A primer on Foreign Direct Investment

I’m Marten, one of the developers at Datawrapper. As a total noob in macroeconomics, I took the opportunity of this Weekly Chart to learn more about Foreign Direct Investment, as well as its advantages and disadvantages for the companies and countries involved.

About a year ago, Russia invaded Ukraine. In the UN’s vote to condemn Russia’s invasion of Ukraine, 17 African countries abstained from the vote. Back then people started voicing concerns about Russia’s growing influence internationally and especially in Africa.

This made me wonder about the scale of Russia’s investments internationally and I stumbled upon a concept that I knew little about — Foreign Direct Investment (FDI).

What is Foreign Direct Investment?

FDI is investments of companies made in projects or companies in a foreign country. FDI is not just about buying the stock of a target company. An investment is only called FDI if the investment is big enough to establish effective control of the foreign business or at least substantial influence over its decision-making. A direct investment often leads to long-lasting economic ties between two economies.

Examples of FDI are a company opening a factory or subsidiary or acquiring a controlling interest (at least 10%) in an existing company in the host country. Let’s take a look at FDI flows on a global level.

In 2021, FDI flows accounted for almost $1.6 trillion in cash flows around the world. In the scatterplot above you can see that in terms of absolute numbers, the U.S. is by far the biggest receiver of FDI followed by China. The U.S. is also the biggest source of FDI followed by countries such as Germany, Japan, Ireland, and China.

FDI flows can be negative as well. FDI financial transactions are negative whenever money flows from the affiliate back to the parent. This can happen for a number of reasons, for example, if the investor sells its interest in the affiliate company either to a third party or back to the affiliate company.

Interestingly, the Netherlands shows huge negative inbound and outbound FDI flows for 2021. Traditionally, a popular country for outside investors due to favorable tax laws the negative FDI flows apparently have to do with large equity divestments following the economic crisis triggered by the Covid-19 pandemic.

While absolute numbers give an idea about the scale of foreign investments of a country, FDI is often measured as a percentage of a country’s GDP (Gross Domestic Product) as well. Showing FDI in relation to GDP can give an idea about a country’s attractiveness to outside investors.

The Cayman Islands prove to be a clear winner. With no corporate tax, many multinational corporations set up subsidiaries in the Caymans to shield some or all of their income from taxation.

Obviously, with such stark outliers, this chart isn’t too enlightening. So let’s look at it again but this time excluding some of the more extreme data points.

Places like Ireland, Hong Kong, Estonia, Singapore, and Hungary come out on top. Location, good infrastructure, and tax incentives make these places attractive for outside investments. Hungary for example has a corporate tax of 9% – one of the lowest corporate tax rates in Europe.

In Africa, the countries of Mozambique and the Republic of the Congo have received the most direct investment relative to their GDP which can be attributed to their vast natural resources of oil and gas.

Pros and cons

FDI often leads to economic growth in both the recipient country and the country making the investment. In developing countries, advantages include the creation of jobs and financing of infrastructure as well as training and technology transfers. Companies from developed countries often use FDI as a means to break into new markets or to benefit from cheaper labor as well as tax incentives.

On the other hand, direct investments in a foreign country bear substantial risks also. It is capital intensive and the economic viability is dependent on a variety of factors such as the political stability of the host country, exchange rates, and cost of machinery and intellectual property which may exceed the local wages.

Moreover, FDI is sometimes criticized as modern-day economic colonialism with multinationals exploiting a country’s natural resources and exposing the local workers to poor working conditions. With high levels of corruption in some countries, often only a handful of the country’s elite benefit from outside investments. For example, the Democratic Republic of Congo (DRC) has some of the highest resources of cobalt – an essential ingredient in the production of lithium-ion batteries. It has the potential to achieve prosperity for its people, yet 75% of the country’s population lives on less than two dollars a day.

Russia’s investments in Africa

This brings me back to Russia and its involvement in Africa. Measured in FDI, Russia’s investments in Africa are far from significant accounting for less than 1% of the continent's inbound FDI.

Rather than bilateral cooperation, Russia’s focus on expanding its influence on the continent can be more attributed to disinformation campaigns, arms for resource deals, deployment of mercenaries, and trafficking of precious metals. Beneficiaries of these deals are politically isolated leaders rather than the country’s general population.

Bottom line

So while FDI is a key factor when it comes to globalization, it’s obviously not the only way to gain influence in a foreign country. Moreover, though FDI is generally said to lead to economic growth for developing countries as well, factors like political stability and the level of corruption ultimately decide if this growth actually trickles down to a country’s ordinary citizens or if it just wanders into the pockets of an elite few.

And that’s it. I definitely enjoyed dipping my toes into the world of macroeconomics and I hope you did too. If you spot any mistakes or have any other comments I’d appreciate it if you dropped me a line at marten@datawrapper.de or on Twitter. Otherwise, we’ll see you next week when our designer Gustav takes the reins.