FDI Policy,Greenfield Investment and Cross‐border Mergers

This paper examines a multinational's choice between greenfield investment and cross‐border merger when it enters another country via foreign direct investment (FDI) and faces the host country's FDI policy. Greenfield investment incurs a fixed plant setup cost, whereas the foreign firm obtains only a share of the joint profit from a cross‐border merger under the restriction of the FDI policy. This trade‐off is affected by market demand, cost differential, and market competition, among other things. The host country's government chooses its FDI policy to affect (or alter) the multinational's entry mode to achieve the maximum social welfare for the domestic country. We characterize the conditions shaping the optimal FDI policy and offer intuitions on FDI patterns in developing and developed countries.     

How Does Foreign Direct Investment Really Affect Developing Countries' Growth?

Two main contributions to literature on foreign direct investment (FDI) and economic growth are made in this paper. First, the paper examines the effect of FDI on economic growth for 44 developing countries using heterogeneous panel cointegration techniques that are robust to omitted variables and endogenous regressors. The main result is that FDI has, on average, a negative effect on growth in developing countries, but there are large differences in the effect across countries. Second, a general‐to‐specific model‐selection approach is used to systematically search for country‐specific factors explaining the cross‐country differences in the growth effects of FDI. The results suggest that the cross‐country heterogeneity in the growth effect of FDI can be explained mainly by cross‐country differences in freedom from government intervention, business freedom, FDI volatility, and primary export dependence.     

The impact of foreign direct investment on the relative return to skill

Since the early 1980s, China has adopted favourable economic policies to attract FDI in order to facilitate technology development. Since inward FDI induces either sector‐ or factor‐biased technical progress, the impact of FDI on the distribution of income between skilled and unskilled labour is not trivial. This paper introduces vertical product differentiation to analyze the impact of FDI on the return to skill and concludes that, for a labour abundant country, this impact depends on whether the FDI‐induced technology transfer is skill‐ or labour‐biased, regardless of which sector receives FDI. The analysis shows that FDI with relatively labour‐biased technology will decrease the wage gap while FDI with relatively skill‐biased technology will increase the profit margin of the host country’s exports as well as its wage gap. The findings provide policy insights for FDI recipient countries in balancing wage growth between skilled and unskilled workers by managing inward FDI with relatively labour‐biased and skill‐biased technologies. This is particularly important for China given the expected further increase of inward FDI following its imminent membership of the WTO. JEL classification: F23, J31, P33.     

Hunting High and Low for Vertical FDI

Recently the horizontal and vertical models of foreign direct investment (FDI) have been synthesized into the knowledge‐capital (KK) model. Empirical tests, however, find that the horizontal model cannot be rejected in favor of the KK model. I suggest this is because the empirical specifications are too restrictive for vertical FDI to manifest itself. Using an alternative specification, I find evidence of vertical FDI. In particular, when I use the stock of FDI I can reject the horizontal model in favor of the knowledge‐capital model and identify countries for which FDI is dominated by vertical investment.     

FOREIGN DIRECT INVESTMENT IN A TWO‐TIER OLIGOPOLY: COORDINATION,VERTICAL INTEGRATION,AND WELFARE*

We study foreign direct investment (FDI) by two independent investors/entrants into a two‐tiered oligopolistic industry. An FDI subsidy at a single stage of production can be sufficient to resolve the coordination problem facing investors thereby inducing entry at both stages. However, due to linkage offsetting, FDI at both stages may yield lower domestic welfare than FDI at a single stage. Vertical integration not only solves the coordination problem, it also eliminates double marginalization. But since the integrated multinational does not sell the intermediate to local firms, its entry generates no vertical linkages and can yield lower welfare than FDI by independent firms.     

Shouldn't Physical Capital Also Matter for Multinational Enterprise Activity?

The foreign direct investment (FDI) literature has generally failed to find strong systematic evidence of “vertical” motivations in bilateral aggregate FDI and foreign affiliate sales (FAS) data, despite recent evidence of vertical FDI in firm‐level data. Moreover, a Bayesian analysis of the empirical determinants of FDI (and FAS) flows reveals that the parent country's physical capital per worker has a strong positive effect on FDI alongside typical gravity‐equation variables; however, this variable is ignored in the knowledge‐capital (KC) model and most empirical work. We address these two puzzles by introducing relative factor endowment differences into the three‐factor, three‐country knowledge and physical capital extension of the 2 × 2 × 2 KC model. Using a numerical version of our model, we show that horizontal and vertical multinational enterprises' (MNEs') headquarters surface in different parts of the Edgeworth box relating the parent country's skilled labor share relative to its physical capital share (of the parent's and host's endowments). The key economic insight is that horizontal MNE headquarters will be relatively more abundant than vertical MNE headquarters in countries that are abundant in physical capital relative to skilled labor, because of the multi‐plant (single‐plant) structure of horizontal (vertical) MNEs—assuming plants (headquarters) use physical capital (skilled labor) relatively intensively in their setups. The theoretical relationships suggest augmenting empirical FAS gravity equations with (polynomials of) the parent's skilled labor share alongside the parent's physical capital share to explain in aggregate bilateral data the coexistence of horizontal and vertical FAS. The theoretical and empirical results shed light on the positive effect of parent's physical capital share on FAS flows, but also suggest that MNE headquarters may be prominent in parent countries with relatively high and low skilled labor shares—once physical capital is accounted for—a result not suggested by the two‐factor KC model.     

The (Im)possibility of Distinguishing Horizontal and Vertical Motivations for FDI

Skill differences between parent and host countries are considered a key variable for distinguishing horizontal and vertical motivations within aggregate foreign direct investment (FDI). This paper tests the robustness of the skill difference term in the knowledge‐capital model for FDI in a sample of Organisation for Economic Co‐operation and Development (OECD) countries. The evidence in this paper indicates that skill differences per se do not properly explain FDI: the skill level of the host country is also important. This paper argues that both horizontal and vertical FDI may increase in the skill level of the host. It follows that the distinction between vertical and horizontal motivations for FDI with respect to skills is less straightforward than generally assumed in the literature.     

FDI Location and the Relevance of Spatial Linkages: Evidence from Provincial and Industry FDI in China

In this study both aggregate and industry‐level foreign direct investment (FDI) data are employed to investigate the spatial dependence of FDI hosts. The analysis contributes to the existing literature by focusing on the heterogeneous spatial correlation of FDI in different industries. Using more comprehensive FDI data across multiple industries and multiple provinces in China from 1999 to 2007, the results show a significant spatial correlation among provinces. Aggregate FDI tends to be regional trade platform oriented indicating neighboring provinces become competitors for FDI. In contrast, results based on industry‐level provincial FDI show stronger support for vertical or complex vertical FDI.     

Foreign Direct Investment: Flows,Volatility, and the Impact on Growth*

This paper contributes to the literature on FDI and economic growth. We deviate from previous studies by introducing measures of the volatility of FDI inflows. As introduced into the model, these are predicted to have a negative effect on growth. We estimate the standard model using cross‐section, panel data, and instrumental variable techniques. Whilst all results are not entirely robust, there is a consistent finding that volatility of FDI has a negative impact on growth. The evidence for a positive effect of FDI levels on growth is not robust, nor is that for any effect of human capital.     

Fire‐sale FDI? The Impact of Financial Crises on Foreign Direct Investment

We analyze the evolution of foreign direct investment (FDI) inflows to developing and emerging countries around financial crises. We empirically examine the Fire‐Sale FDI hypothesis and describe the pattern of FDI inflows surrounding financial crises. We also add a more granular detail about the types of financial crises and their potentially differential effects on FDI. We distinguish between mergers and acquisitions (M&A) and greenfield investment, as well as between horizontal (tariff jumping) and vertical (integrating production stages) FDI. We find that financial crises have a strong negative effect on inward FDI in our sample. Crises are also shown to reduce the value of horizontal and vertical FDI. We do not find empirical evidence of fire‐sale FDI; on the contrary, financial crises are shown to affect FDI flows and M&A activity negatively.     

Foreign direct investment and inequality in developing countries: Does sector matter?

Scholars have studied the relationship between inward foreign direct investment (FDI) and within‐country income inequality in cross‐national contexts, but have not empirically investigated how FDI in different sectors might affect inequality in different ways. We use error correction models to analyze sectoral FDI data compiled from UNCTAD investment reports in 60 middle‐income countries from 1989 to 2010, arguing that FDI in services is more likely to be associated with inequality than FDI in other sectors. We argue that skill biases and changes in employment patterns associated with service sector investments can help explain these findings.     

Institutional Efficiency,Monitoring Costs and the Investment Share of FDI*

This paper models and tests the implications of institutional efficiency on the pattern of FDI. We posit that domestic agents have a comparative advantage over foreign agents in overcoming some of the obstacles associated with corruption and weak institutions. Under these circumstances, FDI is more sensitive to increases in enforcement costs. We then test this prediction, comparing institutional efficiency levels for a large cross‐section of countries in 1989 to subsequent FDI flows through the period of 1990–99, finding that institutional efficiency is positively associated with the ratio of subsequent foreign direct investment flows to both gross fixed capital formation and to private investment.     

Skill Upgrading and Production Transfer within Swedish Multinationals

This paper studies the link between production transfer within Swedish‐headquartered multinational enterprises (MNEs) in the manufacturing industry and skill upgrading in their parent companies in the 1990s. The analysis distinguishes between horizontal and vertical foreign direct investment (FDI). The increased employment share in the affiliates in non‐OECD countries (vertical FDI) has a non‐trivial, significantly positive effect on the share of skilled labor in the Swedish parents. On the other hand, the parents’ skill upgrading is unrelated to employment changes in their affiliates in other OECD countries (horizontal FDI). This is consistent with implications of the newly developed horizontal MNE models.     

Foreign entrants and domestic entrepreneurship: Evidence from Vietnam

This paper examines the impacts of foreign entrants and international trade on potential entrants in Vietnam. Based on a discrete entry model, estimates show that foreign direct investment (FDI) stimulates more domestic entrants in the short run, while the aggregate effect of FDI varies across FDI types. Horizontal FDI tends to have no impact on local start‐ups while vertical FDI is found to have a positive impact on the inflow of domestic entry for only the backward linkage and not for the forward linkage. Moreover, industries with more exports accommodate more domestic entrants, whereas imports tend to deter domestic start‐ups.     

International Factor Mobility,Wages and Prices

This paper analyzes the joint influence of migration inflows and outward foreign direct investment (FDI) on wage bargaining. Labor migration and offshoring supported by FDI affect wage deals by changing the outside options of workers and firms. Unemployed workers may find alternative jobs either in the legal or in the illegal labor markets. Wages in this latter case are highly affected by migrants crowding this segment more than any other market. Firms may have the option of moving production partly or entirely to foreign low‐cost countries. A wage curve is designed theoretically, reflecting cross‐border labor and capital mobility, and estimated on panel data for 13 European countries over the period 1995–2013. The theoretical predictions of a joint negative effect on wages of FDI outflows and labor migration inflows are confirmed with some novel results.     

How does foreign direct investment affect economic growth in China?

How does inward foreign direct investment (FDI) affect a transitional economy? This study attempts to analyze the role of FDI in China’s income growth and market‐oriented transition. We first identify possible channels through which FDI may have positive or negative effects on the Chinese economy. Using a growth model and cross‐section and panel data for the period 1984‐98, we provide an empirical assessment, which suggests that FDI seems to help China’s transition and promote income growth, and that this positive growth effect seems to rise over time and to be stronger in the coastal than the inland regions. JEL classification: F21, F23, O53.     

Foreign direct investment,growth and income inequality in less developed countries

How does foreign direct investment (FDI) affect economic growth in less developed countries (LDCs)? What is its association with changes in the income distribution? This paper empirically examines these issues within a cross section of less developed countries between 1970 and 1989. FDI is positively associated with economic growth within this sample of countries. However, there is no strong association between FDI and changes in income inequality within these same countries and over this same time period. Hence, there is no evidence that FDI is increasing income inequality within this group of LDCs.     

Investment abroad and labour adjustment at home: evidence from UK multinational firms

Abstract. This paper provides new evidence on the effects of overseas FDI on the skill‐mix of multinational firms’ home‐country operations. The analysis exploits China's WTO accession to identify the impact of outward investment into a low‐wage economy and uses plant‐level data to investigate changes in industrial structure within firms driven by plant closures. As predicted by models of vertical FDI, the paper demonstrates that overseas investment in low‐wage economies is associated with asymmetric effects on workers in low‐ and high‐skill industries in the home economy and, in particular, with firms closing down plants in low‐skill industries. JEL classification: F2     

FDI and pollution havens: Evidence from the Norwegian manufacturing sector

This is an empirical study of the firm and country determinants of foreign direct investment (FDI) and how it is affected by the stringency of environmental regulations in host countries. We employ disaggregated data on sales by Norwegian multinationals' affiliates from 1999 to 2005 that allow such affiliates to be categorized as either efficiency-seeking (vertical) or market-seeking (horizontal) FDI. While the environmental stringency of a host country and its enforcement are found to have no effect on the average investment, we find a significant negative effect on multinationals with vertical motives. Compared to those located in lenient countries, the efficiency-seeking affiliates in more environmentally regulated countries receive less investment from their parent companies in terms of (i) equity capital, (ii) capital stock, and (iii) assets. We further find that the total exports from affiliates to parent companies in Norway decrease with the level of enforced environmental stringency in the host countries.     

What drives German foreign direct investment? New evidence using Bayesian statistical techniques

Despite the importance of Germany as an issuer of foreign direct investment (FDI), the studies analyzing its determinants are far from conclusive. This research contributes to filling this gap providing new evidence for the period 1996–2012. In order to reduce model uncertainty, we adopt a Bayesian model averaging (BMA) approach. We find that determinants associated with horizontal FDI appear to be dominant for explaining FDI in developed countries while for the group of developing countries covariates associated with vertical FDI motives play a larger role. Within Europe, while the majority of FDI is horizontally driven in “core” countries, in the “periphery” vertical motivations seem to prevail. Moreover, our results are compatible with more complex FDI models where vertical determinants and institutional variables are gaining prominence as does the leading role currently played by Germany in global value chains (GVC). Our results may provide hints for policymakers’ strategies to attract German investment.