THE ATTRACTION OF FDI IN THE NETHERLANDS

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Master’s Thesis / International Relations and International Organization / International Political Economy

THE ATTRACTION OF FDI IN

THE NETHERLANDS

Vincent Vollers s1446169 G. Meirstr 12 9728TA Groningen v.m.vollers@gmail.com University of Groningen Faculty of Arts

International Relations and International Organization Master’s Thesis

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pg. 2 Abstract

Because of the importance of Foreign Direct Investment (FDI), there has been a growing interest in and research done on the factors which drive locational considerations for firms and investors. To know why investment occurs in one country as opposed to another helps policy makers to design and adopt FDI friendly policies which create jobs and spur economic growth. This study looks at the different models which predict the locational determinants of FDI for the Netherlands and its neighbours. It attempts to answer the question what the influence of government policy is on the attraction of FDI for the Netherlands and what the government can do to increase

attractiveness relative to the neighbouring countries, Germany, Belgium and the United

Kingdom. To this end, it applies aspects of models such as the Diamond Model, the OLI Model and the GEMS model to these countries. Furthermore, it looks at the role of tax incentives for foreign investors and the effect of membership of an organisation with an internal market like the EU on country attractiveness for FDI. It shows how general government policy is important for the attraction of FDI rather than tax friendly policies specifically. Furthermore, it suggests several policy options for the Dutch government which were discovered during the country comparison in order to make the Netherlands more attractive in relation to its neighbours. The policy options suggested are to increase access to credit, to lower bureaucracy, to lower the cost of labour, to increase labour flexibility and to stimulate innovation.

Keywords

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List of Figures

 Figure 1: Determinants of National Competitive Advantage  Figure 2: Extensions to the Diamond Model

 Figure 3: The GEMS model

 Figure 4: FDI Inflow in the Netherlands

 Figure 5: Dutch inward FDI stocks, by region of origin  Figure 6: Division of inward FDI by different countries  Figure 7: Dutch Inward FDI sector composition

 Figure 8: FDI Inflow in Belgium  Figure 9: FDI Inflow in Germany

 Figure 10: German Inward FDI sector composition  Figure 11: FDI Inflow in the United Kingdom

 Figure 12: United Kingdom Inward FDI sector composition  Figure 13: Labour productivity

 Figure 14: Labour cost  Figure 15: Unemployment

 Figure 16: Reported Crime per 100 000 people  Figure 17: Number of enterprises per 100 000 people

 Figure 18: Number of patent applications per 100 000 people

List of Tables

 Table 1: Infrastructure ranking

 Table 2: Ease of getting credit ranking

 Table 3: Trade and Population Statistics 2012

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List of Acronyms

CBS Centraal Bureau voor de Statistiek

CPB Centraal Plan Bureau

DNB De Nederlandse Bank

DTT Double Taxation Treaty

ECB European Central Bank

EEC European Economic Community

EU European Union

FDI Foreign Direct Investment

GDP Gross Domestic Product

IFDI Inward FDI Stock

ILO International Labour Organization

IMF International Monetary Fund

M&A Mergers and Acquisitions

MNE Multinational Enterprise

MNC Multinational Corporation

OECD The Organisation for Economic Co-operation and Development OLI Ownership, Location, Internalization

PLC Product Life Cycle

R&D Research and Development

UN United Nations

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1. Introduction

In the last decades there has been a rapid increase in Foreign Direct Investment (FDI) which can be classified as a form of cross border investment from one economy in another. Compared to other forms of international capital flows and investments, FDI is usually seen as a more

permanent and positive variant of investment. FDI can be a significant source of employment, it facilitates the transfer and adoption of technology, promotes government stability and in some economies it has become a major part of GDP1 (Gross Domestic Product). Furthermore, FDI flows are relatively stable in periods of crisis affecting emerging economies which has caused some scholars to name it “good cholesterol”2_{. Increasing and attracting FDI has become a goal}

for policy makers worldwide and investment promotion schemes are increasingly becoming a major cornerstone of economic policy3.

The boom of FDI can be traced back to the last part of the twentieth century, especially the nineties, which saw the fall of the Iron Curtain and the rapid growth of economies in Asia and Latin America. This, along with breakthroughs in communication and transportation technology, the reduction of trade and investment barriers and rapid global economic growth, spurred the world towards increased globalization. This enabled companies to truly expand into foreign markets. Furthermore, this allowed the companies to create global production chains, leveraging local advantages for their organization. To give a sense of scale, at the start of the nineties, the global amount of FDI was 141 Billion Euro. At the start of the turn of the millennium, this has increased to 989 Billion euro, with a peak of 1806 billion in 20074_{. The economic crisis of 2008}

has tempered FDI flows, but now that economic growth has picked up, FDI levels are expected to rise again5_.

Because of the increasing importance of FDI, there has been a growing interest and research done into the factors which drive locational considerations for firms and investors. To know why investment occurs in one country versus another helps policy makers to design and adopt FDI

1_{John H. Dunning, "The eclectic paradigm as an envelope for economic and business theories of MNE activity."}

International business review 9, no. 2 (2000): 178.

2_{Ricardo Hausmann and Eduardo Fernandez-Arias. "Foreign direct investment: good cholesterol?." (2000).} 3_{CBS, Internationalisation Monitor 2012, (2012): 2.}

4_{Appendix III: Global FDI Stock.}

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friendly policies which create jobs and spur economic growth. A few of the more important theories which attempt to answer these questions are Michael Porter’s Diamond Model, which he described in his famous work “The Competitive Advantage of Nations” in 1990 and the OLI (Ownership, Localisation, Internalisation) Model developed by Peter Dunning, which he described in “The Globalization of business” in 1993.

The objective of this thesis is to identify and analyse these factors for the Netherlands, to measure the effectiveness and the role of government policy in regard to these factors and to compare the Netherlands with its immediate neighbours in order to frame these policies in its geopolitical context. There have been various comparative studies to FDI attractiveness in various regions of the world such as Central Europe and emerging economies, and some work has been done on FDI attractiveness in the agricultural sector in the Netherlands. However, there is no research done which explains how attractive the Netherlands is for FDI compared to its neighbours nor how the government’s policies affect this attractiveness. Therefore, I believe it is relevant to find out how the models as described above apply to the Netherlands and what lessons can be learned from analysing the Netherlands and its neighbours.

The main research question is “To what extent is the Dutch government policy able to effectively attract FDI?”. Sub questions are “What is the relative importance of public policy on FDI

attractiveness compared to other factors?” and “What could the Dutch government do to attract more FDI?”.

In order to answer the main research question, I will divide this thesis in three parts. In the first part I will do a survey of the available literature on FDI models and frameworks which have been developed in the last decades to explain how and why FDI occurs and which factors determine how attractive a country is for foreign investors. Here I will identify the strengths and weaknesses of the most important FDI models and identify the locational factors which I will use in the later sections.

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the attraction of FDI. The first goal here is to identify what the Netherlands and its neighbours do well and what can be improved, the second goal is to identify the relative effectiveness of

government policy compared to other locational determinants.

In the final part I will discuss the findings from the previous chapters and answer the main research question and the secondary research questions. First, I will start by assessing the subject matter by identifying and defining the variables and models used in this study.

2. Theoretical Framework

In this chapter I will describe the research done on the nature of FDI and the scientific history of the term. Furthermore I will create an overview of the literature on current insights on FDI models and theories. The purpose of this chapter is to provide the theoretical background and accountability regarding the choices of the parts of the theoretical frameworks I use in the later chapters. In this chapter I will answer the question of what FDI is, what kind of FDI models and frameworks exist and which insights have been gained over the last few decades in regards to these frameworks. In the following chapters I will attempt to answer the question on how attractive the Netherlands is for foreign investors and what the role of government policy is for said attractiveness.

2.1 Literature Review Methodology

For this thesis I studied literature such as articles, journals and books related to the main themes of this research project. Articles on FDI, on entry and operation modes and on economic data from the Netherlands were searched for relevant information. I scanned leading academic international business publications such as journals, conference proceedings, online databases, books, surveys and trade publications. The main international business journals which are considered influential for my area of interest are the Journal of International Business Studies,

Management International Review, the Journal of World Business and the International Business Review6. Some of these journals contain many articles related to FDI and country attractiveness for foreign investors.

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2.2 What is FDI

There are several definitions used in the literature and several definitions used by leading international organizations. I will list the ones which I believe are the most relevant. The Central Bureau of Statistics of the Netherlands (CBS) defines FDI as follows7

“Foreign direct investment is defined as a cross-border investment made by a resident in one economy (the direct investor) with the objective of establishing a lasting interest in an enterprise (the direct investment enterprise) that is resident in an economy other than that of the direct investor. The ‘lasting interest’ is in evidence when the direct investor owns at least 10 percent of the voting power of the direct investment enterprise.”

According to the International Monetary Fund (IMF), the definition of FDI is8

“Foreign direct investment enterprise is an enterprise (institutional unit) in the financial or non-financial corporate sectors of the economy in which a non-resident investor owns 10 per cent or more of the voting power of an incorporated enterprise or has the equivalent ownership in an enterprise operating under another legal structure.”

The European Central Bank (ECB) defines FDI as follows9

“Foreign direct investments are investments made by a resident of one economy (source economy) with the objective of establishing a lasting interest in a company located in another economy (host economy). With ‘lasting interest’ I mean both the existence of a long-term relationship and a significant degree of influence by the direct investor on the management of the foreign firm. In statistics, ownership of at least ten percent of the ordinary shares or voting stock is the criterion for the existence of a direct investment relationship. Ownership of less than ten percent is considered a portfolio investment. FDI comprises not only mergers and takeovers/acquisitions (brownfield investments) and new investments (Greenfield investments), but also reinvested earnings and loans and similar capital transfers between parents and affiliates.”

7_{Internationalisation Monitor 2012, 252.}

8_{IMF, Issues Paper #20 Definition of Foreign Direct Investment (FDI) Terms, 2004.}

9_{European Central Bank, Foreign direct investment and international business cycle comovement, 2004, No. 401,}

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According to the Organisation for Economic Co-operation and Development (OECD), the definition of FDI is as follows10

“Foreign Direct Investment (FDI) is a category of investment that reflects the objective of establishing a lasting interest by a resident enterprise in one economy (direct investor) in an enterprise (direct investment enterprise) that is resident in an economy other than that of the direct investor.”

The OECD continues to explain various important FDI terms here. First, what actually constitutes FDI and what is another form of investment? The OECD concludes that the minimum level of ownership in order to be seen as FDI is 10%11.

“The direct or indirect ownership of 10% or more of the voting power of an enterprise resident in one economy by an investor resident in another economy is the statistical evidence of such a relationship.”

They differentiate between FDI stocks and FDI flows. FDI stocks or FDI positions are existing ownership and shareholder agreements. FDI flows are the difference in a given time period of these stocks. Or, as the OECD defines it12:

“FDI flows are cross-border financial transactions within a given period (e.g. year, quarter) between affiliated enterprises that are in a direct investment relationship. FDI positions relate to the stock of investments at a given point in time (e.g. end of year, end of quarter). FDI flows and positions include equity (10% or more voting shares),

reinvestment of earnings and inter-company debt.”

All the definitions above describe when an investment is actually ‘counted’ but most agree that on average a 10% or more share in a company by a foreign entity is considered to be qualified as FDI. According to the United Nations Conference on Trade and Development (UNCTAD)13, different countries choose different ranges between 10% and 50% before they consider it FDI and some countries do not specify a threshold at all. However, since the Netherlands (CBS) and the

10_{OECD, FDI IN FIGURES April 2014, 2014: 12.} 11_Ibid.

12_Ibid.

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relevant international organizations (OECD, IMF and the ECB) use the threshold of 10%, this is going to be the threshold used where applicable for this thesis.

Furthermore, many of the organizations such as the IMF and the ECB as well as most of the reports and studies point to the OECD as the leading source for the definition and usage of the term FDI. Thus I will refer to their definition of FDI as the one which I will use in this study.

2.3 Why do firms engage in FDI

Now I will explore the reasons why Firms (and in some cases governmental agencies, although the focus is on commercial FDI) engage in FDI. First I will explore the general ideas and research regarding this topic, then I will give an overview of a few of the more influential theories. Finally I will explore their use in this thesis.

There are many reasons one could imagine why firms engage in FDI, such as investing in a local production plant to reduce transportation cost of the product to a new market. This also has the advantage of customizing the product to better suit the needs and expectations of local buyers. A firm could invest in production capabilities in foreign countries in order to profit from lower wages with the purpose of eventually exporting the product back to the home country. Other reasons include business risk diversification, resource allocation optimization and the ability to create a better position for themselves in the global market14.

Katsikea & Skarmeas explored these reasons. According to them a firm can diversify their risk by engaging in different markets whose national economic systems are not correlated, similar to the way in which stock traders diversify their portfolio. When an economy in one country goes sour, this might not be the case in the other, thus the risk is mitigated. A Global presence also has advantages through product standardization and consumer familiarity. Furthermore, in a similar study Alan Rugman states that firms duplicate production capacity in other countries in order to take advantage of lower costs to market entry,15 because a lot of the work leading up to market entry (design, optimization of the production process, marketing ideas, logistical setup etc.) is already done.

14_{E. S Katsikea and Dionisis, ”Organizational and managerial drivers of effective export sales organizations: An}

empirical investigation” European Journal of Marketing 37, No. 11/12 (2003): 1723-1724.

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Rising levels of FDI, intensified global trade and the rise of upcoming markets in the last decades have made FDI an increasingly interesting topic for researchers. The research done suggests there are basically five dominant theories16 which explain why firms invest abroad: The monopolistic advantage theory; transaction cost and internalization theory; ownership, location and

internalization advantages theory (OLI); product life cycle theory; and horizontal & vertical FDI and knowledge capital. I will now briefly give an overview of these theories except for the OLI advantages theory from Peter Dunning which will be covered later in this chapter.

2.3.1 Transaction cost and internalization theory

The first theory which explains aspects of FDI was developed by Ronald Coase. The main

purpose of Coase’s study was to explain why economic activity was organized within firms17_{. He}

argues it is about overcoming transaction costs in firms which individuals are unable to. Firms are more organized and efficient and are thus able to overcome these transaction costs. He further analysed firm structures and argued that firms have diminishing returns of investment when they grow larger. Williamson extends this idea by focusing on the firm as a governance structure18 and identifies transaction characteristics which play a role in institutional assessment. Williamson argues that using external markets involves a certain cost. Thus there is a drive to perform these transactions within the firm instead. However, this causes internal costs to rise. The individual costs for each transaction and the equilibrium which is reached between these two factors are the core of his theory. FDI in this approach is an economic instrument to bypass international

markets and internalize the transactions within the firm.

Other scientists have built upon this idea of transaction cost internalization. Buckley and Casson argue that firms will internationalize their production when the benefit of joint ownership of domestic and foreign assets is more than the benefit of the international market19. Thus, when a firm can internalize transaction costs across borders by investing in production facilities in another country and this has a lower cost than accessing the market, it will engage in FDI.

16_{Ferry Ardiyanto, "Foreign Direct Investment and Corruption." PhD diss., Colorado State University (2012): 12.} 17_{Ronald H. Coase, "The nature of the firm." economica 4, no. 16 (1937): 386-405.}

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2.3.2 Product life cycle (PLC) theory

The Product Life Cycle theory focuses on the idea of different production stages in a sequential developmental process. This theory was first developed by Vernon20. According to Vernon the first stage in a life cycle is a new product stage21, where a product is highly differentiated and is produced by skilled labour at high cost. The product is sold in limited amounts because the potential market is still unknown. These products are usually first introduced in developed economies because of the technological knowledge and the maturity of the market. The manufacturing capability and the potential market is thus tied to the home base of the firm. The second stage of the life cycle22_{is when the product has been around for a while and the}

production process has matured somewhat. It is no longer needed to create the product using highly advanced labour intensive techniques and economies of scale are becoming a possibility. The knowledge of the product and its production becomes more diffuse. Demand for the product has risen in foreign countries, thus creating an incentive to open production capabilities abroad when this becomes cheaper than producing it in the home country and exporting it.

The final stage of the life cycle23 is a mature standardized product which is produced by many different firms. The only way these firms compete is on price level since the production process is highly efficient and standardized. The barrier to entry in the market is low. The product has become a commodity where price and brand level attachment are the most important motivations for buyers.

Later empirical research on the Product Life Cycle theory suggests that FDI is a natural outcome of the production of firms. First the product and its production is concentrated in high income, advanced countries. Then, as the product and its production process matures, production is distributed to other countries and as the price falls, so does the market. This creates a natural cycle of FDI24.

20_{Vernon, Raymond. "International investment and international trade in the product cycle." The quarterly journal}

of economics (1966): 190-207.

21_{Ibid., 195.} 22_{Ibid., 196.} 23_{Ibid., 197.}

24_{Donald G. McFetridge, "The timing, mode and terms of technology transfer: some recent findings." Governments,}

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2.3.3 Monopolistic Advantage Theory

Another theory is the Monopolistic Advantage Theory by Stephen Hymer which explains firms’ motivation for FDI. In his study25 he first looks at the special features of MNCs (Multinational Corporations) which are not available for purely domestic firms. According to him, MNCs possess specific advantages such as desirable brand names, management and marketing skills, advanced technologies, access to financing and economies of scale. Hymer argues that MNCs do not just have an advantage over domestic firms, they need these advantages to overcome the natural home-base advantage of local firms. Local firms know the local environment better, they have better knowledge of local market and business conditions and the legal framework of the country. These aspects can be obtained by the foreign firm, but only at a certain cost. In addition, there are other costs involved in operating from another country. Therefore the advantages which are available to a firm investing in another country should outweigh the relative disadvantages they have in regard to local firms.

Hymer further differentiates between two different kinds of investment: Direct investment and portfolio investment26. The difference between these is the level of control. Some firms are direct owners of a subsidiary in the foreign country, this Hymer distinguishes as “Direct Investment”. However, when a firm owns less than 25% of the foreign subsidiary, he classifies this as a portfolio investment. It is interesting to see that Hymer’s threshold values about what constitutes FDI are much more conservative than the ones which are used by the international organizations listed above and the other theories which I have studied. I have no explanation for the difference in these values except maybe for the idea described by UNCTAD27 that any threshold value is arbitrary and that it has only marginal influence for the purpose of this study.

According to Hymer, there are two major reasons why firms invest abroad28. First, it is to profit from controlling firms in multiple countries to eliminate competition between these countries. Secondly, he argues that certain firms have certain advantages in different areas and it is tempting

25_{Stephen Hymer, The international operations of national firms: A study of direct foreign investment. (Cambridge,}

MA: MIT press, 1976).

26_{Hymer, The international operations of national firms, 6.} 27_{UNCTAD, Definitions of FDI}

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to exploit these advantages by establishing foreign operations. I find the latter a rather vague description, however.

The core of Hymer’s theory is that firms engage in FDI to exploit their monopolistic advantages, which is better explained by Kindleberger, who expanded upon this theory29. According to Kindleberger, there are several characteristics of monopolistic advantages which induce FDI.30 First of all, there are imperfections in the goods markets associated with product differentiation such as superior managerial and marketing skills and collusion in pricing. Secondly, there are imperfections in factor markets because of patented and proprietary technology, preferential access to borrowed capital, and management and engineering skills. Thirdly, there are internal and external economies of scale that lead to no other choice for MNCs but to expand by producing and marketing on a multinational basis. And finally, market distortions created by government exist that influence monopolistic advantages, for instance tariffs, quotas, subsidies to favoured industries or other nontariff barriers. Ultimately, Kindleberger argues that the greater the market imperfections are, the greater the likelihood that monopolistic profits can be earned which motivates firms to engage in FDI31.

2.3.4 Horizontal FDI, Vertical FDI and knowledge capital theory

In economic FDI theory, there is a difference between Horizontal and Vertical FDI. Horizontal FDI occurs when the same goods are produced in both countries. The firm has basically set up a new production facility of a product in order to be closer to a market or to capitalize on specific production advantages a country has. The objective of Horizontal FDI is usually to strengthen a firm’s global competitive position. According to Feenstra and Taylor32, the reasons for horizontal FDI can be identified as such. First of all, by establishing a plant in another country, the home firm can avoid any tariffs and nontariff barriers from exporting from the home country to the host country. Secondly, the ownership of a foreign subsidiary improves a firm’s access to the local market because it will have access to local market information. Finally, by opening different

29_{Charles Poor Kindleberger, American business abroad: six lectures on direct investment. (Yale University Press,}

New Haven, 1974).

30_{Ibid., 187-188.} 31_{Ibid., 201.}

32_{Robert Feenstra and Alan Taylor, International Economics. Second edition. (New York: Worth Publishers, 2012):}

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production facilities in different countries, the country can share technical expertise between these countries and it will have access to more knowledge (in all areas).

Vertical FDI occurs when a firm has set up different parts of its production in different countries in order to leverage country specific advantages. Thus a firm can establish a subsidiary to create simple parts in a country with low wages while the design and assembly can be done in a country which has a high level of development and education (and higher wages). Other reasons for vertical FDI are identified by Chen33 as follows. First of all, firms establish a plant in a developing country to access non-tradable product or service markets. If transaction costs and tariffs for a product are high or even prohibitive, the firms in the source country will not be able to export the product from the home country to the local market in the host country. Secondly, non-movable resources in the host country such as low wage workers and raw materials with high transportation and export costs. Another reason stated by Chen is the advances in communication, data processing and transportation, which have allowed the creation of global production

networks and value chains. This has made it much easier for firms to take advantage of geographic specializations and advantages.

The knowledge-capital model combines both horizontal and vertical motivations in a single model to explain FDI. Markusen et al developed this model34. According to them the basis of the knowledge-capital model is that it explores the difference of ‘skill’ in both home and host

countries in regards to FDI. The Horizontal FDI model predicts that FDI will become less as the skill difference between countries becomes larger because it is harder to produce a good in a country where the skill level is not similar to the home country. The knowledge-capital model uses Vertical FDI motives to predict that the FDI between the countries actually increases because a MNC can utilize the different skill levels for different parts of the production process. The difference between the knowledge capital model and the vertical model of FDI is that the relative effects of skill difference are lower than anticipated by the vertical FDI model because other factors such as trade costs, market size and geographical distance are also important.

33_{John-ren Chen, "Foreign direct investment, international financial flows and geography." Foreign direct}

investment. (London: Macmillan, 2000)

34_{James R. Markusen, Anthony J. Venables, Denise Eby Konan and Kevin H. Zhang, A unified treatment of horizontal}

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2.4 Why are some countries more attractive than others

Now that I have explored why firms engage in FDI, I will look at the options these firms have. Why and how do they pick the countries where they are going to invest in or expand to? The main analytical modal which I believe is the most relevant to determine a countries attractiveness is the GEMS model, which stands for General Economic Management System. The GEMS model is an extension of Porter’s original Diamond Model35. First I will look at and describe Porter’s model, after which I will include some criticism of the model which has accumulated over the years. Then I will thoroughly describe the GEMS model and list the imperfections of the Diamond Model which it tries to overcome. Finally I will describe how these components are used in this study.

2.4.1 Porter’s Diamond Model

Porter first published about his Diamond Model in an article in the Harvard Business Review called “The Competitive Advantage of Nations” in 1990. In the article Porter argues that nations have their own competitive advantages and he describes a model which explains the factors that determine why some nations are successful in certain businesses and others are not. In Porters article, the principal actors are firms rather than nation states but it is the state which influences the environment in which the firm operates and thus shapes the firms competitive success over time36_.

Porter combines different theories of competitive strategy and international economics and applies it to ten countries (The US, West Germany, Italy, United Kingdom, Sweden, Switzerland, Denmark, Japan, Korea and Singapore). In each country, Porter analyses several industries and firms and studies why some are successful and why some are not and what the role of the state is for such success. The main influence a state has, according to Porter, is to serve as a ‘home

base’37 for a firm. Porter argues that since firms usually develop within a domestic context prior to expanding internationally, the characteristics of its management and organization will be determined by the location of the home base of the firm.

35_{Shyam Kamath, Jagdish Agrawal and Kris Chase, "Explaining geographic cluster Success—The GEMS model."}

American Journal of Economics and Sociology 71, no. 1 (2012): 185.

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“The home base is the nation in which the essential competitive advantages of the enterprise are created and maintained, and where the most productive jobs and most advanced skills are located.”38

Porter views the nation as a set of contextual variables which influence the competitive

performance of its firms and industries. Using this view has several analytical advantages. First, it allows Porter to analyse industrial performance at a national level while drawing upon theories regarding industrial performance at the firm level39. Secondly, it allows for a dynamic approach to the analysis of competitive performance at a national level, including the role of innovation in creating a competitive advantage and the role of imitation in eroding this advantage40. Finally the Diamond Model encompasses both levels of trade and levels of direct investment, thus the model includes different measures of effectiveness41_.

So what does this model look like? Porter’s original theory of national competitive advantage is based on four sets of variables, the ‘Diamond’ (figure 1).

38_Ibid.

39_{Robert M. Grant, "Porter's ‘competitive advantage of nations’: an assessment." Strategic Management Journal}

12, no. 7 (1991): 536.

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(Figure 1) Determinants of National Competitive Advantage42

These interacting sets of variables can be briefly explained as follows. Factor Conditions include the amount of available skilled resources and the local level of technological development. Demand Conditions are the conditions surrounding the demand of a product or service in a local and international market. Porter argues that for example, a more demanding local market will lead to a national advantage for a particular industry. Related and Supporting Industries include the level of competitiveness and the technological level of the suppliers for a certain industry. More advanced and more competitive markets for these suppliers are better for the firm and thus for the possible international advantage a nation might have in a certain industry. Finally, ‘firm strategy, structure and rivalry’ describe the cultural factors influencing the contextual structures which determine in which types of industries a nation’s firms are better.

These factors are interdependent and mutually influence each other. For example, the availability and the quality of skilled labour (Factor Conditions) is influenced by the amount of domestic

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rivalry (Firm Strategy, Structure and Rivalry). Meanwhile, the amount of rivalry (Firm Strategy, Structure and Rivalry) is influenced by the local demand conditions and the prospect of a

growing domestic market (Demand Conditions). The intensity of the interaction between these sets of variables determines the extent to which a national environment is conductive to

international success43.

Porter concludes that the strength of the self-reinforcing interaction between these variables depends on two primary factors. The first is Industry Clustering, which Porter identifies as the vertical and horizontal linkages between successful industries44. Tight clustering, or specializing in a certain type of goods and related industries was found to be a characteristic of the successful smaller nations in Porters case studies. The second factor is the close geographical clustering of successful industries in distinct cities and regions. For example, many chemical related industries are located in the city of Basel. The Financial industry in London, etc.

In conclusion, the original Diamond Model of Porter is generally seen as a solid attempt to study the central theme in the development of the world economy since the last part of the twentieth century: internationalization. Both the variables he identified in the model and the analysis of the interaction between them has added insights and contributed to the theories of international trade and investment of the time45. However, the model has been found to not be without its

shortcomings, which are addressed later by Porter himself and by people who eventually build and expand upon the model, such as the authors of the GEMS model.

2.4.2 Criticism of the Diamond Model

Porter’s original Diamond Model is not without its weaknesses. Here I will analyse some of the criticisms of and additions to the original model.

2.4.2.1 The Canadian Case

After the publication of his thesis on the attraction of FDI, Porter was hired by the Canadian government to advise it on how to best attract FDI. He produced the report called “Canada at the Crossroads: The Reality of a New Competitive Environment”46_{on the Canadian oil industry.}

43_{Grant, “Porter's ‘competitive advantage of nations’: an assessment”, 539} 44_Ibid.

45_{Ibid., 548.}

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However, several scholars have criticized the report and the Diamond Model for not being applicable to the Canadian Case47. According to the scholars, Canada is already operating in a very international world, so the ‘home base’ of Canada should include the entirety of North America. Furthermore they criticize the original work of Porter for carefully selecting the original case studies to match the desired results. They also feel that Porter focuses too much on

measuring output from firms while neglecting more intangible advantages such as certain firm specific marketing and management skills. Finally they feel that Porters study neglected the effect and the advantage of inward FDI, a criticism which another scholar, Peter Dunning, shared.

2.4.2.2 Dunning and the OLI Model

Another form of criticism on the Diamond Model comes from Peter Dunning. Dunning starts by analysing the Diamond Model in his book The Globalization of Business. According to Dunning, Porter’s work is not original nor comprehensive, as other scholars have identified more sources of competitive advantage and Porter fails to acknowledge factors such as investment and

entrepreneurship48_{. However, Dunning states that Porter’s model is very effective in describing}

some of the determinants of national competitive advantage and offering a solid hypothesis as to why these variables may vary between countries and sectors49.

Dunning’s main criticism, however, is that Porter’s case studies have been carefully selected to prove his case while, had other case studies been chosen, it might have proven the opposite of Porter’s conclusions50_{. Furthermore, Dunning criticizes the way Porter views the role and agency}

of the state. According to Dunning, Porter considers government not as an attribute of the Diamond, but merely as the creator of its structure. Dunning prefers a view of the state having more influence on the way the rest of the Diamond operates. Attributing the ability to set the ‘rules of the game’ in a comprehensive way and as such to have a far bigger influence on the competiveness of states. Dunning states “Indeed, we would submit in the global economy of the 1990’s, it is entirely appropriate to consider a country’s involvement in foreign trade and

47_{Alan M. Rugman, "Porter takes the wrong turn." Business Quarterly 56, no. 3 (1992): 59-64.}

48_{Dunning, John H. The Globalization of Business: The challenge of the 1990s. (London: Routledge, 1993): 106.} 49_Ibid.

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commerce as a separate exogenous variable affecting the facets of the diamond in the same way in which Porter treats the role of government.”51

Dunning is famous for his Eclectic Paradigm52 or the so-called OLI framework which tries to merge different theories on international economics in a single paradigm. It focuses on the nature, role and behaviour of MNEs (Multi National Enterprises). It is a theory which looks at both the competitive advantage of firms and those of countries53. The activities of which in a geospatial location are driven by three sets of advantages. The Ownership advantages, the Location advantages and the Internalization advantages. Ownership advantages are knowledge based and firm specific assets which provide enough cost advantages and market power to overcome the cost of producing in a foreign location and this explains why some firms go abroad and some do not54_{. The Location advantages depend on the host country’s characteristics and are}

available to all firms in that country. This is an important factor which helps determine where a firm is most likely to go to. The Internalization advantages are the advantages for a firm to facilitate production themselves instead of through a partnership or licensing agreement. This means trading off the savings in transactions against other entry modes such as exports or setting up joint ventures55. The OLI Framework is a useful framework for looking at the incentives for a firm to go ‘international’ and to look at what advantages a firm looks for while selecting a location for a new market56.

Dunning concludes that while Porter has provided a useful paradigm in identifying the main determinants of national competitiveness, Dunning criticizes the framework for being weak in analysing the ownership structure of firms and the way cross-border markets are organized.

2.4.2.3 The Double Diamond

In response to much of the criticism mentioned above, the original model has been adapted and several alternatives have been proposed to address the perceived shortcomings. One of the major shortcomings is the narrow focus on the home-base and a lack of appreciation for the

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international context in which firms operate. The General Double Diamond Model57 has been a successful attempt to address this shortcoming by broadening the domestic focus of Porter’s single diamond to a more international context. The idea behind this approach is to take all the factors from the original diamond and to also apply them when looking at a firm from an international context, thus, the double Diamond.

2.4.2.4 The Nine Factor Model

Another scholar who has modified the original Diamond Model of Porter is Cho Dong-Sung, who applied the model to South Korea and found it was lacking in certain areas. His adoption of the model is called the Nine Factor Model. He divides the factors in human factors and physical

factors and adds several new factors. The Diamond Model includes both natural resources and

labour, but the nine-factor model replaces natural resources with a factor called endowed resources, while labour is put under a category named workers. In the model, human factors mobilize the physical factors with the goal of increasing competitiveness. Finally, Cho argues that competitiveness is relevant only in comparison with similar countries at a certain stage of economic development but not with all the other countries in the world58.

2.4.2.5 The Dual Double Diamond

Cho later revisited the Diamond Model in another study where he and several others created the Dual Double Diamond Model. Cho argues that the Single Diamond cannot be used in an

international context because it is limited to the national scope, while in a Globalized word, a comprehensive model must take into account the international context. This is similar to the Double Diamond, but it also uses the distinction between human and physical factors from his earlier Nine Factor model. Furthermore, Cho argues that both of these extensions to Porter’s Diamond Model do not consider the importance of international human factors. According to Cho, the Double Diamond focuses solely on the physical factors while his earlier Nine Factor

57_{H. Chang Moon, Alan M. Rugman and Alain Verbeke, "A generalized double diamond approach to the global}

competitiveness of Korea and Singapore." International Business Review 7, no. 2 (1998): 135-150.

58_{Dong-Sung Cho, "A dynamic approach to international competitiveness: The case of Korea." Asia pacific business}

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model only looks at the domestic context of national competitiveness. In a globalized world with a mobile workforce, international human factors should be considered59.

2.4.2.6 Overview of extensions to the Diamond Model

(Figure 2) Extensions to the Diamond Model60

The figure above demonstrates shows the different versions of the Diamond Model and the aspects which have been changed to address the perceived shortcomings according to Cho. The latest attempt at creating a comprehensive model of international competitiveness comes from Shyam Kamath et al and is called the GEMS model which I will describe shortly.

2.4.3 The GEMS model

The GEMS model or General Economic Management System of development of economic

clusters is an adaptation of the classical Diamond Model of Porter by Shyam Kamath et al. It

contributes to the original model with new insights in the understanding of economic

development, strategic management, and economic geography61. The GEMS model attempts to

59_{Dong-Sung Cho, Hwy-Chang Moon, and Min-Young Kim. "Characterizing international competitiveness in}

international business research: A MASI approach to national competitiveness." Research in International Business and Finance 22, no. 2 (2008): 177.

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provide a better understanding of why some regional clusters grow and some do not by addressing the described shortcomings of the original Diamond Model. It expands upon the identified variables to create a more comprehensive picture. Essentially, just like Cho, the authors of the GEMS model expand upon the original factors but adhere to the general ideas of the

Diamond Model.

The main focus for both Porter’s model as well as the GEMS model are economic clusters. An economic cluster can be defined as a localized concentration of industrial specializations62. A cluster can take different forms, such as being confined within a single city, state or between neighbouring countries.63 The GEMS model tries to build a framework which analyses the decision of international companies to settle in certain regions, the development of economic clusters and competitiveness within.

The success factors for certain clusters according to the model64_{are dependent on various factors}

such as the education level in a region, the availability of skilled work force, a good level of information and communication technologies, the availability of intellectual property rights, the level of openness for international trade and investments, a sophisticated domestic and regional demand, the availability of risk capital and a research and development-friendly taxation policy.65 The GEMS model expands upon the variables identified in Porter’s Diamond Model66_which

contribute to local comparative advantage. Porter’s model classifies local comparative advantages into four components: Factor Conditions, Demand Conditions, Related and Supporting Industries and Firm Strategy, Structure and Rivalry. The GEMS model expands upon these with several other factors, all of which I will describe below.

The first component of the GEMS model and the original Diamond Model is the factor conditions that create the foundation for goods and service production in a country. They include the quality and quantity of region’s natural resources, the land, an educated and well trained labour force,

62_{Ibid., 186.}

63_Ibid. 64_{Ibid. 189.} 65_Ibid.

66_{Michael E. Porter, Clusters and competition: New agendas for companies, governments, and institutions (Harvard}

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technological assets, infrastructure, capital assets and scientific excellence67. In addition to determining the quantity and the quality of inputs for companies, factor conditions also determine the level of specialization companies can reach in a target region68.

The second component, demand conditions, includes both the conditions in a company’s home market and the demand of the foreign market. If the demand for certain goods or services in the home market is highly competitive or not large enough, a company might be willing to expand its operations to other regions. The factors which determine how this is assessed include the types of regional buyers, foreign market size and composition, the size of regional demand, the growth rate of the local market and demand, the proximity of local buyers and market accessibility. Porter69 argues that sophisticated and demanding buyers can pressure the companies to innovate and achieve higher quality, which will lead to a comparative advantage70_.

The third component, related and supporting industry, includes the amount, quality,

innovativeness and strength of local suppliers and supporting companies. In practice this means the availability of suitable partners and networks of related firms, the presence of good logistic services, accounting companies, financial and tax services, marketing and distribution

intermediates and legal firms which can provide foreign companies with necessary services. Porter states71 that local suppliers can contribute to a competitive advantage for a region by producing cost-effective inputs in an early, fast, and possibly preferential way. Location choice for FDI near innovative and effective suppliers and supporting companies can create advantages by close communication, constant flow of information, and the exchange of ideas72.

The fourth component of Porter’s model consists of strategy and rivalry, which means the amount and intensity of local competition governed by local incentives, and the rules and norms of the local context. Porter divides this component into two parts73. The first sub-dimension consists of the presence and proximity of competitors and industry leaders, the amount of competition among locally based rivals and the presence of partner companies in the region. Porter states that

67_{Kamath, Explaining geographic cluster success, 191-192} 68_Ibid.

69_Ibid. 70_Ibid. 71_Ibid.

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companies want to be positioned in the same location as their important rivals in order to follow and imitate competitor strategies74. There can be remarkable differences and asymmetries between regional positioning and market shares of leading companies which impact the regional competitive situation which ultimately influences the company’s overall strategy.

The second sub-dimension is regional climate for investment which is determined by

macroeconomic policies, political stability and a business-friendly climate. This includes factors like an openness to trade and foreign investment, low levels of corruption and anti-trust

regulation, the support for intellectual property rights and the amount of government business ownerships. Kamath et al. modify Porter’s original model by using the first subdivision as an independent variable of the GEMS model,75 which is called “strategy and rivalry” and which concentrates on the regional presence of competitors and partner-businesses.

These four determinants are Porter’s original Diamond Model. Porter states that these variables are interdependent and influence each other. Weakness in any of these variables could influence the regional competitiveness as a whole. Porter explains that, for example, levels of innovation might not be increasing despite the presence of a skilled work force and high-quality supporting industry if the region lacks vigorous rivalry between companies. This interconnectedness is one of the main strengths of the model as it explains how the context of one variable has influence on another. I will use this in my research to explain how the government’s influence goes beyond direct measures and policies.

2.4.4 Expanding upon the Diamond

The GEMS model develops Porter’s model further by adding eight new variables to enhance the four components introduced previously which concentrate on regional cluster formation.

According to Kamath et al. this should provide a deeper understanding of why some regional clusters succeed and others do not76. (Figure 3)

74_Ibid.

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(Figure 3) The GEMS model77

The GEMS model differentiates the public policy78_{as its own factor from Porter’s “strategy,}

structure and rivalry” component. Public policy in the GEMS model refers to those factors and policies which create a favourable context for economic activities, investments and the political stability in a country. These factors include corporate governance, business and employment laws, labour market policies and procedures, the efficiency of the taxation system, education systems and work force education incentives. Kamath et al. argue that the public policies are not necessarily directly responsible for national or regional competitive advantages which attract foreign direct investments. Kamath claims the track record of active government intervention in this matter is mixed at best79, however he claims public policy affects attractiveness indirectly by facilitating, supporting and providing the context for economic activity80.

77_{Kamath, Explaining geographic cluster success, 191.} 78_{Ibid., 194.}

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The sixth component of the GEMS model is chance81. This factor in some cases is one of the dominating determinants of cluster formation. When a cluster begins to form, pure luck or simply coincidence might play a large role. There is some evidence that ‘chance’ has been an important factor in the formation of highly successful economic clusters such as Silicon Valley. The element of chance as a GEMS component can be further broken down in several

sub-determinants like the reputation of the region as a leading location and the origins of the founders of the region.

The seventh component in the GEMS-model is a favourable business climate82 which includes sub elements like having favourable business laws, relatively low top marginal tax rates, low levels of corruption, favourable investment climate and encouragement for risk-taking. Kamath et al. also include other social and political factors in this variable83_{. Some of these political factors}

which affect the economic activities and investments in the region are: having a low rate of crime, being politically stable, the level and usage of a common international language such as English, general safety, cultural cohesion, the level of labour unrest such as strikes and walkouts, and general quality of life.

The eighth variable is the existence of inter-firm linkages84. This variable considers inter- and intra-company linkages and ties. The amount and intensity of these linkages are affected by several factors such as the level of cooperation and partnerships between the companies,

government agencies and research agencies. Further factors are the presence of professional and industrial networks which increase the level of knowledge sharing and technology spillovers. In practice these are relationships between connected people which have common interests and collaborate to create local networks which enhance value creation processes. Takeuchi and Nonaka state that these industry networks play a critical role in the competitiveness and success of the clusters85. Additionally, internationality of the networks and cross-border connections are also a significant element.

81_Ibid.

82_Ibid. 83_Ibid. 84_{Ibid. 196.}

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The ninth variable in GEMS model is the agglomeration effects of firms, which is described as a high concentration of companies in a certain geographical area. According to Kamath et al86, there are benefits for the companies to locate where other companies also locate because of knowledge spillovers between firms, a greater specialization of skills and a larger amount of suppliers and intermediaries in the region. Economic geography87 divides agglomeration advantages into external localization economies and urbanization economies, essentially differentiating between cities and other geographic concentrations of economic activity. Localization effects include the concentration of specialized skills and knowledge to the workforce in certain regions. This is beneficial for the companies who need this kind of specialized knowledge.

The tenth variable is the level of innovation and entrepreneurship in the region. This is closely related to the agglomeration effects of the previous variable. The presence of innovative

companies in a region influences the decisions of foreign firms to settle at a certain location, sets the level wages, the number of employment opportunities and affects firm growth as well as the general national economic growth. This variable is affected by the presence of entrepreneur-started companies, the local availability of technology-oriented people and managers, the

presence of local startup incubators and the extent of patent and intellectual property activities in the region.

The eleventh variable is the role of anchor firms which are described as larger firms, often large influential international companies, which have been the first ones to begin a cluster in a

particular region. If a large firm moves somewhere, it automatically starts creating an ecosystem in its environment: labour, suppliers, partners, intermediates, services, etc. The presence of anchor firms can have a critical role in the development of a cluster.

The last variable of the GEMS model is historical factors. This is described as the theory of path-dependence which influences the success of a cluster through ‘natural’ locational advantages of a region. The operational indicators of historical factors according to Kamath et al. are the

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historical presence of key firms in the region and the past history of links between the incoming firms and the firms already located in the cluster88.

2.4.5 The role of government policy on FDI attraction in the models

In the models as outlined above, there are several factors where the role of government policy is used to explain the attraction of FDI. Porter talks about government policy in his Diamond Model “strategy, structure and rivalry” factor. However, he believes the role of government in attracting FDI is not as large and sees government policy more as facilitating the context in which FDI can occur.

The GEMS model does attribute more to the influence of government policy, although Kamath et al also have limited expectations about direct government policies to attract FDI. Both Kamath and Porter seem to favour the view of the government as a facilitator of FDI attractiveness. In the GEMS model, government policy is mentioned in various factors which sometimes blurs the distinction between them. Especially the fifth (public policy) and the seventh (favourable

business climate) component of the GEMS model highlight the role of government policy on FDI attraction and the way it is described in the model makes it seem they overlap. On the other hand, I share the view of both authors that government policy is very important to shape the context of FDI attraction. The notion that government policy touches many different factors in different ways seems consistent with this observation.

In order to better understand the role of government policy on FDI attraction, I will look at the models discussed previously and apply a selection of factors to the Netherlands and its

neighbours. I believe this will enable me to research the effect of government policy on FDI attraction and to answer my research questions.

2.5 A better model of FDI attraction and its application

After carefully studying all the leading theories on FDI there are a few observations to be made. First, about the reasons why firms engage in FDI, I believe the major observation is that firms engage in FDI in order to diversify their assets and make their income less prone to shocks on the home market. Secondly, they engage in FDI in order to profit. They can either profit from

reduced costs of production or by lowering the cost of trade, ‘skipping’ many of the barriers to

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trade which normally exist between countries. Thirdly, the more mature a product becomes, the more likely it is that the firm will engage in FDI. From a horizontal FDI standpoint firms will leverage the advantages of having optimized the management, production and marketing of the product and spread out to new markets. From a vertical FDI perspective, they will isolate different parts of the production process and use country specific advantages such as wages or natural resources to manufacture these parts where it is most optimal.

From the perspective of a country, the reasons stated above naturally play a large role and we can see patterns emerging over the different theories. The Diamond Model and its subsequent related theories essentially describe reasons, factors, which describe why some countries are more attractive to FDI than others. The main contribution of Porter’s Diamond Model is that besides identifying some of these factors, he eloquently describes the interconnectedness of these factors. Different factors have a mutual reinforcing influence on each other. The other theories essentially differ in the amount and the specific definitions of the different factors, but this remains the core of the model.

The main observations made in the other theories which I found very interesting were the modern notion of the mobility of labour by Cho which states that besides firms, labour is also globalized. Another interesting observation of Cho is his claim that you should not compare FDI

attractiveness of different countries when they are in a different stage of development and that it is better to compare similar countries. This relates to a similar observation from other models and criticism of the Diamond Model, namely that the original model is very focused on the home base and that it disregards the interconnected nature and relative international environment in which an economy operates. These observations are especially true for an open economy like the

Netherlands. Essentially this means that an economy does not operate in a vacuum. There are no factors which you can influence without also influencing other factors and/or the global

economy. In a similar vein, there are exogenous variables and influences which you might have no control over which nonetheless influence the way in which your economy is attractive for FDI. I believe this was the main contribution of the GEMS model, essentially researching and describing factors which incorporate all of these variables.

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most advanced variant of Porters Model and the OLI model as the basis for my variant. However, GEMS has certain weaknesses in regards to my area of interest, mainly because the theory was formed to explain industry clusters instead of country attractiveness per se. I believe the elements used and described in the GEMS model can nonetheless be effectively used for my study because they already take into account and amend most of the weaknesses of Porter’s original model. It is an excellent basis to answer Porter’s original question “why are some countries more attractive than others”. Similarly, Dunning’s OLI model mainly looks at FDI from a firm’s perspective, but we can extract the variables from this which are important for a firm and relate them to a general attractiveness indication on the country level.

For my study I will heed Cho’s advice and look at the relative attractiveness of the Netherlands compared to similar countries. Although every country is unique and there are several ways in which the choice for certain countries can be made, I have chosen to compare the Netherlands to its neighbours, namely Belgium, Germany and the United Kingdom. Primarily because when a company is looking to expand in a certain market, it tends to look at a certain geographical area, thus it is likely it will shortlist a number of countries in relative close proximity. Furthermore, all four countries are highly developed and open economies. I believe this will satisfy Cho’s call for similarity when comparing attractiveness. The main criticism why I should not use these

countries is the difference in population and market size. I will attempt to normalize my variables for population size to take this into account, however.

I will now briefly list the GEMS and OLI variables which will be used, followed by an explanation of how I will operationalize them. I will mainly look at statistics from Eurostat, reports from think tanks, statistic bureaus and research on the operationalization variables as described in the original GEMS model. I realize this is a very positivist way of comparing countries and the original OLI and GEMS models actually take into account a more critical perspective in order to account for variables which are not easily measured. Nonetheless, I believe this will allow me to satisfy my research question because the focus of this study is on what government policy can achieve and ultimately how this can be measured.

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labour productivity, labour cost, unemployment, the availability of natural resources and the quality of infrastructure.

The second factor will be 'Demand conditions', which essentially encompasses market demand and behaviour. To measure these variables I will look at the size of the market and the amount of trade as an indicator of market demand.

My third factor will be 'Related and supporting industry' which describes how advanced the suppliers and services are in a nation. For this I will look at the presence of accounting and legal services, marketing bureaus and how large the service sector is.

My fourth factor will be 'Public policy' which includes policies which create a favourable context for economic activities. For measurement I will look at the presence of open trade and investment policies and other government incentives for business and investment.

The fifth factor I will use is 'Favourable Business Climate' which includes elements like

favourable business law, low top marginal tax rates and low corruption. For this I will measure the level of corruption, the proficiency in a widely used common language, the crime rate, the level and intensity of labour strikes and the general quality of life.

The sixth factor is the 'Agglomeration effects of firms' which essentially boils down to the presence of high concentrations of companies in certain areas. At the country level I will look at Urbanization, the number of enterprises per 100 000 inhabitants, the population density and a general outlook on agglomeration areas.

My seventh factor is the 'Level of entrepreneurship and innovation' which includes the presence of innovative companies, and the ease of starting your own business. There are reports available which compare and rank countries on the level of entrepreneurship and there are statistics from Eurostat which describe patent activity in different countries.

The eighth factor comes from the OLI model and is “Location advantages” which Dunning describes89 as the motives for firms to locate abroad. For this factor I will use research done on the “L” of the OLI model to apply this on the researched countries. The underlying empirical data

89_{John H. Dunning, "The eclectic paradigm as an envelope for economic and business theories of MNE activity."}

THE ATTRACTION OF FDI IN THE NETHERLANDS