Advantages and disadvantages of foreign direct investment – advantages and disadvantages for the company and the host country

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There is no doubt that foreign direct investment is an important engine of economic growth. Despite the more obvious benefits of foreign direct investment, it still comes with its share of drawbacks. Let’s take a look at the advantages and disadvantages of FDI for both the company and the host country.

Foreign direct investment is an investment made by a foreign entity (individual or company) in a business based abroad. Foreign direct investment is characterized by the concept of direct control. It is not just a cash transfer. Comes with a lasting interest. This perpetual interest is created when an investor acquires at least 10 percent of the voting power in the business.

According to the International Monetary Fund, when an investor owns 10% or more of a foreign company, it is considered a foreign direct investment. Although a 10% holding does not give the investor the controlling interest, it does give the power to influence management decisions.

Advantages and disadvantages of foreign direct investment

Advantages of foreign direct investment

The advantages of foreign direct investment can be either for the investing company or the investee company. Of course, the ideal situation would be if both parties (and both countries involved) benefited from such arrangements.

The advantages of the investing company will be as follows:

  1. Expand and explore This will help the investing company to explore a new market and expand its market share beyond the borders of their country. When a company reaches maturity in its growth graph in its home country, it will be a huge boost to its profitability if it is able to enter a new market.
  2. Lower costs Production and Employment Generally speaking, in preparing a foreign direct investment arrangement, the investor is from a developed country, and the investment is in a developing country. And in developing countries, the cost of labor and materials is considerably lower. This is one of the main reasons that attract investors to invest in developing countries.
  3. tax incentives Foreign companies are usually given tax incentives by the host countries with the aim of attracting foreign capital. In this way, the investor will pay much less taxes in the host country than in his home country, thus increasing profitability.

Advantages of the investee company:

  1. Access to global technological developments The host country (i.e. the country in which the investment is made) gets access to the new technology through foreign direct investment, and then their domestic competitors gradually receive it. In this way the consumers of the host country also benefit, as they can use new products/services.
  2. Access to advanced business practices and expertise developed over the years An established company brings with it years of experience that it has accumulated over time from dealing with various challenges. Hence, the new company gains this experience without having to face those challenges. This will give an advantage to the investee company over its competitors.

Advantages of foreign direct investment for the host country

1. Job creation

When more industries are set up in a developing economy, it helps generate large-scale employment opportunities that contribute to the economic development of the host country.

It may also provide employees with better work quality, more opportunities to go to foreign countries, experience different cultures, meet new people, and build a diverse network.

This will ensure that they bring home new perspectives and ideas which can be implemented and lead to better productivity.

2. Contribution to the gross domestic product

The revenue generated by these companies contributes to the host country’s GDP. Moreover, as mentioned earlier, it helps in job creation; This improves the purchasing power of employees and thus boosts economic activity in the country.

3. Higher competition, which benefits consumers

It is universally agreed that increased competition benefits consumers.

why is that?

When there are many players in the market, they try to cut the cost as much as possible to keep a profit margin because they cannot increase the market price.

Moreover, they are constantly innovating in order to stay relevant and not lose market share to competitors – this gives consumers access to better quality products.

Likewise, when an established company from a developed country enters the market in a developing country, it usually has better business technologies and practices. Thus, local competitors will be forced to innovate and meet international standards. Thus, ultimately, the consumer benefits.

Disadvantages of foreign direct investment for the host country

Although there are a lot of benefits in Foreign Direct Investments (FDI), there are still a lot of disadvantages that need attention.

Some of the disadvantages of foreign direct investment are as follows:

1. Uncertainty in government policies

Change in government policies is sometimes unpredictable and may have a negative impact on foreign direct investment. Policy changes can be either in the home country of the investor, for example, policy changes by the government (as mentioned earlier).

or they could be in the host country; For example, experts predicted that the flow of foreign direct investment into the UK after Brexit will decrease.

2. Loss of local investment

As the overseas investment increases the profit for the investors, the local country loses the local capital, and this will have a negative impact on the gross domestic product employment, and so on.

3. Exploiting the resources of the host countries

This usually occurs when the host country is a developing or underdeveloped economy. Investors exploit human resources as well as other natural resources without considering the negative long-term effects that may occur on the host country.

For example – paying low wages for labour, massive deforestation for setting up industries, releasing untreated sewage into streams/rivers, etc.

Although this will benefit the investor, such actions will have unfavorable effects on the host country in the long run.

4. The dangers of the unknown

Even where the investor has rich experience in the industry in which the company operates, that experience may fade in a foreign (host) country due to differences in the culture and preferences of consumers there.

Hence, conducting a detailed and thorough market research of your target demographic is essential prior to starting make a decision about foreign investment.

Conclusion

With the increasing focus on the concept of the global village, the advantages and disadvantages of FDI are becoming blurred, as different corners of the world can be connected to the Internet, such FDI arrangements are expected to grow in number and size.

Foreign direct investments can take the form of mergers, acquisitions, joint ventures, etc. However, common challenges that can be faced are the huge paperwork (licenses and permits) that must be adhered to.

In the future, governments are expected to relax these requirements and bring transparency to procedures in order to facilitate the free flow of capital, resources, and people without border barriers.



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