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The World Bank defines foreign direct investment (FDI) as the net inflows of investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor. In a broader sense, FDI consists of the acquisition or creation of assets undertaken by foreigners on a long-term basis.
An outflow of FDI from a country in a way means its "exporting money" to "buy" or "build" foreign productive capacity, the ownership of these assets will remain in the first country's hands. A country attracting an inflow of FDI strengthens the connection to world trade networks and finances its development path. It should be noted that a unilateral massive FDI to a country can make it dependent on the external pressures that foreign owners might exert on it.
As an example, the "classic" FDI is a manufacturing plant setup using foreign technology and management techniques to exploit low-cost local resources, with sales made to the present clients of the investor (thus, usually involving exports). However, market-oriented FDI as well as FDI in other sectors (e.g. tourism resorts, banks, transport) can also happen.
FDI has three components:
1. Equity capital
2. Reinvested earnings, the investor's share of earnings not distributed as dividends by affiliates
3. Intra-company loans, when the investor lends funds to the affiliate, usually without the intention of asking for the money back
Determinants for FDI
The factors that contribute to a firm deciding to make foreign investments can be:
1. Upstream Integration
2. Horizontal Integration
3. Downstream Integration
During the relatively stable UK-dominated world system of 19th century, globalization boosted FDI from the core to the semi-periphery and to colonies. The subsequent conflict between "core countries" exploded in two global wars, with international trade collapse, protectionism, nationalization of foreign affiliates and FDI crises.
The US-dominated world system of the second half of 20th century showed a strong trend of increasing FDI.
However, this overall general tendency is structurally unstable: nervous short-run "flames" of FDI reach a short list of "target" countries, with abrupt crashes (as with the East Asia boom and crise in the last decade of the century).
Debt crises are a dramatic end of FDI "flames" (as in Argentina, Russia, Brazil during the same period), in interaction with external aid, currency crises, bank crashes and political turm-oil.
Behaviour during the business cycle
Being pro-cyclical and lagged, inflows of FDI usually arrive late after robust signs of recovery and growth. The international press helps to tune the sentiment of international investors, providing a kind of "early signal" of FDI inflows in case of "good coverage".
Outflows of FDI can arise especially in two subsequent periods:
a) at the end of the business cycle when very liquid firms try to extend their assets abroad;
b) during recession, when the interest rate is low but no investment opportunity are evident in the domestic economy.