Old wine in new bottles? Non-traditional sources of foreign direct investment

Maximiliano Sosa Andrés, Christiane Krieger-Boden, Peter Nunnenkamp 08 March 2012

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The share of developing and emerging economies in total outward FDI flows multiplied from a meagre 5% in 1990 to almost 30% in 2010 (Figure 1). The flows from the BRICS and other new sources proved to be stable when those from developed economies crashed by 50% due to the financial crisis in 2007–08.

Figure 1. FDI outflows by origin 1990–2010

Note: Emerging economies are defined here to include Argentina, Brazil, Chile, China, Colombia, Egypt, India, Indonesia, Korea (Republic), Malaysia, Mexico, Peru, Philippines, Russia, South Africa, Taiwan China, UAE.

Source: UNCTAD.

Non-traditional sources of FDI have therefore become increasingly important, even though developed source countries may regain some ground after overcoming the financial crisis. The rise of new foreign investors not only involves competitive challenges for established investors from the most advanced countries, however; it may also be hugely important for the host countries of FDI, by providing better chances to attract more FDI and to diversify between different sources. Even prominent critics of globalisation, including Joseph Stiglitz, largely agree that FDI could bring considerable benefits to the host countries. Developing countries may find FDI from emerging markets particularly attractive as it is widely believed to be better adapted to local conditions. Hence, it could be especially those host countries that had been sidelined by direct investors from the most advanced countries which can now benefit from non-traditional FDI flows.

This leads to the question of whether foreign direct investors based in emerging markets and developing countries behave differently from traditional investors. No doubt, FDI from emerging and developing economies requires the same three basic preconditions, stressed by the late John Dunning, to make it worthwhile at all:  specific ownership advantages on the side of the investing firm as push factors, specific locational advantages on the side of the potential host country as pull factors, and a clear advantage of internalising trade relations within the investing firm. However, the relative importance of certain push and pull factors of FDI flows may differ between non-traditional and traditional sources.

Previous literature invites some specific hypotheses on the determinants of FDI, notably as concerns South-South flows to other developing countries. Hypotheses 1 and 2 address the push factors of FDI:

Hypothesis 1: The argument that non-traditional investors offer technologies and products “especially well suited to the needs of other developing countries” (Wells 1983: 3) implies that FDI is more likely to locate in the closer neighborhood with a familiar socioeconomic environment. UNCTAD (2006) considers most multinationals based in developing and transition economies to be regional players. Distance can thus be expected to discourage FDI flows from non-traditional sources more strongly than FDI from traditional sources.

Hypothesis 2: Also, it is expected that investors from non-traditional sources might be more familiar with political uncertainty and economic instability prevailing in developing countries. This could render them less risk-averse than investors from traditional sources.

Hypotheses 3 to 6 concern the pull factors of FDI that are related to the specific advantages offered by the potential host country:

Hypothesis 3: Survey results typically suggest that accessing foreign markets represents the most important motive of FDI –  whatever the source country might be (eg, UNCTAD 2006). Consequently, the market size of the host country is generally expected to be a relevant pull factor. Nevertheless, market size could have a weaker impact on investors from non-traditional sources. The intra-regional focus implies that they often locate where the local purchasing power is still relatively small. Moreover, adapted technologies do not require large-scale operations.

Hypothesis 4: Cost-oriented (or vertical) FDI should figure more prominently for multinational enterprises based in traditional source countries where wage costs are higher than in less advanced source countries. Yet cost advantages might be expected to spark FDI flows from non-traditional sources, too. Wells (1983) observed that export-oriented firms sought lower wages than prevailing in their home countries already during the first wave of ‘new’ FDI. More recently, Taiwanese FDI in mainland China provides a case in point.

Hypothesis 5: A particularly vivid discussion has unfolded over natural resources such as oil as a pull factor of FDI flows. Emerging countries have been suspected of seeking access to, perhaps even dominance over, scarce raw materials via FDI, primarily in poor African countries. However, the prominence of resource-seeking FDI seems to be limited to a few countries such as China and to the more recent past. Therefore, resource-seeking FDI is unlikely to constitute a particularly large share in the FDI portfolio of non-traditional investors.

Hypothesis 6: Apart from South-South FDI flows, another type of FDI may flow from relatively poor source countries to richer countries. Asset-seeking FDI provides a means to acquire superior foreign technology. Some authors spot signs of a new wave of asset-seeking FDI from emerging markets in developed host countries. Its quantitative importance, however, is likely to be limited as long as many non-traditional source countries have insufficient capabilities to absorb superior technology.

In sum, no consensus has emerged from the literature in how far motives for FDI flows from non-traditional sources differ from those from traditional sources. Some authors claim that the recent surge in South-South FDI flows is due to similar factors as the previous rise in North-South FDI flows, and that new investors from at least some emerging source countries are becoming increasingly similar to traditional investors. Other authors (eg, Alan Rugman) doubt that many firms based in emerging economies are “truly internationalised”. So far, however, systematic empirical evidence on similarities and differences has been lacking.

In a recent paper (Andrés et al 2012), we look for exactly this kind of evidence. We estimate a gravity model on bilateral FDI flows featuring all the above-mentioned determinants. We perform Logit and Poisson Pseudo Maximum Likelihood estimations including fixed effects and covering the period from 1978 to 2004. The sample includes more than 110 host countries and 29 source countries, the latter covering the major developed economies plus Argentina, Brazil, Chile, Colombia, Republic of Korea, Malaysia, Mexico, China Taiwan, Thailand, Turkey, and Venezuela as representatives of the emerging economies. Due to insufficient data, China, India, and Russia are not included as source countries, however.

The results from our paper put the widely perceived distinctiveness of non-traditional FDI into perspective. In particular, this applies to the hopes related to FDI from ‘new’ sources. A major result is that various host countries will find it as difficult to attract FDI from non-traditional sources as before from traditional sources. There is strong empirical support for the hypothesis that direct investors based in emerging markets are even more reluctant than their peers based in developed countries to engage in distant host countries (Hypothesis 1). This holds for both stages of location choice, ie, the decision to undertake any FDI at all as well as the decision on the amount of FDI in host countries. Accordingly, investment promotion agencies are well advised to target new sources of FDI in the closer neighbourhood.

The evidence on the pull factors for FDI is ambiguous. Large and growing local markets are no less attractive for FDI from non-traditional sources than for FDI from traditional sources (Hypothesis 3). This suggests that the chances are slim for small host countries with limited purchasing power to attract new investors from emerging economies. This conclusion is corroborated by particularly strong agglomeration effects on FDI from non-traditional sources. Also, cost savings do not only motivate FDI flows from the most advanced source countries, even though the impact on FDI amounts tends to be weaker for non-traditional sources (Hypothesis 4).

Our paper rejects popular concerns about the resource-seeking motive of FDI from emerging economies (Hypothesis 5). In contrast to widespread belief, the endowment of host countries with raw materials proves to be of minor importance for FDI from non-traditional sources, compared to FDI from traditional sources. In other words, it is not only resource-rich countries that have favourable chances of attracting FDI from non-traditional sources.

Also, there is little evidence on asset-augmenting motives for new FDI flows (Hypothesis 6). Asset-augmenting FDI may figure more prominently in the future, however, once non-traditional source countries are less constrained in absorbing superior technologies available in more advanced host countries. A few large spectacular acquisitions of European and US firms by investors from emerging markets (eg, the acquisitions of Arcelor by Mittal in the steel industry and IBM’s PC business by Lenovo) seem to indicate a move into that direction.

Perhaps most striking, however, is that the findings from our paper contradict the view of non-traditional investors being less risk averse than their peers based in advanced source countries (Hypothesis 2). In other words, any hope is misguided that the familiarity of non-traditional investors with macroeconomic instability, political uncertainty, and corruption at home would make them less sensitive to such risk factors. Consequently, host countries are well advised to stabilise their economies and to contain political uncertainty by institutional reforms and better governance. Any deviation from that path might not only deter traditional investors but also investors from emerging markets, and the chances of spreading the benefits of FDI across a wider spectrum of developing countries would remain slim.

References

Andrés, Maximiliano Sosa, Peter Nunnenkamp, and Matthias Busse (2012), “What drives FDI from non-traditional sources? A comparative analysis of the determinants of bilateral FDI flows”, Kiel Working Paper 1755, Kiel institute for the World Economy.

UNCTAD (2006). World Investment Report 2006. FDI from Developing and Transition Economies: Implications for Development. New York and Geneva (United Nations).

Wells, Louis T, Jr (1983), Third World Multinationals: The Rise of Foreign Investment from Developing Countries, Cambridge: MIT Press.

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Topics:  Development International finance

Tags:  FDI, emerging economies, developing economies

Senior Analyst, Towers Watson

Researcher, Kiel Institute for the World Economy

Senior Economist, Kiel Institute for the World Economy

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