Determinants of FDI Flows within Emerging Economies

A Case Study of Poland

A. Mironko

• Publisher: Palgrave Macmillan
• Year: 2014
• Print ISBN: 9781137372154
• eBook ISBN: 9781137372161
• Topic: Commerce
• Subtopic: Commerce Général

This study provides a detailed examination of foreign direct investment (FDI) in Poland and explores the impact this has on foreign investment policy. It analyzes and identifies location patterns of FDI and strives to determine the supporting motives behind location choices of foreign companies.

1

Location Choice and Clustering of Foreign Subsidiaries on the Economic Sustainability and Competitiveness of the Host Regions

1.1   Background and problem setting

In the last two decades many countries in Central and Eastern Europe have ventured onto the road of economic development via privatization, economic reorganization and opening their doors to foreign investors while adopting the rules of the free market economy. For most countries of Central Europe (CE), this journey has by now culminated in their joining the free economic trade and movement of people in different zones of the European Union (EU). Included in that group is Poland, the country whose economic environment and attractiveness to foreign investors is the subject of this study.

As the result of this economic and governance change, Poland’s developing economy is successfully searching for, and accepting a relatively significant amount of, foreign direct investment (FDI) as compared to its neighbors.¹ The relationship between foreign investors, domestic investors, and policymakers is often one that contributes to, or prevents, local economies from benefiting from such investment.

Researchers recognize a number of issues arising from both a lack of, and the presence of, foreign investment in a country. Equally important and researched are patterns of distribution of foreign direct investment within recipient countries (Blomstrom and Kokko, 1997). Potential benefits to both an investor and the local economy may depend on the existing local economic factors required for success of the investment. Obviously, short-term and long-term considerations are taken into account by researchers considering these matters.

The central issue addressed in this research will be the relationship between clustering of foreign firms across regions in Poland, and the country’s future ability to attract further foreign investment into them based on: the regional industry and country-of-origin concentration levels; regional economic drivers; and type of foreign investors. While most studies of FDI location choice concentrate on cross-national decision-making, and few of the studies look into location determinants across regions within a country, this present study will attempt to explain the reasons for concentration of foreign firms in Poland by testing whether foreign firms investing there follow particular industry-based trajectory patterns and, also, whether they locate in the proximity of the leading firms in their industries.

The importance of industrial cluster formation and how foreign investors choose locations in which to establish their operations are important and difficult questions that many researchers have attempted to answer (Marshall, 1920; Porter, 1998b; and Krugman, 1991, among others). Such a choice as whether to locate in an established agglomeration or away from one – therefore independently – is influenced by a number of locational factors and by whether an investor is a leader or follower in an industry (Knickerbocker, 1973).

Besides the locational decisions of foreign investors, national and regional policy issues and local economic factors are significant determinants in the development of an agglomeration of foreign investment patterns and development of local regions. In addition, the influence of industry-leading firms (identified as Fortune 500 companies, along with industry leaders²) and followers (small and medium size foreign firms) will be studied to determine existing interaction effects between both types of firms.

The literature shows mixed positive and negative effects of FDI on host economic developments (Borensztein et al., 1993; Kogut, 1983), especially in the long-term. Therefore, the importance of regional economic factors, the presence of established industrial centers, and the nature of local policies is quite substantial on such an effect. As such, national and local policies further influence the location choices of foreign investors within a country and, in turn, contribute to the recipient regions’ success.

This present work should offer an analysis and reveal location choices of foreign investors establishing their subsidiaries in Poland, with specific determination of the existence and development of industrial trajectories across regions. Also the review of local economic factors and the relationship between them and the existing concentration of foreign firms (based on industrial classification across regions) will be made. In addition, degree of collocation between various types of firms – industry leaders and followers – will be explored to determine its effect on location choices of future investors. Finally, based on the results of this research, national and regional policy considerations will be offered with additional observations as to before and after the European Union accession effect in the flow and location choices of FDI into Poland.

1.2   Outline of the book

This book analyzes the determinants and the impact of foreign direct investment in Poland. The research offered here is based on panel data and on the impact the results have on the location choice of foreign firms across Poland. The organization of this book is as follows:

Chapter 1 introduces the subject of flow of foreign direct investment into developing economies and its determinants.

Chapter 2 sets out the problem and reviews relevant literature by discussing location choice theory and reasons behind clustering of firms.

Chapter 3 develops a model and reviews research design, data and the methodology used to analyze possible relationships between foreign investors and local strengths.

Chapter 4 analyzes the results and outcomes by exploring, at the level of regions in Poland, concentration of foreign firms – an analysis based on industrial specialization and country-of-origin criteria.

Chapter 5 discusses the results of hypotheses testing and offers analysis of location choices by industry-leading firms investing in Poland on the decisions of small and medium size foreign investors. The existence of such relationships is important to both foreign investors as well as to indigenous businesses and regional policy.

Chapter 6 offers conclusions and a final analysis of FDI patterns across regions in Poland and presents policy recommendations. This chapter identifies and reveals the existing preferred location choices for FDI within Poland and determines specific geographic advantages and heterogeneity of its regions. By addressing the questions raised, this research also provides a framework for the analysis of location decisions of multinational firms in regions within developing economies.

2

Heterogeneity of Economic Space: Introduction of the Problem

2.1 Regional location choices and clustering of firms

Although there is a common understanding that almost all industries are somewhat localized, a number of studies measure the localization levels of FDI and its influence on host economies. That relationship between collocating firms and the formation of centers of economic activity within a country influence the location choices of future entrants into that country (von Thünen, 1826, trans. of 1966; Marshall, 1920; Krugman, 1991). Also, so-called “Marshallian factor” market externalities (David and Rosenbloom, 1990), which include capital stock and size of the labor force and markets, strongly contribute to the growth and competitiveness of urban-industrial agglomerations, thereby enhancing the attractiveness of a region to potential foreign investors. Even earlier than Marshall, Adam Smith (1776) spoke of trade impacts on location decisions, suggesting that trade and location are interrelated and have a significant role in regional economic geography.

More recently, Ellison, and Glaeser (1997) developed an empirical test to confirm the same premise, using examples of geographic concentration of industries in some U.S. regions. The researchers also considered the presence of corporate networks emerging as a result of upstream–downstream inter-firm supplier relations (Porter and Stern, 2001). Those specialized inter-industry and intra-industry networks already present in an area were the engines behind the gravitation of new firms to that locale.

As subsidiaries of foreign corporations establish their firms in host economic regions where, according to Ellison and Glaeser (1997), the possibility of cluster formations increases in accord with the strengths of the existing operations and expanding demands of upstream–downstream production networks that, in turn, bring new subsidiaries of multinational corporations (MNCs) into the regions and around them, the neighboring regions (also earlier, von Thünen, 1826, trans. 1966; Marshall, 1920; Krugman, 1991). According to Marshall (1920) regions containing agglomerations of economic activity (termed by the author as clusters, districts, and milieus) become hubs of tacit knowledge accumulation and growth, where physical proximity is an initial prerequisite for the generation of a regional-specific competitive advantage. As it is not easy to determine it concretely, even an assumption of the existence of this tacit capability of the cluster can attract new investors.

As new entrants decide to establish operations in the developing countries, many economic factors play an important role in determining optimal location strategy. This strategy engages crucial factors of economic activity, such as: level of presence of foreign firms in a region, size of the local market, distance to foreign markets, cost and availability of the workforce, availability of a skilled workforce, and the level of R&D investment needed to attract FDI into a region.

The key question related to the one presented in this research is whether the presence of the existing clusters attracts and benefits new entrants. This question was researched by Shaver (1998b), who reviewed the influence of labor and wages and the presence of other firms in the region selected for the location of new subsidiaries. Shaver’s research determined that, when done right, collocation is an essential part of an investment strategy due to its potential intrinsic advantages, which improves the rate of success for investment in the location. Such obvious examples are the Michigan automobile industry, California’s Silicon Valley, and the IT and biotech R&D found along Route 128 in Massachusetts (Saxenian, 1994). Necessary for success is an understanding of the strategic choice of location as an integral element driven by the motives behind cluster formation.

2.2 Nature of cluster formation

2.2.1 Understanding of clusters and their development

While clusters may be viewed and defined from a variety of perspectives, this study will follow close to Porter’s definition of a cluster as a geographically proximate group of interconnected companies and associated institutions in a particular field, linked by commonalities and complementarities (Porter, 2000). Further, we include Marshall’s (1920) understanding of clusters as concentric circles, spheres of various distances, and surrounding towns. These understandings of agglomerations see clusters not limited to a particular industrial class, but inclusive of interaction between various industrial and economic activities.

This study will view clusters as a regionally proximate group of interrelated foreign companies. The analysis of clusters will have dual focus: on industry classification and country-of-origin. Additionally, clusters will be viewed from the perspective of the types of firms, leaders, and small and medium enterprises they are hosting and attracting (Porter, 1998a) to form sustainable agglomerations of economic activity.

Even as former reasons for clustering have diminished in importance with economic globalization, new influences of clusters on competition have a growing importance in an increasingly complex, knowledge-based, and dynamic economy. Understood as such, clusters represent a new way of thinking about national, state, and local economies, and they necessitate new roles for companies, governments, and other institutions for enhancing their competitiveness (Porter, 2000).

That point is supported by Jaffe and colleagues (1993), presenting one obvious explanation why innovative activity in some industries tends to cluster geographically more than the same activity in other industries: the location of production is more concentrated spatially. Marshall (1920) and later Krugman (1991), argue that there may be geographic boundaries to information flows or knowledge spillovers (particularly tacit knowledge) among the firms in an industry, citing localization of economic activity as well, since innovation occurs within a particular area only when other salient conditions, such as agglomeration and interaction of firms, occur first.

For foreign investors, geography is a salient determinant in choosing the optimal location for establishing new subsidiaries (Marshall, 1920; Krugman, 1991; Porter, 2000). In making those choices, (MNCs examine a number of locational conditions which motivate the investment. Choosing an optimally desirable location may be a complicated process, taking into account the correlation of the location’s economic factors which are necessary for a successful investment (Dunning, 1993; and Blomstrom, 1991). These studies determine that regions with developed internal networks use the advantages of flexibility and specialization as a key to technological learning. Lowering the costs of production while retaining flexibility of production are highlighted by Storper (1992) in a study of French, Italian, and American production networks.

Also, Porter (2000) cited “the prevalence of clusters which reveals important insights about the microeconomics of competition and the role of location in developing a competitive advantage.” It is widely recognized that changes in technology and competition have diminished many of the traditional roles of location. Yet, clusters (geographic concentrations of interconnected companies) are a striking feature of virtually every national, regional, state, and even metropolitan economy, especially in more advanced nations (Porter, 2000). This indicates that while the economic development of a nation or a region increases, so does the role of agglomerations of economic activity.

By measuring the relationship between specified economic factors and the regional industrial specialization of foreign firms, this study will point out specific competitive advantages where industrial clusters of foreign investors are identified as being strong.

2.2.2 Development of a regional industrial trajectory and competitiveness

Fundamentally, clustering of multinational corporations within a foreign country develops incrementally over time (Cantwell, 2000), and with accumulation of a particular technological capability in the area. As a result of continuous aggregation and cumulative agglomeration of forces, the cooperation of the foreign firms often develops across industries or according to a particular industrial specialization (Nelson, 1993; Cantwell, Iammarino, and Noonan, 2000). Since the necessary advantages of the host regions are exploited first, the subsequent step (not studied here) would be knowledge transfer between foreign and host firms, and knowledge creation, making those clusters potentially more competitive and sustainable.

This evolutionary path, which as a result of regional industrial specialization is often narrowing, cannot always be promoted effectively by indigenous firms but requires knowledge and processes available from the outside via attraction of foreign investors to supply them (Mutinelli and Piscitello, 1998). Subsequently, the development trajectory of foreign firms indicates the strength of a particular location for a specific type of investment (Cantwell, 2000). A rising trajec...

Table of contents

• Cover
• Title
• 1 Location Choice and Clustering of Foreign Subsidiaries on the Economic Sustainability and Competitiveness of the Host Regions
• 2 Heterogeneity of Economic Space: Introduction of the Problem
• 3 Local Strengths and Foreign Firms’ Location Choice: The Research Design, Data, and Methodology
• 4 Concentration of Foreign Firms in Poland based on Industrial Specialization and Country-of-Origin Criteria: The Results and Summary of the Evidence
• 5 The Results of the Effects of Location Choices by Industry Leading Firms Investing in Poland on the Location Choices of Small and Medium-Size Foreign Investors
• 6 Final Analysis of FDI Patterns Across Regions in Poland and Policy Recommendations
• 7 Afterword
• Appendices
• Notes
• References
• Index