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Foreign direct investment can be defined as the investments made by investors outside their own economy in order for them to earn interest on investment made, the two types of foreign direct investment (FDI) which are determined by the direction of investment include inward FDI and outward FDI, inward FDI takes place when foreign investment capital is invested in an economy whereas outward FDI takes place when local resources are invested in a foreign economy.
This theory explains why a firm will invest abroad, it is a classical theory developed by the work of Adam smith who stated that as firms grow and profits increase foreign direct investment enable the firm to shift surplus capital by investing elsewhere, the firm will also invest abroad due to increased competition in the home country and therefore decides to invest abroad where there is low competition.1
The work of Karl Marx also explains the existence of foreign direct investment, according to Marx as the rate of consumption in the home country decreases the profits of the firm declines and for this reason the firm will invest abroad for the reason of increasing consumption levels and profit levels.2
Therefore a firm according to this macro economic theory will invest abroad due to their abundance in capital and they will invest in the country which uses labour intensive means of production in order to increase profits as the cost of production is lower, the firm will find it more advantageous to invest in a country where labour cost are lower as the cost of labour in the home country is higher than the country abroad. ...
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