Foreign Direct Investment

by

Michael Plouffe

• LAST REVIEWED: 28 October 2020
• LAST MODIFIED: 28 October 2020
• DOI: 10.1093/obo/9780199743292-0294

Introduction

Foreign direct investment (FDI), which is defined by the ownership and control of foreign productive assets by a multinational corporation or enterprise (MNC/MNE), is a core component of economic globalization, particularly in industries where production is commonly characterized by cross-national processes and transactions. The rapid growth in FDI following the end of World War II created new governance challenges, both for the home governments of MNCs and the hosts of their investments. For many host governments in the developing world, foreign-owned assets proved to be a lucrative target for nationalization activities, while MNCs and their home-state governments sought to protect these same investments. These efforts led to the rise of what has developed into the modern investment treaty regime, which itself provides protection for a wide range of international investments, extending well beyond FDI. Concerns over the structure and breadth of disputes have contributed to a new range of political clashes over the same sorts of sovereignty-driven issues that dogged the treatment of earlier investments.

FDI and Global Production

As Markusen 1995 and Helpman 2006 discuss, FDI is one of many options for firms to participate in foreign markets. The required conditions for FDI are often presented in the eclectic paradigm found in Dunning 2000, also known as the OLI framework as Harish and Plouffe 2018 presents it. Helpman, et al. 2004 demonstrates that the costs of engaging in FDI can be compared to those of trade in the context of firm heterogeneity: FDI, while more lucrative, is costlier, limiting entry to a relatively small portion of producers. Harish and Plouffe 2018 discusses the obsolescing bargain, the shift in control over an investment from the MNC to the host government that occurs over time; Ramamurti 2001 extends this logic to a multilevel context involving MNCs and both the home and the host countries.

• Dunning, John H. “The Eclectic Paradigm as an Envelope for Economic and Business Theories of MNE Activity.” International Business Review 9.2 (2000): 163–190.

  DOI: 10.1016/S0969-5931(99)00035-9

  This article by the originator of the eclectic paradigm discusses and relates it to other approaches to understanding MNEs.

• Harish, Nikki, and Michael Plouffe. “The Political Economy of Foreign Direct Investment to Developing Countries.” London: School of Public Policy, University College London, 2018.

  DOI: 10.31219/osf.io/chzpq

  This paper provides a broad overview of the political economy of FDI for a general audience, with a particularly approachable introduction to firm-based explanations of FDI.

• Helpman, Elhanan. “Trade, FDI, and the Organization of Firms.” Journal of Economic Literature 44.3 (2006): 589–630.

  Helpman discusses FDI as a solution to foreign-market engagement in the face of incomplete contracting, within the context of heterogeneous firms.

• Helpman, Elhanan, Marc J. Melitz, and Stephen R. Yeaple. “Export versus FDI with Heterogeneous Firms.” American Economic Review 94.1 (2004): 300–316.

  These authors compare participation in horizontal FDI to exporting, providing important early evidence of the differences in costs between these two internationalization methods.

• Markusen, James R. “The Boundaries of Multinational Enterprises and the Theory of International Trade.” Journal of Economic Perspectives 9.2 (1995): 169–189.

  Markusen provides an early overview of the division of production across facilities and countries, involving both FDI and international trade.

• Ramamurti, Ravi. “The Obsolescing ‘Bargaining Model’? MNC-Host Developing Country Relations Revisited.” Journal of International Business Studies 32.1 (2001): 23–39.

  This article describes the obsolescing bargain and extends the simple traditional framework to a modern multilevel application.