Role of Home Country Determinants in Outward Foreign Direct Investment.
| Author | Das, Minakshee |
Introduction
Data compiled by the United Nations Conference on Trade and Development (UNCTAD) (10 reveals that the emerging-market and developing economies which were previously mere recipients of foreign direct investment (FDI) have become the forerunners in investing abroad in recent years. The bulk of FDI outflows over the past four decades have originated from advanced economies (Fig. 1). However, since 2001the pace of outflows from advanced economies has slowed sharply (Table 1). At the same time, from a rather low base, FDI outflows from emerging-market and developing economies have increased steadily and the pace has exceeded that of outflows from advanced economies. Since 2011, all the country groups (advanced, emerging-market, developing and transition economies) have experienced negative annual growth in FDI outflows.
The growing participation of emerging-market and developing economies in FDI inflows and outflows can be attributed to the gradual liberalization of the capital accounts, deregulation and market opening mechanisms. This transformation is explained by Dunning's "investment development path (IDP) " paradigm which stipulates that there is a close association between capital flows of a country and its level of economic development (Dunning, 1981). The basic theoretical approach of the IDP theory is that with increasing economic growth and development, a country's net outward investment (NOI, which is defined as the difference between outward direct investment stock and inward direct investment stock) undergoes different stages of progression, from the initial one where the country is a receiver of capital inflows, to a matured one where the country becomes a both receiver and investor of capital flows.
This paper fills two gaps in the extant state of knowledge. First, the original IDP framework is tested and later the framework is expanded by incorporating major institutional and macroeconomic factors that enhance outward FDI (OFDI) from four major country groupings, namely: advanced, emerging-market, developing and transition economies. Secondly, policy implications are very important and will be discussed methodically because large amounts of OFDI may lead to a heavy flight of capital which can affect the home country adversely.
The Investment Development Path (IDP) Theory
The IDP theory which was introduced by Dunning (1981) and further refined by Dunning (1986, 1988, 1993, 1997), Dunning and Narula (1998), and Duran and Ubeda (2001, 2005) describes the behavior of a country's investment position by relating it to the country's level of economic development, which is usually proxied by Gross Domestic Product (GDP) per capita. The IDP theory postulates economic development as a succession of structural changes and contends that such economic and social transformations have a systematic relationship with the behavior of international capital flows.
The theory takes a dynamic and intertemporal approach within Dunning's (1977, 1998) eclectic paradigm of international production or the Ownership-Locational-Internalization (OLI) paradigm. The ownership (O) advantages include a firm's superiority over its competitors in terms of marketing practices or on the technological front. Basically, such firms have a competitive advantage on their patents, licenses and in their access to raw materials and/or markets. The locational (L) advantages relate to the factors that increases the host country's attractiveness for FDI: for instance, geographical proximity, labor force skill levels, lower wages relative to productivity and better infrastructure. Finally, the internalization (I) advantages relate to the production activities undertaken by the firm itself rather than licensing/franchising them to another party.
The relationship between inward FDI (IFDI) and OFDI and stages of economic development is presented in diagrammatic form in Fig. 2 and in tabular form in Table 2.
Thus, the crux of IDP theory is that the shape and position of the IDP varies widely across individual countries as a result of specific economic structures (market size, availability of natural resources), the type of FDI undertaken and government policies. In other words, individual countries show their own sub-patterns of inward and outward investment, depending on, among others, the way in which economic activities are organized (Narula, 1996). Hence, it is very important to realize that the IDP of individual countries may be unique.
Literature Overview
Most of the empirical studies have given greater emphasis on the advanced economies, their graphical interpretation and to the conventional econometric IDP model. The qualitative and quantitative studies, particularly in the context of emerging-markets, developing and transition economies remain sparse. A comparison of their findings has received limited attention.
Some of the quantitative works on both the conventional and augmented IDP theory are summarized in Table 3.
Equation (1) was the first econometric model introduced by Dunning (1981). He analyzed 67 developed and developing countries' NOI covering the period 1967-1975. NOI is the net outward investment position measured by the difference of annual per capita outward and inward FDI stocks. GDP is the gross domestic product measured in real terms. and i is a regression error term.
[NOI.sub.i]= [alpha] + [beta][GDP.sub.t]+ [gamma][GDP.sup.2.sub.t] + [[mu].sub.t] (1)
Dunning (1981) found that GDP and squared-GDP were respectively, negatively and positively related to NOI, and both the explanatory variables were statistically significant. This suggests a U or J-shape relationship between a country's economic development and its net outward position.
Distinctive Nature & Criticism of IDP Theory
The IDP paradigm has its shortcomings. Dunning & Narula (1996) acknowledged that patterns of IDP have changed since 1980s. Cantwell & Narula (2003) noted that firms of some countries proceed directly to OFDI by skipping the exporting phase. In effect, some IDP stages may be skipped, specially by leapfrogging globals (7). For instance, Kuada& Sorensen (2000) found that Ghana has gone through the development stages without engaging in international activities. Erkilek (2003) argues that Turkey engaged in a lot of OFDI flows not because of L-advantages but due to political and economic factors. He noted that economic liberalization stimulated OFDI, as a result of which some of the stages of IDP paradigm may be skipped. This is known as accelerated IDP, and is usually found in cases of leapfrogging globals, where firms are anxious to escape the structures of local markets(Svetlicic, 2003). Das (2013) and Stoain (2013) argue that the IDP theory takes for granted that the underlying economic forces work in a certain pattern, and that inclusion of institutional factors would increase the explanatory power of the IDP theory.
The World Investment Report (2006) compiled by UNCTAD used the IDP theory to analyze the emergence of MNEs from developing and transition economies. Though the empirical evidence supported the IDP paradigm, there were some incongruities as well. Many developing countries, such as Brazil, China, India, Mexico, South Africa and Turkey, which are home to leading MNEs and are investing significant amounts of FDI overseas, are actually at stages I and II of the IDP; and they have therefore begun outward FDI earlier than might be expected on the basis of the IDP.
New Approach to IDP Model
Duran & Ubeda (2001) pointed out some methodological flaws in the traditional IDP model, and proposed a new approach, summarized in Table 4.
Firstly, Duran & Ubeda (2001) noted that NOI (OFDI stock minus IFDI stock) fails to be the best indicator to analyze the effect of structural changes on IFDI and OFDI. For instance, in both the first stage of IDP (very small amount on IFDI and zero amount of OFDI) and fifth stage of IDP (with high level of both IFDI and OFDI), NOI is close to zero. Additionally, an increase in NOI, usually interpreted as increased competitiveness of the economy, can also be due to a disinvestment process in the country (i.e. significant decrease of IFDI stock) in response to a deterioration of its investment environment. While doing statistical analysis, the above-mentioned problems can be taken care by using stocks of both IFDI and OFDI in both absolute and relative terms.
Secondly, GDP per capita by itself is an inadequate variable to explain a country's level of economic development because the economic structures and foreign investment structures of countries can be significantly different at the same level of GDP per capita. In order to deal with this problem and capture the country specific peculiarities in addition to the level of economic development, Duran & Ubeda (2001) proposed the idea of adding more structural variables, like gross capital formation per capita, gross enrolment ratio in secondary school and universities, number of scientists and engineers in R& D or health expenditure. They also stated that apart from economic development, foreign investors also study the political stability, endowments (human capital & natural resources) and infrastructure before entering the market.
Thirdly, the quadratic specification in Equation 1 suggested by Dunning (1981) was not enough to assess IDP empirically. Narula (1996) argues that the relationship between GDP and NOI shows different forms if the sample of countries varies (8) and problem of heteroscedasticity arises, as developing countries show a greater variance of errors. Given the drawbacks of the econometric model, an alternative multivariate analysis was proposed that combined three complementary tools:(i) a factor analysis to test if there is (or not) a relationship between the variables that explain the degree of economic development and IFDI and OFDI stocks, which is the essence of IDP; (ii) a cluster analysis to country groups along the...
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