Foreign Direct Investment

Research Issues

Bijit Bora

• Publisher: Taylor & Francis
• Year: 2002
• eBook ISBN: 9781134557233
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Foreign Direct Investment examines the different approaches to explaining the growth and distribution of FDI in the world. Pulling together contributions from an array of international experts, this study combines theoretical with empirical work on issues such as computable general equilibrium modelling, trade, intellectual property, environment, l

1 Introduction

Bijit Bora

In the past decade there has been considerable interest in the ‘forces for globalisation’. Of these, the international trade in goods and services and the increase in international production through multinational corporations have been identified as being important factors. In 2000 global private foreign direct inflows (FDI) reached US$1.1 trillion compared to US$159 billion in 1991. In fact, the annual growth rate of FDI during the past decade exceeded the growth of both the international trade in goods and services and output.

This rapid growth in FDI has raised a number of policy issues at the national and international level. During the 1960s and 1970s FDI and multinational corporations were generally treated with suspicion, as they were seen to use their economic strength to take advantage of developing countries. During the same period many developed countries enacted legislation to monitor and control the flow of FDI and the activities of multinational corporations. Their concern was less in the context of economic exploitation, but more in the context of economic sovereignty.

Today, however, the general policy position of most countries is to be receptive to FDI. As a result, national governments are actively seeking a better understanding of its determinants, impacts and implications. At the international level, considerable discussion has taken place on the topic of incorporating rules on investment in the World Trade Organisation (WTO). Indeed, at the Fourth WTO Ministerial held in Qatar in November 2001, a decision was taken to orient discussions on this topic with a view to negotiating such rules at a later date. Many see such an initiative as complementing the existing set of multilateral rules on trade in goods and services and on trade related investment measures and intellectual property rights. At the same time, there is also some scepticism of the benefits of such rules.

While at its most basic level foreign direct investment is a dollar of capital crossing an international border, in reality the issues surrounding FDI are more complex. FDI is essentially a package of potentially wealth creating assets that can have a significant impact on home and host countries. The issues relating to FDI range from theories of commercial presence and management issues to the impact of FDI on trade employment, wages, intellectual property and development. As a result representatives from the management field, international trade theorists and international macroeconomists are active in the field of FDI research. Each particular sub-discipline brings with them a particular insight into FDI.

The purpose of this book is to bring together representatives from these three different areas to take stock of the literature in their particular area and identify future research areas and impediments to fulfiling this research agenda. The book examines and reviews the role played by FDI in areas such as international trade, employment, technology transfer, economic growth, the environment and development in general. Understanding these transmission channels of the impact of FDI is critical for the development of appropriate policies.

The book is divided into three key subject areas. The first examines some of the theories as to why foreign direct investment takes place and the empirical work on measuring the degree of foreign presence. The chapters by Edwards (Chapter 2) and Nicholas and Maitland (Chapter 3) examine the orthodox models of why multinationals emerge from the point of view of the firm. These papers are from the particular perspective of the international business field and hence focus on organisational and management issues at the level of the firm. Three empirical chapters that examine some key aspects of the international distribution follow these chapters. Chapter 4 (Bijit Bora) is a survey of the empirical work on location and draws conclusions about the generality of the results and some of the key determinants of the distribution of foreign direct investment. Raymond Mataloni (Chapter 5) examines the measurement of foreign presence in an economy using US data while the last chapter in the section by Roger Farrell (Chapter 6) examines issues related to Japanese foreign direct investment.

The second section of the book covers structural issue related to FDI. These relate to the impact of foreign direct investment on international trade by James Markusen (Chapter 7), industry structure, with a special focus on telecommunications, by Edward M. Graham (Chapter 8), the labour market by Noel Gaston (Chapter 9), home country by Ari Kokko (Chapter 10), the host country by Prema-chandra Athukorala and Hal Hill (Chapter 11), intellectual property rights by Keith Maskus (Chaper 12) and environment by Bijit Bora (Chapter 13).

The last section covers analytical and policy issues. It starts with Chapter 14 on how to incorporate multinational corporations into a general equilibrium policy framework by Patrick Jomini and Susan Stone. A key element of this research area, however, is access to reliable data on the barriers to foreign direct investment. Chapter 15 by Alexis Hardin and Leanne Holmes takes up this issue in the context of the services industries. They develop a methodology to construct indices of barriers to FDI that can be used in CGE models in addition to painting a landscape of the pattern of such barriers across countries and sectors.

Equity restrictions on FDI are only one element of government policy that affects the flow and composition of FDI. Tax policy and incentives are also important. Jacques Morisset and Nedia Pirnia take up their role and impact on FDI in Chapter 16.

Chapters 2 to 16 cover many of the analytical issues related to foreign direct investment. In the context of doing good applied research in these and other FDI related areas, researchers require access to data. The United States has excellent data. Indeed, this explains the bias in applied FDI research on American companies. However, other countries are interested in developing statistical databases that will accommodate the research needs of academics and policy makers. Chapter 17 by Mark Lound and Geoff Robertson addresses these issues. Their paper takes up the problem of how to augment the Australian statistical database to help address issues related to FDI and globalisation in general.

Chapter 18, by David Robertson, takes up the question of multilateral rules on investment. The failure of the negotiations on a Multilateral Agreement on Investment at by the members of the Organisation for Economic Cooperation and Development, the discussions surrounding the Agreement on Trade Related Investment Measures and the investment provisions in the North American Free Trade Agreement have raised questions about modality and composition of multilateral investment rules. Robertson examines these issues from the context of identifying avenues for further research.

What is fast becoming one of the most important areas of research is the intensification of the debate on the sign and magnitude of the link between FDI and development. Sanjaya Lall, in Chapter 19, takes up this issue within what he calls the new context.

Research themes

There are two broad themes that run throughout the book. The first is the different approaches that researchers can take when analysing the same question. In other cases, the approach is an aggregate or national one. The second is the nexus between theory, evidence and policy and the third is the identification of impediments to research.

Research methodologies

As discussed in Chapters 2 and 3 the decision to invest in another country is taken at the level of the firm. However, many researchers take an aggregate approach to analysing the pattern of FDI and its impact, such as the work on determinants or the link between FDI and other variables. While considerable insights can be obtained from the aggregate approach there is a need to reconcile results from the different approaches. In some cases, as discussed in the chapters on the environment and development, results from firm level surveys sometimes contradict findings at a more aggregate level. Attempts also need to be made to identify ways to cross-fertilise findings from one particular approach with other approaches. A good example of the benefits of such activities can be found in the chapter on international trade. There, James Markusen, highlights that neglect of international trade theory to account for the multinational firm. He points out that the formal modelling of the multinational corporations in the trade literature relied heavily on the insights of literature from the business perspective, which is covered in Chapters 2 and 3. Similar types of cross-fertilisation can be found in the chapter on intellectual property. Keith Maskus cites firm level evidence on how such rights affect the location decision.

Impediments to research

One of the main reasons for obtaining a better understanding of the determinants and impact of foreign direct investment is to formulate more efficient policies that will assist the development process. In this context, there has to be a link between theory, evidence and policy making. This, however, is difficult to do without good quality data. Researchers can collaborate and work jointly on ideas, but in reality, policy guidance requires solid empirical work. When discussing a future research agenda many of the chapters in this book identify impediments to conducting research. Of these, the most frequently cited impediment is access to good quality data.

Indeed, improving the quality and accessibility of data, should be a priority, but researchers cannot do this. Data on foreign direct investment flows is collected by national statistical agencies. In annual form these are quite good now that there is some standardisation to the data collection. However, as pointed out in the chapters in this book, FDI flow data needs to be disaggregated if there is to be a better understanding of its determinants and impacts. Many countries publish disaggregated statistics of FDI flows, but only to the two digit industry level. This is not sufficient.

A related point that is made strongly in the second section of this book is that flow data is not sufficient for proper analysis of impacts. Since impacts are determined by decisions at the level of the firm, what is required is data at that level. This is difficult to do. However, if such data can be collected the insights gained from research and the quality of research output can increase. This is evidenced by the types of new issues that are investigated in Chapter 5 in terms of measuring the contribution of US multinational corporations in a host country.

How do you proceed to start collecting statistics at the level of disaggregation that is currently done in the United States to meet the research demands set out in this book? This question is taken up to a significant degree in Chapter 17 within the specific context of Australia. It highlights that the task is quite large and argues for the most part that it has to be undertaken by a national statistical agency. The chapter discusses what is required in order to collect such statistics.

The imperative to improve the infrastructure, and hence quality of research on FDI issues is getting stronger as the policy debate on FDI continues to intensify. As David Robertson outlines in Chapter 18 the increased visibility of nongovernmental organisation and critics of globalisation is forcing governments to think harder about rules at the multilateral levels. While this book does not take up this specific issue, it does argue that research on FDI has an important role to play in improving the literacy level of the debate on FDI.

Part I
Theory and measurement of FDI

2 International business research

Steady-states, dynamics and globalisation

Stephen Nicholas and Elizabeth Maitland

Introduction: internationalisation, globalisation and management strategies

The strategic direction of national and international business organisations lies at the heart of wealth creation in modern industrial societies. Stephen Hymer (1976) formulated research on internationalisation by recasting foreign direct investment (FDI) in micro analytic terms.¹ Since Hymer’s pathbreaking conceptualisation of the multinational corporation (MNC), a generic model of the international activities of firms has slowly evolved. While the model’s lineage is multidisciplinary, it draws heavily on new industrial economics and new institutional economic theories of internalisation, challenging neoclassical economic models of international capital flow.

Recently, interest in international business research has been boosted by popular and scholarly fascination with globalisation. Since Levitt (1983) highlighted the trend of increasing integration of national intermediate, factor (particularly finance) and product markets, globalisation, as a word, has assumed many different guises. For some, globalisation is an economic and technological phenomena; for others, globalisation is as much a social and cultural force, threatening national independence, self-determination, individual rights and diversity. Governments seek to understand the new global economy, and the enhanced role of host and home country MNCs in shaping the world economic order.

Yet, globalisation and internationalisation are frequently misunderstood and misused terms. Internationalisation is the process of increasing involvement in international operations, which requires adapting the firm’s strategy, resources, structure and organisation to international environments (Welch and Luostarinen, 1988; Calof and Beamish, 1995). Divestment and exit, as well as growth and expansion, form part of internationalisation. Globalisation is a subset of internationalisation. Globalisation stems from interdependencies across the subsidiaries within an international firm, which need to be actively managed and where corporate dominates subunit maximisation. Internationalisation and globalisation differ from other growth strategies, such as product diversification, because they involve transacting in goods, services and know-how across national borders.

This chapter tracks the theoretical and applied research on the internationalisation of firms. The research focus has been on the growth strategies of MNCs. MNCs grow by expanding their web of contractual arrangements, including market contracts, intermediate arrangements (licenses, franchises and alliances) and internal activities. Until recently, internal expansion has preoccupied researchers. The choice between green field investments and acquisitions has been the predominant focus of empirical studies in international business research. Shortcomings in the generic model of internationalisation and in its empirical testing are identified. The paper reformulates the transaction cost-agency model, linking dynamic capability theory to economic models of the MNC. A reconceptualisation on how MNCs grow is also presented.

The theory of the MNC and internationalisation

Prior to Stephen Hymer’s benchmark doctoral thesis on the pattern of FDI, international business was international economics, with attention directed to trade flows and portfolio investments. Such traditional neoclassical economic models of cross-border transactions were seen to lack explanatory power with respect to the phenomenon of enterprises manufacturing, as well as selling, goods and services in more than one country. Dunning’s (1970) early work using location theory and studies by Knickerbocker (1973) and Graham (1974) on MNC strategic interaction, defined international business as a separate area of study.

Hymer (1976: 23) observed ‘(t)he important theoretical shortcoming of the interest-rate theory is that it does not explain control…If we wish to explain direct investment, we must explain control’. Within the Coasean paradigm, internalisation initially focused on the MNC as the alternative contractual form to transacting in the market (McManus, 1972; Buckley and Casson, 1976; Hymer, 1976; Dunning, 1977). Following Williamson (1979), Casson (1979) and Hennart (1982), internalisation was widened into a transaction cost-agency perspective, incorporating a range of intermediate forms of overseas involvement (such as licenses, franchises, alliances and long-term contracting), as well as markets and hierarchy. The MNC is a firm which transfers know-how between operating entities in two or more countries, through a clear decision-making system linked by ownership or other form of control, with the sharing of knowledge and resources, which allows coherent and common policies and strategies.

While the inclusion of internalisation in the theory of MNC placed international business research at the cutting edge of new schools of thought in economics, the transaction cost-agency approach only explains alternative forms of transacting. As a minimum, the theory of the MNC must explain two simultaneous and interdependent decisions: the choice of contractual form for operating abroad and the location of overseas activity. Alternative theories, such as comparative advantage and location theory, are required to explain the location decision.

Form of overseas involvement

At the centre of the transaction cost-agency approach to international involvement is the concept of internalising market transactions within hierarchical firms or intermediate contracts (including franchises, licenses and alliances), when firms face imperfections in market exchange (Buckley and Casson, 1976; Casson, 1979; Rugman, 1981; 1982; Caves, 1982; Hennart, 1982; Teece, 1986). Firms grow by internalising market transactions. Intermediate product markets frequently are subject to uncertainty and asymmetric information that allow potential opportunistic behaviour by input sellers (agents), who have better and different information than buyers. It is costly for the principal to write market contracts to monitor, bond and enforce input purchases, given potential moral hazard and adverse selection problems. Firms, as principals, are vulnerable to post-contractual opportunistic ‘hold-up’ by input suppliers, when transaction-specific physical and human capital assets, with low or scrap value in second best uses, are present.

Arm’s-length markets also fail to secure the full value of the firm’s tangible and intangible assets (ownership advantages or capabilities), including product and process technology, network co-ordination, work and managerial expertise, advertising, marketing and distribution sk...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Figures
• Tables
• Contributors
• Acknowledgments
• 1 Introduction
• Part I Theory and Measurement of FDI
• Part II Structural Issues Related to the Impact on FDI
• Part III Analytical and Policy Issues