Foreign direct investment (FDI) is a direct investment in a host country by an international firm. It is the investment of foreign assets into the host country’s business or companies, but not in its stock markets. FDI is a durable and long-term investment that can stay irrespective of the prevailing economic conditions, unlike foreign investment in equity.
FDI is responsible for capital inflows into the host country. The host country gets returns from the capital investment in terms of taxes, and capital invested could act as a source of low-interest loans for the host country. This is what happens when China invests in Africa’s oil.
FDI facilitates job creation in the host country. In some cases, it is responsible for labor mobility in the host country. It reduces the rate of unemployment in the host country. However, one must understand the general impact of FDI in influencing unemployment in the host country because of the magnitude of FDI, e.g., it might not be large enough to affect the rate of unemployment significantly. Still, some factors, such as interest rates, may also affect the impact of FDI in the host country.
FDI creates better jobs in the host country in terms of technology and knowledge transfer. However, one cannot easily measure this impact of FDI on the host country, but one can compare the productivity of domestic firms against foreign firms. For instance, when US firms invest in emerging economies, they use technologies that enhance productivity per employee as opposed to local firms. Moreover, investment is capital intensive and attracts high wages.
The host country benefits from tax revenues due to increased employment and high incomes. There are also taxable profits from the revenues. However, foreign firms tend to look for favorable agreements with the host country to avoid double taxation. This explains why several countries have bilateral trade agreements — the improved balance of payment results from FDI. For instance, multinational firms are responsible for account surplus in most of the host countries because of the trade balance due to outputs from new investments or factories. This replaces imports in some cases to improve trade balance because foreign investors tend to draw large profits than initial investments in the end.