National and Kapodistrian University of Athens

Department of Economics

Master of Science in the Management and Administration of Business and

Organization

Strategic Management pathway

SIMETGO KEIVAN

SUPERVISORS: ELENI E. PITELI

Introduction
This paper analyzes the determinants and policies to attract IB1& FDI2& ME 3foreign direct
investments, and why some country attract more than others. The scope of international
transactions has changed considerably in the past thirty years with international trade in services
and foreign direct investment (FDI) becoming increasingly important. As a result, the research
effort into these two areas has intensified, especially in FDI. While FDI has traditionally been the
domain of academics in the international business community, international trade theorists have
recently moved into this area. The lack of a general model of FDI has resulted in a wide variety
of approaches to answering the question of why firms would seek to locate production facilities in
another country. These approaches vary in terms of their choice of independent and dependent
4
variables. The changes just described offer huge intellectual challenges both to scholars
interested in the locational strategies of firms and especially those of multinational enterprises
(MNEs) and to those researching into the actions of extra market actors, as each seeks to advance
their economic and social goals in a global market economy. Of course, international economists
have long since attempted to identify and evaluate the determinants of cross border economic
activity.5

1
International business
2
Foreign Direct Investment
3
Multinational enterprises
4
Bijita Bora Foreign Direct Investment: Research Issues, the international distribution of multinational production
5
Dunning J., Gugler P. Foreign Direct Investment 84p
 1. Why some countries attract more foreign investment than others

Most of empirical analyses on the determinants of FDI use cross-country regressions to identify
country characteristics such as market size, labor cost, labor skills, and political instability that
attract of deter FDI. Fig 1 presents the effect of some variable that have been extensively use in
the literature.6

Fig1

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Elizabeth Asiedu On the determinants of FDI to developing countries: is Africa different? University of Kansas p3
Accordant to dunning ingredients are threefold, the first is the form and content of factor
endowments – both natural and created – possessed by the trading or investing entities. This
comprises the physical environment (PE) within which firms make their locational choice. The
second is the policies and institutions of the participating organizations. Together with the needs
and aspirations of the various constituents of society, these make up the human environment (HE)
facing firms. The third is the specific situations under which particular products can be produced
and traded; e.g. whether they are subject to economies of scale or scope, and/or whether the firms
producing them, benefit from being part of a geographical cluster of related firms or institutions.
This I shall refer to as the contextual environment (CE) facing firms.

Fig2

Fig3
Return on investment in the host country
FDI will go to countries that pay a higher return on capital. But finding an appropriate measure
for the return on investment is problematic, especially for developing countries, thereby making
testing this hypothesis very difficult. This is because most developing countries do not have well-
functioning capital markets, and therefore it is difficult to measure the return on capital7.

The competition to attract inward FDI by a wide range of economies has resulted in a number of
responses. First, there have been widespread policy changes – more specifically, a marked trend
towards the liberalization of regulatory frameworks (UNCTAD, 1999). Second, competition for
FDI has contributed to the growing provision of incentives and inducements (Mytelka, 1999).
Third, for a number of economies, the desire to avoid extreme competition has encouraged more
Selective targeting. Ireland is an example of a country that has increased its focus on particular
industries, and even particular companies within those industries. It is this area of selective
targeting that is addressed in this article and, particularly, the idea that FDI varies in its
“desirability”. “Desirability” appears to be generally interpreted as relating to the magnitude of
likely impacts, specifically, economic impacts. A variety of bases for determining desirability have
been suggested. A common feature is that they are generally built on simple dichotomies, such as
the size of firm (larger firms are thought to be more desirable than smaller firms), industry (higher

7
Elizabeth Asiedu On the determinants of FDI to developing countries: is Africa different? University of Kansas p4
value-added is preferred to lower value-added), the functional focus of an affiliate (higher order
functions such as research and development (R&D) or regional headquarters are preferred to
assembly operations), the form of entry mode (greenfield investment is superior to mergers and
acquisitions), or the orientation of a firm (Poynter and White, 1984). While the simplicity of such
distinctions may appeal to policymakers, they are unlikely to provide meaningful insights into the
complex issue of assessing the impact of FDI.8

Some stylized facts about FDI assisted development strategies

Although inward FDI is not the only option available to promote economic catching-up, it may be
the most efficient option (Dunning and Narula, 2004). FDI, however, is not a sine qua non for
development. There are at least four main preconditions that need to be satisfied:
1. The FDI being attracted must generate significant spillovers.
2. The domestic sector needs to develop the capacity to absorb these Spillovers.
3. The FDI being attracted should be complementary to domestic industry, rather than substitutive.
4. A regulatory and institutional environment must be developed in Order to facilitate the
integration of the foreign affiliates into the domestic economy.
These conditions tend to make FDI more sticky and sustainable in particular locations. It is true
that the determinants of economic development are similar to the determinants of FDI, but this
does not mean that there is a simple cause and effect between them. Particular types of FDI tend
to be attracted to countries with certain levels of economic development and appropriate economic
structures. But simply to “pump” a country full of FDI will not catapult it to a higher stage of
development. In other words: there are no automatic gains from FDI (see e.g. Mencinger, 2003).
For instance, FDI may not compensate for the low ratio of domestic savings in the host countries;
nor do we know whether inward FDI will generate sufficient externalities.

It is generally acknowledged that there are four main motives for foreign investment: 1) to seek
natural resources; 2) to seek new markets; 3) to restructure existing foreign production through
rationalization; and 4) to seek strategically related created assets. These, in turn, can be broadly
divided into two types. The first three represent motives which are primarily asset-exploiting in
nature: that is, the investing company’s primary purpose is to generate economic rent through the
use of its existing firm-specific assets. The last is a case of asset-augmenting activity, whereby the

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Transnational Corporations August 2005 united nation new York and Geneva 2005 p95
firm wishes to acquire additional assets that protect or augment their existing created assets in
some way. In general, developing countries are unlikely to attract much asset-augmenting FDI,
but tend to receive FDI that is primarily resource seeking, market-seeking or efficiency-seeking.
Empirical evidence (e.g. Bellak et al., 2009a) shows that in the CEE countries, besides market
size, the level of infrastructure plays a crucial role for attracting FDI, while unit labour costs are
comparatively less important

The point here is that not all affiliates provide the same opportunity for spillovers. A sales office
or an assembly unit may have a high turnover, or employ a large number of staff, but the
technological spillovers will be relatively fewer than, say, those from a manufacturing facility
(figure 2). Likewise, resource-seeking activities can be capital- intensive, but also provide fewer
possibilities for spillovers than say, a market-seeking type of FDI. Prior to economic liberalization
and EU integration, TNCs responded to investment opportunities primarily by establishing
truncated miniature replicas of their facilities at home, although the extent to which they were
truncated varied considerably between countries. The extent of truncation was determined by a
number of factors, but by far the most important determinant of truncation – and thereby the scope
of activities and competence level of the subsidiary – were associated with market size, and the
capacity and capability of domestic industry (Dunning and Narula, 2004). There is thus a
hierarchy of the quality of FDI activity in Europe which reflects the stage of industrial
development. At the “bottom” are countries that are at an early stage of transition (and furthest
away from convergence with the EU norm), with a very limited domestic sector and with low
domestic demand. Such countries have been host to the most truncated subsidiaries, often single-
activity subsidiaries, primarily in sales and marketing, and in natural resource extraction. The
most advanced economies with domestic technological capacity (such as the core EU members)
have hosted the least truncated subsidiaries, often with R&D departments. Cohesion countries
(with the exception of Greece) have been in the middle.9

2. Factors affecting foreign direct investment

Foreign direct investment is a kind of private investment aimed at maintaining control Capital
holds at least 10% of voting shares in a foreign company. Factors Effective in attracting capital

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Transnational Corporations August 2005 united nation new York and Geneva 2005 p 71-75
can be divided into four parts: natural, ecological, supportive and encouraging factors Politics.
Obviously, countries with a tense foreign policy are very unsuccessful in attracting foreign
investment. A fundamental force of globalization is the rising level of attractiveness of different
countries and geographical locations. Traditionally, factors such as market potential and size,
relative labor unit costs, exchange rate, and relative endowments have been seen as important
determinants for the location decision and investment activity of MNEs (Caves, 1974: dunning.
1980). While the view that good institutions such as non-corrupt bureaucracy, security of property
rights, and political freedom are conductive to economic growth, and in the same spirit may attract
direct investments from MNEs, is intuitively compelling, the findings of empirical research have
not fully confirmed this impression. In general, institutions seem to have an influence on FDI.
According to dunning, MNEs invest abroad because of three distinct advantages deriving from
aspect of ownership, internationalization, and location.10 Foreign Direct Investment has increased
significantly in past few decades. This is because:

Lower transport costs

Improved technology which has helped increase low capital intensive startups

Increased global trade and lower tariff costs11

Barrier to FDI

1. Level of restrictions on foreign ownership 2. Ease of doing business vs red tape (screening&
approval procedures) 3. Constraints on foreign personnel and operational freedom

Other factor that affect FDI

1, Political stability and property rights 2. Size of economy and potential for Growth 3. Safety and
security concerns 4. FDI incentives: tax breaks/ tax reductions and rates 5. Labor productivity
and skills 6. Cost of wages 7. Transport links, costs and infrastructure 8. Levels of infrastructure
(such as internet 1 Wage rates 9. Access to free trade areas. Connectivity, and existence of
commodities10. Exchange rate11. Clustering effects

10
KALLE. PAJUNEN, Institutions and Inflows of Foreign Direct Investment: A Fuzzy-Set Analysis
Author: p3
11
World Bank, Statistics analysis of FDI
Potential for productivity improvements

Hence, the potential for productivity improvements is positively related to the technology gap
between local and foreign firms in an industry. A stream of theoretical models demonstrates that,
for a given level of foreign presence, spillovers increase with the technology gap between foreign
and domestic firms (Findlay, 1978; Wang and Blomström, 1992; Perez, 1997). John Dunning
(1977; 1981; 1993). Dunning proposed that there are three conditions needed for firms to have a
strong incentive to undertake DFIs.

1. Ownership advantage: the firm must have a product or a production process such that the firm
enjoys some market power advantage in foreign markets. 94 James R. Markusen

2. Location advantage: the firm must have a reason to want to locate production abroad rather
than concentrate it in the home country, especially if there are scale economies at the plant level.

3. Internalization advantage: the firm must have a reason to want to exploit its ownership
advantage internally, rather than license or sell its product/process to a foreign firm.12

The crucial question then is, why should knowledge capital be associated with multinationals while
physical capital is not? I have suggested that the answer lies in two features of knowledge capital.
These will appear as assumptions in theoretical models. First, the services of knowledge capital
can be easily transported to foreign production facilities, at least relative to the services of physical
capital. Engineers and managers can visit multiple production facilities with some ease (although
stationing them abroad is costly) and communicate with them in a low-cost fashion via telephone,
fax, and electronic mail. This property of knowledge capital is important to firms making either
horizontal or vertical investments.

According to empirical evidence leads us to make three assumptions.

A. Transportability: the services of knowledge-based assets are easily supplied to geographically
separate facilities.
b. Jointness: the services of knowledge-based assets are (at least partially) joint (“Public”) inputs
into geographically separate production facilities.
c. Factor intensity: Knowledge capital is skilled-labor intensive relative to final Production.13

12
Bijit Bora 2002, Foreign Direct Investment: Research Issues p 95
13
Bijit Bora 2002, Foreign Direct Investment: Research Issues p 96
One of the important theory for international industry is Porter’s diamond model for analysis of
competitive advantage. According this theory we can obtain some variable by factors in market
segmentation. For example Japanese car manufacturing, technique
Korea, electronics, Switzerland in pharmaceuticals, Britain Chocolate and biscuit industry
US is expert in weapons and internet business. If we considered these countries for analysis, we
can conclude that they have different factor of production, labor cost, and government policies but
although, they have got competitive advantage in that particular industry.

Michael porter diamond model

Description of explanatory variables and return on investment in the host country

1 Countries will tend to interact by direct investment when (A) they are relatively similar in size
and in relative endowments (horizontal investment), or (B) when one country is smaller but skilled-
labor abundant (vertical investment).
2 Investment liberalization can reverse the direction of trade when one country is small and
skilled-labor abundant. Such a country substitutes the export of services for the export of X.

3 Investment liberalization can decrease the volume of trade in X if trade barriers are relatively
high and countries are similar (horizontal investment), but can increase the volume of trade if
trade barriers are low and the countries differ in relative endowments (vertical investment).

4 Trade liberalization (in the presence of relatively liberal investment) will tend to reduce
investment for relatively similar countries (horizontal investment) but tend to increase investment
for relatively dissimilar countries (vertical investments).

5 Investment liberalization has a skilled-labor bias for source countries, but may also have a
skilled-labor bias for host countries. The latter occurs when branch plants of foreign
multinationals draw factors from less skilled-labor intensive sectors rather than from competing,
skilled-labor intensive local firms.14

Conclusion
The rise in FDI is based upon a combination of both ‘technology push’ and ‘market pull’ factors.
As the world economy grows, the increase in the size of worldwide markets has enabled many
international firms to set up new businesses in foreign countries that achieve similar cost
structures to those achieved in their own countries. For some countries that they have lack of
capital potential or monetary, financial policy problems, and they forced to borrow capitals from
countries and international organizations or banks, for this countries the FDI is an opportunity to
invest, to increase work place, sustainably economy for long-term or macroeconomic period.
According to Paulo Elicha Tembe 2012, Mwilima (2003) the reason and theory for the developing
countries in FDI sector more or less is the same factors or close each other’s. Southern Africa,
China, Latin America, East Asia countries want to attract FDI is just because they see FDI as an
important source of capital formation; the second reason is the transferring of technology; another
reason is argued that FDI will lead to employment creation; the reason number four, the
government expect FDI to transfer management skills to local managers and the last one is the

14
Bijit Bora 2002, Foreign Direct Investment: Research Issues p 108
increase of export competitiveness.15 Investment incentives to attract FDI are widespread and used
by governments in both high-income and developing countries. Developing country policy makers often
view incentives as necessary for their countries to compete for FDI. (Fig 4 p28)

Fig4

Duty-free imports, tax holidays, and VAT exemptions are the top three most important incentives
for investors fig5 p29 fig5

15
Paulo Elicha Tembe, Attracting Foreign Direct Investment in Developing Countries: Determinants and Policies-A
Comparative Study between Mozambique and China
Where there is a potential for developing standardised products for the global market place,
realizing considerable economies of scale, firms may prefer a global strategy. This involves
forgoing some of the benefits of a multidomestic strategy, preferring the cost savings of scale
economies to any demand advantages of product differentiation. Global strategy may involve
dispersing elements of the production process around the world on the basis of cost minimization,
with subsidiaries exchanging parts and products with other subsidiaries in the MNC’s global
system. Coordination of such an interdependent global production system necessarily involves a
high degree of control over the operations of subsidiaries16

Reference:

 Michael, E. Porter. (1998). Competitive Advantage of Nations

 Dunning, J. Gugler. (2007). Foreign Direct Investment, Location and Competitiveness

16
Bijit Bora 2002, Foreign Direct Investment: Research Issues p 35
 Bijit, Bora. (2002). Foreign Direct Investment: Research Issues

 Shyami, Puvimanasinghe. (2007). Foreign Investment, Human Rights and the

Environment
 Rugraff, E., & Sánchez, Ancochea. D., & Sumner, Andy. (2009). Transnational
Corporations and Development Policy
 Theodore, H. Moran. (1998). Foreign Direct Investment and Development the New
Policy Agenda for Developing Countries and Economies in Transition
 Paulo, Elicha. Tembe. & Kangning. Xu. (2012). Attracting Foreign Direct Investment
in Developing Countries: Determinants and Policies A Comparative Study between
Mozambique and China
 Meyer, K. E., & Sinani, E. (2009). When and where does foreign direct investment generate
positive spillovers? A meta-analysis. Journal of International Business Studies, 40(7):
1075-1094.
 Pajunen, K. (2008). Institutions and inflows of foreign direct investment: A fuzzy-set
analysis. Journal of International Business Studies, 39(4): 652-669

 Asiedu, E. (2002). On the determinants of foreign direct investment to developing

countries: is Africa different?. World Development, 30(1): 107-119

 Transnational Corporations August 2005 united nation New York and Geneva 2005 p95

 World Bank, Statistics analysis of Foreign Direct Investment (FDI)

 https://data.worldbank.org/indicator/BX.KLT.DINV.CD.WD