Understanding Foreign Direct Investment
A comprehensive guide to FDI concepts, benefits, and policy frameworks
What is Foreign Direct Investment?
Foreign Direct Investment (FDI) occurs when an investor in one country establishes a lasting interest and significant degree of influence over an enterprise in another country. Unlike portfolio investment (such as buying shares), FDI involves a direct stake in the operations and management of a foreign business.
Official Definition
According to the OECD and IMF, FDI is defined as cross-border investment where an investor resident in one economy establishes a lasting interest in and a significant degree of influence over an enterprise resident in another economy. The internationally agreed threshold is ownership of at least 10% of voting power.
đFDI Stocks
The total accumulated value of foreign-owned assets in an economy at a point in time. Measured as the market value or book value of direct investors' equity in, and net loans to, enterprises in the host economy.
đFDI Flows
The value of cross-border transactions during a specific period (usually a year). Includes equity capital, reinvested earnings, and intra-company loans between parent and affiliate enterprises.
Key Characteristics of FDI
- Long-term commitment â FDI represents a lasting interest, not short-term speculation
- Management influence â Investors have significant say in enterprise operations
- Transfer of resources â Often brings capital, technology, and expertise together
- Two-way flows â Economies both receive (inward) and make (outward) FDI
Types of Foreign Direct Investment
By Entry Mode
Greenfield Investment
Creating new facilities from scratch â building factories, offices, or operations. This directly adds to productive capacity and typically creates new jobs immediately.
Example: A Japanese automaker building a new manufacturing plant in Thailand
Mergers & Acquisitions (M&A)
Acquiring or merging with existing companies. While this doesn't immediately add new capacity, it often leads to restructuring, efficiency improvements, and technology upgrades.
Example: A US tech company acquiring an Australian software firm
Joint Ventures
Partnering with local firms to establish new operations. Combines foreign capital and expertise with local market knowledge and networks.
Example: A German engineering firm partnering with an Indian company
By Strategic Orientation
Market-Seeking FDI
Investing to access local or regional markets. The primary goal is to sell goods and services to consumers in the host economy.
Resource-Seeking FDI
Investing to access natural resources, raw materials, or specific assets not available in the home country. Common in mining and agriculture.
Efficiency-Seeking FDI
Investing to reduce costs through economies of scale, lower wages, or better productivity. Often part of global value chain strategies.
Strategic Asset-Seeking FDI
Investing to acquire strategic assets like technology, brands, distribution networks, or R&D capabilities.
Horizontal vs Vertical FDI
Horizontal FDI
Replicating the same business activities in different countries. A company produces the same products abroad that it produces at home.
Example: Toyota manufacturing cars in both Japan and the USA
Vertical FDI
Different stages of production located in different countries. A company fragments its supply chain internationally.
Example: Apple designing in the USA, sourcing components from Asia, assembling in China
Benefits of Foreign Direct Investment
Research from institutions including the OECD, World Bank, and Australia's Productivity Commission consistently demonstrates that FDI brings significant benefits to host economies when supported by appropriate policy frameworks.
Economic Growth
FDI expands productive capacity, increases output, and contributes to GDP growth. Foreign capital allows investment levels beyond what domestic savings alone could finance.
10%
increase in FDI linked to 1.2% GDP growth
Source: Access Economics
Employment Creation
Greenfield investments directly create new jobs. In 2023, greenfield FDI created 2.8 billion new jobs globally, with 1.8 billion in emerging markets.
1,000
jobs created per $1B of FDI in Australia
Source: Economist Intelligence Unit
Higher Wages
Foreign-owned firms typically pay higher wages than comparable domestic firms, contributing to improved living standards for workers.
35%
higher wages at foreign firms vs domestic
Source: OECD
Productivity Growth
Foreign affiliates are more productive due to better access to capital, technology, and talent. This productivity advantage can spill over to domestic firms.
70%
productivity premium at foreign affiliates
Source: OECD
Innovation & R&D
Foreign firms are significantly more likely to invest in research and development, bringing new technologies and processes to host economies.
80%
more likely to invest in R&D
Source: OECD
Market Access
FDI connects local firms to global value chains and international markets through supplier relationships and distribution networks.
4-9%
TFP increase for first-time MNE suppliers
Source: Academic Research
Benefits for Australia
According to Australia's Productivity Commission and DFAT, foreign investment has been fundamental to Australia's economic development:
Capital Formation
International capital has enabled higher rates of economic growth than could have been achieved with domestic capital alone.
Productivity Premium
Foreign-owned firms in Australia are on average 13% more productive and pay 11% higher wages than domestically owned firms in the same sector.
Tax Revenue
Higher growth supported by FDI increases tax revenues, funding hospitals, schools, roads and essential services.
Competition & Innovation
New businesses bring fresh technologies and services, encouraging competition and innovation in the Australian market.
FDI Spillovers & Technology Transfer
Beyond direct contributions, FDI can generate spillover effects that benefit domestic firms and the broader economy. These externalities are a key reason why countries actively seek to attract foreign investment.
Horizontal spillovers occur within the same industry when domestic firms benefit from the presence of foreign competitors:
Demonstration Effects
Local firms observe and learn from foreign firms' technologies, management practices, and production methods.
Labour Mobility
Workers trained at foreign firms move to domestic companies, bringing knowledge and skills with them.
Competition Effects
Increased competition forces domestic firms to become more efficient and innovative to survive.
Imitation
Local firms reverse-engineer products or adopt similar processes after observing foreign success.
Vertical spillovers occur through supply chain relationships between foreign and domestic firms:
Backward Linkages
Foreign firms source inputs from local suppliers, providing them with training, technology, and quality standards to meet requirements.
Forward Linkages
Domestic firms use inputs, equipment, or services from foreign firms, gaining access to better technology and quality.
Supplier Development
MNEs actively develop local supplier capabilities through training programs and technical assistance.
Export Facilitation
Becoming a supplier to MNEs can open doors to export markets through the multinational's global network.
The extent to which host economies benefit from FDI spillovers depends on their absorptive capacity â the ability to identify, assimilate, and apply new knowledge.
Key Factors Affecting Absorptive Capacity
- âĸTechnology gap: Moderate gaps allow learning; very large gaps may limit absorption
- âĸHuman capital: Skilled workforce better equipped to adopt new technologies
- âĸR&D investment: Firms investing in R&D are better positioned to absorb external knowledge
- âĸInstitutional quality: Strong property rights, rule of law, and contract enforcement support knowledge transfer
- âĸFinancial development: Access to finance enables firms to invest in capacity building
Research Note
While the theoretical case for FDI spillovers is strong, empirical evidence is mixed. Macro-level studies tend to find positive associations between FDI and growth, but micro-level evidence on firm-to-firm spillovers is more varied. The benefits depend heavily on host country conditions and policy frameworks.
FDI Policy Frameworks
Countries balance openness to foreign investment with safeguards to protect national interests. Policy frameworks typically include screening mechanisms, sector restrictions, and promotional measures.
Investment Screening
Review mechanisms to assess whether proposed foreign investments are consistent with national interest
- Security reviews
- Sector-specific thresholds
- National interest tests
Sector Restrictions
Limits or prohibitions on foreign ownership in sensitive sectors
- Defence & security
- Media & telecommunications
- Critical infrastructure
- Land & real estate
Investment Promotion
Measures to attract and facilitate beneficial foreign investment
- Investment promotion agencies
- Incentive programs
- One-stop shops
- Aftercare services
Australia's Foreign Investment Framework
Australia operates a foreign investment regime that is open, transparent and welcoming. Foreign investment proposals are reviewed against the national interest on a case-by-case basis.
Key Institutions
- 1Treasury â Administers the foreign investment framework
- 2FIRB â Advises the Treasurer on investment proposals
- 3ATO â Supports compliance and enforcement
- 4DFAT â Promotes and protects Australia's investment interests internationally
Recent Reforms (2021)
- âNew national security test for sensitive investments
- âStronger compliance and enforcement options
- âStreamlined processes for low-risk investments
- âRisk-based approach for faster approvals
FDI Glossary
Foreign Direct Investment (FDI)
Cross-border investment where an investor in one economy establishes a lasting interest in and significant influence over an enterprise in another economy. The threshold is typically 10% or more of voting power.
Greenfield Investment
A form of FDI where a company builds new operational facilities from the ground up. Creates new productive capacity and employment.
Mergers & Acquisitions (M&A)
A form of FDI where a company acquires or merges with an existing foreign company. Transfers ownership without immediately adding new capacity.
FDI Stock
The total accumulated value of foreign-owned investment assets in an economy at a specific point in time.
FDI Flow
The value of FDI transactions during a specific period (usually one year). Can be inward (into a country) or outward (from a country).
Reinvested Earnings
Profits earned by foreign affiliates that are retained and reinvested in the host economy rather than repatriated to the parent company.
Investment Promotion Agency (IPA)
A government or quasi-government organization responsible for attracting and facilitating foreign investment.
Spillover Effects
Indirect benefits that flow from foreign-owned firms to domestic firms and the broader economy, such as technology transfer and knowledge diffusion.
National Interest Test
A review process to determine whether a proposed foreign investment is consistent with a country's national interest. Used in countries like Australia, Canada, and the US.
FIRB (Foreign Investment Review Board)
Australian government body that examines foreign investment proposals and advises the Treasurer on whether they are contrary to the national interest.
Explore FDI Data
Now that you understand FDI concepts, explore our comprehensive data hub with 50+ years of FDI statistics from authoritative sources.