The Determinants of Foreign Direct Investment

What are the determinants for MNEs to invest abroad? Kahouli and Maktouf

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(2014) identified the main determinants of FDI in Latin America during the period 1990–2010. They showed that the main determinants positively influence on FDI inflows are trade openness, maintaining low short-term debt levels and presenting a balance of payment deficit, government stability and low expropriation risk. Mukhtar etal. (2014) explored different factors responsible for variation in foreign direct investment to developing countries. They found that openness to the international market, market size, tax rate, exchange rate, infrastructure development, institutions, labor cost, GDP, inflation and political risk are determinants that have significant impact on the flow of FDI towards developing countries or on investor's decision to invest.

Dunning (1993) classified MNEs’ FDI motives into four orientations: market seeking, efficiency seeking, resource seeking, and strategic-asset seeking. In addition to surveys the above Dunning motives, this study also discusses a newly classified network seeking.

2.2.1 Market Seeking

Large market size is often found in regions with high per capita GDP, implying that more developed areas attract firms with a strong market-seeking orientation.

Numerous studies show that FDI flow associates positively with market size and GDP. Kolstad and Wiig (2012) found that host country GDP is significantly associated with Chinese outward FDI. Chinese outward FDI is attracted to countries with large markets. Castro et al. (2013) indicated that the domestic market dimension of Brazil and Mexico is an important factor for attracting FDI. Luo and Tung (2007) concluded that due to their high per capita GDP, most advanced assets are more attracted in more developed regions. Moreover, many research emphasized that market size has a positive and significant effect of outward FDI (Herzer et al., 2008; Chan et al., 2014).

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Buckley et al. (2007) studied the relationship between FDI performance and market size, they found that a large market tends to have higher profit opportunities than a small one. Makino et al. (2002) indicated extensively that specify market size is the antecedent that positively impacts FDI location choice.

In connection with market size and population, host country’s population and per capita income are found having significant effect on outward FDI (Loungani et al., 2002).

2.2.2 Resource Seeking

Resource is defined as physical resource of one kind or human resource. The resource includes most minerals, raw materials (oil, zinc, copper, tin and bauxite.) and agricultural (rubber, tobacco, sugar, bananas, pineapples, palm oil, coffee and tea.

Deng (2004) studied investment motivations for Chinese firm to go to overseas. He showed that gaining security over access to raw materials (endowments of natural resources, energy) is often cited as a reason for Chinese firms to invest overseas. Large sources of natural resources are attracted to outward FDI (Kolstad and Wiig, 2012;

Ramasamy et al., 2004).

Human resource comprises plentiful supplies of cheap and well motivated unskilled or semi-skilled labors. Zhang (2005) investigated the issue by assessing specific assets possessed by Hong Kong and Taiwan investors and China’s location advantages relative to other developing countries. They found that Hong Kong and Taiwan’s direct investment in China was primarily motivated by low labor costs. Bellak et al. (2008) expressed that higher unit labor cost as well as higher total labor cost negatively affect FDI, whereas higher labor productivity impacts positively on FDI.

Bartels et al. (2014) examined the characteristics of Location Specific Factors (LSFs) in

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Sub-Saharan Africa (SSA). They found that production inputs become the most important factor for FDI followed by political-economic stability.

2.2.3 Strategic-asset Seeking

Strategic asset seeking is defined as MNEs aim at acquiring a technological rather than exploiting an existing asset. MNEs pursue strategic operations through the purchase of existing firms and assets for protecting their specific advantages and then to sustain or advance global competitive position. The Strategies asset seeking can be classified as R&D, patent, technology, knowledge, and human resource.

Previous study indicated that R&D significant affect MNEs’ outward investment decision. MNEs endeavor in overseas R&D focus on learning from developed countries.

Overseas R&D emphasizes its role as knowledge seekers and learners for new and relevant technology (Minin et al., 2012). Human resource of host countries is also a key factor attracting MNEs to undertake R&D activities in host country (Li and Zhong, 2003).

2.2.4 Efficiency Seeking

Efficiency seeking is to restructure the existing investments so as to achieve an efficient allocation of international economic activities of the firms. Efficiency seeking MNEs is to take advantage of different factor endowments, large and diversified MNEs producing fairly standardized products and engaging in internationally accepted production. Efficiency seeking can be classified into three elements: host country infrastructure, agglomeration economies, economic of scale.

The insufficient development of infrastructure in least developed country raise the operation costs for MNEs while invest in the host countries. Thus, insufficient

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infrastructure has a negative impact on MNEs’ FDI decisions and increasingly arises the costs of attracting investment for host countries (Yamin and Sinkovics, 2009). Thus, the availability of infrastructure in a country definitely can attract inward FDI (Backar et al., 2012; Sun et al., 2010).

Combine with specific agglomeration, production costs of MNEs may decline significantly. For host country, specific agglomeration and diverse industry of local division exist positive impact on attracting inward FDI (Chen 2009; Tuan and Linda, 2004). Milner et al. (2006) studied the phenomenon that there exists a large amount of trade between Japan and Mexico for transiting to the U.S. market under NAFTA agreements between Mexico and U.S. They concluded that predominantly production for a non-host country market contains special exporting advantages and facilitates MNEs’ willingness to invest abroad for a third country market.

Political risk of host country includes government stability, internal and external conflict, corruption and ethnic tensions, law and order, democratic accountability of government, and quality of bureaucracy are highly significant determinants of outward FDI (Busse and Hefeker, 2006).

Kowalewski and Radło (2014) found evidence that foreign direct investment projects undertaken by Polish companies are motivated by the need for efficiency or strategic assets.

2.2.5 Network Seeking

In addition to survey the four categories Dunning (1993) had classified, there are still some considerations, e.g., ethnical ties, historical ties, or cultural proximity, which motivate MNEs’ FDI activities.

Kubny and Voss (2014) found that the share of local sourcing is similar to other

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foreign investors with more extensive forward linkages. Chen et al. (2004) treated local linkages as an investment in local relationships. Chen and Chen (1998) further divided network linkage into internal (intra-firm) and external (inter-firm) linkages. They found that Taiwanese firms are keen on making external linkages, but are indifferent to, or incapable of, making internal linkages through FDI. Taiwanese FDI in the United States is motivated by strategic linkages, but relational linkages facilitate Taiwanese FDI in Southeast Asia and China.

Ethnic ties are specific aspects of social networks which are characterized by personal relationship elements such as mother tongue, national origins, ethnic group, and region of birth (Zaheer et al., 2009). Ethnic ties may facilitate FDI location choice, however, ethnic ties do not help to improve firm performance (Jean et al., 2011).

Moreover, cultural proximity between host country and MNEs is also an important factor that affects FDI. Pangarkar and Lim (2003) found that cultural proximity has a positive impact on only one performance measure of FDI.

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