Advantages and disadvantages of FDI

Dharna Rajpal

23 Feb, 2023

After the introduction of Liberalisation, privatisation and globalisation policies (LPG), nations have started promoting and generating various attractive schemes for investments in various economic sectors in the form of Foreign Direct Investment (FDI). An investment is said to be an FDI when a person or a business entity owns equity of at least 10% in a foreign company. If one invests in less than 10% of equity, it is a part of the stock portfolio. Foreign direct investment influences decision-making and management in the organisation. In this blog, we will discuss the advantages and disadvantages of FDI.

Organisations in developing countries need funding and the expertise of experts from developed counties and expand their business and increase their sales. It helps an organisation to work globally and effectively. Such foreign investments are utilised for the development of infrastructure, electricity and other important resources which in turn promotes employment opportunities in the domestic as well as international workforce.

An investment by means of FDI can be done in several ways:

• By means of a merger or acquisition;
• Investing in equity in a joint venture internationally;
• Expansion of an already existing company in a foreign country.

What is FDI?

Before we discuss the advantages and disadvantages of FDI, lets understand the meaning of FDI. FDI stands for Foreign Direct Investment. When a person of one country invests directly into a business established in another country, it is said that such a person has made foreign direct investment in a company. Such investments are made with the intention of having a long-term interest and a substantial interest in a foreign company or to expand one’s business internationally in a country other than the domestic country.

Such investments play an important role in economic growth and development. There are some advantages and disadvantages of FDI which might affect a person’s decision to invest.

What are the Advantages and Disadvantages of FDI?

Following are the advantages and disadvantages of FDI:

Advantages of foreign direct investment

1. Economic growth
   Investments help an organisation to expand its production, manufacturing units and other related departments which requires the hiring of more employees, both skilled and unskilled. It generates employment in the country. This is the most important reason why a developing nation seeks foreign direct investment from other developed nations. This reduces unemployment and helps people to earn a source of livelihood. This boosts the gross domestic product of a nation and promotes economic growth. The people who earn have money to make expenses to buy basic necessities which leads to more production as demand increases.
2. Human capital development
   One of the major factors of production is human capital. Technological advancements have reduced the need for human capital. But there are areas where people are required to perform certain activities. A human being is said to be a capital investment when he has the prescribed knowledge and skill set required to perform an action. When people are hired, they are provided with the training and development skills required for the work. This in turn increases the human capital of a country.
3. Technology
   Developed countries have access to the latest technology, and sources of finance which removes several problems. With the help of such investments, this technology reaches other nations as well. These newly advanced techniques result in effective and efficient production. This boosts the industry at large.
4. Increase in exports
   The government of different nations have declared schemes from time-to-time to promote the export of goods from one nation to another. Most of the organisations with FDIs have goals to serve the domestic country and other nations as well so that the people around the globe have access to their goods.
5. Exchange rate stability
   It is an obligation upon every country’s central bank to maintain a certain percentage of foreign exchange^[1] reserves with them. Thus, with the help of FDI, there lies a good flow of foreign exchange in a country. This results in the stabilization of exchange rates between nations.
6. Improved Capital Flow
   In countries that have limited resources for production or which have limited opportunities due to unavailability of resources and technology, an inflow of capital is very important to support economic growth.
7. Creation of a Competitive Market
   The establishment of foreign-based companies in a domestic country creates healthy competition in the market. It helps in removing the monopolies created by domestic organisations. It increases the options to buy a certain category of product at competitive prices. It motivates domestic organisations to perform effectively and efficiently. 
8. Research and Development
   Many companies need investments for the purpose of investing such funds into the research and development department for enhancing the quality of their product. It helps in developing the existing product to serve better. It increases innovation and decreases the amount being utilised for research.

Disadvantages of FDI (Foreign Direct Investment)

1. Hindrance of domestic investment
   FDI creates a good level of competition between domestic and foreign organisations. Due to this, small domestic organisations find it hard to survive or either try to compete with foreign organisation. Most of the time, the small-scale or cottage industries fail to compete and survive due to a lack of skills, technology and quality which being provided by foreign organizations. As people have a wide range of products with varied prices, the demand for domestic goods reduces. This leads to the closure of domestic businesses.
   Thus, FDI negatively affects domestic investments and companies start to lose interest in domestic organisations
2. The risk from political changes
   With the change of political parties in power, the rules and regulations change. This creates a direct impact on foreign direct investments and affects the interest of investors.
3. Inflation and Exchange crises-
   Such investments might to the devaluation of exchange rates for a nation and overvaluation for another nation. It also creates a situation of inflation in the economy as a huge expenditure made by foreign companies on advertisement of the product they sell is added to the price of the product. Such price rise creates a situation of inflation in the market.
   Inflation reduces the demand and purchase of goods as a rational buyer would not buy products at inflated rates. This also reduces the export of goods. The reduction in export devalues the domestic currency. Such countries create a negative impact on the minds of foreign direct investors and they start to withdraw their investments from such companies. This also affects the exchange rates.
4. Economic non-viability
   Foreign direct investments are of a capital nature. It involves huge capital investment which is risky. Thus, not every investment made leads to a successful company.
5. Poor performance
   Many multinational companies have established poor working environment to save costs involved. It leads to resignation by workers and employees which in turn reduces the growth of the company.
6. Trade Deficit
   A trade deficit occurs when the value of a country’s imports is more than the value of its exports. The enactment of international trade-related policies has established policies and restrictions over the production of certain products. Only a few countries have been provided with the authority to produce. The countries which don’t have the permission to need such product to have to import the product from another country or bring it into their nation in the form of FDI causes them to pay huge costs. This affects the trade system and leads to the trade deficit.
7. Increase in Pollution
   Many of the developed nations have established their manufacturing and production units in less developed nations, which leads to higher pollution levels. The production units emit harmful gases and chemicals which pollute the environment in the country where investment has been made.

Conclusion

Every business comes with certain advantages and disadvantages of FDI. One should work on removing such disadvantages and enhance the pros by performing better. For example: in order to cure the problem of pollution, the investor can install plants for proper and safe waste disposal. This will reduce pollution and increase productivity. Foreign direct investments encourage employment opportunities and lead to the growth and development of an economy.

Also Read:
What are the pros and cons of FDI?
What are the types of Foreign Direct Investment?
A Complete Overview of Foreign Direct Investment Compliance under FEMA