Final answer:
Foreign direct investment (FDI) refers to the flow of capital from one country to another for the purpose of establishing business operations. It involves private investors investing in foreign countries, and is not a government subsidy or an economic policy. Capital inflows can help finance a nation's trade deficit.
Step-by-step explanation:
Foreign direct investment (FDI) refers to the flow of capital from one country to another for the purpose of establishing business operations. It can involve purchasing a firm in another country or starting a new enterprise in a foreign country. For example, when the Belgian beer-brewing company InBev bought the U.S. beer-maker Anheuser-Busch, it required supplying euros to the foreign exchange market and demanding U.S. dollars.
FDI is not a government subsidy for domestic industries, an economic policy promoting autarky, or a trade agreement between two neighboring countries. Instead, it involves private investors investing in foreign countries to establish business operations.
In the context of international flows of capital, foreign countries may provide loans or investments to a nation with a trade deficit, expecting eventual repayment. A trade deficit occurs when a nation's imports exceed its exports. The inflow of foreign capital can help finance the trade deficit and enable a nation to repay its loans or investments.