Question

Define and explain Foreign Direct Investment. What is the difference between a closed and open Economy? How would they obtain the financing for investment?

Answer 1

Foreign direct investment refers to the business investment by indivituals or organisation in other country where the investor operates his business from his country. The motive behind FDI might be different. The cost difference in production system between the countries encourage one to invest in the country where his business can flourish easily. Mainly countries with open economies are preferred for FDI as it offeres a market where skilled labourers, improved technology and cheap raw materials are easily available and does not have strict regulation for foreign businesses which help these countries also to boost their economy. Business investment in the foreign countries can be of different types. One can expand his business empire in foreign countries or buy a foreign company or merge his business with a foreign allied company. When an investor establishes same type of businesses in foreign countries that is present in his home country , it is called horizontal direct investment. When an investor starts related business activities which helps in running his main business activities in his home country, it is called vertical direct investment. FDI is a boon for the foreign countries as capital influx in their economy helps in development of infrastructure, higher employment oppotunities, more revenues from the foreign companies and increasing competition among producer companies help in more productivity and efficiencies leading to the expansion of the economy

In an economy, where export and import of goods are strictly prohibited and does not share any economic relation with rest of the world is called as closed economy. Countries with closed economy remain confined to their own produced goods and services and they never borrow or give loans to others in times of emergency. For e.g North Korea who has a closed economy allows only to conduct its trade and commerce within the border of the country. But when countries allows export and import of products from foreign countries and have good economic relation with other countries, funds from across the world flow in these countries economy which help them to expand their economy and develop their infrastructure.

Countries with Closed economy always avoid investment from outside investors. It totally depends on its local investors within the border of the country to invest in the production system. But countries with open economy has the option of rely on outside investment in the form of FDI apart from its local investors which lead to capital inflow to its market and expanf its economy by opening more avenues for employment, more revenues from FDIs, development of infrastructure and technology etc.