As regional and bilateral trade liberalization in Asia has progressed at an extremely high pace in recent years, how Asian multinational corporations decide where to locate their production factories has received considerable attention. The basic logic is that in the absence of tariff barriers, it would in many cases be optimal for Asian MNCs to produce in other countries where the wage level is lower. Then these outputs are sold to the third-country market and even sold back to the home- country market. In other words, trade liberalization, which allows the unrestricted flow of goods and services sharpens competition and motivates innovation. It augments the rewards that result from producing the best products, with the best design, at the best price. However, the success in trade will not last long, and it will shift from one firm to another while the market changes or the latest technology make cheaper and better goods possible. According to this point of view, manufacturers are encouraged to go abroad in order to exploit firm-specific advantages, locational advantages, and internalization advantages (Dunning, 1981). Therefore, the role of regional comparative advantages in shaping the pattern of production locations is evident due to such a discernible trend of trade liberalization.
According to the World Investment Report (2008), there is a widespread increase in inward FDI (foreign direct investment), which rose for the fifth consecutive year and reached $249 billion (a 18% increase), in South, East and South-East Asia due to improvements in the investment environment. In recent years, further liberalization of trade and FDI, continued economic growth and robust industrial development in some counties of this region are all important factors which contribute to attracting FDI. At the same time, South, East and South-East Asia with $150 billion in
outward flows has been an evident source of FDI for other developing countries. In other words, this region plays a crucial role in cooperating with other developing countries. It is self-evident that firms from this region tend to globalize more actively than those from other developing countries. In particular, started from mid 1990s, Taiwanese firms increased their outward FDI to exploit their assets, which include patents, technological assets, reputation, production efficiency, marketing, and advertising. Taiwanese FDI outflow is conventionally concentrated in less-developed countries, such as China and Southeast Asian. However, this pattern shifts toward developed countries like the U.S. and Europe after 1996 under the ”go-slow, be patient” policy, which puts a $50 million cap on any single investment in China, as well as the strike of Asian financial crisis. As a result, in order to shed the light on the tradeoff in FDI in North versus in South, our paper uses firm-level data of Taiwan, which is top 10 sources of FDI outflows in South, East and South-East Asia in the year 2005.1
This raises the question of how the uncertainty has an influence on Taiwanese MNCs’ decision makings of FDI locations. Foreign direct investment (FDI) is conventionally considered as an attempt to exploit firm-specific assets in a foreign market (Hymer, 1960). To exploit these ownership advantages via FDI arises while the transaction costs of licensing and joint venture are too high (Buckley and Casson, 1976). Moreover, the decision of FDI location depends on the geographic advantages that maximize the value of firm-specific assets minus set-up costs (Dunning, 1981). However, we recognize that exploiting firm-specific advantages and resource seeking orientations are all important factors to describe the reason why
1 Source: UNCTAD, FDI/TNC database (www.unctad.org/fdistatistics) and annex table B.1.
domestic firms go abroad, but they are not the whole story. In reality, all firms inevitably face incomplete information for FDI decision-making, and on the other hand, domestic firms investing overseas directly for the first time would lack experience in foreign markets compared to established multinational firms.
Our focus throughout is on the decision of FDI locations, which is related to the trade-off of how to allocate their manufacturing factories and their final outputs.
This paper investigated the pattern of FDI location by firm heterogeneity in the spirit of Aw and Lee (2008) in which the authors develop a three-country model accounting for the interdependence between host country and other final consumption countries.
In addition, we modify the framework of Aw and Lee (2008) by drawing on the insight from the process model of internationalization (Johanson and Vahlne, 1977, 1990) to explore the role of uncertainty on locating production overseas. In contrast to Aw and Lee (2008), the export function of domestic factories is not completely replaced by that of Southern ones even though there is a comparative advantage of cheap labors in South country. Accordingly, “pure” horizontal FDI in South would be the optimal strategy in our theoretical analysis. Furthermore, our paper contributes to the literature by using plant-level data to examine how either firms’
concerns with sovereign risks or their own production levels affect their decision makings of FDI locations. More specifically, we use the data on the operations of Taiwanese MNCs in twenty-four manufacturing industries and eighteen foreign countries in the year 2005. In contrast, most of previous works in this area have used data of multinationals in a small number of industries or used data aggregated to the country level.
Our analysis proceeds as follows. The next section begins with some literature
reviews. The data used for our empirical estimation is described in the subsequent section, followed by the development of a theoretical model for firms’ decisions of locating production overseas and the empirical counterpart to the theoretical model.
The penultimate section goes on the empirical results. The final section provides some conclusions drawn from this study.