Definition of Foreign Direct Investment
The concept of Foreign Direct Investment (FDI) has continued to acquire increasing importance as economies strive to develop well beyond the capabilities provided by resources that are available locally. It has evolved from mere investment in fixed assets of a business to the acquisition of a management interest in a company by a foreign firm. Initially, FDI was defined as a company from one country making a physical investment in building a factory in another country. The direct investment in buildings, machinery and equipment is in contrast with making a portfolio investment like buying shares in a company, which is considered an indirect investment. In recent years, given rapid growth and change in global investment patterns, the definition has been broadened to include the acquisition of a lasting management interest in a company or enterprise outside the investing firm’s home country.
As such, it may take many forms, such as a direct acquisition of a foreign firm, facility or construction. It may also take the form of investment in a joint venture or strategic alliance with a local firm with attendant input of technology or licensing of intellectual property. In the past decade, FDI has come to play a major role in the internationalization of business. Reacting to advancements in technology, growing liberalization of the national regulatory framework governing investment in enterprises and changes in capital markets, profound alterations have occurred in the size, scope and methods of FDI. New IT systems and the decline in global communication costs have made FDI management easier than before. The changes in trade and investment policies and the regulatory environment globally in the past decade, including trade policy and tariff liberalization, easing of restrictions on FDI and acquisition in many nations, and the deregulation and privatization of many industries, have probably been the most significant catalysts for FDI’s expanded role (Graham and Spaulding, 2004).
FDI can either take the form of “green field” investment (also called “mortar and brick” investment) or merger and acquisition (M&A), depending on whether the investment involves mainly newly created assets or just a transfer from local to foreign firms. Most FDI investments have taken the form of acquisition of existing assets (M&A) rather than investment in new assets (“green field”). Thus, M&As have become a popular mode of investment for companies wanting to protect, consolidate and advance their positions by acquiring other companies that will enhance their competitiveness (Ntwala Mwilima, 2003).
Determinants of FDI
It is argued that a strong policy and regulatory regime, appropriate institutions, good infrastructure, and political and economic stability are important to attract FDI. UNCTAD has further indicated different determinants for decisions to invest abroad. Some of these determinants include: The policy framework for FDI such as political and social stability, rules about treating operations of affiliates of foreign companies, and international FDI agreements. Others are Economic determinants such as the size of the market and per capita income, natural resources, cheapness of factors of production or efficiency-cheaper costs for infrastructure or intermediate products. Other determinants such as business affiliation provisions (like investment incentives which are mostly mistaken as important determinants, and yet are not, except in case of choice between two equally attractive locations) and Privatization programmes have become sources for attracting FDI (Odenthal, 2001).
In studies of 81 UK, Swiss and German firms to investigate determinants of FDI inflows to the SADC region, the findings reveal that 84% are lured by local market Size, 40% by local raw materials, 26% by personal reasons, 21% by strategic reasons and 19% by Privatization Investment facilitation (Econews, 15 April 2003).
FDI is viewed as a major stimulus to economic growth in developing countries. Its perceived ability to deal with major obstacles such as shortages of financial resources, technology, and skills has made it the center of attention for policy makers in developing countries such as Africa.
Gateways for Foreign Direct Investment (FDI)
FDI can take the form of either “greenfield” investment (also called “mortar and brick” investment) or merger and acquisition (M&A), depending on whether the investment involves mainly newly created assets or just a transfer from local to foreign firms. Most investments have taken the form of acquisition of existing assets rather than investment in new assets (“greenfield”). M&As have become a popular mode of investment for companies wanting to protect, consolidate and advance their positions by acquiring other companies that will enhance their competitiveness. Mergers and acquisitions are defined as the acquisition of more than 10% equity share, involving transfer of ownership from domestic to foreign hands. M&As do not create new productive facilities. Based on this definition, M&As raise particular concerns for developing countries, such as the extent to which they bring new resources to the economy, the denationalization of domestic firms, employment reduction, loss of technological assets, and increased market concentration with implications for the restriction of competition (Ntwala Mwilima, 2003).
UNCTAD studies for the World Investment Report 2000 revealed that, for the host country, the benefits of M & As are lower and the risks of negative effects are greater when compared to Greenfield investments, especially at the time of entry over the short term. An UNCTAD research on M&As concluded on five issues. First, that FDI through M&As correspond to a smaller productive investment than Greenfield as the financial resources do not necessarily go into increasing the capital stock. Secondly, M&As are less likely to transfer new or better technologies than Greenfield investment FDI. Third, FDI through M&As do not generate employment at the time of entry into the host economy, and may lead to lay-offs as the acquired firm is restructured. Fourthly, FDI through M&As can reduce competition, and may be used deliberately to reduce or eliminate competition; and lastly, over the longer term, cross-border M&As are often followed by sequential investment that do increase the capital stock. Ideally the purpose of investment is to benefit both the investing company and the host economy. However M&As are likely to result in profit for the investing firm but destruction of the domestic industry. Evidence shows that in some cases, foreign investors enter a market solely with the purpose of closing down domestic competitors and establishing a monopoly in the economy. The most noteworthy policy mechanism against such practices and which also serves to protect the domestic economy is a competition policy (Ntwala Mwilima, 2003).