Research Note on Foreign Direct Investment (FDI)

1. Introduction to Foreign Direct Investment (FDI)

Foreign Direct Investment (FDI) refers to the investment made by a foreign

entity (individual, company, or government) in a business or tangible assets
(e.g., real estate, factories) in a country other than their own. FDI usually
involves a long-term interest and provides the foreign investor with a
significant degree of control or influence over the company or operation in
which they invest.

FDI is a crucial driver for economic growth, bringing in capital, technology,

managerial expertise, and access to international markets. Countries with
higher levels of FDI tend to have more robust economic development, job
creation, and productivity growth.

Foreign Direct Investment (FDI)** refers to an investment made by a firm or

individual in one country into business interests located in another country. It
involves either establishing business operations, such as a subsidiary or
branch, or acquiring assets like shares in a foreign company. Essentially, it is
an investment that directly controls or has a significant influence on the
company in which the investment is made.

Unlike **foreign portfolio investment (FPI)**, where investors only purchase

stocks or bonds without taking a controlling interest, FDI usually involves a
long-term interest and a degree of control or influence in the foreign
business.

2. Importance of FDI
1. Economic Growth: FDI contributes to the GDP of the host country by
infusing capital and boosting production capabilities.

- FDI can boost the host country's economic development by introducing

new capital, technology, and management practices.

- It can also create new jobs and infrastructure development, which are
vital for growth in developing economies.

[Link] Transfer: FDI often brings advanced technology, innovative

processes, and management practices to the host country.

FDI helps transfer advanced technology and knowledge from the investor
country to the host country, which can improve productivity and
competitiveness.

3. Employment Creation: FDI can create direct jobs through new companies
and factories, as well as indirect jobs in supporting sectors.

[Link] Productivity: Access to foreign capital and expertise improves

productivity in both the foreign investment firm and the broader economy.

[Link] Integration. FDI enhances the internationalization of local

businesses and integrates the host economy into global supply chains.

(Optional)

6*Enhancement of Trade**:

- FDI often leads to increased exports and imports between the host and
home countries, contributing to the global trade flow.

7 **Improvement in Balance of Payments**:

- The inflow of capital via FDI helps improve the host country's balance of
payments, as it represents long-term financial inflows.
8.**Market Access**:

- For the home country, FDI allows companies to access new markets and
diversify their investment portfolios.

9. **Boosting Domestic Competition**:

- FDI can increase competition in the domestic market of the host country,
encouraging local firms to improve their efficiency

10. **Cultural Exchange and Global Networks**:

- With increased foreign presence, there is an exchange of cultural

practices and the creation of global networks, which can benefit businesses
and consumers.

3. Types of Foreign Direct Investment

FDI can be classified based on the motivation of the investor and the form of
the investment. These include:

A. Horizontal FDI- company replicates its existing business operations in a

foreign country.

In horizontal FDI, the foreign investor establishes or acquires a subsidiary

that operates in the same industry as its parent company, but in a different
market or country. This type of investment is typically motivated by market
expansion. For example, a European car manufacturer opening a
manufacturing plant in the U.S.
b. Vertical FDI-A company invests in a foreign country to obtain inputs or
distribute its products.

In vertical FDI, the foreign investor either invests in a business that is part of
the supply chain (backward vertical) or in a business that serves as a
distributor for the investor’s products (forward vertical). This type of
investment is motivated by efficiency or control over production processes.

c. Conglomerate FDI-A company invests in a foreign country in an unrelated

industry.

Conglomerate FDI involves an investment in an entirely different industry

from the parent company’s current business activities. This is a way to
diversify risk. For instance, a company focused on energy might invest in a
food processing business in a foreign market.

4. Forms of Foreign Direct Investment**

FDI can take various forms, based on how the investment is structured and
the level of involvement by the foreign investor. Two main forms of FDI are
Greenfield Investments and Brownfield Investments.

a. Greenfield Investment

Greenfield investment occurs when a foreign investor establishes a new

business operation in a host country from the ground up. This could involve
building new facilities, hiring staff, and establishing operations in a new
market. It is often associated with **high initial costs** but can offer
significant control and flexibility over operations.

- Characteristics of Greenfield Investment:

- New Projects: The investor creates new production capacity.

 - Long-term Commitment: It often requires long-term planning and
commitment to local economic integration.

- Job Creation: Creates new jobs for the local workforce.

- Control: The investor has full control over the operations.

- Advantages:

- Total control over the business.

- Ability to implement the company’s own corporate culture and operations.

- Can foster local innovation and capacity building.

- Disadvantages:

- High setup costs.

- Time-consuming to establish operations.

- Riskier due to the unknown business environment in the new country.

b. Brownfield Investment

Brownfield investment occurs when a foreign investor acquires or leases

existing facilities and infrastructure in the host country. This type of
investment is typically used to expand an already existing operation or enter
an established market. In contrast to greenfield investments, brownfield
investments usually require lower initial cost and quicker returns.

- Characteristics of Brownfield Investment:

- Acquiring Existing Assets: The foreign investor takes over or partners with
an existing business.

- Efficient Utilization of Resources: Utilizes existing resources and

infrastructure.
 - Faster Setup: Investments can be integrated into the host economy more
quickly.

Advantages

- Lower investment costs.

- Faster time-to-market since the facilities are already operational.

- Reduced risks related to land acquisition and infrastructure development.

Disadvantage

- Limited control over existing operations or assets.

Potential issues with the integration of the acquired assets.

Possible negative public perception or regulatory hurdles due to prior

ownership.

5. Factors Influencing FDI Decisions

Several factors influence a foreign investor’s decision to invest in a particular

country:

Market Size and Growth Potential: Large and growing markets attract FDI as
they promise higher returns.

Economic Stability and Policies: Countries with stable economic policies, low
inflation, and favorable taxation are more likely to attract FDI.

Regulatory Environment: Favorable regulatory conditions such as ease of

doing business, investor protection laws, and property rights enforcement
are crucial.

Labor Availability and Costs: Availability of skilled labor at competitive wages

is an attractive factor.

Infrastructure: A country with strong infrastructure (transport,

communication, and energy) can be a strong attractor of FDI.
 6. Challenges of FDI

Political and Economic Risk: Investors may face risks due to unstable political
environments, changes in trade policies, or currency fluctuations.

Cultural and Market Barriers: Cultural differences, language barriers, and

consumer behavior variations can pose challenges.

Legal and Regulatory Risks: Differences in laws related to business

operations, intellectual property, and corporate governance can complicate
FDI.

7. Conclusion

Foreign Direct Investment is a vital mechanism for economic growth,

technological progress, and international business integration. Both
greenfield and brownfield investments offer different advantages and
challenges depending on the investor’s strategy, risk appetite, and the
specific dynamics of the host country. Understanding the motivations behind
FDI, as well as the forms it takes, Is essential for businesses and
policymakers alike in ensuring that investments contribute to sustainable
growth and development.

### 1. **What is the current state of FDI in the Philippines?*

**Answer**:

The Philippines has seen fluctuating levels of Foreign Direct Investment (FDI)
over the years. Despite challenges such as infrastructure gaps, regulatory
issues, and political instability, the country remains an attractive destination
for FDI due to its strategic location, large consumer market, and skilled
workforce. Major sectors that receive significant FDI include manufacturing,
real estate, information technology (IT), business process outsourcing (BPO),
and renewable energy. Over recent years, FDI inflows have been rising, but
they still trail behind some of its neighbors in Southeast Asia, such as
Vietnam and Indonesia
### 2. **What are the main sectors attracting FDI in the Philippines?**

**Answer**:

FDI in the Philippines is concentrated in several key sectors:

- **Manufacturing**: The country has a growing manufacturing base,

especially in electronics, automotive, and food processing.

- **Business Process Outsourcing (BPO)**: The Philippines is a global leader

in BPO services, attracting foreign investors in call centers, IT services, and
customer support.

- **Real Estate and Infrastructure**: Urbanization and demand for housing

and office spaces have made real estate a major sector for FDI.

- **Renewable Energy**: With growing interest in clean energy, foreign

investments have been directed toward wind, solar, and geothermal
projects.

- **Retail and Consumer Goods**: Due to the Philippines' growing middle

class, retail and consumer sectors have also seen significant foreign
investments.

### 3. **What are the challenges for FDI in the Philippines?**

**Answer**:

Some of the challenges to FDI in the Philippines include:

- **Regulatory and Bureaucratic Hurdles**: While the government has been

making efforts to streamline regulations, investors still face delays and
inefficiencies in business registration, licensing, and permits.

- **Infrastructure Issues**: The country still faces infrastructure gaps,

especially in transportation and logistics, which can increase business costs.

- **Political Instability**: Shifts in political leadership and policies can create

uncertainty for foreign investors.

- **Protectionist Policies**: The Philippines has a relatively high level of

foreign ownership restrictions in certain sectors (e.g., utilities, retail, and
media).

- **Labor Issues**: Despite a skilled workforce, there can be labor-related

concerns such as the cost of skilled labor, union activities, and strikes.

### 4. **What government policies are in place to attract FDI to the

Philippines?**

**Answer**:

The Philippine government has introduced several policies to attract FDI:

- **The Foreign Investments Act**: This law allows foreign investors to invest
in the Philippines, with certain restrictions in specific industries (e.g., natural
resources, media, and retail). However, the law also provides incentives for
investments in strategic industries like manufacturing and infrastructure.

- **The CREATE Law (Corporate Recovery and Tax Incentives for Enterprises
Act)**: This law, enacted in 2020, aims to provide more competitive tax rates
for corporations and introduce a more transparent and efficient system of
incentives.

- **Philippine Economic Zone Authority (PEZA)**: PEZA offers tax holidays,

exemptions from certain taxes, and other benefits for businesses operating
within special economic zones.

- **Build, Build, Build Program**: The government's infrastructure

development program aimed at improving the country's roads, airports, and
transportation systems to make the Philippines more attractive to foreign
investors.

- **Investment Promotion Agencies (IPAs)**: These include the Board of

Investments (BOI) and other regional agencies that provide incentives for
investments in priority sectors.

### 5. **How does the Philippine government support foreign investors?**

**Answer**:

The Philippine government supports foreign investors in various ways:

- **Incentives**: Foreign investors may benefit from tax holidays,
exemptions from import duties, and other incentives, particularly in
industries like manufacturing, IT, and renewable energy.

- **Investment Promotion**: The government promotes the Philippines as a

destination for FDI through trade missions, international conferences, and by
participating in international investment forums.

- **Legal Support**: There are legal frameworks in place to protect foreign

investments, including protection from expropriation and the guarantee of
fair treatment under Philippine law.

- **Streamlined Business Registration**: The government has introduced

initiatives such as the ease of doing business law to simplify the process for
registering businesses and obtaining permits.

- **One-Stop Shop**: Agencies like PEZA and BOI offer "one-stop-shop"

services to make the process of investment approval and incentive
applications more efficient.

### 6. **What are the benefits of FDI for the Philippine economy?**

**Answer**:

FDI brings several benefits to the Philippine economy:

- **Job Creation**: FDI leads to the creation of new jobs in sectors like
manufacturing, services, and construction, helping to reduce unemployment.
- **Technology Transfer**: Foreign investments introduce new technologies,
processes, and management techniques, which help improve productivity in
local industries.

- **Infrastructure Development**: FDI often leads to the development of

infrastructure projects, such as roads, ports, and energy facilities, which
benefit the wider economy.

- **Export Growth**: Many foreign investors use the Philippines as a base for
export-oriented production, which helps improve the country's export
performance.

- **Increased Government Revenue**: The taxes paid by foreign companies

contribute to government revenue, which can be reinvested in public
services and infrastructure.

### 7. **Can foreign investors own 100% of a business in the Philippines?**

**Answer**:

Foreign investors can own 100% of a business in the Philippines in certain

sectors. However, there are restrictions in some industries. For instance:

- **Retail Trade**: Foreign ownership in retail trade businesses is limited to

40% unless the business has a paid-up capital of at least $2.5 million.

- **Utilities**: Foreign ownership is restricted in public utilities (electricity,

water, and telecommunications) to a maximum of 40%.
- **Land Ownership**: Foreign investors are not allowed to own land in the
Philippines, but they can lease land for up to 50 years, renewable for another
25 years.

In most sectors, however, foreign investors can own 100% of the business,
particularly in industries like manufacturing, technology, and services.

### 8. **What is the role of the Philippine Economic Zone Authority (PEZA)
in attracting FDI?**

**Answer**:

The **Philippine Economic Zone Authority (PEZA)** plays a critical role in

attracting FDI by offering incentives to foreign investors. These incentives
include:

- **Tax Holidays**: Investors in economic zones may be eligible for income

tax holidays (ITH) for a specified number of years.

- **Duty-Free Importation**: PEZA-registered companies can import raw

materials and capital equipment without paying import duties.

- **Simplified Procedures**: PEZA facilitates business operations by providing

a one-stop-shop for permits and applications.

- **Exclusive Zones**: PEZA manages various special economic zones that

provide infrastructure, security, and ready-to-use facilities for foreign
investors.
### 9. **How does the Philippines compare to its ASEAN neighbors in terms
of FDI attraction?**

**Answer**:

The Philippines has been a relatively strong performer in attracting FDI

within the **ASEAN region**, but it still lags behind some countries like
**Vietnam**, **Indonesia**, and **Thailand**. Countries like Vietnam, in
particular, have attracted large inflows of FDI due to their lower labor costs
and favorable investment climate. However, the Philippines is competitive in
certain sectors like **BPO** and **real estate**.

The government's **"Build, Build, Build" infrastructure program**, the

implementation of the **CREATE Law**, and its young, educated workforce
continue to make the country an attractive investment destination.
Nevertheless, addressing infrastructure challenges and improving the ease
of doing business remain key to further increasing FDI inflows.