Indirect Foreign Direct Investment Essay ⋆ Business Essay Examples ⋆ EssayEmpire

Indirect foreign direct investments (indirect FDI) are foreign direct investments of a multinational enterprise (MNE) that are carried by a foreign subsidiary located in a third country. The MNE obtains a lasting interest in a foreign market, being the ultimate owner of the investment made, but the actual investment operation is carried out by a subsidiary located in a country that is different from its original country.

According to the Organisation for Economic Cooperation and Development–published benchmark definition, foreign direct investment (FDI) is defined on the basis of the objective of an entity that is resident in an economy of establishing lasting interests in an enterprise that is resident in a foreign economy, implying a long-term relationship between them. FDI can be direct, made up by the entity in the target market directly, or indirect, when a third country is involved.

The Balance of Payments and International Investment Position Manual of the International Monetary Fund (the IMF Manual), in its 6th edition, states that

indirect direct investment relationships arise through owning of voting power in one direct investment enterprise that owns voting power in another enterprise or enterprises, that is, an entity is able to exercise indirect control or influence.

Three different countries are involved in an indirect FDI relationship. One is the origin country, where the parental company is located. Another is the destiny country, where the investment is made. There is a third country, in which the parental company owns an entity, and the latter is the one that actually makes the investment in the destiny country. The key difference between direct and indirect investment is that, in the first type, the operation is straight from the origin to the destiny and, in the second type, there is the intermediate country. It is noteworthy that indirect FDI may be viewed as part of two direct FDI flows: one from the origin to the intermediate, where the parental company sets up an interest in the intermediate country; and another from the intermediate county to the destiny.

For data recording, a threshold of 10 percent of ownership is generally taken as the minimum evidence of a long-lasting FDI relationship. Such threshold refers to both direct and indirect ownership. Therefore, if data on foreign direct investment were to follow the ownership criterion, there should be included both the direct and indirect interests of the parental MNE. However, balance of payments statistics usually take into account the location of the origin and destiny enterprises so that countries may not be able to trace back the actual ownership of the companies. Countries may require companies to detail their entire worldwide consolidated accounts.

The most typical motives for indirect FDI include public policies and corporate strategy. Public policies that may induce or discourage indirect FDI include the different national patterns of taxation, which may stimulate or discourage some forms of corporate property and control. In addition, countries vary in terms of their specific forms for treatment of foreign investments. There are other public policies that may affect incentives to use a direct investing company located in a country that is different than the original investing group. Embargoes on investments may also play a role in inducing indirect FDI, so that the interested investor may overcome the restriction by investing through a base country not affected by the embargo.

Corporate strategy may induce indirect FDI. One of the typical situations may include the decentralization of the investment decisions of a company with international presence, by empowering a specific subsidiary for doing the investments in a particular region or group of countries, on behalf of the parental MNE. In certain types of corporate networks, one subsidiary may gain autonomy for prospecting regional opportunities and deciding on the target markets that will be chosen in a region. In such case, the subsidiary benefits from its advantages in geographical and cultural proximity, including the costs for moving executives, more detailed market knowledge and information availability, and several other advantages. The strategy may include the formation of regional hubs for investments, which may be responsible for identifying and exploiting potential business opportunities in the vicinity countries. Other corporate strategies may also require the formation of decentralized investing companies, leading to indirect FDI.

One of the consequences of the existence of indirect foreign direct investment is that outward FDI figures for a given country may not accurately reflect the country’s actual investment, but may rather include figures for investment of affiliate enterprises, which ultimately belong to another foreign-based company. In that situation, those figures will be overestimated in relation to the actual outflows, but may also come to be underestimated as long as the nonresident affiliates of the country’s companies may also have their own investment abroad channeled through subsidiaries. In the latter case, national statistics may not be able to fully register the amount of direct investments of the resident companies that were carried out through non-resident affiliates.

Therefore, indirect foreign direct investment may bring difficulties for an assessment of the consolidated stock of direct investments of a specific country. One may face difficulties in evaluating the actual stock of a county’s foreign direct investment, when only direct FDI is accounted for.

The growing importance of global corporate networks together with the increasing sophistication of direct investment forms and vehicles are reasons behind the boost in importance of indirect FDI.

Bibliography:

Steven Brakman and Harry Garretsen, Foreign Direct Investment and the Multinational Enterprise (MIT Press, 2008);
Susan M. Collins, Foreign Direct Investment, Brookings Trade Forum, 2007 (Brookings Institution, 2008);
IMF, Draft Balance of Payments and International Investment Position Manual—March 2008, www.imf.org (cited March 2009);
OECD, Benchmark Definition of Foreign Direct Investment, 4th ed. (2008);
Carin Persson and Dumitru Slonovschi, “New Patterns of Foreign Direct Investments Indirect Internationalisations of MNCs Using Platform Countries,” Master’s Thesis, School of Economics and Commercial Law, Gothenburg University (Elanders Novum, 2003);
Torsten Wezel, “Have Structural Factors Influenced German FDI in Latin America? A Panel Econometric Analysis for the 1990s,” Revista de Economía y Estadística—Cuarta época (v.XXXIX-XLI, 2001–03).

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