Foreign Direct Investment (FDI)
 Background:
Foreign direct investment (FDI) is the investment made by a company in one country (the home
country) into another country (the host country). It can take various forms, such as the
establishment of a subsidiary or branch, the acquisition of an existing company, or the expansion
of operations in a foreign country.
FDI plays a crucial role in the globalization of the world economy, as it promotes economic
growth, creates jobs, transfers technology, and facilitates international trade.
FDI has become increasingly important in the global economy in recent years. In 2021, the total
value of FDI flows was $1.6 trillion. The top three recipient countries were the United States,
China, and Hong Kong.
 Types of FDI:
There are four main types of FDI:
Horizontal FDI: Horizontal FDI 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, Nike, a USbased firm, may purchase Puma, a Germany-based firm. They are both in the industry of
sportswear and therefore would be classified as a form of horizontal FDI.
Vertical FDI: Vertical FDI is another type of foreign investment. A vertical FDI occurs when an
investment is made within a typical supply chain in a company, which may or may not necessarily
belong to the same industry. It can be categorized into two types:
a. Backward Vertical FDI: This occurs when a company invests in a foreign country to gain control
over the inputs or raw materials needed for its production process.
b. Forward Vertical FDI: Involves investment in a foreign country to gain control over the
distribution channels or access to the market for the final products.
For instance, Hershey, a US chocolate manufacturer, may look to invest in cocoa producers in
Brazil. This is known as backward vertical integration because the firm is purchasing a supplier,
or potential supplier, in the supply chain.
We then have forward vertical integration. So this is where a firm invests in a foreign company
that is further along in the supply chain. For instance, Hershey may look to purchase a share in
Alibaba; where it sells its products.
Conglomerate FDI: When investments are made in two completely different companies of
entirely different industries, the transaction is known as conglomerate FDI. As such, the FDI is not
linked directly to the investor’s business. For instance, the US retailer Walmart may invest in
TATA Motors, the Indian automobile manufacturer.
Platform FDI: The last types of foreign direct investment is platform FDI. In the case of platform
FDI, a business expands into a foreign country, but the products manufactured are exported to
another, third country. For instance, the French perfume brand Chanel set up a manufacturing plant
in the USA and export products to other countries in America, Asia, and other parts of Europe.
 Theories of international investments:
There are several theories that attempt to explain why companies engage in FDI. Some of the most
important theories include:
The product cycle theory: This theory argues that companies invest in foreign countries
as their products mature and they need to expand into new markets.
The Product Cycle Theory by Raymond Vernon: This theory argues that FDI is driven by
the different stages of the product life cycle. In the early stages of the product life cycle, a
company will typically produce its products in its home country and export them to foreign
markets. As the product matures, the company may choose to invest in production facilities
in foreign markets in order to be closer to its customers. In the decline stage of the product
life cycle, the company may choose to exit foreign markets altogether.
The market imperfections theory: This theory argues that companies invest in foreign
countries to overcome market imperfections such as tariffs, transportation costs, and
information asymmetry.
Market Imperfections Theory: This theory suggests that FDI occurs due to market
imperfections, such as monopolistic advantages, economies of scale, or product
differentiation. Firms invest in foreign countries to exploit these imperfections and gain a
competitive advantage. By establishing a presence in a foreign market, companies can
overcome barriers to trade, reduce transportation costs, or respond more effectively to local
customer preferences.
The eclectic paradigm: This theory argues that companies invest in foreign countries
based on a combination of factors, including ownership advantages, location advantages,
and internalization advantages.
The Eclectic Theory of International Production (OLI) by John Dunning: This theory
argues that there are three main factors that drive foreign direct investment (FDI):
ownership advantages, location advantages, and internalization advantages. Ownership
advantages are the firm-specific assets that give a company a competitive edge in the
market (such as technology, brand reputation, or managerial skills possessed by the
investing firm). Location advantages are the factors that make a particular country or region
an attractive place to invest. Internalization advantages are the benefits that a company
gains from controlling its own production and distribution processes.
Internationalization theory: The central premise of the internationalization theory is that
firms expand into foreign markets incrementally, starting with countries that are
geographically or culturally close to their home country and gradually moving into more
distant or dissimilar markets. This gradual internationalization process allows firms to accumulate
knowledge, learn about foreign markets, and reduce the risks associated with operating in
unfamiliar environments.
Factors affecting foreign direct investment (FDI):
• Wage rates:
A major incentive for a multinational to invest abroad is to outsource labor-intensive production
to countries with lower wages. For example: average wages in the US are $15 an hour, but $1 an
hour in the Indian sub-continent, costs can be reduced by outsourcing production. This is why
many Western firms have invested in clothing factories in the Indian sub-continent.
• Labor skills:
Some industries require higher skilled labor, for example, pharmaceuticals and electronics.
Therefore, multinationals will invest in those countries with a combination of low wages, but high
labor productivity and skills. For example: in recent years, foreign countries invested in the Indian
IT sector because they get a vast amount of skilled manpower at low wages.
• Tax rates:
Large multinationals, such as Apple, Google, and Microsoft have sought to invest in countries with
lower corporation tax rates. For example, Ireland has been successful in attracting investment from
Google and Microsoft because of its low tax rate.
• Transport and infrastructure:
A key factor in the desirability of investment is the transport costs and levels of infrastructure. A
country may have low labor costs, but if there are high transport costs to get the goods onto the
world market, this is a drawback. Countries with access to the sea are at an advantage over
landlocked countries, which will have higher costs to ship goods. Example: FDI increased in
Bangladesh after the construction of Padma Bridge.
• Size of economy/potential for growth:
Foreign direct investment is often targeted at selling goods directly to the country involved in
attracting the investment. Therefore, the size of the population and scope for economic growth will
be important for attracting investment. Example: One of the main reasons for Kellogg’s to enter
into the Indian Market was the population of the country.
• Political stability/property rights:
Foreign direct investment has an element of risk. Countries with an uncertain political situation
will be a major disincentive. Also, an economic crisis can discourage investment. Related to
political stability is the level of corruption and trust in institutions, especially the judiciary, and the
extent of law and order.
• Raw materials: One reason for foreign investment is the existence of raw materials.
• Exchange rate: A weak exchange rate in the host country can attract more FDI because it will
be cheaper for the multinational to purchase assets. However, exchange rate volatility could
discourage investment.
• Access to free trade areas: A significant factor for firms investing in Europe is access to EU
Single market, which is a free trade area but also has very low non-tariff barriers because of the
harmonization of rules, regulations, and free movement of people
 Patterns of FDI:
Here are some common patterns of foreign direct investment:
• Conglomerate FDI:
In this pattern, a company invests in a business that is unrelated to its existing activities. It involves
diversification into different industries or sectors. For instance, a technology company investing
in a hotel chain or acquiring a food processing company.
• Market-seeking FDI:
This pattern occurs when companies invest in foreign markets to gain access to larger customer
bases or to tap into emerging markets with growth potential. For example, a multinational retail
chain expanding its operations into a new country to serve the local consumers.
• Resource-seeking FDI:
Companies invest in countries that possess natural resources or raw materials necessary for their
operations. This pattern is common in industries such as mining, oil and gas, and agriculture. An
example is a multinational energy company investing in oil exploration and production in a country
with significant oil reserves.
• Efficiency-seeking FDI:
Companies invest in foreign countries to take advantage of lower production costs, including labor,
raw materials, or operational expenses. This pattern is often observed in industries with significant
cost differentials between countries. For instance, a manufacturing company setting up a
production facility in a country with lower labor costs.
• Export-oriented FDI:
Companies establish production facilities in foreign countries with the intention of exporting goods
back to their home markets or third countries. For example, German car manufacturers built
factories in the United States to produce vehicles for export.
• Knowledge-seeking FDI:
Companies invest in foreign countries to access specialized knowledge or technology. For
instance, a pharmaceutical company acquires a biotech firm in another country to gain access to
its research and development capabilities.
• Platform FDI:
Companies establish a foreign base or platform for regional or global operations. For example, a
multinational e-commerce company set up a regional headquarters in Singapore to oversee its
operations in Southeast Asia.
It's important to note that these patterns can overlap or coexist within a single investment.
Companies may have multiple motives or objectives when making FDI decisions, and the patterns
can evolve over time based on changing circumstances. Additionally, government policies, such
as tax incentives, investment regulations, and trade agreements, can influence the pattern of FDI
in a particular country or region
 Advantages of Foreign Direct Investment (FDI):
• Economic Growth:
FDI can stimulate economic growth by bringing in new capital, technology, and management
skills. This can lead to increased production, job creation, and higher productivity levels,
contributing to overall economic development.
• Technology Transfer:
FDI often involves the transfer of advanced technology and know-how from the investing country
to the host country. This can help the host country upgrade its industrial capabilities, enhance its
competitiveness, and improve the quality of its products and services.
• Employment Opportunities:
FDI can create job opportunities in the host country. Foreign companies may establish new
businesses, expand existing operations, or invest in infrastructure projects, all of which can lead to
increased employment opportunities for the local workforce.
• Increased Exports:
FDI can boost a country's exports by integrating it into global value chains. Foreign companies
may use the host country as a production base, utilizing local resources and labor, and subsequently
export the finished goods to other markets, thereby increasing the host country's export earnings.
 Disadvantages of Foreign Direct Investment (FDI):
• Loss of Sovereignty:
FDI may result in a loss of economic sovereignty for the host country. The presence of foreign
companies can exert influence over economic policies, market conditions, and even political
decisions, potentially limiting the host country's ability to pursue its own developmental
objectives.
• Economic Dependence:
Heavy reliance on FDI can make a country vulnerable to economic fluctuations and shocks in the
global economy. Economic downturns in investing countries or sudden withdrawal of foreign
capital can negatively impact the host country's economy, leading to job losses and reduced
investment.
• Repatriation of Profits:
Foreign companies that invest in a host country may repatriate their profits back to their home
country. This can result in a net outflow of financial resources from the host country and limit the
potential for reinvestment and further economic development.
• Negative Impact on Local Industries:
In some cases, FDI can have adverse effects on domestic industries, particularly in sectors where
foreign companies have a competitive advantage. Local companies may struggle to compete with
foreign firms, leading to market consolidation, loss of market share, and potentially, closures or
job losses.
Current Foreign Direct Investment (FDI) situation in Bangladesh
The current situation of FDI in Bangladesh is positive. In 2022, the country received $ 3.44 billion
in FDI, a 37% increase over 2021. This is the highest level of FDI inflows in Bangladesh since
2019. Here are some industries and companies that have received.
FDI inflows in Bangladesh in recent years:
• Manufacturing: The manufacturing sector is one of the largest recipients of FDI in Bangladesh.
Some of the major companies that have invested in this sector include Samsung, LG, and Toyota.
• Infrastructure: The infrastructure sector is also a major recipient of FDI in Bangladesh. Some of
the major companies that have invested in this sector include China Harbor Engineering Company,
Power China, and Marubeni Corporation.
• Energy: The energy sector is also a major recipient of FDI in Bangladesh. Some of the major
Companies that have invested in this sector include Shell, Total, and Chevron.
There are a number of factors that have contributed to the recent increase in FDI inflows into
Bangladesh. These include:
• The government's efforts to improve the business environment, such as streamlining the
investment approval process and reducing taxes.
• The country's strong economic growth, has created a favorable investment climate.
• The growing middle class in Bangladesh, which has increased demand for consumer goods
and services.
• The country's strategic location, which makes it a gateway to the South Asian market.
However, there are still some challenges that need to be addressed in order to attract even more
FDI into Bangladesh. These include:
• The need to improve the country's infrastructure, particularly in the areas of transportation and
energy.
• The need to reduce corruption and improve the rule of law.
• The need to improve the skills of the workforce.
Despite these challenges, the future of FDI in Bangladesh looks bright. The country has a
number of strengths that make it an attractive destination for foreign investors. With continued
government support and investment in the right areas, FDI inflows into Bangladesh are likely to
continue to grow in the years to come
Sub Note for Self-Understanding:
For example, Horizontal FDI
Walmart: Walmart Inc. (Walmart) is a retailer that operates grocery stores, supermarkets,
hypermarkets, department and discount stores, and neighborhood markets. The company’s stores
offer grocery and consumables, health and wellness, technology, office and entertainment,
hardlines, apparel, and home categories at everyday low prices.
D-Mart: D-Mart is a one-stop supermarket chain that aims to offer customers a wide range of
basic home and personal products under one roof. Each D-Mart store stocks home utility products
- including food, toiletries, beauty products, garments, kitchenware, bed and bath linen, home
appliances, and more - available at competitive prices that our customers appreciate.
Dunning's Eclectic Paradigm: Developed by John Dunning, the eclectic paradigm, also known
as the OLI framework (Ownership, Location, and Internalization), is one of the most influential
theories of FDI. It suggests that three factors determine the viability of FDI: ownership-specific
advantages (such as technology, brand reputation, or managerial skills possessed by the investing
firm), location-specific advantages (such as access to markets, resources, or favorable business
environment in the host country), and internalization advantages (the benefits of controlling
foreign operations instead of using other market entry modes).
Internalization Theory: Internalization theory emphasizes the idea that firms engage in FDI to
internalize certain activities or resources that are more efficiently managed within the firm rather
than relying on market transactions. By establishing foreign subsidiaries, companies can gain
better control over critical assets, specialized knowledge, or production processes, which may lead
to cost savings, protection of proprietary information, or reduced transaction costs.
Market Imperfections Theory: This theory suggests that FDI occurs due to market
imperfections, such as monopolistic advantages, economies of scale, or product differentiation.
Firms invest in foreign countries to exploit these imperfections and gain a competitive advantage.
By establishing a presence in a foreign market, companies can overcome barriers to trade, reduce
transportation costs, or respond more effectively to local customer preferences.
Product Life Cycle Theory: Proposed by Raymond Vernon, this theory explains the sequential
pattern of FDI based on the life cycle of products. According to this theory, a firm begins by
exporting its new product, then transitions to establishing production facilities in foreign countries
as the product matures and faces increasing competition. Eventually, as the product becomes
standardized and globalized, the firm may engage in FDI to access new emerging markets or
reduce production costs.
Prepared by Tonmoy + Group 1 Assignment.