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Foreign direct investment, explained

What FDI is, how it is measured, why governments compete for it, and the policies that shape it — a primer for students, analysts and policymakers.
Glossary of FDI termsSources & methods

The basics

What is foreign direct investment?

Foreign direct investment (FDI) happens when an investor in one country takes a lasting stake in, and meaningful influence over, a business in another. A carmaker building a plant abroad, a pension fund buying a controlling share of a foreign airport, a tech company acquiring a start-up overseas — all are FDI. Buying a few shares in a foreign company through a stock exchange is not: that is portfolio investment.

The international standard: an investor resident in one economy owning at least 10% of the voting power of an enterprise resident in another.

The 10% line — set out in the IMF's Balance of Payments Manual (BPM6) and the OECD's Benchmark Definition of FDI (BMD4) — is a convention, not a law of nature. It exists so that every country measures the same thing. Above it, the investor is presumed to have a lasting interest and a say in management.

Four features distinguish FDI from other capital flows:

  • Long-term commitment — FDI represents a lasting relationship, not a short-term trade.
  • Influence over management — the investor helps run, or at least shape, the enterprise.
  • A bundle, not just money — FDI often brings technology, management practices and access to global markets along with capital.
  • Two-way — most economies both receive FDI (inward) and invest abroad (outward).

Measurement

Flows, positions and income

FDI flows

Transactions during a period, usually a year: new equity, reinvested earnings and net lending between related companies. Published net of disinvestment — so they can be negative.

FDI positions (stocks)

The value of accumulated direct investment at a point in time. Positions move with flows but also with prices and exchange rates. Breakdowns by partner and industry are usually published for positions.

FDI income

The return on direct investment: dividends, reinvested earnings and interest on intra-company loans. It appears in the current account and is often a large outflow for host economies.

Three components

  • Equity capital — buying shares in, or injecting capital into, a foreign affiliate.
  • Reinvested earnings — profits the affiliate keeps rather than paying out, treated as if paid to the parent and reinvested.
  • Debt instruments — loans between parents, affiliates and fellow group companies (intra-company debt).

Handle with care

A large share of recorded FDI passes through special purpose entities in financial centres, and standard bilateral data attribute investment to the immediate rather than the ultimate investor. Our sources & methods page explains what this means for the numbers.

Types

Types of foreign direct investment

By entry mode

Greenfield investment

Building new facilities from scratch — factories, offices, data centres. Adds directly to productive capacity. Example: a Japanese automaker building a plant in Thailand.

Mergers & acquisitions (M&A)

Buying or merging with an existing company. Transfers ownership rather than adding capacity immediately, though it can bring restructuring and new technology. Example: a US technology company acquiring an Australian software firm.

Joint ventures

Partnering with a local firm in a new or existing enterprise, combining foreign capital and know-how with local market knowledge. Example: a German engineering firm and an Indian partner.

By motive

Market-seeking

Serving customers in the host country or region.

Resource-seeking

Accessing minerals, energy, land or, sometimes, labour.

Efficiency-seeking

Cutting costs by spreading production across countries within a value chain.

Strategic asset-seeking

Acquiring technology, brands, networks or R&D capabilities.

Horizontal FDI

The same activity replicated abroad to serve the local market. Example: a carmaker producing the same models at home and in the United States.

Vertical FDI

Different stages of production in different countries. Example: design at home, components in one country, assembly in another.

Export-platform FDI

Producing in one country to serve third markets. Example: a plant in one member of a free-trade area supplying the whole region.

Why do firms invest abroad at all? Dunning's eclectic (OLI) paradigm is the classic answer.

Economics

Why countries seek FDI

Research by the OECD, the World Bank, UNCTAD and national bodies such as Australia's Productivity Commission points to several ways FDI can benefit host economies — when the policy framework and local conditions are right.

Capital and growth

Foreign capital lets investment exceed what domestic savings alone could finance, expanding productive capacity.

Jobs

Greenfield projects create jobs directly; acquisitions can secure jobs in firms that need capital or restructuring.

Productivity and wages

Foreign-owned firms are typically more productive and pay more than comparable domestic firms, although part of that gap reflects which firms foreign investors choose to buy.

Technology and R&D

Multinationals account for a large share of global business R&D and can bring new technologies and processes.

Market access

Affiliates and their suppliers gain access to global value chains and the parent's distribution networks.

Competition

New entrants push incumbents to improve, benefiting consumers.

The caveats

Benefits are not automatic. Profits are repatriated as FDI income; acquisitions may add little new capacity; incentives can cost more than they return; and some investments raise legitimate security or competition concerns. Macro studies generally find positive associations between FDI and growth, but firm-level evidence is more mixed and depends heavily on host-country conditions.

Economics

Spillovers and technology transfer

Beyond its direct effects, FDI can generate spillovers — benefits to local firms and workers that the investor does not capture. They are a central reason governments court foreign investment.

Horizontal spillovers (within the same industry)
  • Demonstration effects — local firms observe and adopt foreign firms' technologies and management practices.
  • Labour mobility — workers trained by foreign firms move to domestic companies, taking skills with them.
  • Competition — pressure from foreign entrants pushes local firms to improve (or, sometimes, crowds them out).
  • Imitation — reverse-engineering products or processes after seeing them succeed.
Vertical spillovers (through supply chains)
  • Backward linkages — foreign affiliates buy from local suppliers and help them meet quality, delivery and technical standards (more).
  • Forward linkages — local firms gain access to better inputs, equipment and services supplied by foreign affiliates.
  • Supplier development — multinationals and agencies run programs to upgrade local suppliers.
  • Export facilitation — supplying a multinational can open doors to its global network.
Absorptive capacity: why spillovers vary

How much a host economy gains depends on its absorptive capacity — the ability to identify, assimilate and apply new knowledge. Key factors:

  • Technology gap — moderate gaps allow learning; very large gaps can prevent it.
  • Human capital — skilled workforces adopt new technologies faster.
  • Local R&D — firms that do their own research absorb external knowledge better.
  • Institutions — property rights, contract enforcement and the rule of law.
  • Finance — access to credit lets firms invest in upgrading.

Research note: the theoretical case for spillovers is strong, but empirical evidence is mixed. Studies tend to find clearer evidence of vertical spillovers to suppliers than of horizontal spillovers to competitors.

Policy

Investment policy frameworks

Governments balance openness to foreign capital with safeguards for national interests. Most frameworks combine three kinds of tool.

Screening

Review of proposals against national security or national-interest tests, often with sector-specific thresholds. More

Sector restrictions

Limits or bans on foreign ownership in sensitive sectors — defence, media, telecoms, critical infrastructure, land. Measured by the OECD's FDI Restrictiveness Index.

Promotion and facilitation

Investment promotion agencies, one-stop shops, incentives and aftercare to attract and keep investors.

International rules matter too: bilateral investment treaties, investor–state dispute settlement, and the global minimum tax, which reduces the value of low-tax incentives.

Case study

Australia's foreign investment framework

Australia welcomes foreign investment while reviewing sensitive proposals case by case. Under the Foreign Acquisitions and Takeovers Act 1975, the Treasurer can block or impose conditions on proposals found to be contrary to the national interest.

Key institutions

  • Treasury — administers the framework and makes decisions under delegation.
  • FIRB — advises the Treasurer on proposals and the operation of the framework.
  • Australian Taxation Office — administers residential real estate and certain land applications, and supports compliance.
  • Austrade and DFAT — promote Australia as a destination and represent its investment interests internationally.

Reforms since 2021

  • A national security test for sensitive investments, alongside the national interest test.
  • Stronger compliance and enforcement powers, including higher penalties.
  • A Register of Foreign Ownership of Australian Assets, commenced in 2023.
  • A stated aim of faster processing for low-risk proposals and closer scrutiny of higher-risk ones.
Australia's FDI profileAustralia data hub

Keep going

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