Foreign direct investment: types, theories, benefits and costs
FDI is investment that gives a foreign investor lasting interest and significant influence in an enterprise abroad. It brings capital and technology, but also profit outflows and dependence.
Types of FDI
| Basis | Type | Meaning | Example |
|---|---|---|---|
| Activity | Horizontal | Same business abroad as at home | Suzuki making cars in India through Maruti Suzuki |
| Activity | Vertical (backward) | Investing abroad to secure inputs | A refiner buying an oilfield abroad |
| Activity | Vertical (forward) | Investing abroad to get closer to buyers | A carmaker setting up its own dealerships abroad |
| Activity | Conglomerate | Unrelated business abroad | A textile firm buying a hotel chain abroad |
| Entry mode | Greenfield | New facility built from scratch | Hyundai's car plant near Chennai |
| Entry mode | Brownfield (M&A) | Buying or leasing an existing firm or facility | Walmart's acquisition of Flipkart (2018) |
| Direction | Inward / outward | Into India / from India abroad | Tata Motors buying Jaguar Land Rover (2008) was outward FDI |
Theories of FDI
| Theory | Author | Core idea |
|---|---|---|
| Monopolistic (firm-specific) advantage | Stephen Hymer, 1960 | Advantages such as brand or technology offset the extra costs of operating abroad |
| Product life cycle | Raymond Vernon, 1966 | Production moves abroad as the product matures and standardises |
| Oligopolistic reaction | F.T. Knickerbocker, 1973 | Rivals follow the leader into foreign markets |
| Internalisation | Buckley and Casson, 1976 | Firms keep activities in-house when markets for know-how are imperfect |
| Eclectic (OLI) paradigm | John Dunning, 1977 | FDI happens when Ownership, Location and Internalisation advantages are all present |
Benefits and costs
| Side | Benefits | Costs |
|---|---|---|
| Host country | Capital, technology, jobs, skills, exports, more competition | Profit repatriation, transfer pricing, crowding out of local firms, loss of control over key sectors, later BoP outflows |
| Home country | Income from abroad, access to markets and resources, exports of inputs | Loss of jobs and output at home, capital outflow |
FDI vs FPI
FDI in India (in words)
- FDI policy is framed by DPIIT (Ministry of Commerce and Industry) and administered under rules made under FEMA 1999.
- Automatic route: no prior government approval; the Indian company that receives the money reports it to RBI afterwards.
- Government route: prior approval from the ministry concerned. The FIPB was abolished in 2017.
- Sector caps exist and are revised; check the current policy rather than memorising old limits.
- A few sectors are closed to FDI, such as lottery, gambling and betting, and atomic energy.
NET asks you to classify an FDI example (horizontal, vertical, conglomerate, greenfield, brownfield), to separate FDI from FPI, and to expand Dunning's OLI.
Typical MCQ: “Walmart buying a majority stake in Flipkart is which entry mode?” Brownfield FDI by acquisition. Trap: greenfield means building a new facility from scratch.
Typical MCQ: “What do the letters in Dunning's OLI stand for?” Ownership, Location and Internalisation advantages. Trap: 'I' is not 'Investment'.
Dunning asks three questions: why go abroad? (Ownership), where? (Location), how? (Internalise rather than license).