What is FDI?explain with example?

FDI stands for Foreign Direct Investment.

Foreign direct investment (FDI) is the movement of capital across national frontiers in a
manner that grants the investor control over the acquired asset. Thus it is distinct from
portfolio investment which may cross borders, but does not offer such control

Consistent economic growth, de-regulation, liberal investment rulse, and operational

flexibility are all the factors that help increase the inflow of Foreign Direct Investment or
FDI.

FDIs require a business relationship between a parent company and its foreign subsidiary.
Foreign direct business relationships give rise to multinational corporations. For an
investment to be regarded as an FDI, the parent firm needs to have at least 10% of the
ordinary shares of its foreign affiliates. The investing firm may also qualify for an FDI if
it owns voting power in a business enterprise operating in a foreign country.

Foreign direct investment (FDI) in its classic definition, is defined as a company from
one country making a physical investment into building a factory in another country. Its
definition can be extended to include investments made to acquire lasting interest in
enterprises operating outside of the economy of the investor.[1] The FDI relationship
consists of a parent enterprise and a foreign affiliate which together form a Multinational
corporation (MNC). In order to qualify as FDI the investment must afford the parent
enterprise control over its foreign affiliate. The UN defines control in this case as owning
10% or more of the ordinary shares or voting power of an incorporated firm or its
equivalent for an unincorporated firm; lower ownership shares are known as portfolio
investment..

FDI is invetment by foreign entity in which they invest in a country through

physical means.
by Physical means i mean they FDIs can buy some physical property either through
aquisition or buying some stack in the company.
 WHAT IS FOREIGN DIRECT INVESTMENT OR FDI?
1. INTRODUCTION
FDI occurs with the purchase of the “physical assets or a significant
amount of ownership (stock) of a company in another country in order
to gain a measure of management control.”
FDI is distinguished from portfolio investment that does not involve
obtaining a degree of control in a company.
Internationally, FDI inflows are counted from 10% stock or asset
ownership in a company.
FDI may take the form of “greenfield” projects or…
FDI is also often accomplished through “merger and acquisition”
activities or through international franchising.
FDI is especially critical in both emerging and transition economies.
FDI helps to answer the question:
“How do you create capitalism in a nation where there are neither
capitalists nor capital?”
2
 2. WHY DO COMPANIES ENGAGE IN FOREIGN DIRECT
INVESTMENT?
1. Gain a foothold in a new geographic market;
2. Increase a firm’s global competitiveness and positioning;

3. Fill gaps in a company’s product lines in a global industry;

4. Reduce costs in such areas as R&D, production, and distribution.

3
3. FDI may be easier to attract because of the existence of the following
factors:
• LOW COST BUT QUALIFIED, EDUCATED/SKILLED LABOR
POOL
• LONG-TERM MARKET POTENTIAL OR YIELDS GREATER
THAN CAN BE ACHIEVED DOMESTICALLY
• ACCESS TO NATURAL RESOURCES
• GEOGRAPHY
• STABILITY OF THE ECONOMIC AND POLITICAL
ENVIRONMENT

4
4. FDI: POSITIVES AND NEGATIVES
POTENTIAL POSITIVES:
• INCREASE IN DOMESTIC EMPLOYMENT/DROP IN
UNEMPLOYMENT
• INVESTMENT IN NEEDED INFRASTRUCTURE (THROUGH
EITHER BOOs OR BOTs)
• POSITIVE INFLUENCE ON THE BALANCE OF PAYMENTS
• DEVELOPMENT OF DOMESTIC SUPPLIERS
• NEW TECHNOLOGY AND “KNOW HOW” TRANSFER
• INCREASED CAPITAL INVESTMENT
• TARGETED REGIONAL AND SECTORAL DEVELOPMENT

POTENTIAL NEGATIVES:
• INDUSTRIAL SECTOR DOMINANCE IN THE DOMESTIC
MARKET
• TECHNOLOGICAL DEPENDENCE ON FOREIGN
TECHNOLOGY SOURCES
• DISTURBANCE OF DOMESTIC ECONOMIC PLANS IN
FAVOR OF FDI-DIRECTED ACTIVITIES
• “CULTURAL CHANGE” CREATED BY “ETHNOCENTRIC
STAFFING,” THE INFUSION OF FOREIGN CULTURE, AND
FOREIGN BUSINESS PRACTICES

5
5. WHAT ARE THE MOST IMPORTANT INVESTMENT FACTORS
IN SUCCESSFUL FDI ACTIVITIES?
• FEW RESTRICTIONS ARE PLACED ON INVESTMENTS OR
THE REPATRIATION OF CURRENCIES
• DECLINE OF THE “GOLDEN SHARE”
• NATIONS POSSESS A SOUND “COMPANY LAW,” AND
COMMERCIAL CODE
• NATIONS POSSESS TRANSPARENT CUSTOMS AND TARIFF
PROCEDURES
• THE ADOPTION OF A “PERCEIVED AS FAIR” AND
FAVORABLE TAX CODE (OFTEN WITH INCENTIVES)
• POLITICAL/ECONOMIC STABILITY
• SIZE OF THE DOMESTIC MARKET
• LACK OF CORRUPTION
• QUALITY OF LOCAL MANAGEMENT AND BUREAUCRACY
• AVAILABILITY OF LAND AND SUITABLE
INFRASTRUCTURE (ESPECIALLY
TELECOMMUNICATIONS, ROADS AND HIGHWAYS)

6
 6. WHAT IS THE ROLE OF A SPECIALIZED AGENCY DESIGNED
TO ATTRACT FDI?
1. Generate foreign investment activity and interest by identifying
suitable domestic partners;
2. Provide professional management assistance;
3. Point out specific FDI opportunities;
4. Create and foster a favorable domestic climate for FDI;
5. Monitor and report on FDI activities;
6. Provide necessary “market entry” data; and
7. Provide necessary information on taxation, administrative
regulations, and other legal and financial matters.

7
What Is FDI?
These three letters stand for foreign direct investment. The simplest explanation of FDI
would be a direct investment by a corporation in a commercial venture in another
country. A key to separating this action from involvement in other ventures in a foreign
country is that the business enterprise operates completely outside the economy of the
corporation’s home country. The investing corporation must control 10 percent or more of
the voting power of the new venture.

According to history the United States was the leader in the FDI activity dating back as
far as the end of World War II. Businesses from other nations have taken up the flag of
FDI, including many who were not in a financial position to do so just a few years ago.

The practice has grown significantly in the last couple of

decades, to the point that FDI has generated quite a bit of opposition from groups such as
labor unions. These organizations have expressed concern that investing at such a level in
another country eliminates jobs. Legislation was introduced in the early 1970s that would
have put an end to the tax incentives of FDI. But members of the Nixon administration,
Congress and business interests rallied to make sure that this attack on their expansion
plans was not successful.

One key to understanding FDI is to get a mental picture of the global scale of
corporations able to make such investment. A carefully planned FDI can provide a huge
new market for the company, perhaps introducing products and services to an area where
they have never been available. Not only that, but such an investment may also be more
profitable if construction costs and labor costs are less in the host country.

The definition of FDI originally meant that the investing corporation gained a significant
number of shares (10 percent or more) of the new venture. In recent years, however,
companies have been able to make a foreign direct investment that is actually long-term
management control as opposed to direct investment in buildings and equipment.

FDI growth has been a key factor in the “international” nature of business that many are
familiar with in the 21st century. This growth has been facilitated by changes in
regulations both in the originating country and in the country where the new installation
is to be built.

Corporations from some of the countries that lead the world’s economy have found fertile
soil for FDI in nations where commercial development was limited, if it existed at all.
The dollars invested in such developing-country projects increased 40 times over in less
than 30 years.

The financial strength of the investing corporations has sometimes meant failure for
smaller competitors in the target country. One of the reasons is that foreign direct
investment in buildings and equipment still accounts for a vast majority of FDI activity.
Corporations from the originating country gain a significant financial foothold in the host
country. Even with this factor, host countries may welcome FDI because of the positive
impact it has on the smaller economy.

Copyright © 2008 by Juan Alcacer and Paul Ingram

Working papers are in draft form. This working paper is distributed for purposes of comment and
discussion only. It may not be reproduced without permission of the copyright holder. Copies of working
papers are available from the author.

Spanning the Institutional

Abyss: The Intergovernmental
Network and the Governance
of Foreign Direct Investment
Juan Alcacer
Paul Ingram
Working Paper
09-045
Spanning the Institutional Abyss: The Intergovernmental Network
and the Governance of Foreign Direct Investment
Juan Alcacer
Harvard Business School
Soldiers Field Boston, Massachusetts 02163
[email protected]
Paul Ingram
Columbia Business School
Columbia University
712 Uris Hall
New York, NY 10027
[email protected]
August 22, 2008
Authors are listed in alphabetical order; contributions were equal. We are grateful to
Gordon Hanson, Ray Horton, Felix Oberholzer, Jordan Siegel, Dennis Yao and Bernard
Yeung for helpful comments on earlier drafts.
2
Spanning the Institutional Abyss: The Intergovernmental Network
and the Governance of Foreign Direct Investment
Global economic transactions such as foreign direct investment must extend over an
institutional abyss between the jurisdiction, and therefore protection, of the states
involved. Intergovernmental organizations (IGOs), whose members are states, represent
an important attempt to span this abyss. IGOs are mandated variously to smooth
economic transactions, facilitate global cooperation, and promote cultural contact and
awareness. We use a network approach to demonstrate that the connections between two
countries through joint-membership in the same IGOs are associated with a large positive
influence on the foreign direct investment that flows between them. Moreover, we show
that this effect occurs not only in the case of IGOs that focus on economic issues, but
also on those with social and cultural mandates. This demonstrates that relational
governance is important and feasible in the global context, and for the most risky
transactions. Finally we examine the interdependence between the IGO network and the
domestic institutions of states. The interdependence between these global and domestic
institutional forms is complex, with target-country democracy being a substitute for
economic IGOs, but a complement for social and cultural IGOs.
3
Recent decades have seen a substantial increase in economic transactions that span
national borders, a phenomenon known widely as economic globalization. As with
international interactions of all types, economic globalization presents intriguing
questions regarding governance. Theories of the governance of economic transactions
have been developed mostly in the domestic context. The state is always conspicuous in
these theories, as the ultimate institutional authority within a country, and therefore the
backbone of the relevant institutional framework, even when private institutions are
prominent in that framework. In stark contrast, there is no equivalent of the state to serve
as the ultimate authority over international transactions. In terms of extant accounts of
governance which depend on the state even if they don’t focus on it, such transactions
must cross an institutional abyss.
The bridges across this abyss are organizations, specifically multinational
corporations (MNCs) and intergovernmental organizations (IGOs). MNCs may subsume
international economic transactions within their bureaucracies when they operate
interdependent units in different countries. This phenomenon, called foreign direct
investment (FDI), is the fastest growing economic indicator of globalization. Between
1980 and 2003 the stock of FDI as a percentage of world GDP increased by 240%, much
faster than the trade to GDP ratio, which increased 22% over that period (Guillen, 2006).
The role of IGOs, which are organizations of states, is to provide international
institutional rules that may facilitate international surety, coordination and trust (Fligstein
and Stone-Sweet, 2002). In this paper we consider the interdependence between these
two forms of organizational governance by investigating how FDI extending from a
company based in one country to another country is affected by the connections between
4
the two countries forged by simultaneous joint membership in IGOs. In other words, the
phenomenon of MNCs investing in operations that span borders is our dependent
variable, and the network of IGO connections between countries is our main explanatory
variable.
Our approach is motivated by the recognition that FDI is at the same time a
solution to some of the challenges of governing international economic exchange, and a
source of unique governance problems. FDI enables some global transactions by
enfolding them in the organizational structures of MNCs, where bureaucratic rules and
policies may govern them. This role is particularly important to facilitate the transfer of
intangible assets, such as the knowledge or reputation of an MNC across borders (Teece,
1985; Carr, Markusen and Maskus, 2001). On the other hand, FDI creates and
exacerbates other governance problems because, relative to the alternative of trade, it
represents greater investments of capital and intangible assets by the company, and
therefore increases the risk. FDI also typically is accompanied by some (perhaps
temporary) transfer of workers between countries, which creates a type of transaction
cost which is typically absent in trade.
It is because FDI presents notable governance challenges that we ask what other
sources of institutional support may facilitate FDI. Here, we build on recent work that
has identified the network of bilateral connections forged by IGOs as an important
influence on the management of international relations of many types. Many IGOs exist
explicitly to promote collective global goals, such as peace and efficient trade. However,
it is only recently that evidence has begun to accumulate in support of the idea that they
contribute to these ends. The foundation for this new evidence is the recognition that
5
IGOs operate by forging a network of connections between countries, and infusing that
network with institutional content1. We show that when two countries become more
strongly connected through the IGO network, FDI flows between them increase.
Furthermore, our analysis indicates that it is not only connections through IGOs formed
for economic purposes that matter, but that connections through social and culture IGOs
also promote FDI. Social and cultural IGOs operate to promote familiarity, goodwill and
trust between nations, so our finding that they also promote FDI shows that social
mechanisms are also important for the governance of international economic transactions.
We further investigate the operation of IGOs to promote FDI by asking whether
IGO governance is more effective for some countries than others. The uneven flow of
FDI has been cited as a major inhibition to economic development. Indeed, in his
criticism of the failure of IGOs such as the IMF, World Bank and WTO to promote
development in poor countries, Stiglitz (2003:6) specifically cites the inability of African
countries to attract foreign investment as fundamental to the problem (see also Easterly,
2006). To explain country-variation, we analyze whether the efficacy of IGO
connections depends on the level of democracy in the target country. Democracy and the
democratic division of powers may allow target-country governments to credibly commit
to MNCs to protect their investments, and therefore may be a substitute for the
governance that IGO connections provide. Our results indicate that this substitution
between domestic and global institutions does in fact occur in the case of economic IGO
connections. Surprising to us, social/cultural IGO connections and target-country
1 The“network turn” of IGO analysis has recently yielded important evidence that IGOs influence
important bilateral outcomes such as the incidence of war (e.g., Russett and Oneal, 2001; Gartzke, 2002;
Hafner-Burton and Montgomery, 2006) and trade (Ingram, Robinson and Busch, 2005) and encourage the
production of global collective goods such as environmental sustainability (Ward, 2006).
6
democracy have the opposite interdependence: They complement rather than substitute
for each other.
The Challenge of International Economic Exchange
How different is international economic exchange from its domestic equivalent?
A telling result is Anderson and van Wincoop's (2003) finding that national borders
reduce trade between the US and Canada by about 40% and among other industrialized
countries by about 30%. By comparing the magnitude of border effects to those of
distance in gravity-models of trade, Helliwell (2002) concludes that the effect of a border
to discourage trade is equivalent to adding 10,000 miles of distance between the traders.
This equivalency is all the more impressive in light of the fact that effect of physical
distance to discourage trade is substantial, more than would be expected merely from
transportation costs.
The effect of borders to discourage trade derives from two sources. The first is
that (ideally) states provide institutions to facilitate economic exchange domestically, and
these institutions do not operate across borders because of the limitations on any one
state’s jurisdiction. The relevant institutions may be roughly divided into those that
provide surety and those that facilitate coordination. In the realm of surety, strong laws
that enforce contracts, protect property rights, and otherwise reduce transaction costs at
the domestic level enable exchange partners to credibly commit to future actions, and
reduce the risk of malfeasance (North, 1990). And while private actors also provide
surety for economic transactions, in doing so they typically depend on the background of
formal institutions of the state, as when private bargaining over contract disputes takes
7
place “in the shadow of the law” (Macauley, 1963) or when organizations that make
assurances, such as auditors, stock exchanges, and banks, rely on state regulation to
facilitate their own credible commitments. As for state institutions that facilitate
coordination, the most obviously relevant is the provision of a common currency, a
critical ingredient for smoothing exchange (Rose, 2001). Likewise, almost all states
support communications and travel within their borders, and provide exchange-relevant
standards (e.g., for measurement).
The second source of border effects is the distribution of social networks and
norms. Normative governance may facilitate exchange in markets where formal
institutions of the state are absent or insufficient. For example, DiMaggio and Louch
(1998) have shown that buyers in what might otherwise be “markets for lemons” (e.g.,
used cars) are particularly likely to transact with relatives. And Clay (1997) shows how
coalitions of merchants employing social sanctions facilitated trade in early 19th century
California, when there was no state enforcement of contracts. Of course, social relations
sometimes span national borders, but they are overwhelmingly more common within a
country. Gravity-model analyses of outcomes such as migration and telephone calls
show that there is a massive border effect for social relations as well as economic ones
(Rietveld and Janssen, 1990; Helliwell, 1998).
Although the evidence of border effects in global exchange has developed
through the analysis of trade, we expect that they are even more discouraging of FDI than
of trade. FDI avoids some of the challenges of international economic transactions, by
subsuming them within the organizational structure of a multinational firm. This is
particularly useful for transacting intangibles, such as knowledge or permission to use a
8
valuable brand. In many cases, communication mechanisms and intellectual property
rights are insufficient to allow such intangibles to be transferred across borders in any
other way than by a multinational company that extends its operations via FDI (Vernon,
1971). Even in the case of intangibles, however, some familiar border effects apply. In
particular, the internal operations of a multinational corporation cannot completely
resolve coordination problems because even thought the corporation may standardize
within, its various national operations must, in some ways, integrate with their local
environments.
There are also border effects that are unique to FDI, or worse in the case of FDI
than trade. Foremost among these is the exposure of investments in and profits from a
target country to some form of expropriation by the target-country government. Such
expropriations may range from the nationalization of a plant to a domestic legal change
that makes it more difficult for a multinational to extract profits from a target country.
Compared to trade, the exposure of FDI investments are notable because they are
typically larger, and they are mainly to the target-country government, rather than to
private companies that may be engaged in trade.
Culture is another barrier that is uniquely problematic for FDI. “Cultural
distance”, that is, the extent of differences between countries regarding important cultural
values, has been argued to discourage international transactions because it inhibits
communication and knowledge transfer (Siegel, Licht and Schwartz, 2006; Kogut and
Singh, 1988). Further, FDI, unlike trade and some other international transactions,
typically involves some transfer of persons. Employees of the multinational company
often relocate, even if temporarily, to the target country to set up operations, coordinate
9
with the parent firm, facilitate the transfer of intangible and tangible assets between the
parent firm and the FDI operation, and protect those assets. Thus, FDI between culturally
distant countries represents an added cost of submerging employees in a national
environment they may find confusing, stressful, or even hostile. At the least, this
increases concrete costs to the multinational due to premium pay and turnover. At the
most, firms may forego altogether some profitable FDI opportunities because the
prospect of “living there” is so unappealing to managers and other employees.
The Governance Role of IGOs
If border effects exist because the traditional bases of governance of
transactions—states and networks—are more relevant within than between countries, a
natural source of relief would be from institutional structures that are explicitly
international. There is no more likely candidate than the IGO, which is an organization
with three or more states as members. Prominent examples are the UN, the International
Monetary Fund (IMF), and the World Bank, but there are currently more than three
hundred IGOs operating in the world system. While the majority of IGOs receive little
public attention, all of them work to promote collective international goals, and many of
these are specifically aimed at smoothing global economic transactions. Many of these
efforts facilitate FDI.
The most heavy-handed FDI influence comes from IGOs such as the IMF and
World Bank, which encourage neo-liberal economic reforms. For example, Polillo and
Guillen (2005:1775) quote a letter of intent from the Indonesian government to the IMF
wherein the government reports amending the banking law to, among other things,
“permit major improvements in…openness to FDI.” Similarly, Henisz, Zelner and
10
Guillen (2005) show that pressure from the IMF and the World Bank increased
privatization and regulatory reform in telecommunications and electricity industries
around the world, opening the door to increased FDI in these important sectors. While
these studies expose a coercive element of some important IGOs to push neoliberal
policy on dependant countries, these same organizations promote less controversial
policies which may be even more important for FDI. Critical in this regard is the IMF’s
sponsorship of convertible currency. Its members agree to “promote international
monetary cooperation, exchange stability, and orderly exchange arrangements…(IMF,
2006).”
Some IGOs provide dispute resolution processes that may encourage MNC’s to
take the commitments of target governments as credible, and thereby reduce the
perception of risk associated with FDI. A sample of the IGOs that facilitate such credible
commitment includes the African Reinsurance Corporation, the European Court of
Justice, and the Permanent Court of Arbitration. Many other IGOs promote the
recognition and protection of property rights, among them the European Patent Office,
the International Patent Cooperation Union, and the World Intellectual Property
Organisation. Still others promote communication and standardization, including the
International Bureau of Weights and Measures, a number of postal unions, railway
congresses, aviation councils, information banks, and centers for statistics.
With so many IGOs so clearly aimed at reducing international transaction costs,
we might expect that their effect on FDI would already be well documented. In fact, we
are aware of only one analysis relevant to this question, that of Buthe and Milner (2005),
which looks at the effect of only one IGO (the GATT/WTO). More than that, until
11
recently there was very little evidence that IGOs promote economic outcomes of any
type.2 The previous failure to find evidence of IGO influence was probably due to
underattention
to the network structure through which IGOs operate. Earlier research focused
on the effects of membership of a single IGO. By focusing only on one IGO, previous
studies miss the interdependence of overlapping institutions and the complexity of dyadic
connections.
Recent research that specifies the influence of IGOs as working through mutliple
and simultaneous IGO memberships of countries, has documented substantial influence
of IGOs on a number of bilateral outcomes, including reduction in the incidence of war
(Hafner-Burton and Alexander, 2006), and increased trade (Ingram et al., 2005) and
environmental cooperation (Ward, 2006).
Similarly, we expect that connections through the IGO network are the best way
to operationalize the institutional governance that IGOs provide for FDI between two
states. This approach is aimed directly at capturing the dyadic nature of FDI. Often, a
given IGO is only useful for promoting FDI between two countries if both are part of the
IGO and therefore subject to its policies. This is obviously true in the case of IGOs that
promote coordination. It is also likely in the case of IGOs that promote FDI-friendly
reforms, which align the economic systems of rich members and poor ones. Moreover,
this approach recognizes institutional interdependencies across IGOs: investing in a
country may not depend on common membership in a single IGO, but in common
2 One notable exception is research in international economics, which has looked at the impact of
GATT/WTO membership on bilateral trade flows, with mixed results: Rose (2004) concludes that a
GATT/WTO connection does not promote trade, while Subramanian and Wei (2007) conclude it does and
estimate an increase in 120% of world trade due to GATT/WTO connectedness.
12
membership in a group of IGOs that complement and reinforce each other. Thus we
expect that
Hypothesis 1: FDI flows will be stronger between two countries when the connection
between them in the IGO network is stronger.
IGOs and Social Governance
The proceeding argument reflects the role of the many IGOs that aim explicitly to
smooth economic transactions (we will refer to these as economic IGOs, or EIGOs).
There are, however, a substantial number of IGOs that exist to promote social and
cultural cohesion between nations (social/cultural IGOs, or SCIGOs). The effect of
SCIGOs on FDI is also worth considering, particularly because cultural differences
between nations are an important impediment to FDI. If cultural distance inhibits FDI
(Kogut and Singh, 1988) and increases the failure risk of foreign ventures (Zaheer, 1995),
then SCIGOs that aim to close that distance, and reduce the “foreignness” of other
countries’ corporations, may produce FDI. Many SCIGOs encourage awareness through
cultural contact, such as as with the Asia-Europe Foundation, whose mission is “to foster
contacts and intercultural dialogue among people from all walks of life in Asia and
Europe” (www.asef.org), or the Bureau International des Expositions, which promotes
world fairs (www.bie-paris.org). Many other SCIGOs promote cohesion between the
peoples of two countries through the pursuit of shared goals, such as the eradication of
disease and the improvement of human rights.
The possibility that SCIGOs, and not only EIGOs increase FDI evokes the claim
from sociology’s theory of embeddedness that social relations between traders can be the
basis of trust, and therefore reduce transaction costs (Granovetter, 1985; Uzzi, 1996).
13
Greif (1989) provides historical evidence of the social governance of international
business by documenting the role of kinship in trading relations in the 11th century
Mediterranean region. Contemporary analyses have shown that there is more trade
between countries whose populations have more trust for each other (Guiso, Sapienza
and Zingales, 2004) and that bilateral connections through SCIGOs are associated with
higher trade (Ingram et al., 2005). And most directly, Bandelj (2002) shows that FDI is
more likely to flow to Central and Eastern European countries from investor countries
that had stronger cultural ties to the target countries, as indicated by historical
immigration. This evidence, combined with arguments that cultural differences are
particularly deleterious for FDI suggests that IGOs that promote social and cultural ends
may also affect this important economic outcome. Therefore we expect that
Hypothesis 2: FDI flows will be higher between countries that are more strongly
connected through SCIGOs, and not only through EIGOs.
IGOs and Domestic Institutions: Target Country Democracy
The most salient risk of FDI is that that government of the target country will
expropriate the profits from the investment, or even the investments itself (Li, 2006).
This can occur outright through nationalization, or if the government changes policies
regarding taxes, the repatriation of profits, or competition. These possibilities suggest
that the efficacy of IGO connections to promote FDI may depend on domestic institutions
in the target country. To put it simply, we suspect that IGOs will do more to promote
FDI for target countries whose domestic governments are unable to make credible
commitments to investing MNCs. In other words, we see IGO governance and domestic
institutions as potential substitutes.
14
The risk to an MNC’s investment in a target country is generally understood to be
higher when the political institutions of the target are more autocratic, because
democracies do a better job of ensuring that investments are secure (Olson, 1993).
Evidence from economic history supports the idea that absolute power reduces a
sovereign’s ability to make credible commitments to investors, and that the democratic
division of power increases that ability (North and Weingast, 1989). Li (2006) reports
that 564 expropriation acts in 56 developing countries between 1960 and 1995, only 59
occurred in democracies, and the level of democracy was negatively related to
expropriation in a multivariate regression. Buthe and Milner (2005) find that the division
of political powers increases the inflow of FDI to developing countries.
There are alternative arguments of the relationship between democracy and FDI.
Li and Resnick (2003) argue that democracies are more exposed to public demands for
the redistribution of capital, to demands for improved labor practices, and to arguments
by domestic competitors against advantageous competitive positions held by MNCs.
They find that after controlling for the democratic protection of property rights, the
residual effect of democracy is to reduce investment flows to developing countries.
These arguments, however, apply specifically to developing countries, where poverty is
highest and MNCs may be attracted by cheap labor and poorly regulated competition.
The fact remains that most FDI inflows are to developed countries (Guillen, 2006).
Further, previous analyses of the influence of democracy on FDI may have suffered from
misspecification, because they did not consider the simultaneous impact of IGO
connections
15
If democracies do indeed provide better surety for FDI, then the role of IGOs for
this purpose would presumably be smaller, suggesting that target-country democracy and
IGO connectedness will be institutional substitutes. This leads us to test the following
interaction hypothesis:
Hypothesis 3: Connections in the IGO network will do less to increase FDI to target
countries that are more democratic.
Method
We use gravity models to test our hypothesis. Gravity models, originally created
to explain bilateral trade flows, "have produced some of the clearest and most robust
empirical findings in economics" (Leamer and Levinsohn, 1999). The widespread
acceptance of gravity models in international economics has been reinforced by
continuous efforts to link them to different trade theories (Anderson, 1979; Bergrstrand
1989; Feenstra, Markusen and Rose, 2001, and Evenett and Keller, 2002) and by recent
econometric research that has improved their statistical reliability (Anderson and
Wincoop, 2003; Santos and Tenreyro, 2006). Based on their successful application in
the analysis of international trade, gravity models have also been applied to other dyadic
empirical contexts, such as migration flows (Heliwell, 1997), equity flows (Portes and
Rey, 2005), and FDI flows (Brenton et al. 1999; Brainard, 1997; Carr et al., 2001).
Equation (1) represents a basic specification for a gravity model that explains FDI
flows between countries i and j ( ) as a function of country specific variables ( and
), such as GDP or population, and dyadic variables ( ) such as joint income, joint
economic size, physical and cultural distance between country pairs, etc.

(1)
16
is an error term assumed to be statistically independent of , and , and
with 1 .
The standard practice is to log-linearize equation (1) and estimate the coefficients
by ordinary least squares (OLS) using the following equation:
(2)
However, Santos and Tenreyro (2006) raise two issues with this approach. First, it relies
heavily on the assumption that and are statistically independent of the
covariates, an assumption that is normally violated when error terms are heteroskedastic3.
As a result, OLS estimates of equation (2) would be inconsistent. Second, when the
dependent variable is equal to zero the log-linearization is infeasible. This issue is
especially important in our empirical context because only a few countries account for
most of the FDI4 and zero flows are common among the remaining countries. Although
several methods are used to overcome this limitation, such as dropping the pairs where
the dependent variable equals zero, using 1 as the dependent variable
instead
of , or using Tobit estimation, no method guarantees that the coefficients are
properly estimated.
To address these problems, Santos and Tenreyro (2006) suggest a variation of the
traditional gravity model that does not use a log-transformation of the dependent variable.
This model, estimated by Poisson pseudo-maximum likelihood and using a robust
3 Because , that is, the expected value of the logarithm of a random variable y is
not
equal to the logarithm of its expected value (Jensen's inequality), the independence assumption between the
log value of error terms and log values of covariates holds only under very specific conditions of the error
term. When there is heteroskedasticity in the data, the independence does not hold.
4 USA, Japan, and the countries of the European Union accounted for 78% of the senders and 50% of the
receivers of FDI, (World Development Report 2005).
17
covariance matrix5 instead of OLS, produces consistent estimators even in the presence
of heteroskedasticity. Following their approach, we estimate the following equation:
β β β

β Σφ Σα ε (3)
whe
• is the real value of the FDI flow from country i to country j in year t.
re i and j denote the countries in the dyad, t represents time, and:

• is the bilateral trade flow between countries i and j in year t.

• is the GDP per capita in real terms for country i in year t.
• is the sum of the democracy and autocracy (reverse coded) scores
(taken from the Polity III Database) of country j in year t.
• is IGO connectedness, the number of IGOs that countries i and j are
simultaneously members of in year t.
• is a set of fixed effects at the dyad level.
• is a set of year fixed effects.
To examine hypothesis 2, we decompose the variable for IGO connectedness into two
subcomponents:
• is economic IGO connectedness, the number of economic IGOs that
countries i and j are simultaneously members of in year t.
• is social/cultural IGO connectedness, the number of social/cultural
IGOs that countries i and j are simultaneously members of in year t.
We use dyad fixed effects to account for the dependence of observations in our
data and to control for all static dyadic influence in FDI flows, such as distance between
5 We obtain robust standard errors by bootstrapping.
18
the two countries, and whether they share a common language, border, religion, or
colonial history. Similarly, we use year fixed effects to control for historical events that
affect all dyads, such as global economic shocks, the opening of Eastern European
markets and technological changes. These two sets of fixed effects control for all
influences on FDI flows except those that vary simultaneously across time and within a
dyad.
Data
Our dependent variable comes from two sources: the OECD, whose data for the
year 2005 recorded FDI flows for 31 countries representing 87% of all outflows (World
Investment Report, 2005), and the UNCTAD, providing data for FDI flows among
countries that are not members of the OECD. Using both inflow and outflow data, we are
able to identify unidirectional FDI flows between almost 200 countries from 1980 to
2000.
Some idiosyncrasies of the FDI data require further comment. If both countries in
the dyad are in the dataset, the same unidirectional FDI flow is reported twice. For
example, our dataset registers the FDI flow from Canada to the USA twice: (1) as
outflow from Canada to the United States, reported by the Canadian government, and (2)
as inflow in the United States from Canada, reported by the American government.
Unfortunately, a pair of data points associated with the same flow may be different since
the OECD and the UNCTAD build their dataset based on figures provided by national
governments, which differ on the definition of what constitutes FDI6. That is, the
outflow figure from Canada to USA may differ from the inflow figure to the USA from
6 Although OECD countries comply with the definitions for FDI contained in the IMF Balance of Payments
Manuals (BPM5) and the OECD Benchmark Definition of FDI (BMD), they still have some freedom to
define the level of foreign ownership required.
19
Canada due to differences in what each country defines as FDI. We dealt with the
problem of duplicated flows in three ways: using their average, randomly choosing one of
the reported flows as the actual flow, or selecting the flow reported by the country with
the largest overall level of FDI. Although all three approaches produce similar results, we
use average flows in our main analysis and introduce the alternative approaches in
robustness checks.
Countries also vary on the way they report zero FDI flows. Although some
countries report them explicitly, most countries exclude zero FDI flows from their data.
In most cases, zero FDI flows occur between country pairs where at least one country
shows low values in the democracy variable. Therefore, excluding these observations
may decrease heterogeneity in our independent variables and cause a bias toward flows
among developed and democratic countries. To avoid this potential problem, we consider
missing reported values as zero FDI flows. Specifically we follow two steps. First, we
consider conservatively that a missing reported value is equal to zero only for those years
between two non-zero FDI flows for a given country pair. For example, if in our data we
observe a non-negative FDI outflow from Latvia to Mozambique for the years 1995 and
1997, we assume that the outflow is zero for the year 1996. We call this approach
interpolation7. Second, we consider missing FDI data points equal to zero if we observe
at least one non-zero FDI observation before or after for the dyad. We call this approach
extrapolation8. In the previous example, we will assign zero FDI outflows from Latvia to
7 The average difference of interpolated zero FDI flows with reported contiguous data points is 0.7. This
low value reinforces a detailed inspection of the data where the interpolated zero FDI flows occur within
data points that are either zero or close to 0.
8 The average difference for extrapolated zero FDI flows within reported data points within a pair is 0.3.
The low value suggests that the extrapolated values are not different from existent data.
20
Mozambique from 1980 to 1995 and from 1997 to 20009. Although our results are
similar when we exclude interpolated and extrapolated observations, we present our main
results using the extended dataset. Dyads for which there were no explicit reports of FDI,
zero or otherwise, in our data were excluded from the analysis.
Our key independent variable, the IGO network, is built using is the time-varying
listing of IGOs and their members compiled by Pevehouse et al. (2003). According to
their definition, an IGO must:
(1) include three or more members of the Correlates of War-defined state system;
(2) hold regular plenary sessions at least once every ten years; and
(3) possess a permanent secretariat and corresponding headquarters.
We first aggregate all IGOs (AIGOs) regardless of their mandates. We then
classified the IGOs into economic or social/cultural based on their mandates as described
in the Yearbook of International Organizations. We defined economic IGOs (EIGOs) as
those whose mandates stipulate any of the following: (1) perform multiple economic
functions, monitor and enforce international economic transactions, establish
international trade agreements or protect property rights; (2) promote standards and
conventions that smooth international transactions; (3) promote development or manage
international public goods; or (4) address issues regarding the international structure and
operations of specific industries. This definition yielded 126 EIGOs in 1980 and 158 in
2000. Social/cultural IGOs (SCIGOs) are those that: (1) engage in activities related to
conservation and environment; (2) address health, disease, disaster, social welfare or
9 Some restrictions still apply. For example, if a country did not exist as a political entity for any year
within the range of interpolation or extrapolation, we do not consider a non-existent FDI flow as a zero FDI
flow.
21
cultural issues; or (3) promote education, technology and scientific research. Using this
definition, we identified 77 IGOs as social/cultural in 1980 and 116 in 2000.
For AIGOs, EIGOs and SCIGOs, we used the IGO-member listing to create timevarying
affiliation matrices of connectedness between two countries. The affiliation
matrix for AIGOs at time t, At , is produced by multiplying Xt, a matrix whose cells
indicate whether a country is a member of a given at time t, by its transpose Xt
T. Thus, At
is a symmetric country-by-country matrix where the cell aijt indicates the number of
AIGOs in which country i and country j share joint membership at time t, the measure we
call AIGO connectedness. Similarly, Et is a symmetric country-by-country matrix where
the cell eijt indicates the number of EIGOs in which country i and country j share joint
membership at time t, the measure we call EIGO connectedness. Finally, the affiliation
matrix for SCIGOs, St, is created in the same way by multiplying Yt, a country-by-SCIGO
matrix whose cells indicate whether a country is a member of a given SCIGO at time t,
by its transpose Yt
T. We take the natural logarithms of the IGO connectedness variables
for consistency with the treatment of other independent variables in the gravity model.
We tap different sources to obtain the other country-level variables used in our
models. Our trade data comes from the compilation of unilateral trade flows generated
by Feenstra & Lipsey (2005) that is rapidly becoming the standard in trade data. GDP
per capita data comes from the World Development Indicators (WDI) from the World
Bank. With the WDI data, we also calculate the GDP deflators per country-year required
to obtain real figures for FDI and trade flows. Data for the democracy variable come
from the Polity III Database, a widely used dataset in political science and international
relations research. Democracy is the aggregate of two orthogonal ten-point sub-scales,
22
one representing the presence of autocratic institutions in a state (reverse coded), the
other the presence of democratic institutions. The original range, from -10 to 10, is
transformed into a 1 to 21 scale to allow for the log transformation. Thus 21 is the
maximum democratic score with the value 1 capturing the most autocratic states.
Unless otherwise indicated, the IGO independent variables in our analyses are
lagged one year. Table 1 shows the summary statistics and correlation matrix for our
variables.
Results
Model 1 in Table 2 contains our control variables. Model 2 adds the measure for
connectedness through all IGOS, AIGO connectedness. Consistent with our fundamental
assertion (hypothesis 1) the FDI flow from country i to country j is significantly greater
as a function of the number of IGOs that they are jointly members in. The Poisson
regression model is multiplicative, so the magnitude of the coefficient represents the
impact of a change in AIGO connectedness on the ceterus paribus rate of FDI from i to j.
The coefficient in model 2 indicates that a one-standard deviation increase in logged
AIGO Connectedness is associated with an eighty-two percent increase in FDI (e1.421 * 0.42
= 1.816). Model 3 adds the interaction between AIGO Connectedness and the level of
democracy of the target country. The interaction term has a negative and significant
coefficient. Consistent with hypothesis 3, IGO connections and target-country
democracy are substitutes.
Model 4 examines hypothesis 2 by decomposing the aggregate AIGO
connectedness variable into two subcomponents, E IGO connectedness and SCIGO
connectedness. Both of these variables are interacted with the democracy level of the
23
target country to reflect our argument that IGO efficacy depends on target country
institutions. The main effect of SCIGO connections between countries is not significant,
while the interaction between SCIGO connectedness and target country democracy is
significant and positive. For EIGO connectedness, the main effect is positive, and the
interaction with target-country democracy is negative. Figure 1 plots the combined main
and interaction effects of SCIGO and EIGOs ties (both evaluated at their mean level)
over the range of target-country democracy. The cross-over point where the combined
main and interaction effects of SCIGO connectedness acts to increase predicted FDI is at
a target-country democracy of four or higher. This includes 95% of our dyads, so there is
general support for hypothesis 2, that SCIGO connectedness are associated with more
FDI10. However, hypothesis 3 suggested that IGO connectedness and target-country
democracy would be substitutes. This relationship is apparent for EIGO connectedness,
whose efficacy decreases with target-country democracy, but SCIGO connectedness
appear to complement target-country democracy. We consider this unpredicted result in
the discussion section.
There are deep and reciprocal interdependencies between inter-state economic
and political relationships, so the issues of causality and endogeneity in our models
deserve careful attention. To begin, we highlight that in the models we have so far
shown, the dependent variables are lagged one year, so there is no possibility of reverse
10 The fact that SCIGO-ties at very low levels of target-country democracy, and EIGO connectedness at
high levels of target-country democracy are associated with reductions in the expected level of FDI was
surprising to us. It is not clear why an IGO tie would ever decrease the expected level of FDI.
Supplementary analysis suggests that these outcomes are attributable to the influence on our models of a
small set of outlier observations. If we exclude the 100 of our 64,485 observations for which the actual
FDI is most in excess of our estimate (these observations are mostly associated with states in obviously
unusual circumstances, such as Argentina during the hyper-inflation period we obtain estimated multiplier
effects for SCIGO connectedness that go up from one and for EIGO connectedness that decline to one as
target-country democracy increases, but are never less than one.
24
causality in the simplest sense that our dependent variable causes the independent
variable. A much bigger worry is that both FDI and IGO connectedness could be driven
by some common cause which was not reflected in our model. Certainly, there are many
dimensions of the dyadic relationship between states that affect both FDI and IGO
connectedness, such as geographic proximity, language, a history of colonial
relationships, and common religious or cultural heritage. All of these influences,
however, are accounted for by the dyad fixed effects in our model, which represent all of
the time invariant features of a dyad. Similarly, our year fixed effects account for global
trends over time that might influence both FDI and IGO connectedness, such as
technological changes that increase bi-national awareness and sympathy (the internet and
cheaper air travel come to mind), shocks to the global system such as the fall of the
Berlin Wall, or a diffuse cultural trend of globalization. What our fixed effects don’t
account for are variables that change within a dyad over time, but the two that seem most
likely as simultaneous influences on FDI and trade are directly controlled for in our
models: (1) the wealth of the countries in a dyad; and (2) the trade between the countries
in a dyad.
While we believe that the most likely common cause variables are accounted for
in our model specification, there are other possibilities that our controls do not preclude.
It is therefore worth highlighting just what an alternative explanation would have to
account for. It is not sufficient merely to account for a positive association between IGO
connectedness and FDI; our theory also predicts, and our results show, a negative
interaction between IGO connectedness and target-country democracy. A credible
alternative explanation would also have to account for this interaction. Furthermore, our
25
results show very different effects of EIGO and SCIGO connectedness as target-country
democracy increases. Although we had not predicted this a priori, we will explain in the
discussion that these findings are consistent with our position that EIGO and SCIGO
connectedness represent very different mechanisms of governance.
The set of omitted variables and alternative explanations that might account for
this complex, but theoretically consistent, pattern of IGO tie effects is vanishingly small.
Add to this some important facts about the processes that bring about IGO connectedness
and FDI. First, different agents are responsible for these two outcomes—states engage in
IGOs, while companies engage in FDI. Thus, alternatives must explain the mobilization
of these two agents, and cannot rely only on the initiative of states, or that of companies.
Furthermore, IGO connectedness are not easily focused on a signal dyadic relationship—
when a country joins an IGO it adds a tie with at least two countries, and typically many
more. This frustrates alternatives that derive from purely dyadic mechanisms.
Altogether, the hurdles for alternative explanations to the causal logic we present loom
very large. Nevertheless, we conducted additional analyses to test our approach in model
5, which relies on five-year lags of our IGO tie variables. All of the coefficients for
EIGO connectedness, SCIGO connectedness, and their interactions with target-country
democracy are comparable whether IGO connectedness are lagged one or five years.
This is consistent with our theoretical claims, because the information, trust and affect
impact of an IGO tie would be expected to endure over time. The result further raises the
bar for alternative explanations by demanding that they account for this lag.
The subsequent models establish in table 2 demonstrate robustness of our results
regardless of assumptions about the level of FDI between dyad-years for which we don’t
26
have explicit reports of FDI. In model 6 we include only dyads for which we have at
least one positive FDI report in the year for one of the countries in the dyad (which
demonstrates that they participated in FDI reporting in the year). In model 7 we include
only observations for which we have an explicit report of FDI, making no interpolation or
extrapolation of zero FDI flows for countries that did not report. These screens reduce
our number of observations by roughly two-thirds, but the results are comparable in all
substantive ways to our full model.
In table 3 we reproduce the specifications of models 1-5 three times, using
different approaches for reconciling the flow of FDI from country i to country j as
reported by i and by j. (Recall in table 2 we took the average of duplicate reports). In
models 6-10 we choose randomly between duplicate reports; in models 11-15 we take the
report of the country that engages in more FDI; and in models 16-20 we use a three-year
moving average of reported flows. In all cases results correspond to those in table 2 in all
substantive ways.
Our robustness checks serve another purpose, as a response to concerns about
multicolinearity. As would be expected, there is a large positive correlation (.80)
between ln(EIGO connectedness) and ln(SCIGO connectedness). Could the opposite
signs on the main effects of these variables and on their interactions with target-country
democracy be attributable to multicolinearity? The consistency of our results across six
different samples and versions of our data suggests no. As Greene (1997) suggests,
multicolinearity results in coefficients that are sensitive to small changes in the
construction of variables, or the inclusion of observations. Across the models reported
here, and many other estimations conducted in supplementary analysis, the pattern of
27
influence of EIGO and SCIGO connectedness, across the range of target-country
democracy, remained the same.
Discussion
Economic globalization presents severe governance challenges. The insufficiency of
states as a source of surety for transactions that transcend national borders creates an
opportunity for an increased role for organizations in the global institutional framework.
In this paper we applied a network methodology to show how one type of organization,
the IGO, facilitates the cross-border investments of another type, the MNC. We further
document a fascinating interdependence between domestic institutions, specifically
democracy, and the international institutions represented by IGOs. The results help to
understand which countries attract FDI, and from which senders. They also point to an
emerging rivalry between states and organizations as sources of governance in the global
economy.
We show that both economic and social/cultural IGO connectedness increase the
FDI that flows between two countries. The social/cultural effect is the more novel of
these two, and it is provocative for both FDI and theories of governance. For FDI, the
influence of SCIGO connectedness reinforces arguments that social and cultural
differences are a major barrier to cross-border investment, and therefore to global
economic integration. More optimistically, the result also suggests that IGOs are a
mechanism for reducing social/cultural differences, or at least for reducing the negative
effect of those differences on FDI. For governance, this result highlights the role the
social mechanisms can play in smoothing even the most high-stakes economic
exchanges. Sociologists have long argued that socially embedded sentiments, such as
28
trust, empathy and affinity, support exchange (e.g., Granovetter, 1985). Nevertheless,
unambiguous evidence in support of that claim is scarce, mostly because important and
ongoing exchange relations often co-occur with social relations, making it difficult to
isolate the benefit of social governance (Uzzi, 1996; Gibbons, 1999). The distinction
between economic and social/cultural IGOs provides a rare opportunity to compare
economic and social governance mechanisms. Furthermore, as Figure 1 suggests,
SCIGO connectedness have a more positive affect on FDI than EIGO connectedness
when target-country democracy is greater than 10, a condition that is met for roughly
three-quarters of our observations. That SCIGO connectedness are not only a positive
influence on FDI, but often more positive than EIGO connectedness is a victory for one
of economic sociology’s core assumptions, that social governance is sometimes the best
support for transactions, and not merely a second-best alternative to more formal
governance mechanisms.
As for economic IGO connections, their influence, is from one perspective
unsurprising. After all, many economic IGOs are formed explicitly to facilitate global
economic exchanges such as trade and FDI, so this result may be seen as merely
confirming that they serve their intended function. On the other hand, the fact that an
IGO performs its intended function may be surprising to many, particularly in the face of
popular and scholarly arguments that these organizations are either ineffectual or shells
through which powerful and rich countries legitimize their exploitation of the poor and
weak (examples include Stiglitz, 2003; Rose, 2004; and Easterly 2006).
Whether or not our main EIGO result is viewed as surprising, it indicates the
empirical utility of the “network turn” in research on international organization. Only a
29
few years ago, there was little evidence that IGOs did anything at all. The great leap
forward in the evidence of IGO efficacy occurred with the methodological innovation of
considering the network of bilateral connections created by IGOs, rather than merely
counting the numbers of IGOs in the world, or the number of IGOs a given country was
part of. The demonstrated utility of this approach for the field of international
organization suggests an opportunity for the field of organizational theory. We began
this paper by pointing to the equivalence of IGOs and MNCs as organizational responses
to the governance challenges of global economic exchange. Just as many bilateral
transactions are better understood by conceptualizing the influence of IGOs in network
turns, we would argue that a kindred approach would add much clarity regarding the
influence of MNCs. We foresee a network where nodes are countries, and the edges are
connections forged by MNCs that operate in both countries. Just as we have
differentiated ties forged by SCIGOs and EIGOs, the MNC network could be
differentiated by key characteristics of the MNCs, such as experience, ownership
structure, and strategy. We predict that an MNC network thus conceived would predict
many of the same outcomes that the IGO network predicts: trade, FDI, political change,
and war. This line of research would provide a path to a more fully integrated account of
international political economy, and clarify MNC interdependence with and influence
relative to states, IGOs, and NGOs.
Some reconciliation between our evidence that IGO connections encourage FDI
and criticisms that certain IGOs are ineffective or worse comes through the interactions
we estimate between IGO connectedness and target-country democracy. As the critics
have observed, IGO connections do less to encourage FDI flows to some countries.
30
Intriguingly, the impact of EIGO and SCIGO connections move in opposite directions
with increases in the democracy and relative power of target countries. When the target
country is more democratic, EIGO connections do less and SCIGO connections do more
to increase FDI flows. The negative interdependence between EIGO connections and
target-country democracy suggests a substitution between international and domestic
governance mechanisms. This effect is intriguing because it suggests that even though
FDI is a transaction that spills over the legal jurisdiction of any one state, the
commitments of target-country governments, which are more credible if those
governments are more democratic (Henisz, 2000), go a substantial way to assuring MNCs
that their investments will be safe. This estimation also helps to clear up a baffling
finding in previous research, that FDI was sometimes found to be less likely to flow to
democratic countries. When we consider the interaction between target-democracy and
IGO connections, the main effect of democracy switches to be positive. This suggests
that previous analyses may have suffered from misspecification, and that, consistent with
theory on states’ capacity to commit to foreign investors and business folk wisdom as
reflected in country risk rankings, democracies are more attractive targets for FDI.
Target democracy interacts in the opposite way with SCIGO connections, to
increase the flow of FDI, an effect that surely derives from the unique governance
mechanisms embedded in networks of social/cultural, as opposed to economic, relations.
One explanation for this is that the sources of FDI are overwhelmingly the “first world”
democratic countries (Guillen, 2006). The social/cultural connections of these sender
countries to potential targets may be more effective if those targets are more democratic
due to an international equivalent to interpersonal homophily. When an SCIGO brings
31
the citizens of two democracies together, political similarity may enhance trust, smooth
communication, and facilitate relationship building. Another explanation is that
nondemocratic
targets may not get as much out of SCIGO connections because they are less
open, and therefore less willing to exploit to the fullest opportunities for social and
cultural contact. Consider for example the stereotype that the contingents from Eastern
Bloc countries at international events during the cold war were heavily guarded,
constrained and otherwise inhibited. Either way, the result indicates that for states as for
individuals, employing social governance requires a certain capacity for sociability—the
ability to strike up and maintain social relationships with others that are sufficiently
positive that they may be the basis of trust, empathy and affect.
If the direct implications of this paper are to inform as to what institutional
conditions make FDI more or less likely, a very important indirect implication is with
regard to the interdependence between institutional forms. The contest between states and
international organizations for institutional primacy is shaping up to be one of the
fundamental political economy issues of our time. One characterization of this contest is
that international organizations are winning it, affecting what Strange (1996) has called a
retreat of the state. Our results support this as they show a substitution effect between
states and IGOs, at least for the EIGOs which are explicitly targeted at governing global
economic transactions. On the other hand, it could be argued that the mere fact that
target democracy affects FDI at all signals a victory for the relevance of the state for
global transactions. Even more significant is that there is a positive interdependence
between SCIGOs and target democracy, a relationship that is largely unforeseen in a
literature that has highlighted rivalry between international organizations and states, and
32
attended more to the influence of EIGOs such as the IMF and the World Bank than on
SCIGOs which rely on very different governance mechanisms.
The resulting conclusion must be that the interrelationship between domestic and
international governance is more complex than previous accounts have recognized. And
while our findings may give hope to those who see a substantial role for the state as
economic globalization progresses, there can be no claim that the network forged by
international organizations is not massively and increasingly important in this regard.
We have argued that inter-governmental networks fill an institutional chasm, by forging
relationships that span country borders. The evidence supports this argument: The
connections between states through both economic and social/cultural IGOs weigh
positively and heavily as influences on which states receive FDI from which others.
33
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Variable Mean Std. Dev (1) (2) (3) (4) (5) (6) (7) (8) (9)
(1) FDIij 92.44 1,194 1
(2) ln(Tradeij) 10.06 4.27 0 .103 1
(3) ln(GDP per capitai x GDP per cap 17.05 2.13 0.098 0.449 1.000
(4) ln(Target Democracy) 2.61 0.70 0.037 0.177 0.328 1.000
(5) ln(All IGO Tiesij) 3.60 0.42 0.107 0.406 0.300 0.245 1
(6) ln(Economic IGO Tiesij) 2.97 0.40 0.107 0.440 0.315 0.258 0.960 1
(7) ln(Social/Cultural IGO Tiesij) 2.30 0.43 0.103 0.281 0.203 0.227 0.905 0.797 1
DESCRIPTIVE STATISTICS
TABLE 1
38
(1) (2) (3) (4) (5) (6) (7)
ln(Tradeij) 0.05 0.054 0.054 0.054 0.047 0.054 0.054
(2.80)** (3.23)** (2.68)** (3.18)** (3.09)** (3.70)** (3.61)**
ln(GDP per capitai x GDP per capitaj) 0.193 0.159 0.097 0.113 0.166 0.797 0.797
(1.28) (0.87) (0.64) (0.81) (1.11) (3.08)** (3.43)**
ln(Target Democracy) -0.954 -0.976 2.13 2.606 1.861 1.399 1.143
(7.28)** (8.51)** (2.06)* (2.85)** (2.12)* (1.21) (1.02)
ln(All IGO Tiesijt-1) 1.421 3.587
(2.75)** (4.64)**
ln(All IGO Tiesijt-1) * ln(Target Democracy) -0.841
(3.04)**
ln(Economic IGO Tiesijt-1) 4.62 2.829 2.519
(6.37)** (2.79)** (2.18)*
ln(Social/Cultural IGO Tiesijt-1) -0.952 -1.286 -1.298
(1.39) (1.53) (1.54)
ln(Economic IGO Tiesijt-1) * ln(Target Democracy) -1.77 -1.307 -1.204
(6.02)** (3.52)** (2.99)**
ln(Social/Cultural IGO Tiesijt-1) * ln(Target Democracy) 0.784 0.793 0.782
(2.50)* (2.47)* (2.30)*
ln(Economic IGO Tiesijt-5) 3.683
(3.95)**
ln(Social/Cultural IGO Tiesijt-5) -2.218
(2.44)*
ln(Economic IGO Tiesijt-5) * ln(Target Democracy) -1.812
(5.23)**
ln(Social/Cultural IGO Tiesijt-5) * ln(Target Democracy) 1.147
(3.94)**
Dyad fixed effect Y Y Y Y Y Y Y
TABLE 2
FIXED EFFECTS (Dyad and Year) GRAVITY MODELS OF UNILATERAL FDI FLOWSij, 1980-
2000. POISSON
Year fixed effect Y Y Y Y Y Y Y
Observations 65,039 64,485 64,485 64,485 61,373 2 3,819 2 0,185
# of dyads 1,952 1,949 1,949 1,949 1,925 1 ,733 1 ,712
z statistics in parentheses. Standard errors corrected via boostrapping
* significant at 5%; ** significant at 1%
39
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15)
ln(Tradeij) 0.044 0.048 0.048 0.047 0.048 0.038 0.041 0.041 0.041 0.043 0.041 0.046 0.046 0.046 0.047
(2.51)* (2.67)** (2.73)** (2.96)** (2.76)** (2.19)* (2.43)* (2.11)* (2.18)* (2.47)* (2.21)* (2.62)**
(2.71)** (2.54)* (2.86)**
ln(GDP per capitai x GDP per capitaj) 0.173 0.146 0.118 0.144 0.135 0.293 0.28 0.242 0.3 0.28 0.75 0.667
0.542 0.617 0.525
-1.24 -1.06 -0.77 -1.01 -0.77 -1.53 -1.56 -1.26 (2.39)* -1.21 (2.64)** (2.25)* (1.99)* (2.15)* -1.73
ln(Target Democracy) -1.1 -1.132 0.403 -1.11 1.233 -1.027 -1.044 1.426 -1.023 2.203 -1.031 -1.061 2.482
-1.052 2.719
(9.56)** (9.59)** -0.31 (10.87)** -1.2 (7.77)** (7.06)** -0.92 (6.67)** (2.37)* (7.49)** (9.43)** -1.65
(9.75)** (2.58)*
ln(All IGO Tiesijt-1) 1.554 2.653 1.08 2.828 1.745 4.281
(2.94)** (2.46)* (2.01)* (2.27)* (3.12)** (3.86)**
ln(All IGO Tiesijt-1) * ln(Target Democracy) -0.416 -0.67 -0.956
-1.2 -1.59 (2.43)*
ln(Economic IGO Tiesijt-1) -0.245 3.889 -0.707 4.264 0.238 4.951
-0.42 (3.60)** -1.05 (4.67)** -0.38 (4.63)**
ln(Social/Cultural IGO Tiesijt-1) 1.353 -1.208 1.448 -1.201 1.107 -0.612
(2.62)** -1.45 (2.24)* -1.21 (2.37)* -0.99
ln(Economic IGO Tiesijt-1) * ln(Target Democracy) -1.479 -1.8 -1.71
(3.45)** (5.45)** (4.97)**
ln(Social/Cultural IGO Tiesijt-1) * ln(Target Democracy) 0.926 0.964 0.628
(2.39)* (2.50)* (2.15)*
Dyad fixed effect
Year fixed effect
Observations 65,425 64,871 64,871 64,871 64,871 64,951 64,397 64,397 64,397 64,397 58,526 58,526
58,526 58,526 58,526
# of dyads 1,952 1,949 1,949 1,949 1,949 1,952 1,949 1,949 1,949 1,949 1,959 1,959 1,959 1,959 1,959
z statistics in parentheses. Standard errors corrected via boostrapping
* significant at 5%; ** significant at 1%
Unilateral flows are chosen randomly when
duplicates exist
Unilateral flows are chosen by precedence when
duplicates exist
Unilateral flows are calaclauted as a 3 year moving
average
FIXED EFFECTS (Dyad and Year) GRAVITY MODELS OF UNILATERAL FDI FLOWSij, 1980-2000. ALTERNATIVE
DEPENDENT VARIABLES
TABLE 3
40
.1 1 100 10000
Multiplier of the FDI level
0 5 10 15 20
Democracy
EIGOs EIGO 5% CI EIGO 95% CI
SOCIGOs SOCIGO 5% CI SOCIGO 95% CI
Effect of IGO Connectedness on FDI over the range of Democracy
Figure 1

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Foreign direct investment

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This article is about economics. For the magazine, see FDi magazine.

Foreign direct investment (FDI) in its classic form is defined as a company from one
country making a physical investment into building a factory in another country. It is the
establishment of an enterprise by a foreigner. [1] Its definition can be extended to include
investments made to acquire lasting interest in enterprises operating outside of the
economy of the investor.[2] The FDI relationship consists of a parent enterprise and a
foreign affiliate which together form an international business or a multinational
corporation (MNC). In order to qualify as FDI the investment must afford the parent
enterprise control over its foreign affiliate. The IMF defines control in this case as
owning 10% or more of the ordinary shares or voting power of an incorporated firm or its
equivalent for an unincorporated firm; lower ownership shares are known as portfolio
investment.[3]

Contents
[hide]

• 1 History
• 2 Type of Foreign Direct Investors
• 3 Methods of Foreign Direct Investments
• 4 See also
• 5 References

• 6 External links

[edit] History

Foreign direct investment (FDI) is a measure of foreign ownership of productive assets,

such as factories, mines and land. Increasing foreign investment can be used as one
measure of growing economic globalization. Maps below show net inflows of foreign
direct investment as a percentage of gross domestic product (GDP). The largest flows of
foreign investment occur between the industrialized countries (North America, North
West Europe and Japan). But flows to non-industrialized countries are increasing.

US International Direct Investment Flows:[4]

Period FDI Outflow FDI Inflows Net

1960-69 $ 42.18 bn $ 5.13 bn + $ 37.04 bn
1970-79 $ 122.72 bn $ 40.79 bn + $ 81.93 bn
1980-89 $ 206.27 bn $ 329.23 bn - $ 122.96 bn
1990-99 $ 950.47 bn $ 907.34 bn + $ 43.13 bn
2000-07 $ 1,629.05 bn $ 1,421.31 bn + $ 207.74 bn
Total $ 2,950.69 bn $ 2,703.81 bn + $ 246.88 bn

[edit] Type of Foreign Direct Investors

A foreign direct investor may be classified in any sector of the economy and could be any
one of the following:[citation needed]
 • an individual;
• a group of related individuals;
• an incorporated or unincorporated entity;
• a public company or private company;
• a group of related enterprises;
• a government body;
• an estate (law), trust or other societal organisation; or
• any combination of the above.

[edit] Methods of Foreign Direct Investments

The foreign direct investor may acquire 10% or more of the voting power of an enterprise
in an economy through any of the following methods:

• by incorporating a wholly owned subsidiary or company

• by acquiring shares in an associated enterprise
• through a merger or an acquisition of an unrelated enterprise
• participating in an equity joint venture with another investor or enterprise

Foreign direct investment incentives may take the following forms:[citation needed]

• low corporate tax and income tax rates

• tax holidays
• other types of tax concessions
• preferential tariffs
• special economic zones
• investment financial subsidies
• soft loan or loan guarantees
• free land or land subsidies
• relocation & expatriation subsidies
• job training & employment subsidies
• infrastructure subsidies
• R&D support
• derogation from regulations (usually for very large projects)

[edit] See also

• List of countries by received FDI

• International investment position
• International Centre for Settlement of Investment Disputes
• Foreign Affiliate Trade Statistics
• World Association of Investment Promotion Agencies
• Articles on international trade organizations
[edit] References

1. ^ Sullivan, arthur; Steven M. Sheffrin (2003). Economics: Principles in action.

Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 551. ISBN 0-
13-063085-3.
http://www.pearsonschool.com/index.cfm?locator=PSZ3R9&PMDbSiteId=2781
&PMDbSolutionId=6724&PMDbCategoryId=&PMDbProgramId=12881&level=
4.
2. ^ Foreign Direct Investment, United Nations Conference on Trade and
Development, www.unctad.org
3. ^ International Monetary Fund (IMF), 1993. Balance of Payments Manual, fifth
edition (Washington, DC).
4. ^ http://www.bea.gov/international/xls/table1.xls

[edit] External links

• UNECE Database with Historical Trade data

Retrieved from "http://en.wikipedia.org/wiki/Foreign_direct_investment"

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1. Through financial collaborations.

2. Through joint ventures and technical
collaborations.
3. Through capital markets via Euro issues.
4. Through private placements or preferential allotments.

Forbidden Territories:
FDI is not permitted in the following industrial sectors:

1. Arms and ammunition.

2. Atomic Energy.
3. Railway Transport.
4. Coal and lignite.
5. Mining of iron, manganese, chrome, gypsum, sulphur, gold, diamonds, copper, zinc.

Foreign Investment through GDRs (Euro Issues)

Foreign Investment through GDRs is treated as Foreign Direct Investment
Indian companies are allowed to raise equity capital in the international market through
the issue of Global Depository Receipt (GDRs). GDRs are designated in dollars and are
not subject to any ceilings on investment. An applicant company seeking Government's
approval in this regard should have consistent track record for good performance
(financial or otherwise) for a minimum period of 3 years. This condition would be
relaxed for infrastructure projects such as power generation, telecommunication,
petroleum exploration and refining, ports, airports and roads.
Clearance from FIPB
There is no restriction on the number of Euro-issue to be floated by a company or a group
of companies in the financial year . A company engaged in the manufacture of items
covered under Annex-III of the New Industrial Policy whose direct foreign investment
after a proposed Euro issue is likely to exceed 51% or which is implementing a project
not contained in Annex-III, would need to obtain prior FIPB clearance before seeking
final approval from Ministry of Finance.

Use of GDRs
The proceeds of the GDRs can be used for financing capital goods imports, capital
expenditure including domestic purchase/installation of plant, equipment and building
and investment in software development, prepayment or scheduled repayment of earlier
external borrowings, and equity investment in JV/WOSs in India.

Restrictions
However, investment in stock markets and real estate will not be permitted. Companies
may retain the proceeds abroad or may remit funds into India in anticiption of the use of
funds for approved end uses. Any investment from a
foreign firm into India requires the prior approval of Ads by Google
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involving:

• foreign equity up to 50% in 3 categories

relating to mining activities (List 2).
• foreign equity up to 51% in 48 specified industries (List 3).
• foreign equity up to 74% in 9 categories (List 4).
• where List 4 includes items also listed in List 3, 74% participation shall apply.

The lists are comprehensive and cover most industries of interest to foreign companies.
Investments in high-priority industries or for trading companies primarily engaged in
exporting are given almost automatic approval by the RBI.

Opening an office in India

Opening an office in India for the aforesaid incorporates assessing the commercial
opportunity for self, planning business, obtaining legal, financial, official, environmental,
and tax advice as needed, choosing legal and capital structure, selecting a location,
obtaining personnel, developing a product marketing strategy and more.

The FIPB Route:

Processing of non-automatic approval cases
FIPB stands for Foreign Investment Promotion Board which approves all other cases
where the parameters of automatic approval are not met. Normal processing time is 4 to 6
weeks. Its approach is liberal for all sectors and all types of proposals, and rejections are
few. It is not necessary for foreign investors to have a local partner, even when the
foreign investor wishes to hold less than the entire equity of the company. The portion of
the equity not proposed to be held by the foreign investor can be offered to the public.

Total foreign investment and FDI

Total foreign investment in IFY 1997-98 was estimated at dols 4.8 billion in 1997-98,
compared to dols 6 billion in 1996-97. Foreign Direct Investment (FDI) in 1997-98 was
an estimated dols 3.1 billion, up from dols 2.7 billion in1996-97. The government is
likely to double FDI inflows within two years. Foreign portfolio investment by foreign
institutional investors was significantly lower at dols 752 million for fiscal 1997-98,
down compared to dols 1.9 billion in1996-97, partly reflecting the effect of the recent
crisis in Asia.

Foreign institutional investors

Foreign institutional investors (FIIs) were net sellers from November 1997 through
January 1998. The outflow, prompted by the economic and currency crisis in Asia and
some volatility in the Indian rupee, was modest compared to the roughly dols 9 billion
which has been invested in India by FIIs since 1992.

FII investments
FII net investment declined to dols 1.5 billion for IFY 1997-98, compared to dols 2.2
billion in 1996-97. The trend reversed itself in February and March 1998, reflecting the
renewed stability of the rupee and relatively attractive valuations on Indian stock
markets.

Large outflows of capital

Large outflows began again in May 1998, following India's nuclear tests and volatility in
the rupee/dollar exchange rate. In an effort to avoid further heavy outflows, the RBI
announced in June that FIIs would be allowed to hedge their incremental investments in
Indian markets after June11, 1998.

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