What Is Backward Foreign Direct Investment?

Foreign direct investment (FDI), especially in the post-World War II world, has become one of the most significant elements of the world economy. FDI refers to the practice of investing in another country's economy by buying shares in foreign firms or even building a factory overseas. Incentives that have created FDI are cheaper labor abroad, as well as access to resources and markets. Firms engage in FDI to develop a “leg up” on their competition.

Horizontal FDI is similar to the idea of “horizontal integration,” except that it happens in a foreign state. Horizontal FDI refers to a “lateral” sort of investment in a foreign economy. Nike assembles shoes in America, then builds a shoe assembly plant in Thailand. This is horizontal, and it is typified by building the same sort of industry abroad that exists at home. Vertical FDI refers to different industries represented in the supply chain. In this case, “vertical integration” means that parts of the supply chain are brought together under the control of one firm. So, Nike, making shoes in Thailand, then buys important retail outlets abroad. It can also buy rubber plants in Malaysia. Nike can integrate itself vertically by buying input, or “upstream,” industries such as rubber, or “downstream” industries such as transportation or retail.

Backward FDI is buying “upstream” industries within international vertical integration. “Backward” refers to the location of the industry in the production chain. “Backward” or "upstream" means those parts of the production chain dealing with supplies and raw materials.

Companies are interested in backward FDI for the same reason that any firm is interested in vertical integration – to keep needed supplies out of the hands of competitors. This becomes especially important when a specific raw material exists in only a few countries. Bauxite is a good example. Bauxite is the main ingredient in most aluminum. It exists in large quantities in the Caribbean and in smaller quantities in parts of Africa. Hence, aluminum manufacturers have a great incentive to buy up the bauxite firms operating in Jamaica as a means of dominating the competition.

In general, the justification for vertical integration at any level is efficiency. Political economy professor Ashoka Mody holds that when a supplier is bought, the buying firm now has every incentive to make that supplier as efficient as possible. This means if an aluminum firm in America buys bauxite producers in Jamaica, the American firm will now invest heavily in the Jamaican firm to make it produce more, quicker and in better quality. Ultimately, this means cheaper aluminum, higher profits and increased market share.