portfolio investors typically do not have control over the enterprises they invest in. FPI is generally more liquid than FDI, allowing for easier entry and exit, and often has a shorter-term focus. It provides investors with a chance to diversify their portfolios across international markets.
Warning
FPIs are subject to exchange rate risks, as the value of investments can be significantly affected by fluctuations in the currency exchange rates between the investor’s home country and the foreign country.
Country-Specific Insights on Foreign Portfolio Investments
Foreign indirect investments involve corporations, financial institutions, and private investors buying stakes or positions in foreign companies that trade on a foreign stock exchange. In general, this type of foreign investment is less favorable, as the domestic company can easily sell off its investment very quickly, sometimes within days of the purchase.
FDI vs. Foreign Indirect Investments or FPI
Foreign Direct Investment
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Buying a significant, lasting interest in a company or asset in another country.
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Could be a merger or acquisition, joint venture, or the opening of a subsidiary and manufacturing plants.
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The investor generally gains influence over how the foreign asset or entity is run.
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These investments aren’t always liquid and are considered long term.
Foreign Indirect Investments
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Purchasing shares, bonds or other securities in foreign entities.
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Holdings can include stocks, ADRs, GDRs, bonds, mutual funds, and exchange traded funds (ETFs).
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The investor doesn’t usually gain direct control of the foreign entity it invests in.
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These investments tend to be smaller and shorter term in nature.
The Relationship Between Foreign Investments and Tax Havens
Large corporations often seek to do business in countries with the lowest taxes. They might relocate to a tax haven or a country with favorable tax laws to attract foreign investors.
Fast Fact
Some of the more popular tax haven countries that attract foreign investors include the Bahamas, Bermuda, Monaco, Luxembourg, Mauritius, and the Cayman Islands.
Examples of Foreign Investment
FDIs generally involve taking a significant stake in a foreign company or building facilities in a foreign country. That could mean a merger or acquisition, a joint venture, or creating a foreign subsidiary.
Many companies build large factories in countries where labor and other costs are lower. An American company, for example, could sell its goods in the U.S. but get them made, say, in Vietnam. By building factories in Vietnam, the company is investing in that country. Its investments lead to jobs and paychecks that get spent in the local economy as well as taxes.
Indirect foreign investments are generally less grand in scale. They could involve a retail investor buying a foreign country’s government bond, which would essentially mean lending that government money or shares in a company that doesn’t trade in their country.
If you buy shares in a foreign company, or any other type of investment, including bonds, mutual funds, and ETFs, you are indirectly helping to fund the economy of the country where it is located. However, unlike with the FDI, your investment should be easy to sell and will be passive in nature—you won’t be influencing how it is run. It should also be more affordable and accessible.
Additional Categories of Foreign Investment
Two additional types of foreign investments should be considered: commercial loans and official flows. Commercial loans are typically bank loans issued by a domestic bank to businesses in foreign countries or the governments of those countries. Official flows are a general term that refers to different forms of developmental assistance that developed or developing nations receive from a domestic country.
Commercial loans were the largest source of foreign investment in developing countries and emerging markets until the 1980s. Following this period, commercial loan investments plateaued, and direct and portfolio investments increased significantly around the globe.
Fast Fact
Foreign investment flows can be highly sensitive to changes in economic indicators such as interest rates, inflation, and political stability in both the investor’s home country and the target market.
Multilateral Development Banks: A Different Kind of Foreign Investment
A different kind of foreign investor is the multilateral development bank (MDB), which is an international financial institution that invests in developing countries to encourage economic stability. Unlike commercial lenders who have an investment objective to maximize profit, MDBs use their foreign investments to fund projects that support a country’s economic and social development.
The investments—which typically take the form of low- or no-interest loans with favorable terms—might fund the building of an infrastructure project or provide the country with the capital needed to create new industries and jobs. Examples of multilateral development banks include the World Bank and the Inter-American Development Bank.
Weighing the Pros and Cons of Foreign Investment
Foreign investment can boost both the recipient country’s economy and the investor’s home economy. The foreign country benefits, for example, from the constriction of new infrastructure and the creation of jobs for their local workers, while the country of origin may indirectly benefit from the returns generated from the investment.
It also helps build strong ties between different countries. It boosts international trade and makes it easier for the world to share its resources, which, in theory, should benefit everyone.
There are also plenty of disadvantages. Common criticisms about foreign investment include that it drives out local businesses and results in profits being reinvested elsewhere. Foreign investment is sometimes viewed as an unethical way for companies to save money. By opening operations in cheaper countries, they fatten their pockets without passing on the savings to consumers and take jobs away from their country of origin.
Likewise, foreign indirect investment comes with pros and cons. On the one hand, it’s great that investors have the option to invest anywhere in the world. Meanwhile, it means investment capital is being directed abroad rather than domestically. If people start investing in foreign companies over domestic ones, it could lead domestic companies to struggle, which could lead to job losses and maybe even higher prices.
Why Is Foreign Investment Important?
Foreign investment helps develop ties between different countries, promotes international trade, and can be economically beneficial to both the foreign and domestic country. The International Trade Administration claims foreign investment “plays a major role in the U.S. economy, both as a key driver of the economy and an important source of innovation, exports and jobs.”
What Is the Difference Between Investment and Foreign Investment?
An investment is called foreign when it is made in a foreign country. If the investment was made in the country of the investor, it would simply be an investment. If, meanwhile, it was made in a foreign country, it could be labeled a foreign investment instead.
Can I Directly Invest in Foreign Stocks?
Investors can invest in foreign stocks via American depository receipts, global depository receipts, or directly by opening an account with a local broker in the target country. Alternatively, it’s possible to gain exposure to foreign stocks by investing in a mutual fund or ETF that invests in foreign shares.
Do I Have to Pay Taxes on Foreign Stocks?
When Americans buy foreign stocks, their income and capital gains are taxed in the U.S. and may also be taxed by the government of the country where they invested. If you are also taxed by the foreign country’s government, you may qualify for a “foreign tax credit” that allows you to use all or some of those foreign taxes to offset your liability to Uncle Sam.
The Bottom Line
Foreign investment is a vital part of the global economy, allowing investors to put capital into companies, assets, or projects in another country. FDI lets investors acquire significant ownership or control in businesses or long-term assets like plants and buildings, while FPI involves purchasing financial assets such as stocks or bonds without management control. Foreign investment can stimulate economic growth, but it also raises concerns about national sovereignty, wealth inequality, and economic dependence. Major destinations for foreign investment include the U.S., China, and India, while tax havens often attract capital seeking favorable conditions.