“Drivers of Outward Foreign Direct Investment from Developing Countries” -A country-of origin analysis-

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“Drivers of Outward Foreign Direct Investment from

Developing Countries”

-A country-of origin analysis-

Msc. International Business and Management

S. NEUMANN

S1635484

University of Groningen

Faculty of Economics and Business

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“Drivers of Outward Foreign Direct Investment from

Developing Countries”

-A country-of origin analysis-

ABSTRACT

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1. INTRODUCTION

Foreign Direct Investment (FDI) has been a subject that has been given much attention over the last decades. With borders becoming more virtual and penetrable many firms easily expand their businesses abroad by means such as exports and FDI in order to enlarge markets or reduce their costs. Not just firms but also governments and institutions have a stake in the development of foreign investments. “FDI has the potential to generate employment, raise productivity, transfer skills and technology, enhance exports and contribute to long-term economic development of the countries involved. Currently, one third of global trade is intra-firm trade making FDI the largest source of external finance for developing countries” (UNCTAD, 2007).

Up until now, FDI from a contributing perspective has been largely restricted to industrialized country investors. Generally, it is argued that a country’s net outward investment position is related to its level of development (Barry, Görg & McDowell, 2002) suggesting that developing countries do not play a large part when it comes to FDI. Yet, the World Investment Report 2006 (UNCTAD, 2006) has pointed out that developing countries emerge as a significant source of FDI. Outward foreign direct investment (OFDI) from developing countries has been almost insignificant until the mid-1980s but amounted to $ 849 billion or circa 12.37 per cent of world outflows in 2002 (UNCTAD, 2003). Thus, with the globalization progressing, developing countries are not just recipients of FDI but trends suggest that they will increasingly constitute to outward flows as well.

1.1 Problem Indication and Main Research Question

Several researchers in the past few years started focussing more on the reasons of outward foreign direct investment flows. In some cases interest was on what specific factors govern FDI flows from developed nations such as Canada or some European Union (EU) members (Kyrkilis and Pantelidis, 2003; 2005). An increasing number of researches have also been aimed at identifying drivers of OFDI with regards to specific developing nations and/or the companies operating within those nations (Buckley, Clegg, Cross, Liu, Voss and Zheng, 2007; Svetlicic, 2007).

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from developed countries (Mishra & Daly, 2007; Tallman, 1988; Schneider & Frey, 1985). Researchers often use country characteristics to determine the inbound flow of FDI into countries (Bandelj, 2002). Many additional aspects have been added in order to incorporate for contingencies such as institutional and cultural aspects.

Outbound FDI, on the other hand, is often described by researching one MNE or one industry within the source country or region, separately or in comparison to others. This is especially true for the few researches that centred on developing nations (Lecraw, 1993; Yang, 2003). Usually, the reasons for OFDI from those nations where found to be related to firm- or industry specific determinants.

Yet, Busse and Hefeker (2006) argue that as economic development depends on profitable investments, a host country’s settings especially with regards to political situation can greatly influence an investor. Thus, they believe that in either direction, inbound and outbound, FDI flows would be significantly affected. According to Andreff (2002) changes in countries political, economic and social systems, as could be observed in transition economies, have an effect on FDI. Taking this into account and then looking at Pantelidis and Kyrkilis (2003; 2005) who have found that country specific aspects can be more descriptive of outbound than inbound FDI as they demonstrated on a number of EU countries, it suggests that home-country factors could have an influence on the outbound position of FDI.

Since previous researches compared developing nations based on their characteristics to determine factors influencing inflows, it is possible to analyze them on an outgoing basis. Given Pantelidis and Kyrkilis (2003; 2005) findings, it would be helpful to know whether or to which extent country-of origin factors affect outgoing FDI.

Thus, as mentioned above, even though a number of researches have been able to point out how country-specific factors had an effect on FDI, they often tend to focus on one country only and thus lack the extent and significance to be generally pertinent or they view country-specific factors as determinants for inbound FDI into developing countries. Instead of viewing country specific aspects as sole determinants of inflowing FDI, it should also or could possibly even more so influence outbound FDI.

Since it became clear that normally studies were on country-level when considering the inbound position or on firm-level when considering the outbound position, this research will focus on outgoing FDI from developing nations and the country-of origin characteristics that have an effect on it. Thus, the main research question is:

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1.2 Significance of Research

Given that FDI can bring several advantages and is considered to bring economic gain means that knowing which factors contribute to it can help to focus efforts more accurately. It is possible that some countries have responded more adequately to globalization and created a more favourable atmosphere for growth and investment, which through liberalization can constitute outbound FDI. Bearing that in mind then determining whether certain country-specific characteristics can have in influence on emerging countries expansion of OFDI can shed some light on potential developments in the future, that developing countries can incorporate to facilitate their outward position.

Policy makers in not just the developing nations themselves but in developed nations with economic ties to such countries, or stakeholders in organisations such as the World Bank (WB) or the United Nations and their conference of trade and development (UNCTAD) that try to promote the economic development in those countries will find it useful knowledge to know which determinants can promote outward FDI. Outward FDI can further the integration in the international economy and possibly economic development, it could promote the transfer of knowledge or generate employment (UNCTAD, 2007). Knowing which factors influence firms and consequently the outgoing position can help to determine which stance to take and which policies to focus on to possibly facilitate the economic development of developing nations.

1.3 Outline of Research

This paper empirically determines which country-of-origin characteristics have a significant effect on OFDI from developing countries or in other words: whether outward FDI can be considered a function of country-specific determinants. It will be structured as follows:

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2. BACKGROUND AND DEVELOPMENTS

The World Investment Reports observe an increase in outward FDI from developing countries every year (UNCTAD, 2003; 2004; 2006). The United Nations Conference on Trade and Development (UNCTAD) has pointed out that developing countries emerge as a significant source of FDI. Outward foreign direct investment from developing countries has been almost immaterial until the mid-1980s but from then on started increasing (See Table 1). The figures in table 1 represent the outward FDI stocks, which are presented at historical cost (reflecting prices at the time when the investment was made). Ususally FDI stocks are estimated by cumulating FDI flows over a period of time (UNCTAD, 2003).

In 2000 already, Outward FDI stock from developing nations contributed to 13.6 % of world wide FDI outward stocks, whereas in 1990, developing nations only could account for 7.5% of world wide outward FDI stocks. In 2007, the OFDI stocks increased to 14.7%. In absolute terms this rise seems even more significant as outward stocks increased from 133 billion US dollars in 1990 to 2,288 billion US$. Thus, with the globalization progressing, developing countries are not just recipients of FDI anymore but trends suggest that they will increasingly constitute to outward flows as well.

Table 1: Outward FDI stock, by group of economies, 1980, 1990, 1995, 2000, 2005 and 2007

(in Billions US Dollars)

Group of economies 1980 1990 1995 2000 2005 2007

World 564 1763 2901 5992 10597 15602

Developed countries 499 629 2584 5155 9146 13042

Developing countries 65 133 311 817 1299 2288

Source: UNCTAD. World Investment Report 2008

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nations have participated in 76% of all of them. 42% of all treaties are between developed and developing nations, 26% between developing nations themselves and 8% between developing nations and the Commonwealth of Independent States (CIS) and South East European (SEE) countries. However, it is not completely surprising as there are more developing nations in the world than developed. Nevertheless, the figures show an active and increasing participation of developing nations in world investment.

Figure 1: Percent of all BITs by country group up to 2008 Between

countries of SEE & CIS: 3%

Between developed countries and

SEE & CIS: 12%

Between developing countries and SEE & CIS: 8% Between developed countries: 9% Between developing countries: 26% Between developed and developing countries: 42%

Source: UNCTAD, World Investment Report, 2009

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3. LITERATURE REVIEW

3.1. General theory of FDI

The literature explaining the emergence of FDI is extensive. The early studies even followed the beginnings of FDI back to the international trade theory with the comparative advantage of the recipient country as determinant of FDI (Faeth, 2009). This was the first attempt to explain “resource-seeking” FDI. This approach however did not suffice to determine why some countries chose FDI and trade and why others did not (Banga, 2006). Hymer (1976) thus ventured an explanation of FDI as a result of imperfect global market conditions such as tariffs and other barriers. Nevertheless, FDI continued with the integration of markets globally and instead was described by the “internalization theory” (Rugman, 1986), this “market- or efficiency-seeking” FDI was explained by the need to internalize transaction costs improving profitability (Banga, 2007). Using a similar approach, Buckley and Casson (1976) determined the theory of FDI to be relying on two general principles. Firstly, firms expand by internalizing markets; they use FDI to substitute for imperfect external markets (such as business by licensing) until the costs offset the benefits. Secondly, firms choose locations that minimize the overall costs of operations.

Thus, a number of factors such as resources, restricted markets, and the expansion of markets and economies of scale were examples of why companies would choose to invest abroad. Nevertheless, none of these theories and explanations are capable of elucidating the nature of FDI entirely as they generally lacked one perspective or another to give complete understanding.

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involved. The major focus of the theories, which Dunning more or less combined in his paradigm, is on the firm conducting the FDI (Ownership advantages and internalization) and the recipient countries (Location advantages). The OLI paradigm explains FDI streams from developed countries to a large extend yet with regards to developing countries it is more suitable to explain FDI inflows according to location advantage than account for the increasing outward FDI from there, especially if it flows into developed countries. Dunning (2003) suggests to analyze developing countries further, especially given the increase of FDI inflows, which is not in complete accordance with the location advantages of the OLI paradigm.

The behavioural stream of research used some other approaches on firm level such as the internationalization theory, which used an incremental stage process to explain firm internationalization (Johanson and Vahlne, 1977). Firms begin their international operations in geographically and culturally close regions and export first before they move to a more committed mode such as licensing and then FDI. However, in reality not every firm follows a gradual path. Other explanations tried to include social relationships among involved actors as explanations for FDI flows (Bandelj, 2002). There are many theories of FDI and the literature is extensive. Early reviews already illustrate the diversity of this area of research (Hennart, 1982; Hood and Young, 1979), which has been extending continuously.

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3.2. Outward FDI

However, FDI has increasingly been viewed from an outward perspective. Kyrkilis and Pantelidis (2003) found that for member countries of the European Union, the outward FDI position depends on country specific macroeconomic determinants such as income and openness of economy. Their approach was different as they did not consider the host country as much but focussed on the country-of origin, not on inflowing but on out-flowing FDI. Dunning and Narula (1996) believe that the further a nation develops the higher the OFDI flows of the more technologically-intensive companies or industry. Yet, they also find that countries have a u-shaped relationship between their outward position and economic development. In the same line of argument, Barry et al. (2002) note that OFDI from nations that are less developed, according to the investment development path (IDP) theory, are simply contributing their FDI from industries that are not “created-asset” intensive industries. Lecraw (1993) generally supports this view as he determines that Third World MNCs (TWMNC) already contributed to world OFDI in the 1980s in labour- but not in technology-intensive sectors as he proved was the case with Indian MNCs. However, his findings were also related market protection and quotas in the recipient countries as drivers of OFDI.

Banga (2006) looked into the economic and trade-related drivers behind OFDI from developing Asian countries and argues that most theories such as the OLI framework fit to a large extent but none of the theories are appropriate to explain the OFDI perspective well or explain the increasing outward FDI flows from developing countries. She contributed the increasing OFDI to the increased trade with developing countries and domestic factors such as functioning governments and infrastructure.

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and political stability to explain FDI (Lunn, 1980), examples are Asiedu (2002) and Zhang and Markusen (1998) in their respective studies.

Instead of bending existing theories to developing nations, the outward position of FDI was usually analyzed in specific contexts. Kim & Kang (1996) for example determined that OFDI and exports in and from South Korea and Japan had neither a negative nor positive effect on each other. Buckley et al (2007) found that OFDI of Chinese firms is related to political risk, cultural and geographic proximity as determinants and can be explained by capital market imperfections and ownership advantages. Banga (2006) found that OFDI from Asian developing countries is driven by trade related factors such as exports, imports and trade agreements on one hand; on the other hand the capabilities of investors, which largely depend on advantages gained from inward FDI, and domestic constraints pushing firms to invest abroad. As can be seen, a large number of researches with regard to OFDI specific to industries, firms or regions of developing countries have been conducted.

In the wake of this new research, Pantelidis and Kyrkilis (2003; 2005) consider country specific aspects to be more descriptive of outbound than inbound FDI in comparison. As an example to this theory, European transition economies have been undergoing considerable changes, since hindrances were removed due to economies opening up (Andreff, 2002). Outward FDI was not as hampered anymore through macroeconomic aspects such as foreign trade restrictions, hard currency shortage, low quality goods and governments’ interference. According to Andreff (2002) changes in countries political, economic and social systems had an effect on OFDI. He points out that in order for FDI to be received somewhere it has to originate somewhere else. This reasoning supplies that it is country-specific aspects that affect firms’ capabilities to invest overseas.

3.3. FDI and country characteristics

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economic and political indicators that would promise increased revenues and decreased costs. Faeth (2009) evaluated a number of models explaining FDI and concluded that a combination of country factors is best suited to explain FDI. Among those factors are market size and characteristics, cost factors, transport costs, protection, risk factors and policy variables. Bandelj’s (2002) summary on country characteristics singled out economic factors as those most regularly found to have an effect in different researches along with political stability. Chakrabarti (2001) reviewed economic factors that had been researched earlier and aside from market size found trade-related factors to be influencing inbound FDI. Other variables such as taxes and exchange rates were found to have an effect, yet a smaller and less determinant one. As mentioned before, Lecraw (1993) focussed on host country specific aspects such as market protection and quotas as drivers of OFDI. The literature on country characteristics determining FDI is extensive, yet mostly focussed on the recipients’ side.

A few focussed on home country aspects such as Banga (2006) who found home country drivers related to trade such as exports and inflowing FDI to be descriptive of OFDI from South Asian countries. It can be reasoned that host-country specific aspects are more descriptive of why a firm would choose to invest in a country, which is the inward position. The outward position is more likely to be explained by home-country specific factors, which would have an effect on home firms being able to invest abroad. Kyrkilis and Pantelides (2003) argue that developed as much as developing nations provide a firm with assets that it can employ to invest. Countries have assets such as natural ones - natural resources and unskilled labour force - or created ones - capital, skilled labour and technology - that constitute to a firm’s ability to invest abroad.

Furthermore, not just assets provided by countries but also a developing nations’ government can influence its firms and home market by a considerable amount of factors. Tallman (1988) was one of the first to stress that home country political risk was determinant of FDI flows from the source countries into the US. Desbordes and Vicard (2007) determined that political relationships based on treaties between the respective nations promote FDI and have both been increasing since the 1990s. Globerman and Shapiro (2002) researched that the political, institutional and legal environment determines outflows as much as inflows of FDI and improving these structures facilitates the development of domestic MNCs and investment abroad.

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4. THERORETICAL FRAMEWORK

Not all factors of a country can be considered nor should be considered in order to establish, which characteristics are determinant of OFDI. Determinants such as exchange rates are more recommendable when comparing countries, for example. A number of determinants were found in previous researches that focussed on the inbound perspective, as mentioned before. Additionally, with regards to the outbound perspective, some studies focussed on certain regions and industries of developed as much as developing nations. Several of these determinants can be extended and used to describe developing nations’ OFDI considering the findings presented earlier, especially of Kyrkilis and Pantelides (2003).

4.1 Market size.

Research that focused on the OFDI perspective of developed nations (Tallman, 1988; Dunning, 2003) found that the relative market size is determinant of their outward FDI. For developed nations it has been an accepted indicator describing inbound FDI (Chakrabarti, 2001). It is considered that a larger market is efficient because within this market, resources and economies of scale can be exploited (Chakrabarti, 2001). Banga (2006) on the other hand argues that a small market can lead a company to look abroad instead and act as a push factor to further FDI. This rationale can be easily turned around when considering that a country has more chance to accumulate expertise and skills when operating form a larger market, which then can be utilized to undertake investments abroad (Kyrkilis & Pantelidis, 2003). Kayam (2009) found that inbound FDI into developing nations stimulates OFDI as competition of the home market drives firms to invest abroad. Thus, with this line of argumentation, a market for inbound FDI needs to exist first to increase outbound FDI.

The income of a country is considered an important indicator of the current economic development and status. Economic structure influences and changes a country’s income and with it the competitive advantages of a country (Kyrkilis and Pantelidis, 2005).

H1: Market size has a positive effect on OFDI.

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demand patterns and growing markets, which in turn improve economies of scale through specialization, increased output and new technologies (Chenery, Robinson and Syrquim, 1986).

4.2 Investment liberalization.

Furthermore, if a market with firms that can operate abroad exists, they will need the possibility to do so. The general openness of an economy is the foundation of being able to do business abroad. The absence of capital controls allowing unhindered flows of funds (Scaperlanda, 1992) and openness generally allows a freer flow of information needed to acquire information and skills needed to invest abroad (Kyrkilis & Pantelidis, 2003). FDI is considered to be encouraged by a country’s openness to trade (Mishra & Daly, 2007). However, FDI is more strongly affected by bilateral investment treaties (BIT) as they are specific to investments abroad. Desbordes and Vicard (2007) determined that political relationships based on treaties between the respective nations promote FDI and have been increasing since the 1990s. Generally, several studies have noted that bilateral trade agreements or treaties (BITs) have a positive effect on inward FDI and trade between nations as risks associated with investments decrease with the increased commitment as guaranteed by the involved governments. Additionally, among industrialized nations such as Canada or the USA, the CUFTA and NAFTA agreements increased inward and outward FDI (Globerman and Shapiro, 1999). The openness and fewer restrictions facilitate business. BITs in particular then should have an encouraging effect on OFDI as they signify investment liberalisation and reduce the risks that can be involved in FDI (Gast & Herrmann, 2008). Hence,

H2: Investment liberalization (BITs) has a significant positive effect on OFDI.

Curiously, Neumayer and Spess (2005) even view BITs as a means to attract and facilitate FDI that can partly substitute for a lack of functioning domestic institutions within a country.

4.3. Government effectiveness.

Busse and Hefeker (2006) even argue that as economic development depends on profitable investments, a host country’s settings described by political risk and functioning institutions can “change the game” for the investor. They believe that in either direction political variables should have an effect on FDI flows.

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of business, banking sector reform, foreign exchange and trade liberalization, and legal development influence FDI. Especially, being based in a country, these aspects will influence a home firm even more than an investing one, which can simply choose not to go there. Kogut and Spicer (2002) argue that new functioning institutions in transition economies are probably more important than macroeconomic policy. Institutions influence the strategies of previously state-owned firms before and after privatization, the creation of new firms and the strategies of foreign investors (Bevan et al., 2004). They also specified that the direction a government chooses and how well it is functioning along with its institutions determines FDI inflows, the choice of entry mode for foreign firms and enhances the development of the private and the banking sector. All these factors suggest that a market can be augmented through functioning institutions. From the reverse perspective of OFDI, institutions could influence or hinder the possible investment abroad. Any argument, such as expropriation in unstable countries could be a threat for certain private companies based in that country, too, even if to lesser extent. From the other perspective, Meyer (2001) proposed that functioning institutions determine whether foreign companies invest or simply import. Bitzenis, Tsitouras and Vlachos (2007) even found that bureaucracy, taxation and corruption were hampering FDI flows into Greece. Therefore, from the outward perspective, the political situation and effective institutions are necessary for companies to repatriate profits and maintain ongoing businesses. Tallman (1988) was one of the first to stress that home country political risk was determinant of FDI flows from the source countries into the US. Especially institutions and the political status quo was often found to be a determinants of inflowing FDI stocks (Busse & Hefeker, 2006) particularly into developing countries. An effective government and stability and efficiency of institutions are important factors that guarantee continuity (Mishra & Daly, 2007).

Globerman and Shapiro (2002) found that various governance indicators - as usually produced by many firms, organisation and governments - have a significant positive influence on inflows and outflows of FDI. Globerman and Shapiro (1999) found earlier that especially functioning institutions create favourable conditions for OFDI. In other words, the quality of public and civil services and the degree of their independence from political pressures is essential to OFDI. Thus, a government’s formulation of policy and the consequent implementation and follow-through of it are essential to create a favourable setting for OFDI. Functioning governments and independent public and civil services are necessary for a continuous business environment and subsequently OFDI and constitute an effective government.

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H3: Government effectiveness has a positive effect on OFDI.

Nevertheless, on the other hand, Kayam (2009) found that with increased political stability and functioning institutions less capital would flow out of developing and transition countries as firms would primarily invest abroad to escape their situation.

4.4. Rule of law.

In line with some of the arguments above, rule of law is considered an important factor in a smooth economy allowing trade and business to go on. Even if institutions are in place they will need to be adhered to and led according to law. Kaufmann, Kraay & Zoido-Lobaton (1999) found that a number of factors such as corruption and law enforcement influence the quality of institutions and political risk is linked to functioning or rather non-functioning institutions, which all then affect FDI flows. Busse and Hefeker (2007) discovered that factors associated with political risk such as institutions, corruption and law and order are highly significant determinants of FDI inflows into developing countries. Thus, a lack of law and order would discourage private investment. Given that home firms would have to suffer to some degree as well, it would hamper their development and ability to invest as Banga (2006) determined that FDI inflows stimulate outflows in return. Moenius and Berkowitz (2004) even found that functioning institutions, enforcement of contracts and property rights increased the volume of complex product’s exports of a country. Functioning institutions are necessary for the operation of an economy (Mishra & Daly, 2007) and should they not operate efficiently or are non-existent than additional costs would occur for businesses (Wei, 2000). Kayam (2009) on the other hand found that developing and transition nations would have increased OFDI with little rule of law and institutions as firms would flee by investing abroad. Globerman and Shapiro (2002) suggest investments in governance infrastructures of countries in order to increase FDI in- and outflows. They conclude that these functioning structures attract capital and create favourable conditions under which domestic multinational corporations emerge and invest abroad. Mishra & Daly (2007) concluded that a sound legal system and a functioning regulatory process have positive effects on inward FDI. Aizenman & Spiegel (2004) determined that regulatory quality is positively correlated to FDI flows in general. Thus,

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4.5. Voice and accountability.

Adam and Filippaios (2007) determine that democracy is facilitating FDI, especially from an inward perspective. Under repressive regimes they argue that there is a risk of policy reversal and a lack of credibility.

Globerman and Shapiro (2002) researched that the political, institutional and legal environment determines outflows as much as inflows of FDI and concluded that investments in these structures create conditions that facilitate the development of domestic MNCs and investment abroad. Busse (2004) even discovered a relationship between the protection of democratic rights and FDI for the last three decades.

Li and Resnik (2003) uncovered an indirect relationship between the increase in FDI into developing countries when democracy increased suggesting that rights and civil liberties may stimulate the working of a free market, providing better outcomes for productivity and growth. Adam and Filippaios (2007) go a step further and link repression and lack of democracy to a decrease in productivity as workers are robbed of their initiative and have less incentive to be productive, thus, reducing the returns a company can expect. They view democracy as a disciplinary control for the government which would be punished for a declining economy, which would not allow OFDI. Thus, freedom and democracy can be considered drivers of OFDI. Thus,

H5: Voice and accountability within a country have a positive effect on OFDI.

4.6. Choice of determinants

When looking at developing nations, the companies that are large enough to invest abroad are not comparable to those of developed nations (Yang, 2003). Changes in the economy and the political systems are likely to be greater or simply very different from those of developed nations (Andreff, 2003).

The development of a nation should have an effect on the size of its market. A country’s size or its economic capacity and development is often measured by its market size (Chakrabarti, 2001). This is based on the assumption that the larger the more capacity there is for FDI. Therefore, the size of the market should be taken into consideration.

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2003). This can be measured by political relations with regards to investments in other nations.

Additionally, the political development of the nation itself should influence OFDI greatly. As Tallman (1988) already proved that home country political risk was determinant of FDI flows from the source countries into the US. Kaufmann et al. (1999) previously stated that quality of institutions and political risk is linked to functioning institutions, which then affect FDI flows. Moenius and Berkowitz (2004) findings of functioning institutions and contract enforcement increasing the volume of complex product’s exports of a country suggest the strong influence of policy and political environment on economic development, which simplified would lead to firms profiting enough to be able to invest abroad.

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Figure 2: Visual Representation of Model

Outward

FDI

(flows)

Market Size • GDP Investment liberalization • Bilateral investment treaties

Voice and Accountability

• Index of Democracy and Freedom

Rule of Law

• Index of law abidance and enforcement H1+ H2+ H3+ H4+ H5+ Government effectiveness • Index of quality of

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5. METHODS

5.1. Data and Sample

In order to collect coherent data the source will be mainly the World Bank and UNCTAD statistics. Developing countries were defined according to the World Bank (2009), which uses the classification of the International Monetary Fund (IMF).

However, there are between 120 and 200 countries that are classified as developing countries depending on the source. Some distinguish further between least developed and transition economies whereas others include them in the list of developing countries. World Bank and IMF list about 130 countries as developing and emerging countries, which could be monitored consistently for data by the IMF (IMF, 2009).

Several were eliminated since no coherent and reliable or only partial data, even by the IMF, was found leaving a list of about 80 countries. All data collected is based on the year 2007, including the countries defined as developing nation in that year. All other data, has been collected in million US$ at current prizes or, with regard to the indices, is based on indices on a scale from 0 to 100 (WTO; UNCTAD; 2009).

5.2. Dependent variable

.

The dependent variable in this case is outward FDI from developing countries.

5.2.1. OFDI. The dependent variable (DV) OFDI will be measured by outward FDI

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in order to avoid a non-normal distribution of the variable the log10 of OFDI is used after adding a constant (see Results).

5.3. Independent variables

5.3.1. Market size. Market size (GDP) is measured by GDP in million US$. The data has been

collected from the World Trade Organization (WTO, 2009). Real Gross domestic product (GDP) is often proposed as a proxy for a country’s level of income and structural transformation as it accounts for manufacturing and services within the country, increasing capital intensity of production, demand patterns and growing markets, which in turn improve economies of scale through specialization, increased output and new technologies (Chenery, Robinson and Syrquim, 1986). In this case the log10 of GDP is used to avoid non-normal distribution.

5.3.2. Investment liberalization. Investment liberalization (BIT) is measured by the number of

bilateral treaties that each country has signed and is thus a numerical value. The data is taken as recorded by UNCTAD. In this case the log10 of BIT is used to avoid non-normal distribution.

The three variables governance effectiveness (INS), rule of law (LAW) and voice and accountability (VAA) are based on the indices produced by the World Bank (2009) taking into account all methods and existing findings. They are measured in comparison to all other countries on a scale of 0 to 100.

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many firms, organisation and governments have a significant positive influence on inflows and outflows of FDI, it is acceptable to use the indicators as produced by the World Bank (2009).

5.3.3. Government Effectiveness. “Government Effectiveness measures the quality of

public services, the quality of the civil service and the degree of its independence from political pressures, the quality of policy formulation and implementation, and the credibility of the government’s commitment to such policies” (World Bank, 2009).

5.3.4. Rule of Law. Rule of Law is a measurement of law abidance and enforcement

and the likeliness of crime and violence (World Bank, 2009).

5.3.5. Voice and Accountability. Voice and Accountability measures the extents to

which country’s citizens are able exert democracy, as well as freedom as expressed through “freedom of expression, freedom of association, and a free media” (World Bank, 2009).

5.3. Empirical specifications.

These hypotheses will be tested by means of multiple regression analysis. The number of countries used is approximately 80 developing countries as defined by the World Bank. The results should indicate whether and which factors influence outbound foreign direct investments from developing countries. Within the regression the OFDI flows per annum is the dependent variable (DV). The regression analysis can be performed for each hypothesis as all the data is interval data

OFDI = f [GDP, BIT, INS, LAW, VAA) + + + + + Where:

OFDI= Outward flows of FDI (log10 of OFDI) GDP = Home country GDP (log10 of GDP)

BIT = Number of bilateral trade agreements (log10 of BITs) INS = Government Effectiveness

LAW = Rule of law

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In this research, normal distribution is an underlying assumption, including linearity. Thus, a multiple linear regression analysis will be used in order to analyse whether there is a causal relationship of the hypothesis.

Model hypothesis:

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6. RESULTS

The objective was to test whether BITs, democracy, institutions, markets size and rule of law have a significant effect on outward FDI from developing countries. The regression analysis was conducted using = 0.05. The actual regression that will be used is a least squares multiple regression analysis.

First of all, one needs to have a look at the descriptive statistics in table 2.

Table 2: Descriptive Statistics

N Minimum Maximum Mean Std. Dev. Skewness Kurtosis

Statistic Statistic Statistic Statistic Statistic Error Std. Statistic Error Std.

FDI outflows in million US$ _{81 -45,4452} _{4790 452,7902} _1012,75 _2,734 _0,267 _6,89 _0,529 Bilateral Trade Agreements 80 1 100 26,68 19,339 1,073 0,269 1,608 0,532 Voice and accountability 81 2,88 81,73 36,9183 20,0606 0,169 0,267 -0,732 0,529 Effective governance 81 0,9 84,8 36,5926 20,1856 0,181 0,267 -0,813 0,529 Rule of law 81 0,48 87,62 32,9159 19,3918 0,393 0,267 -0,329 0,529 GDP million US$ ₇₉ ₁₄₅ _{657091 62038,15} ₁₀₆₇₇₁ _3,222 _0,271 _0,68 _0,535 Valid N (listwise) ₇₈

OFDI net flows are between -45 and 4790 million US dollars and GDP ranges from 145 to 657091 million US$. The developing nations have between 1 and 100 BITs with other nations in effect. Furthermore, the data is slightly skewed as all data in real life is, yet if the standard error reaches 2, it is considered to be skewed to a significant degree (Tabachnick & Fidell, 1996). As it is not the case here, the majority of data is viewed as having no significant skewness after checking using the appropriate test formula (6/N) 0.5_.

Additionally, the same can be extended to the level of kurtosis. The closes to zero the better and once it reaches 2 standard deviations, it could be too peaked to be considered mesokurtic. In this case, the formula to check is (24/N) 0.5 (Tabachnick & Fidell, 1996), applied to this case: (24/79)0.5 multiplied by 2 equals 1.11.

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Table 3: Descriptive Statistics II

N Mean Std. Dev. Skewness Kurtosis

Statistic Statistic Statistic Std. Error Statistic Error Std.

Log OFDI ₈₀ _2,1428 _0,62528 _1,119 _0,269 _0,041 _0,532 Log GDP ₇₈ _4,2855 _0,73121 _-0,226 _0,272 _0,068 _0,538 Log BIT ₇₉ _1,2791 _0,41777 _-0,987 _0,271 _0,821 _0,535 Effective governance 80 36,3275 20,17059 0,209 0,269 -0,782 0,532 Voice and accountability _{80 36,5445 19,90121} _0,189 _0,269 _-0,679 _0,532 Rule of law _{80 32,9286} _19,5139 _0,389 _0,269 _-0,364 _0,532 Valid N (listwise) ₇₇

As observed in table 3, skewness and kurtosis are not an issue anymore and the data can be described as normally distributed, which is the bases for linear regression analyses.

Correlations were observed in table 7, which can be found in the appendix. Some drivers show a significant correlation such as rule of law and effective governance with roughly +0.8 showing that they have an almost linear positive relationship, which is not considered to be of significance in this case as collinearity does not need to be considered an obstacle since causal predictions will still be accurate, and the overall still quantifies how well the model predicts the dependent variable as is the aim of the research.

The ANOVA confirms, at a significance level of = 0.05, that the dependent variable Outbound FDI flows is predicted by the independent variables as significance is 0.000 (see table 4).

Table 4: ANOVA

Model Squares Sum of df Mean Square F Sig.

1 Regression _18,851 ₅ _3,770 _23,586 _,000

Residual 11,349 71 ,160

Total _30,200 ₇₆

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Table 5: Regression Model Summary

Model R Square R

Adjusted R

Square the Estimate Std. Error of

1 _,790 _,624 _,598 _,39981

As the adjusted R square indicates in table 5, only a portion of the variance, namely 60% can

be explained by the inserted variables. Apart from the fact that the model was significantly tested, only few variables showed significant results as can be noted in table 6.

The best descriptor of the model is GDP at t=7.086.Generally, t values must be over +2 or less than -2, the higher the number the better are they in predicting the dependent variables. Furthermore, GDP is a highly significant factor, too.

Table 6: Coefficients of predictor variables

Model Unstandardized Coefficients Standardized Coefficients t Sig.

B Std. Error Beta 1 (Constant) -,841 ,335 -2,509 ,014 Log GDP _,703 _,099 _,820 _7,086 _,000 Log BIT -,270 ,166 -,177 -1,623 ,109 Effective governance ,007 ,005 ,233 1,346 ,182 Voice and accountability ,002 ,003 ,077 ,784 ,436 Rule of law _-,001 _,005 _-,029 _-,179 _,859

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7. DISCUSSION

In most researches conducted on Outward FDI, country characteristics were never researched across developing nations in general. The objective of this study was to examine whether country-of origin characteristics have a significant effect on outward FDI. The results were inconsistent as the model held true for 60% of all cases, yet only GDP or rather market size was the only truly significant independent variable.

The first hypothesis holds as Market size has been found to be a reliable determinant of outward FDI from developing nations. Chakrabarti (2001) found market size to be descriptive of FDI, in every study reviewed it proved to be a significant determinant. Faeth (2009) concurred with the findings, finding that a combination of country characteristics is best suited to explain FDI. The assumption is reasonable as market size can be considered to reflect the economic capacity of a nation (Chakrabarti, 2001). This suggests that the assumption that the larger the market the more capacity there is for FDI is correct. Therefore, the size of the market is determinant of OFDI. As mentioned earlier, Kayam (2009) had a different reasoning behind this, as in the research a sufficient market in developing nations would attract inward FDI which would force home firms to invest abroad fleeing the competitors. Thus, Kayam’s (2009) reasoning was different but the results were the same. On the second hypothesis, the results show that BITs do not have a particularly strong significant relationship with OFDI. Among industrialized nations such as Canada or the USA, Globerman and Shapiro (1999) found that trade and investment agreements increased inward and outward FDI. Desbordes and Vicard (2007) determined that political relationships based on treaties between the respective nations promote FDI. Thus, it could be possible that BITs only promote FDI in developed nations. Another possibility is that BITs do only affect OFDI flows on a longitudinal basis increasing FDI from developing nations with each new treaty signed over time. Each new treaty signed in time would promote OFDI into the respective country. There could be a number of reasons. BITs might be industry-related and thus do not reflect capital-intensive sectors or are simply facilitated by developed nations which profit from them more than developing nations.

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Busse & Hefeker (2006) determined that especially institutions were often found to be a determinants of inflowing FDI stocks particularly into developing countries. However, they and others often related functioning governments to be determinant of inward FDI flows or stocks. It is possible that for the inward position indicators can be descriptive of FDI. Furthermore, they related their findings to FDI stocks. It is a possibility that on a historical cost basis the assumption of effective governments influencing OFDI positively can be significant. This reasoning could be an explanation for the weak significance of the predictor. It is also possible that Kayam (2009) was right about companies from developing nations mainly investing abroad to get away, which would mean less OFDI when political stability through freedom, functioning institutions and government, increases and vice versa.

Functioning and effective governments are assumed to make life easier, not just for companies. However, even though an effective government and stability and efficiency of institutions are important factors that guarantee continuity (Mishra & Daly, 2007), it does not significantly explain OFDI flows. It is possible that on a longitudinal basis the government plays a stronger role. In that case, the stability of a government could possibly have a stronger effect on OFDI as firms in those countries count on their effective and stable government in the long run. Freedom, effective governments and rule of law develop and might therefore promote the growth of international firms. But it might be that once a developing nations reaches a certain level of development that firms will focus on their home market in order to get the first of the “pie” when it is divided and thus will focus on their home market instead of undertaking investments abroad.

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Moreover, democracy and freedom do not appear to be significant. The 5th hypothesis was based on the assumption that political, institutional and legal environment determines outflows as much as inflows of FDI and concluded that investments in these structures create conditions that facilitate the development of domestic MNCs and investment abroad (Globerman and Shapiro, 2002). Busse (2004) even discovered a relationship between the protection of democratic rights and FDI for the last three decades. Yet, even if the factor can help explain the model to some extent by itself it does not significantly affect OFDI flows. It was assumed that companies in a free environment can operate more freely than under repressive regimes they argue that there is a risk of policy reversal and a lack of credibility. Institutions, law and order and democracy are interrelated. Yet, it is possible that they invest abroad to avoid their lack of freedom in doing business (Kayam, 2009). Thus, the reverse would be the case for the some of the countries. Lack of freedom, of voice and accountability, might actually be a driver of OFDI in some of the cases, but possibly not in all. This would have to be analyzed and researched separately.

Even though Adam and Filippaios (2007) have determined that democracy is facilitating FDI, especially from an inward perspective. It is also possible that democracy, as reasoned above with effective governments, has a stronger impact on OFDI in the long run.

In any case, explaining OFDI flows from developing nations can be explained by country characteristics as the model holds for 60% of the cases. Yet, the hypotheses with regard to political status quo, 3 to 5, are not significant.

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8. CONCLUSION

The model that was developed could account for more than half of the cases however was not able to link all the variables significantly to OFDI. Thus, OFDI from developing nations can be described and explained by country-of origin characteristics. There was strong evidence that the market size of a nation effects the outward position suggesting that a developed, larger market promotes FDI. Thus, as reasoned a larger market is more efficient because within this market, resources and economies of scale can be exploited.

The other variables were not significant, especially not rule of law.

8.1. Limitations and further research.

The research is not set out to be longitudinal but further research into the development over time would elucidate the matter some further. This study was designed to establish whether the characteristics where determinants of OFDI and not analyze changes over a period of time. Using a longitudinal approach would enable to compare results for the same country instead of comparing different countries at the same time. Yet, maybe the independent variables are more descriptive for changes over time then whether the relationship moves into one direction at a given time.

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C or re la tio ns 1 ,7 44 ** ,4 34 ** ,3 80 ** ,1 39 ,1 92 * . ,0 00 ,0 00 ,0 00 ,1 09 ,0 44 80 78 79 80 80 80 ,7 44 ** 1 ,7 15 ** ,2 51 * -,0 91 ,0 14 ,0 00 . ,0 00 ,0 13 ,2 14 ,4 51 78 78 77 78 78 78 ,4 34 ** ,7 15 ** 1 ,3 39 ** -,0 36 ,2 04 * ,0 00 ,0 00 . ,0 01 ,3 75 ,0 36 79 77 79 79 79 79 ,3 80 ** ,2 51 * ,3 39 ** 1 ,5 88 ** ,8 66 ** ,0 00 ,0 13 ,0 01 . ,0 00 ,0 00 80 78 79 80 80 80 ,1 39 -,0 91 -,0 36 ,5 88 ** 1 ,6 12 ** ,1 09 ,2 14 ,3 75 ,0 00 . ,0 00 80 78 79 80 80 80 ,1 92 * ,0 14 ,2 04 * ,8 66 ** ,6 12 ** 1 ,0 44 ,4 51 ,0 36 ,0 00 ,0 00 . 80 78 79 80 80 80 P ea rs on C orr ela tio n S ig . (1 -ta ile d) N P ea rs on C orr ela tio n S ig . (1 -ta ile d) N P ea rs on C orr ela tio n S ig . (1 -ta ile d) N P ea rs on C orr ela tio n S ig . (1 -ta ile d) N P ea rs on C orr ela tio n S ig . (1 -ta ile d) N P ea rs on C orr ela tio n S ig . (1 -ta ile d) N lo gO FD I lo gG D P lo gB IT E ffe ctiv e g ov ern an ce V oic e a nd a cc ou nta bili ty R ule o f la w lo gO FD I lo gG D P lo gB IT E ffe ctiv e go ve rn an ce V oic e a nd ac co un ta bili ty R ule o f la w C orr ela tio n i s s ig nif ica nt at th e 0 .0 1 l ev el (1 -ta ile d). **. C orr ela tio n i s s ig nif ica nt at th e 0 .0 5 l ev el (1 -ta ile d). *.

APPENDIX

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Figure 3: Distribution of Dependent Variable

-3 -2 -1 0 1 2 3

Regression Standardized Residual

0 5 10 15 20 Fr eq ue nc y Mean = 3,79E-15 Std. Dev. = 0,967 N = 77

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39

Table 8: List of countries and data collected

Country FDI outflows in million US$ GDP in Million

US$ VAA BIT INS LAW

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“Drivers of Outward Foreign Direct Investment from Developing Countries” -A country-of origin analysis-

“Drivers of Outward Foreign Direct Investment from

Developing Countries”

-A country-of origin analysis-

Msc. International Business and Management

S. NEUMANN

S1635484

University of Groningen

Faculty of Economics and Business

“Drivers of Outward Foreign Direct Investment from

Developing Countries”

-A country-of origin analysis-

ABSTRACT

TABLE OF CONTENTS

1. INTRODUCTION

2. BACKGROUND AND DEVELOPMENTS

3. LITERATURE REVIEW

4. THERORETICAL FRAMEWORK

Outward

FDI

(flows)

5. METHODS

.

6. RESULTS

7. DISCUSSION

8. CONCLUSION

REFERENCES

APPENDIX