What Location Influences Foreign Direct Investment?
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Chapter 1 Introduction
This chapter offers an introduction to the research, with paragraph 1.2 detailing the problem it focuses on, leading to the research question in paragraph 1.3. Paragraph 1.4 discusses the relevance of the research. The chapter ends with an outline of the thesis. The next paragraphs contain the various purposes and the general research design, and finish with the disposition of the study.
Foreign Direct Investment (FDI) is an important source of capital and economic growth in recent business. It provides a package of new technologies, management techniques, finance and market access for the production of goods and services. However, attracting FDI is a major challenge for most host countries as they face the challenge of identifying the major factors that motivate and affect the FDI location decision.
Nowadays, regions try to attract Foreign Direct Investments to stimulate their economic development (OECD, 2002a). Certain regions consider the ecological issues as well and promote sustainable FDI. Recently, while working at AgentschapNL, an agency of the Dutch secretary of Economic Affairs, the awareness for sustainable investment rose. AgentschapNL promotes sustainable development and innovation, both in the Netherlands and abroad.
One region that is engaged in an initiative to attract FDI is the Swedish province Jämtland. This initiative is called Midscand and it involves stimulating business investments and cooperation (joint ventures, business development, acquisitions, strategic alliances, outsourcing and new start-ups). One of their target countries is the Netherlands. The activities that are discussed are the sectors: cleantech, tourism, mechanical industry, forestry and call centres. The scope of this research is limited to the cleantech sector. This sector deals with sustainable innovations and investments in Jämtland, with special focus on wind and bio energy. The main goal of this project is to attract new investments from the Netherlands to Swedish regions.
1.2 Problem Indication
The literature dealing with FDI can be classified in two main streams, as pointed out by Agiomirgianakis, Asteriou and Papathoma (2003): the first explains the effect of FDI on the process of economic growth, while the second one goes in depth into the study of the determinants of FDI. This thesis focuses on the second part of literature. Among all the factors influencing the location decisions of FDI, the location-specific determinants need particular exploration, since they can help the host governments to attract and increase FDI inflows using several instruments (Chakrabarti, 2001). Location-specific factors will always influence the decision to enter or exit a location for investment purposes (Audretsch and Fritsch, 2002).
FDI is a key element of the international economic relations as it is an engine of employment, technology transfer and improvement of productivity, which ultimately leads to economic growth. The need to attract FDI forces governments to provide a favourable climate for business activities (Nordstrom, 1991). The foreign firms can be influenced by the political and economic institutional framework of the host country, which could affect the choice of where to invest their capital (Makino and Chan, 2004).
The challenge of this research is to explore which location determinants make a region attractive for FDI. The definition of the problem is:
What should Swedish regions do to positively influence FDI?
By presenting a thorough overview of FDI and the determinants that could influence the location choice for a company, this research aims to provide a framework, tested in interviews for the applicability of investments.
1.3 Research questions
To solve the problem the following research questions are answered:
What is FDI?
Based on a literature review that provides theoretical information on this phenomenon.
What are the location factors?
Galan and Gonzales (2007) are used as basis for the location factors. Several other papers on location factors are evaluated and criticized.
What does Sweden have to offer?
This final question deals with the application of the theoretical framework to Swedish region as case study and the relationship between the factors they possess and the factors they need to stimulate to influence FDI.
1.4 Purpose and Objective
The purpose of this thesis is to examine which regional factors influence foreign direct investments. Theories regarding FDI and location-specific characteristics will be reviewed and analysed in the theoretical framework. A thorough overview of the location factors will be part of the framework that can be used by regions, willing to attract sustainable investments. But first of all, the objective as described in the definition of the problem is to give recommendations to Swedish regions regarding the factors they should highlight to attract or influence direct foreign investment.
1.5 Research Design
The literature framework is based on relevant papers. According to Ghauri (2005), theoretical data will be used to understand and interpret the research question, and it will help to “broaden the base from which scientific conclusion can be drawn”. The relevance of the papers will be based on quality. To reach the goal of collection qualitative data for the research question, a phased selection is made. The emphasis of the courses Corporate Level Strategy and Research Methods of Strategy within the master Strategic Management is on testing all data on quality. By examining the relevance, publication form and impact factor of the information, the quality of the paper will be showed.
The research is divided into two parts: (1) the literature research and (2) a case study. The first part of the research is explorative, because it is intended to gain more information on the situation and to get familiar with the research area. Qualitative studies -observations and interviews- are used to gain more knowledge of the research topic (Sekaran, 2003).
The research mainly relies on secondary data; books and articles by various authors are considered. Literature is compared and new insights are gained. Interviews are conducted for the verification of the interests, which are characterized as primary data. In this research, qualitative data is the main source. The time dimension of this research is cross-sectional, which implies that the research is conducted at one particular moment in time.
For useful literature, the data will be collected on acknowledged databases (e.g. ABI/Inform, JCR, Web of Science). The keywords that will be used during the search period are “FDI”, “entry modes”, “choice of country”, “region”, and “location determinants”. All literature sources can be found in the list of references. The theory will be examined by a qualitative case study. Case studies are used to understand a specific case under particular circumstances (Patton, 2002).
In chapter 2 the contemporary theory that has been evaluated and reviewed is presented. An introduction will be followed by a presentation of FDI and the factors that influence the location choice, followed by the location factors that are important for wind and bio-energy. In
the methodology is elaborated and provides a description of the way this thesis was written and the choices that are made. In the second paragraph the data and sample size are explained. Theoretical and empirical frameworks are discussed, as well as the reliability and validity of this study. In
the participating respondents are interviewed, which leads to an analysis and concludes the empirical results.
includes the results of the findings and the discussion that compares the theoretical statements that were researched and found necessary for this research presented in chapter 2. The mode of procedure is explained and the model of the empirical results is presented in this part.
includes the answers of this research by modifying the analysis model. The conclusion is based on the discussion in chapter 5. The answers serve as a proposal for further research in a broader context and give an opportunity of generalization.
Chapter 2 Theoretical framework
The literature review provides the foundation for this research, through discussions of previous studies on FDI and international business. Section 2.2 offers a review of studies regarding FDI. Next, it is essential to identify the location factors that influence that move, as it contains the answer to the second research question:
What are location factors?
The third paragraph contains a detailed overview of the location factors. An overview of the selected factors can be found in table 1. The list contains determinants to measure the impact on the location factors and their impact on FDI. The last paragraph contains a summary of the findings and a conclusion.
2.1 What is FDI?
Modern day literature increasingly concentrates on subjects covering the globalization of markets and the internationalization of companies. Governments contribute to this situation by opening their regulations with the intention to profit from a more open economy (Dunning and Nurala, 2002). The growing number of liberal policies is a driving force for companies to go abroad and make FDI (Galán and González-Benito, 2001). There are several definitions of a foreign direct investment presented by a number of researchers. A central theme of the definitions available on FDI, with the one illustrated by Moosa (2002) as a typical example, is that the companies undertaking such a venture aspire to gain a controlling stake in the asset or entity purchased. An FDI is not to be confused with an international or portfolio investment, where the aim merely is to diversify the holdings of the firm and make a financially sound investment (Buckley, 1998). FDI is defined as a firm based in one country (the 'home country') owning ten per cent (10%) or more of the stock of a company located in a foreign country (the 'host country'). This amount of stock is generally enough to give the home country firm significant control over the host country firm. Most FDI is in wholly owned or nearly wholly owned subsidiaries. Other non-equity forms of FDI include: subcontracting, management contracts, franchising, and licensing and product sharing .In view of the above, FDI can be either inward or outward. FDI is measured either as a flow (amount of investment made in one year) or a stock (the total investment accumulation at the end of the year).
Outward FDI can take various forms, home country residents can:
- purchase existing assets in a foreign country;
- make new investment in property, plant & equipment in a foreign country;
- participate in a joint venture with a local partner in a foreign country (Dunning, 1976).
2.2 Location factors
There is considerable literature on the determinants of location factors for multinational Corporations (MNCs) when they choose their foreign market location, but very little on the relative importance of the location factors for FDI in a specific country and industry. It is widely believed that the trend towards globalized production and marketing has major implications for the attraction of developing countries to FDI inflows. The relative importance of FDI location determinants have changed. Even though traditional determinants and the types of FDI associated with them have not disappeared as a result of globalization, their importance is said to be on the decline. More specifically, "one of the most important traditional FDI determinants, the size of national markets, has decreased in importance. At the same time, cost differences between locations, the quality of infrastructure, the ease of doing business and the availability of skills have become more important" (UNCTAD 1996). Likewise, Dunning (1999) argues that the motives for and the determinants of FDI have changed.
Buckley and Ghauri (2004) point to the limited attention researchers have given to the FDI location factors in the literature. They suggest that international business strategy is distinct from main stream or single country business strategy only because of differences of location. Hence, location specifics are essential to the possibility of international strategy having a distinctive content. They, too, suggest that a focus on location, and possibly the question of why locations differ, could be a response to the issue of what forms the next 'big question' in international business research. Dunning (2008) suggests that the more recent lack of attention to location by IB scholars could have arisen from an assumption that the location decision principles are the same for both international and domestic locations. Thus, scholars were either satisfied with existing explanations or as Dunning (1998) points out 'maybe theywere just not interested'.
In attempting to determine the relevant set of location factors, Michael Porter's (1990) work cited in Hodgetts (1993) offers a valuable starting point. Porter notes that success for a given industry in international competition depends on the relative strength of that industry with regards to a set of business-related features or 'drivers' of competitiveness, namely 'factor conditions'; 'demand conditions'; 'related and supporting industries'; and 'firm strategy, structure, and rivalry'. 'Government' and 'chance' are seen to influence competitiveness through their impact on the above four basic drivers. This framework - the drivers of competitiveness - has been used in a number of studies of industries and individual economies. Porter's competitiveness framework has been the subject of major criticisms.
Paul Krugman (1994) specifically criticized the idea that nations, or locations, compete in the same way as firms do, and his wide-ranging critique attacks this concept. Also, the empirical evidence for national competitiveness and the policies that follow are what Krugman (1994) describes as 'a dangerous obsession'. Another criticism is that Porter places government involvement in international business outside of the core determinants. Many authors have claimed that Porter's framework pays insufficient attention to relevant specific location factors such as globalization (Dunning, 1993), multinational companies (Dunning, 1993; Rugman&Verbeke, 1993), technology (Narula, 1993. Several authors have questioned the validity of the model, and the conclusions drawn from the model, for countries such as Austria (Bellak& Weiss, 1993), Canada (Rugman & d'Cruz, 1993), Hong Kong (Redding, 1994) and Mexico (Hodgetts, 1993). A lot of research interested in providing the determining factors for FDI location decisions is seen to be done by managers. Some of the major studies are the following (Dunning, 2000): theories of risk diversification (Rugman, 1979); agglomeration theories (Krugman, 1993; Porter, 1994, 1996); theories related to government-induced incentives (Loree and Guisinger, 1995); and theories of location (Dunning, 1997). All these new theories are certainly insightful, but they are all context-specific, and interested solely in stressing the relevance of certain factors to the detriment of others that may be equally significant. None of them has yet provided a satisfactory explanation of the relative importance of specific factors that lead managers to locate their investments via FDI in a specific country and industry (Dunning, 2008).
Dunning (2008) believes that “it is not possible to formulate a single operationally testable theory that can explain all forms of foreign-owned production any more than it is possible to construct a generalized theory to explain all forms of trade or the behaviour of all kinds of firms.” Cohen (2007) believes that location factors for a specific location and industry that affect the location decision are based on the perceptions of a small group of senior managers, not a scientific formula. Furthermore, Buckly et al(2007) argue that studying a single firm or group of firms in the same industry is the best way to identify the most important factors, because firms in the same industry usually follow a systematic process for location choices, and seek to prioritize certain location factors as they become more internationally mature.
Cohen (2007) argues, “No standard set of attributes, each with an assigned relative weight of importance, exists in the many lists of what matters in location published by business groups, international organizations, and scholars. Determining where to invest is a case-by-case decision”. Cohen (2007) also suggests that no single formula exists because specific strengths and weaknesses of a country or region might receive high priority by one team of corporate evaluators and can be ignored by another, depending on what kind of investment is contemplated, which in turn will determine a subsidiary's objectives and operational needs. Furthermore, individual corporate cultures will assign a different relative importance to what attributes they require in a country, what they would like to see, what negatives they can work around, and what is unequivocally unacceptable. Calculating trade-offs between positive and negative location characteristics is an art, not a science.
Galan et al (2007) conducted an empirical research into location factors that has been researched by several theorists. This list provides a detailed overview of the main location factors and sub factors considered by several empirical studies that have examined their positive or negative influence on the location decisions of MNE managers in both DCs and LDCs. All these factors are usually included in the analyses made via the eclectic paradigm (Galan et al, 2007). They recognise that MNE managers' motivation to eventually choose either or both groups of host countries will depend on the specific location factors available in them.
These location factors are classified in the following categories:
- Cost factors
- Market factors
- Infrastructure and technological factors
- Political and legal factors
- Social & Cultural factors
The order of this list is random. According to Noorbakhshs, Paloni and Youssef (2001), foreign investors are attracted to regions that offer a combination of the location factors. The location factors are discussed separately in the next paragraph.
2.2.1 Cost factors
This paragraph contains theoretical information about the cost factor as one of the location factors. The determinants that are criticized are labour costs and cost of materials.
184.108.40.206 Labour Cost
The costs linked with the profitability of investment are one of the major determinants of investment (Asidu, 2002) . The rate of return on investment in a host economy influences the FDI decision. Asiedu (2002) noted that the lower the GDP per capita, the higher the rate of return and, therefore, the FDI inflow. Charkrabarti (2001) claims that wage as an indicator of labour cost has been the most arguable of all the potential determinants of FDI. There is no unanimity even among the comparatively small number of studies that have explored the role of wage in affecting FDI: results range from higher host country wages discouraging inbound FDI, to having no significant effect or even a positive association ( Dunning, 1989). Goldsbrough (1979) and Shamsuddin (1994) demonstrate that higher wages discourage FDI. Tsai (1994) obtains strong support for the cheap-labour hypothesis over the period 1983 to 1986, but weak support from 1975 to 1978. Charkrabarti (2001) stated that empirical research has found relative labour costs to be statistically significant, particularly for foreign investment in labour-intensive industries and for export-oriented subsidiaries. However, when the cost of labour is relatively irrelevant (when wage rates vary little from country to country), the skills of the labour force are expected to have an impact on decisions concerning FDI location. This is not the case for the investments in this case study, which is more knowledge based than labour intensive.
Cheap labour is another important determinant of FDI flow to developing countries. A high wage-adjusted productivity of labour attracts efficiency-seeking FDI both aiming to produce for the host economy and for export from host countries. Studies by Wheeler and Mody (1992), Schneider and Frey (1985), and Loree and Guisinger (1995) show a positive impact of labour cost on FDI inflow. Countries with a large supply of skilled human capital attract more FDI, particularly in sectors that are relatively intensive in the use of skilled labour.
220.127.116.11 Cost of Materials
The analysis above leads to two variables that can be measured to determine the importance of the cost factor that is labour cost (wages). The availability of raw material and cheap labour can be of crucial importance in the choice of location.
The return on investments is not important for this study, because this is not region-constrained, so it is not an important factor for a location choice. FDI uses low labour costs and available raw materials for export promotion, leading to overall output growth.
2.2.2 Market Factors
This paragraph contains theoretical information about the market factor as one of the location factors. The determinants that are criticized are market size, openness of the market, labour market and economic growth.
18.104.22.168 Market size
The size of the host country market is a relevant determinant to the extent that the FDI is destined to serve the host market and not merely to set up an export platform. Larger markets should attract FDI because firms face economies of scale as FDI entails sunk costs (for example, in terms of adapting management to local conditions or getting familiar with host country legislation). Market growth should work in the same direction. Nunnenkamp (2002), Chakrabarti (2001) Campos and Kinoshita (2003), Braga Nonnenberg and Cardoso de Mendonca (2004), Addison and Heshmati (2003), Kolstad and Villanger, (2004) all find market size and/or growth to be relevant determinants of FDI.
An economy with a large market size (along with other factors) should, therefore, attract more FDI. Market size is important for FDI as it provides potential for local sales, greater profitability of local sales to export sales and relatively diverse resources, which make local sourcing more feasible (Pfefferman and Madarassy 1992). A large market size provides more opportunities for sales and profit to foreign firms, and in doing so attracts FDI (Wang and Swain, 1995: Moore, 1993; Schneider and Frey, 1985; Frey, 1984). FDI inflow in any period is a function of market size (Wang and Swain, 1995). However, studies by Edwards (1990) and Asidu (2002) show that there is no significant impact of growth or market size on FDI inflows. Further, Loree and Guisinger (1995) and Wei (2000) find that market size and growth impact differ under different conditions.
Artige and Nicolini (2005) state that market size, as measured by GDP or GDP per capita, seems to be the most robust FDI determinant in econometric studies. This is the main determinant for horizontal FDI. Jordaan (2004) mentions that FDI will move to countries with larger and expanding markets and greater purchasing power, where firms can potentially receive a higher return on their capital and by implication receive higher profit on their investments. Charkrabarti (2001) states that the market-size hypothesis supports an idea that a large market is required for efficient utilization of resources and exploitation of economies of scale: as the market-size grows to some critical value, FDI will start to increase with its further expansion. This is a questionable conclusion, because there are firms who are looking for niche markets for their products and a large expanding market is a disadvantage to them.
Concluding the size of the market and the GDP of a region are not important determinants for the location choice.
22.214.171.124 Openness of the Market
There is mixed evidence concerning the significance of openness, which is measured mostly by the ratio of exports plus imports to GDP, in determining FDI as well (Charkrabarti 2001). Jordaan (2004) claims that the impact of openness on FDI depends on the type of investment. If the investments are market-seeking oriented, trade restrictions (and therefore less openness) could have an impact on FDI. The reason stems from the “tariff jumping” hypothesis, which argues that foreign firms that seek to serve local markets may decide to set up subsidiaries in the host country if it is difficult to import their products into the country. In distinction, multinational firms involved in export-oriented investments may choose to invest in a more liberal economy since increased imperfections that accompany trade protection generally imply higher transaction costs associated with exporting. Wheeler and Mody (1992) observe a strong positive support for this theory in the manufacturing sector, but a weak negative link in the electronic sector. Kravis and Lipsey (1982), Culem (1988), Edwards (1990) find a strong positive effect of openness on FDI and Schmitz and Bieri (1972) obtain a weak positive link. Trade openness generally has a positive influence on the export-oriented FDI inflow into an economy (Edwards (1990), Gastanaga et al. (1998), Housmann and Fernandez-arias (2000), Asidu (2001)). In general, the empirical literature reveals that one of the important factors for attracting FDI is trade policy reform in the host country. Theoretical literature has explored the trade openness or the restrictiveness of trade policies (Bhagwati, 1973; 1994; Brecher and Diaz-Alejandro, 1977; Brecher and Findley; 1983). Investors in general prefer big markets to invest in and they like countries that have regional trade integration, as well as countries with greater investment provisions in their trade agreements. Theory does not give any clear-cut answer to the question how trade barriers affect the level of FDI flows. “Horizontal” FDI tends to replace exports if the costs of market access through exports are higher than the net costs of setting up a local plant and doing business in a foreign environment. Traditionally, governments have used trade barriers to induce “tariff-jumping FDI”, i.e. horizontal FDI that takes place to circumvent trade barriers. On the other hand, “vertical” FDI relies on a constant flow of intermediate products in and out of the host country and therefore benefits from a liberal trade environment. In that case, trade barriers should encourage “horizontal FDI” and discourage “vertical FDI” and its effect on the aggregate level of FDI depends on which type of FDI dominates. Empirical studies, however, support a positive effect of openness on FDI. Chakrabarti (2001) finds the sum of imports and exports as a share of GDP to be the variable most likely to be positively correlated with FDI besides market size in an extreme bounds analysis. Braga Nonnenberg and Cardoso de Mendonca (2004) and Addison and Heshemati (2003) also find this variable to be positively correlated with FDI. The problem with using trade as a share of GDP as a measure of trade policies is that it reveals a trade policy outcome, rather than trade guidelines. The openness of a market is clearly linked with the policy regulations of the potential market. Pärletun (2008) finds that trade openness is positive but statistically significant from zero. Moosa (2002) states that while access to specific markets is important, domestic market factors are predictably much less relevant in export-oriented foreign firms. A range of surveys suggests a widespread perception that “open” economies encourage more foreign investment (Moosa, 2002).Therefore, the openness of a market is relevant to the appeal of a region. Restrictions will decrease the appeal of the region.
126.96.36.199 Labour market
Labour is also a determinant for market factors according to Majocchi and Presutti (2009), they investigated whether entrepreneurial culture plays a role in attracting foreign direct investment (FDI). Multinationals are a network of distributed assets that contain entrepreneurial potential and are highly innovative to increase competitiveness (Rugman and Verbeke, 2001). Firms and entrepreneurs are valuable in gaining access to local knowledge. However, entrepreneurial culture may also rely on resources in the local environment, which is not mentioned in particular by Majocchi et al. (2009). In this respect, natural resources are taken for granted. The availability of a cheap workforce (particularly an educated one), personnel policy, female participation and ageing influences investment decisions and in doing so are a determinant that influences the FDI inflow. A negative effect of these determinants will lead to an increase in wages and a decline in the return of investments in the future. Due to the static framework of this thesis, these determinants are not investigated.
188.8.131.52 Economic Growth
If the host country's market has a high-growth rate, it attracts more investors on a long-term basis (Chen, 2007). Economic environment growth in a country serves underlying factors when company decide which country to enter (Erramilli 1991).The role of growth in attracting FDI has also been the subject of controversy. Charkrabarti (2001) states that the growth hypothesis developed by Lim (1983) maintains that a rapidly growing economy provides relatively better opportunities for making profits than the ones growing slowly or not growing at all. Lunn (1980), Schneider and Frey (1985) and Culem (1988) find a significantly positive effect of growth on FDI, while Tsai (1994) obtains a strong support for the hypothesis over the period 1983 to 1986, but only a weak link from 1975 to 1978. On the other hand, Nigh (1985) reports a weak positive correlation for the less developed economies and a weak negative correlation for the developed countries. Gastanagaet et al. (1998) and Schneider and Frey (1985) found positive significant effects of growth on FDI
FDI has the ability stimulate economic growth only in the short run while the economy is shifting from one short-lived equilibrium to another. The only source of long-term economic growth is technological progress, which is considered to be independent of investment activities. This factor is discussed in the next paragraph. However, in endogenous growth theory, the diminishing returns on investment can be avoided if there are positive externalities associated with investments (Oxelheim, 1996). If investment brings enough new knowledge and technologies, it can lead to long-term economic growth. As, typically, FDI brings new technologies and knowledge, in accordance with endogenous growth theory it can be viewed as a catalyst of long-term economic growth in a host economy.
Economic growth will improve the ability to compete with other regions and this will increase the quality and ability of other location factors. The relevance of economic growth for FDI is not very clear: it depends on the distribution of the new capital.
The analysis above leads to four validated variables that determine the relevance of market factors: (a) market size, (b) openness of the market, labour market and (c) economic growth. Market size is the only variable that is less important. The openness of a market and the economic growth are very important, these variables are positively linked with political, infrastructural and technological factors. An open market as well as a positive economic growth will lead to more FDI in a region.
2.2.3 Infrastructure & Technological Factors
This paragraph contains theoretical information about the Infrastructure & technological factors as one of the location factors. The determinants that are criticized are level of infrastructure and high industrial concentration (clustering).
184.108.40.206 Level of Infrastructure
Research on the determinants of FDI has focused mainly on classical factors such as comparative labour costs, market size, economic openness investment and political factors. More importantly, few scholars have actually acknowledged the important role of infrastructure in stimulating FDI. Among the few proponents feature Wheeler and Mody (1992), Loree & Guisinger (1995), Richaud et al (1999), Morisset (2000) Asiedu (2002), Sekkat et al. (2004). These authors have argued that good infrastructure is a necessary condition for foreign investors to operate successfully. Poor infrastructure or unavailable public inputs increase costs for firms. A freeway is faster than a washed-out dirt road, email is faster than the post office, and time is money. To the extent that the public input is non-excludable and non-congestible, it will lower the cost of doing business for multinational and indigenous firms alike. Multinationals are in fact profit-seeking entities that seek to minimize the costs of doing business. If moving to a developing economy to take advantage of lower labour cost means losing patent protection to imitators, higher transport costs due to inadequate transportation or missed supply shipments due to communication problems, they will not choose to do business there. Infrastructure and public inputs, or the lack thereof, contribute to firms' cost structures and should be included in a model that explains the multinationals' as well as the host government's decision for investment.
Infrastructure is every bit as much input to production as labour, capital, and resources. Infrastructure should, therefore, improve the investment climate for FDI by subsidizing the cost of total investment by foreign investors and in doing so, raise the rate of return. Availability of crucial infrastructure, such as roads, highways, ports, communication networks and electricity should increase productivity and attract higher levels of FDI. As Wei et al. (2000) says: ‘a location with good infrastructure is more attractive than the others'.
In summary, the determinants for transportation (the availability of highway systems, air transport, ports, trans-shipment and rail systems, and the degree of the interactions between transport modes, are very important for the location choice. The lack of proper infrastructure will increase the costs and reduce the efficiency for FDI.
220.127.116.11 High Industrial Concentration (Clustering)
A lot of FDI concentrate on areas where firms already operate in related industries, this leads to high industrial concentration, also known as clusters (Majocchi and Pressuti, 2009). Besides, multinational firms invest where other firms have already developed their activities (foreign agglomeration economies). Majocchi et al. (2009) noted that not all clustering is similar, you have industrial clusters and foreign agglomeration economies, the distinction between the two clusters is quite unclear. A better distinction may be ‘vertical clustering', which is clustering related to the supply chain, and ‘horizontal clustering' related to similar activities. Wheeler et al. (1992) found agglomeration economies to be the dominant influence in investor calculation.
To conclude, the determinants for infrastructure and technological factors are: (a) level of infrastructure, (b) high industrial concentration (clustering), (c) the availability of a well-qualified workforce and (d) the availability of reliable corporative suppliers. Several modalities and their interrelationships have been explained before. Consequently, the factors can be divided in two headings; (a) vertical clustering, and (b) horizontal clustering. According to Galan and Gonzales (2007), this factor is important to the appeal of a region. The availability of quality infrastructure, particularly electricity, water, transportation and telecommunications, is an important determinant of FDI. Infrastructure facilities and clustering have a positive effect on FDI inflows (Asidu, 2002).
2.2.4 Political and Legal Factors
The paragraph gives an overview of the political and legal factors that could influence the choice of location, and contains the determinants political stability and tax.
18.104.22.168 Political Stability
According to Erramilli (1991) the political environment within the host country should be considered in investment decisions. Further on, Driscoll (1997) maintains that an uncertain political situation creates unpredictable conditions for the investor. The ranking of political risk among FDI determinants remains rather unclear. According to UNCTAD (1998), where the host country owns rich natural resources no further incentive may be required, as it is seen in politically unstable countries, such as Central-African countries, where high returns in the extractive industries seem to compensate for political instability. In general, as long as the foreign company is confident of being able to operate profitably without excessive risk to its capital and personnel, it will continue to invest. For example, large mining companies overcome some of the political risks by investing in their own infrastructure maintenance and their own security forces. Moreover, these companies are limited neither by small local markets nor by exchange-rate risks, since they tend to sell almost exclusively on the international market at hard currency prices. Specific alternative variables (e.g. number of strikes and riots, work days lost, etc.) have proved significant in some studies; but these quantitative estimates can capture only some aspects of the qualitative nature of political risk. An empirical relationship between political instability and FDI flows is unclear. For example, Jaspersenet al. (2000) and Hausmann & Fernandez-Arias (2000) find no relationship between FDI flows and political risk, while Schneider and Frey (1985) find an inverse relationship between the two variables.
22.214.171.124 Governmental Incentives
The last decades, it has been important for many countries to attract FDI and to appear different from others, and many countries have started to offer investors incentives like loan guarantees, tariff protection and subvention loans. The hard competition between different countries wanting to attract investment has created an increase in the offers for foreign investors. Moreover, future investors are challenged by the overwhelming choice of host countries offering different incentives. A few examples of incentives are tax relief, subvention of local wages and money contribution for a part of the total investment cost. In addition, different companies find different incentives more attractive than others, while at the same time, countries offer a variety of incentives to attract foreign direct investment (Rolfe, 1993). Darling (2004) maintains that companies have to design strategies before entering a new market. In order to do so, companies accept assistance from government agencies or other organisations that might be helpful, such as foreign trade councils and chambers of commerce (Darling, 2004). The research of Makino (2004) also supports Rolfe's and Darling's argument regarding governmental incentives. Moreover, according to Lim (2008) it is not only economic factors that have to be considered when deciding where to make an investment. Instead, investment promotion activities, investments support and administrative services are of importance. A research conducted by Wells (1990) supports the fact that there is a positive link between promotion agencies and foreign direct investment inflow into a country.
126.96.36.199Laws and Regulations
Companies have to consider laws, rules and regulations within the entry country. Otherwise, information asymmetry can appear, as the foreign company often has a hard time understanding the new information flow (Calhoun, 2002). As previously mentioned, there are governments working with incentives to attract foreign investors and at the same time there are governments working to protect their domestic market from investors by various governmental regulations (Makino, 2004). Other researchers who stress laws and regulation as important components are Driscoll (1997) and Darling (2004). Hood and Young (1979) identify an additional factor that plays an important role when deciding to invest in a foreign country. In some countries or regions there are trade barriers in place to limit the volume of imports into the country. Sometimes, the most effective way to bypass these barriers is for a company to set up production in the targeted country. There might also be laws and regulations in a country, put in place to limit the volume of imports into the country, and an FDI is the only option available to penetrate the market.This concludes that governmental implications have an influence on FDI, with a lot of barriers and restriction this influence is negative.
The literature remains fairly uncertain regarding whether FDI may be sensitive to tax incentives. Some studies have shown that host country's corporate taxes have a significant negative effect on FDI flows. Others have reported that taxes do not have a significant effect on FDI. Hartman (1994), Grubert and Mutti (1991), Hines and Rice (1994), Loree and Guisinger (1995), Cassou (1997) and Kemsley (1998) find that the host country's corporate income taxes have a significant negative effect on attracting FDI flows. However, Root and Ahmed (1979), Lim (1983), Wheeler and Mody (1992), Jackson and Markowski (1995), Yulin and Reed (1995), and Porcano and Price (1996) conclude that taxes do not have a significant effect on FDI. Swenson (1994) reports a positive correlation. The direction of the effects of the above-mentioned determinants on FDI may be different. A variable may affect FDI both positively and negatively. For example, factors such as labour cost, trade barriers, trade balance, exchange rate and tax have been found to have both negative and positive effects on FDI.
The elements of the overall policy framework are economic freedom and political stability, as well as regulations controlling the entry and operations of multinational corporations. Business facilitation is represented by the administrative procedures, FDI promotion (e.g. facilitation services) and FDI incentives (Dunning, 1998). This political stability is not relevant for this case study as the study concerns FDI between two developed countries, with quite similar stability and tax systems. This is also mentioned by Galan and Benito-Gonzales (2007).The previous literature shows the impact of government policies, including investment incentives, on FDI inflows into a host country (Dunning, 2002). Though investment incentives are considered another determinant for FDI, the recent paper by Blomstrom and Kokko (2003) suggests that investment incentives alone are generally not an efficient way to increase FDI.
2.2.5 Cultural & social factors
This paragraph contains the last location factors that could influence the location choice, the determinants that are reviewed are culture and the quality of life.
When a company decides to invest in a host country the cultural distance between the countries is important to recognise. Research shows that if the host country culture is similar to the entrants culture, the entrant already have valuable information on how to behave on the new market, and the opposite if the culture differs in many areas (Makino, 2004). Moreover, Calhoun (2002) means that attention when choosing country is put into entering countries with cultural similarities. Further on, he discusses different aspects of cultural variation. Institutional environment is something that the company has to find their own way within, since it reflects the unspoken way of doing things (Calhoun, 2002). Makino (2004) means that it can be extremely hard for new entrants to get accepted by local firms and society if their culture differ to widely. Additionally, Erramilli (1991) states that market and culture similarities reduce uncertainty and will be helpful when transferring technology and human resources. Further on, Chen (2007) explains how language similarities make it possible to communicate and it is a huge advantage if the international company can communicate in the local language. It is obvious when looking at corporate behaviours that different nation's cultural differences are playing a major role when deciding what country companies chose to invest in. It is not the culture itself that makes the decision, but it is clearly one of the factors (Head, 2005).
International business and national business differ because countries and societies are different. Societies differ because their cultures vary. Their cultures vary because of profound differences in social structure, religion, language, education, economic philosophy, and political philosophy. (Hill, 2007) The social structure of a country is important because the political system shapes the legal and economic systems. Differences in social structure affect the way people think and behave.
Thus, negative cultural distance will decrease the amount of FDI to a region, this makes culture adaptation an important factor for FDI.
188.8.131.52 Quality of Life
This paragraph focuses on the employees of a firm and their requirements for the environment and external factors of the new region. Personal identity is significant in evaluating the quality of life, because it leads to certain economic behaviour (Akerlof& Kranton,2000). Shifts in social categories and behavioural prescriptions may lead to a change in preferences. In this thesis, a general overview is aimed at. Rondinelli et al. (2000) found the following quality of life factors: ‘education facilities, cost of living, climate, recreational & cultural activities, nearby population of similar nationality, availability of professional & collegiate sporting events, and proximity of golf activities'. Borjas (2001) puts emphasis on the relationship between quality of life and labour market prospects. Positive relationship between qualities of the labour market will improve the appeal of a region.
From the analysis provided above, it can be concluded that the main factors determining the cultural familiarity is measured by means of (a) power distance, (b) uncertainty avoidance, (c) individualism versus collectivism, and (d) masculinity versus femininity. Cultural distance, the negative concept of cultural familiarity, is used as explanation for country differences. The negative concept has been chosen, because it reflects the differences across countries better, as well as the quality of life as factors influence the appeal of a region. This factor is relevant for the location choice, cultural aspects are important to measure the appeal of a country. Culture distance will also increase the cost of adaptation.
The location factors are divided into five categories: cost factors, market factors, infrastructure and technological factors, political and legal factors, social &cultural factors. The case study focuses on testing which factors are important for a region that wants to stimulate investments in bio and wind energy. The case study pays particular attention to these factors and the measurement determinants.
The literature review shows that all the determinants have impact on FDI. The cost factor is important because it is linked to all others. An investment in another region has to be profitable, so a cost analysis is always included: relatively high costs have a negative impact on FDI. The same applies to the cost of labour, infrastructure, natural resources, new tax regulations and even adapting to a new culture. Next to the cost factor, the availability of quality infrastructure (e.g. electricity, water, transportation and telecommunications) is an important determinant of FDI. Another very important determinant is the political and legal factor. Policies can promote FDI in several ways, the most common being partial or complete exemptions from corporate taxes and import duties. Standard policies to attract FDI include tax holidays, import duty exemptions, and different kinds of direct subsidies. FDI inflows are also affected by corporate tax rate differentiation. Subsidizing FDI helps multinational firms reduce production costs, improves incentives to create patents and trademarks, enhances the relative appeal of locating production facilities in the country offering incentives, and raises the economic benefits of FDI relative to exporting.
Table 1: list of location factors
Costs of materials
2. Market factors
openness of the market
3. Infrastructure and technological factors
Level of infrastructure
High industrial concentration (Clustering)
Availability of well qualify of work force
Access to reliable and corporative suppliers
4. Political and legal factors
Laws and regulations
5. Social & Cultural factors
Quality of life
Regarding the theoretical analysis the most important factors for attracting FDI are market size, GDP and GDP growth, the availability of human capital and a market openness, economic and political stability, transport costs, labour costs, labour laws, tax rates, subsidies and fiscal and financial incentives provided by the host country government, tariffs, corruption, expropriation risk, and regime type. Not much evidence was found on the importance of cultural distance and infrastructure as determinants of FDI. It must be noted though that the importance of these factors varies between countries, companies, and industries.
Chapter 3 Methodology
This chapter presents the methods used to perform the study. The choice of method will be explained, followed by the sample notification. It contains information on the data and the data method used to create the theoretical framework and to provide the right questions for the interview. An overview of the variables used in this research is included, followed by general interview information and the chosen interview method to conduct this research. It ends with a critical review of the methods and sample that are chosen.
3.1 Choice of Method
There are two types of methods that are commonly used: qualitative and quantitative (Saunders et al, 2003) (Holme& Solvang, 1997). When using a quantitative method, the researcher gathers numerical data, often in form of surveys or questionnaires. A study based on relatively measurable data, such as numbers or statistics, often creates answers that are somewhat less difficult to analyse, since the resulting hypotheses can be either rejected or accepted (Saunders et al, 2003). The measurability of the quantitative method makes the study more objective, which is one of the more positive sides of this method. There are also drawbacks to the quantitative method, one of the prominent ones being that it requires a large sample in order to get a statistically viable result and to make correct assumptions about the entire population (Gordon &Langmaid, 1988). A qualitative method is often employed in studies where the authors try to gain a deeper understanding of a problem (Sekeran, 2003). Instead of relying on numerical data, as with the quantitative method, researchers using the qualitative method often employ interviews as a source of data collection (Silverman, 1993). Data that has been gathered through an interview will enable the researcher to analyze and explain a phenomenon in an in-depth fashion. The qualitative method is by nature a subjective form of study, since it entails an interpretation of the data by the researcher, giving the researcher more possibilities to affect the outcome (Holme& Solvang, 1997). The subjectivity of the data and the method asks a lot from the researchers since the results depend on their views and interpretations. This is one of the drawbacks of the method (Eriksson &Wiedersheim- Paul, 1999). In this study a qualitative research approach is used since the purpose is to understand and explain the phenomena ‘foreign direct investments'. The goal is, to get an in-depth comprehension of how the respondents view investments made by their respective company. The aim is to fully grasp the reasons behind an investment and the factors that influenced the respondents' decisions. The choice of method is, therefore, a direct reflection of the purpose of this study. Data is collected by conducting interviews, data that encompass a larger subject and can be interpreted to obtain the responses needed for the intended purpose of the study (Sekeran, 2003). The final purpose of this study is to offer an overview of the location factors that are important for the host country, while attracting FDI.
A population is any group or area of interest that researchers aim to study. The goal is always to capture the responses of the entire population, but this is often impossible due to the size of the group. It is, therefore, necessary to narrow down the number of respondents, and to create a sample. A sample is a smaller group within the population, used to make generalizations about the characteristics of the population (Lekwall & Wahlbin, 1993). In order for the sample to be representative, the sample needs to be selected in a certain way. In a qualitative study, different strategies or techniques may be used when choosing a sample; among which purposeful, nominated, theoretical, and convenience sampling. Purposeful sampling involves researchers identifying respondents that have certain characteristics, desirable for the intended study. Nominated or snowball sampling occurs when the initial respondents suggest other suitable respondents for further inquires. The technique using the theories of the study to form the basis for respondent selection is theoretical sampling. Convenience sampling is a technique to select respondents on the basis of their convenience: they are available and willing to participate (Morse & Richards, 2002). In this thesis the purposeful sampling method was the most appropriate, due to the nature of the study. The target group contains companies that deal with sustainability, and when selecting respondents the authors searched for certain characteristics in the companies. A search was conducted by the author and Mr John van den Elst, in order to find suitable companies. The sample will contain three groups, the first group to interview consists of companies dealing with wind and bio-energy and additional companies that intend to deal or are already dealing with FDI. The second group contains advisors of government institutes that deal with FDI and sustainability. In Holland these are SenterNovem and EVD, on behalf of Sweden ISA and ISEP. Group 3 will be a small group of neutral experts in the field of FDI and sustainability, for instance researchers and advisors. Sekeran (1998) noted that in a qualitative study the number of respondents selected should be sufficiently large to be able to draw conclusions from the results and to answer to the purpose of it. Eisenhardt (1989) argues that in theory, the number of respondents in a qualitative study should be somewhere between four and te
Data collected by researchers are often referred to as either primary or secondary.
Primary data collection carried out by researchers is often done using two basic techniques: through observations, or by means of a varying type of survey or interview. Surveys and interviews are used more frequently and the choice between these two techniques is often based on the size of the sample (Lantz, 1993). A large sample often calls for a survey type of study. The choice of the data collection method is also connected to the purpose of the study. An interview enables the researcher to go deeper into the problem and to discuss the questions more thoroughly (Lekwall & Wahlbin, 1993). The choice to collect data through interviews was found to be the most appropriate for the purpose of the study. Secondary data is gathered by search engines for relevant papers and journals. The data collection should be carried out in a way that enables the researchers to acquire the right information needed (Lekwall & Wahlbin, 1993). It is vital to use search engines that are confirmed qualitative search engines, represented by universities.
3.4 Case Description
The Confederation of Swedish Enterprise (2006) states that Swedish companies are making major investments abroad but at the same time the investment level in Sweden is quite low. The result is an unbalanced economic situation, since Swedish companies invest more money in other countries than Sweden receives. Moreover, research stresses different negative reasons in Sweden that make it hard for investors to choose and operate on the market (Confederation of Swedish Enterprise, 2006). Additionally, a publication by the Swedish Institute for Growth Policy Studies (ITPS) maintains that the degree of foreign investments in Sweden is relatively low in comparison to other developed countries (ITPS, 2007). A research conducted by Invest in Sweden Agency (ISA), the Swedish promotion agency, stresses that Sweden as a country has accomplished much during the last decade to attract FDI. They state that Sweden is an attractive investment market because of its overall package (ISA, 2006). At this moment, according to the Confederation of Swedish Enterprise (2006), Sweden is viewed as a country with a growing economy and great welfare. ISA (2008) further states that new establishments from international investors can bring capital, new technologies, know-how and job opportunities to Sweden. One problem is that many Swedish local companies choose to move their production to foreign markets and take these values away from Sweden, which makes it even more important to captivate international investors (ISA, 2008). We can clearly conclude from the used publications that an ongoing global discussion exists. There are several interested parties taking part in the discussion, and is it also an up-to-date discussion in Sweden. We believe it is important to stress that the two investigations (conducted by ISA and the Confederation of Swedish Enterprise) have two different purposes and viewpoints, where one has the mission to deliver a publication of the present situation in Sweden to the government, and the other aims to advertise Sweden to potential investors worldwide. We therefore ask ourselves if any of these reflect the reality in Sweden or if they are published to satisfy their clients. How are we to know whether the investment climate is competitive compared to other countries? In either case, Sweden has to work actively and consciously to attract more foreign investors to keep up in the fierce competition between developed countries. In a pre-study interview with Karin Darlington, former employee at ISA, the investment climate in Sweden was discussed. Darlington (2008) maintains that international companies often have a preconceived notion about Sweden and the business environment, and that foreign companies “listen to what they want to hear”. When Darlington (2008) answers the question if there are any tendencies of specific industries choosing to establish themselves in Sweden, she answers: “It is hard to see a trend in what industry foreign investments take place” (Mrs. Karin Darlington, former employee ISA, 2008) After the meeting with Karin Darlington our interest in the present investment situation in Sweden increased even more. We decided to broaden our knowledge and learn more and will therefore answer the question below in order to give recommendations to Sweden and concerned parties, which will be presented at the end of this report.
There are three basic ways to structure an interview. The choice between these structures is often based on the purpose of the study and the size of the sample. If the sample is large, an unstructured type of interview can be too time-consuming and a survey or structured interview may be preferable (Lantz, 1993). The main difference between a structured and an unstructured interview is that the latter has more open questions, which leaves more room for the respondent to elaborate his answers (Morse & Richards, 2002). Through the unstructured interview the respondent is given an opportunity to describe a subjective view of a phenomenon. The subjectivity is interesting, since different respondents may have different answers to the same question. The structured interviews, however, are commonly based on pre-determined a
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