Foreign Direct Investment: Meaning, Types, and How It Impacts Economic Growth

Foreign Direct Investment

What is Foreign Direct Investment (FDI)?

Foreign direct investment is typically an investment by a party in one country into a business located in another country. The sole purpose of Foreign direct investment (FDI) is to establish lasting interest. FDI occurs when an investor acquires a business asset in a foreign company or develops international business operations.

They are different from foreign portfolio investments where investors passively hold securities from an international company.

Foreign direct investments are usually in open economies that offer above-average growth prospects for the investor and a skilled workforce. They involve more than capital investment and include the provision of management and technology services.

Types of Foreign Direct Investment

Foreign direct investments comprise horizontal, vertical, conglomerate and platform FDIs.

1. Horizontal FDI

Under horizontal FDI, an investor establishes the same type of business operation in another country. This business is similar to the one operating in his home country. For instance, an electronics dealer in China opening up a store in Nigeria.

2. Vertical FDI

In this type of FDI, an investor establishes a different but related business activity in a foreign country. For instance, a manufacturing company acquires interest in an international company that deals with raw materials needed for manufacturing.

3. Conglomerate FDI

Here, a business purchases foreign securities in a business that is unrelated to its existing business in the home country. It often takes the form of joint ventures since the investor has no previous experience in the new industry.

4. Platform FDI

In this type of FDI, a business establishes its operations in another country. However, the output of the company moves to a third country.

Reasons for Foreign Direct Investments

  1. Labour Skills: Some industries require highly skilled labour. Therefore, multinational companies will invest in a country that offers low wages for high productivity.
  2. Tax Rates: Investing in countries with low tax rates is always an attractive option for multinationals. This way, they can maximize their profit returns without worrying about high taxes.
  3. Commodities: One of the reasons why foreign direct investment is popular is the existence of products. For example, a significant reason for the growth of FDI in Africa is that investors are looking for a secure supply of commodities.
  4. Exchange Rate: If the exchange rate is weak in a host country, it attracts more FDI because it becomes cheaper for a multinational to purchase assets in that country. However, a high exchange rate could discourage investment.
  5. Economy Size: The size of a country’s population and the potential for economic growth is essential to attract investment as FDI often occurs in countries with good financial track records and large populations. For instance, China could be a target for FDI as they have a strong demand for the goods and services offered by multinational companies.

Foreign Direct Investment in Nigeria

Foreign Direct Investments enable the growth of any economy, and Nigeria is the third host economy for FDI in Africa after Egypt and Ethiopia. This is because Nigeria offers a significant amount of natural resources, a low cost of labour, an advantageous taxation system and a partially privatized economy.

On the other hand, lack of transparency, political instability and corruption has limited the progress of FDI in Nigeria. Although Nigeria has attracted many investors in the Energy, Building, Oil and Gas sectors, it is still susceptible to the after-effects of oil countershock, mainly because the economy depends heavily on oil.

Under the Federal Ministry of Industry, Trade and Investment, Nigeria intend to diversify its economy by creating a competitive manufacturing sector. The effect of this is that it opens Nigeria to more investors as they now become producers and not just consumers. This will eventually boost economic growth and facilitate integration into global value chains.

However, in recent times, the COVID-19 pandemic has had its impact on our Foreign Direct Investment, and this impact will continue to be studied in the years to come.

Categories: Finance