What is Foreign Direct Investment: Definition, Numbers and Protection Opportunities
In today’s world, domestic capital is not sufficient for the development of countries that will ensure competitiveness in global markets. Foreign investments, that enter the host state as debt or capital, constitute important financial resources for developing economies. States, especially developing countries, need foreign investment to strengthen their economies and continue their development; thus, they need foreign investors to meet their various needs such as technological infrastructure, capital and expertise which they do not have or have limited.
The idea that investments that stay within the home state would be better for the development of this state has lost its validity. Foreign investment has become an indispensable element of the development of states in terms of labor, access to raw materials and opening to new markets.In order to carry out energy, infrastructure and natural resources investments which have high costs and requiring expertise, foreign investors are seen as indispensable in terms of financing and transfer of technology.
In the literature there are different definitions for foreign direct investment (FDI). According to one definition; foreign investment can be defined as the transfer of movable or immovable assets in whole or in part, from the country of origin to the host country for the purpose of using it to improve the welfare of the host country, under the control of the owner.This definition ignores that the main objective of the investor, whether it is operating in its own country or in a foreign country, is always to make profit rather than to increase the welfare of the country. The most significant indicator of this is FDIs in the African continent. With the exception of some countries with rich oil and natural resources, direct investments in African countries account for only 0.8% of all direct investments. As can be seen from here, it is clear that foreign investors do not act with the motive of increasing the welfare of countries, but with the aim of making a profit.
To make a more general definition that takes into account the objectives of investors, a foreign direct investment can be defined as a long-term investment made by a firm or an individual in one country, into business interests located in another country, with all risks and profit opportunities. In the context of FDI, it is possible for an investor to invest in an enterprise in another country, as well as starting a new business, complete its investment through direct acquisition or even know-how transfer only.
When the definitions of “foreign direct investment” in the literature are examined, it is seen that, most of the time, such investments are generally described as the investments from developed countries to developing economies. Although the views in the doctrine are in this direction, this view began to lose its validity with the changing conditions. In today's economic order, it is seen that FDIs to developed countries are as much as FDIs to developing countries. For example, in 2015, FDIs to developed countries accounted for 55% of all direct investments. Although there was a downward trend since 2015, reaching their lowest point since 2004, declining by 27 per cent, in 2018 FDIs to developed countries still accounted for 43% of all direct investments.
The Organisation for Economic Co-operation and Development (OECD) defines FDI as, a category of cross-border investment made by a resident in one economy (the direct investor) with the objective of establishing a lasting interest in an enterprise (the direct investment enterprise) that is resident in an economy other than that of the direct investor.
Difference Between Foreign Direct Investment and Portfolio Investment (Indirect Investment)
All these definitions above also identify differences between FDI and portfolio investment. Foreign direct investments are long-term, generally costly transfers from a source country to the host state, which are mostly preferred by multinational companies. Indirect foreign investments (portfolio investments) on the other hand, are savings made by the holders in the form of purchasing securities on international capital markets in order to obtain an interest or dividend income. These investments may take the form of the purchase of stocks or government bonds or corporate bonds traded on the country's stock exchange or elsewhere.
There are 4 difference between FDI and a portfolio investment:
1- In portfolio investments, unlike direct investments, the investor has no influence on the control and management of the investee. On the other hand, FDI involves more than just buying a share or a security, foreing investor has control over the equity. The motivation of the direct investor is a strategic long-term relationship with the direct investment enterprise to ensure a significant degree of influence by the direct investor in the management of the direct investment enterprise. IMF defines the foreign investment as FDI when the investor holds 10 percent or more of the equity of an enterprise.
2- Another difference that distinguishes direct investments from indirect investments is the risk factor. The inflow of portfolio investments into the country can be rapid as well as the outflows in a negative situation. Especially nowadays, the processing times can be reduced to seconds, given that the processes can be performed easily in electronic environment. Therefore, portfolio investments are considered more risk-free. In the case of direct investments, it is accepted that the investor takes a greater risk, since both the entry costs and the exit costs will be high.
3- The third difference arises in the contribution of investments to the development of states. While direct investments can permanently contribute to the development of the economies of developing countries, indirect investments do not make a permanent contribution to the economy since they are easy to enter and exit and are usually short-term investments.
4- The last difference emerges in the investor profile. While direct investments are mainly made by multinational companies in line with detailed strategic investment plans, this is not the case for indirect investments. Since there is no high entry and exit costs or detailed planning is required, the investor who sees the profit potential can turn to indirect investment instruments and withdraw his investment at any time.
Definition of Foreign Direct Investments in Investment Treaties
In the field of international agreements law, there is no uniform definition of the concept of “foreign investment”. There is no comprehensive document regulating all aspects of foreign investment, including all or the majority of the relations between home and host states. Even the Convention for the Settlement of Investment Disputes between States and Nationalities (ICSID) and the Multilateral Investment Guarantee Institution Agreement (MIGA) do not include an investment definition.
Governments define investment through bilateral investment agreements signed among themselves and thus determine the definition and scope of the investment. The purpose of not to include the definition of investment in these contracts is not to limit the scope of foreign investment by making a restrictive definition and to ensure that special arrangements can be made according to the relations between countries or according to the nature of the contract, leaving this definition to bilateral investment agreements or other multilateral investment agreements to be signed between countries. In this context, both multilateral investment agreements on regional or specific economic issues, as well as bilateral investment agreements for mutual incentives and protection of investments, have an investment definition within their structure that may vary depending on the scope, subject matter of the agreement and the relations between the parties to the agreement.
Foreign Direct Investment Figures
Foreign direct investments and foreign investors are increasing their importance and share in the international arena. In 2015, international direct investments increased by 38% to $ 1.7 trillion, the highest figure since the 2009 crisis. However, since 2015 FDIs have a downward trend, the decline had third consecutive year fall in FDI.
Global FDI flows also continued their slide in 2018, falling by 13 per cent to $1.3 trillion from a revised $1.5 trillion in 2017. In the first half of 2019, global FDI flows also decreased by 20% compared to the last half of 2018, to USD 572 billion. FDI flows dropped by 5% to USD 361 billion in Q1 2019 and by 42% to USD 210 billion in Q2 2019. Despite this decline, direct investments are still one of the most important actors in the global economy.
Protection of Foreign Direct Investments
As mentioned above, profit making is the main purpose of foreign investors; but profit potential is not sufficient for foreign investors to invest in one country. Investors wish to secure themselves and their investments by making this investment in the countries whose investment climate is safer. Foreign investors will want to safeguard themselves and their investments in the country they will invest in, to protect and isolate themselves as much as possible from political and economic risks. These risks may arise in various ways, such as political or economic instability in the host country, nationalization, expropriation, hidden expropriation, nationalization, violation of property rights, the application of high taxes, confiscation, amending foreign investment legislation, and expulsion of foreign investors.
Apart from the country's investment climate, political and economic stability, country's legal arrangements related to foreign investment, relations between the investors and the state in past investments or problems that have arisen and the applications adopted by the state in resolving disputes may play an important role in the decision of foreign investors to invest in a country.
When investing in a foreign country, the investor should rely on fair and effective remedies in respect of his investment with the host country, in the event of a confiscation of his property or expropriation or in the event of a transfer of profit. Otherwise, even if it is a very favorable investment climate, the investor will not want to invest in a country he cannot claim his rights when he is injustice.
In this context, countries that wish to attract foreign investors to make investments to their country, tend to sign bilateral and multilateral investment agreements to secure foreign investments and investors in order ensure that they seek their rights in international arena. In these investment agreements, the most important right in procedural sense granted to the investor to seek his right is investment arbitration.
Investment arbitration is a procedure to resolve disputes between foreign investors and host States (also called Investor-State Dispute Settlement). The possibility for a foreign investor to sue a host State is a guarantee for the foreign investor that, in case of a dispute, he will have access to independent and qualified arbitrators who will solve the dispute and render an enforceable award. This allows the foreign investor to bypass national jurisdictions that might be perceived to be biased or to lack independence, and to resolve the dispute in accordance to different protections afforded under international treaties.
Salacuse, J. W. The Law of Investment Treaties. Oxford: 2015, p. 47. FDIs can also contribute to training of the workforce and improvement of the management. Foreign investors can offer necessary information on foreign markets, knowledge about how to reach and use these markets. Additionally, foreign investors can facilitate privatization process. SeeVig, Z. (2019). Taking In International Law .Budapest, p. 11. Sornarajah, M. (2010). The International Law on Foreign Investment. Cambridge: Cambridge University Press, p .4. UNCTAD (visited on Jan. 04, 2020) World Investment Report 2019. https://unctad.org/en/PublicationsLibrary/wir2019_en.pdf, p. 2. OECD (visited on Jan. 04, 2020) Benchmark Definition of Foreign Direct Investment. https://www.oecd.org/daf/inv/investmentstatisticsandanalysis/40193734.pdf. UNCTAD (visited on Jan. 04, 2020) World Investment Report 2016.https://unctad.org/en/PublicationsLibrary/wir2016_en.pdf, p. 2. UNCTAD, 2019, p. 2.