Foreign direct investment and host country interaction: A strategic approach.

Abstract

A vast empirical literature on Foreign Direct Investment (FDI) uses cross country regressions to search for the determinants of FDI. The literature is extensive and controversial. The lack of a consensus over the conclusions reached by the wide range of studies investigating the determinants of FDI makes it imperative to examine which, if any, of the conclusions from the existing studies are robust. Chapter 1 uses a variant of Extreme Bound Analysis (EBA) to analyze the sensitivity of the coefficient estimates of the major candidates for the determinants of FDI which have, by far, received most attention in the empirical literature on the determinants of FDI. The EBA indicates that the observed correlations between FDI and many of the controversial variables, that have so far found their place in the empirical literature, are highly sensitive to small alterations in the conditioning information set. Chapter 2 takes as its objective context the growing disparity in the distribution of FDI among the developing nations. While FDI in the developing world has grown fairly rapidly since the late 1980s, a disaggregated analysis demonstrates a considerable imbalance at the macro level. While China stands out as the largest recipient, the Sub-Saharan African (SSA) countries and the countries of the Middle East and North Africa (MNA) are experiencing a continuous drying up of inbound FDI. The paper first develops a theoretical model of the economic determinants of FDI and then uses the structural model to identify empirically the causes of, and suggest potential remedies for, the disparity in the distribution of inbound FDI among the developing economies. Inbound FDI is found to be more strongly responsive to regional market size than any other potential determinant in the model, followed by a country's own market size and regional protection, respectively. Chapter 3 extends the analysis presented in chapter 2 to take explicit account of the element of political uncertainty, particularly in view of the powerfully robust correlation between political stability and FDI, observed in chapter 1. Second, while horizontal FDI (the focus of chapter 1) relates closely to the issues raised in the literature on new trade theory and strategic trade policy, and is more important quantitatively than vertical FDI, the latter is growing rapidly among the developing countries. Chapter 3 presents a theoretical model that takes into account both types of transnational investment. The results re-validate the significant role (pointed out in chapter 2) of regional variables, namely, regional market size and regional protection in a country's FDI. FDI is found to be more strongly responsive to a country's political stability than to any other potential determinant in the politico-economic model, followed by regional market size, regional protection, and own protection respectively.