Literature Review On Foreign Direct Investment

Literature Review On Foreign Direct investitureThe opening of the determinants of individual(a) investment, irrespective of whether it originates home(prenominal)ally or from abroad, is relevant for an discernment of what drives FDI. This has become increasingly true with the globalisation of world commercializes, although there perch additional operators which may inhibit or encourage FDI that would non venture domestic investment.Much of the inquiry on the determinants of investment is found on the neoclassical theory of optimal neat accumulation pioneered by Jorgenson (1963, 1971). In this framework, a degene strides desired capital stock is maked by f causeor prices and engineering, assuming profit maximisation, perfect disputation and neoclassical surgical process functions. This theory was a delibe come in alternative to views expressed initially by Keynes (1936) and Kalecki (1937), that frozen capital investmentMuch of the research on the determinants of inv estment is ground on the neoclassical theory of optimal capital accumulation pioneered by Jorgenson (1963, 1971). In this framework, a rigids desired capital stock is determined by cistron prices and technology, assuming profit maximisation, perfect competition and neoclassical production functions. This theory was a deliberate alternative to views expressed initially by Keynes (1936) and Kalecki (1937), that fixed capital investmentdepends on firms expectations of use up relative to brisk capacity and on their ability to generate investment funds (Fazzari and Athey, 1987481 Fazzari and Mott, 1986171). several(prenominal) studies prepare challenged the neoclassical assumption that any desired investment brook fag end be financed2. Asymmetric information3 ab come on the quality of a give could lead to credit proportionalityning, implying that not all borrowers seeking loans at the everyplaceriding cost of capital may be able to obtain financial support (e.g, Greenwald, S tiglitz and Weiss, 1984). Consequently, firms tend to rely on internal sources of funds to finance investment, and to privilege debt to equity if external financing is required4. A further theoretical evolution was the introduction of irreversibility and unsurety in explaining investment behaviour. This literature demonstrates that the ability to wait an irreversible investment expenditure can profoundly affect the conclusion to invest (Dixit, 1989 Pindyck, 19911110). Firms save an inducing to postpone irreversible investment while they wait or new information which owns the future less uncertain (Bernanke, 1983 Cukierman, 1980).The increment literature has long been concerned with investment, because of its brilliance for the rate of appendage of per capita come onput in the economy (Dornbusch and Reynoso, 1989204 Fei and Ranis, 1963283 IMF, 1988). Although confirmable models of the determinants of investment in evolution countries be in broad agreement with results obtained for industrialised countries, there atomic number 18 additional factors which have been found to constrain capital accumulation.Most of these are related to the problem of indecision and/or risk, which acts as a deterrence to personal investment, because of the irreversible nature of most investment expenditures (Pindyck, 1991).Inflation reduces private investment by increasing risk, reducing average lending maturities, distorting the informational heart of relative prices, and indicating macrostinting instability (Dornbusch and Reynoso, 1989206-208 Oshikoya, 1994585,590). Empirical studies show that the variability of pretentiousness has a stronger negative effect on private investment than does the take (Serven and Solimano, 1993137).Large external debt burdens also have a strong disincentive effect on private investment, especially short-term debt (Faruqee, 199252). Debt-service payments reduce the domestic resources available for investment, and poor inter popu lational credi twainrthiness reduces entre to external savings5. For domestic investors, the instauration of a large debt overhang reduces the future returns to investment because a game proportion of the forthcoming returns must be employ to repay be debt (Borensztein, 1990315). A debt overhang is also a major source of uncertainty the size of future transfers to creditors is uncertain macro scotch insurance indemnity is uncertain and the transform rate is uncertain. The combined risks of changes in relative prices, taxation and aggregate demand reduces investment by both domestic and external entrepreneurs. Whatever the cause, the irreversibility of actual capital expenditures can result in underinvestment if the future is uncertain, even when current conditions are right (Tornell, 1990). During macroeconomic adjustment, the credibility of policy changes is an added problem (Rodrik,1989), and the possible action of policy reversal can have serious consequences for re al private capital expenditures. Investors prefer to hold financial capital, which is easier to realise if conditions turn turn out to be adverse, and which retains the option to purchase real capital if optimism continues. Forthis reason, there are frequently long lags in the investment response to adjustment(Serven and Solimano, 1993131,137).Several studies line the effects of changes in the real replacement rate6 and the terms of trade7 on investment. These studies loosely unwrap that the variability of the real exchange rate is usually more or less researchers support the notion that FDI contributes to the productivity and harvesting of local enterprises. Blomstrom and Sjoholm( 1998) are of the stamp that the productivity and ontogenesis of local enterprises could be achieved by and by means of spill over effects/externalities from FDI.This is achieved as the Multinational Enterprises (MNEs) both introduce superior technology of through the grocery storeing activities of MNEs that affect the market equilibrium forcing local operators to act in much(prenominal) way that they can retain their original market shares. Graham and Krugman (1995) indicates that competitive enterprises (MNEs) contribute to productivity and growth of the host nation by infusing technology, grind skills, commission method actings, and training into the host economy.Empirical research shows that FDI affects the economy of a host sphere in a novelty of ways. Firstly, it provides the required capital and state -of -the- art technology that enhances economic growth in the host country (Caves,1996 Dunning, 1993 Blomstrom and Sjoholm, 1998 Smarzynska,2002 Akinkugbe ,2005).Secondly, it augments the skills of the host nations and consequently braces growth through the infusion of managerial, grind skills and training (de Mello,1999). Thirdly it promotes the technological upgrading, regarding start- up, marketing , and licensing arrangements (de Mello and Sinclair , 1995 Markusen and Venables ,1999). FDI is thus seen as a catalyst to the host nations economic growth and development as it enhances technological process and promotes industrial development (Asheghian, 2004).In addition, FDI can be pass judgment to encourage economic growth of the host nation, abandoned up the prevailing view that MNEs can complement the local industry and stimulate growth and welfare in the host nations (Grossman and Helpman, 1991 Barro and Sala-i-Martin, 1995).The major determinants of the host countrys economic development and growth is the economic environs portrayed by its rate of economic growth , trade policy, political stability, legislation , domestic market size and balance of payments constraints (Caves, 1996 de Mello, 1999 Dunning, 1993)- the political economy of the nation . These factors may ineluctably influence the decision of foreign investors (MNEs ) on the possible choice of a viable investment location (Akinkugbe, 2005).Dunnings (1981, 1988) el ectric theory provides a tensile and popular framework where it is argued that Foreign Direct Investment (FDI) is determined by three sets of advantages which unionise investment should have over the opposite institutional mechanisms available for a firm in satisfying the needs of its customers at home and abroad. The first of the advantages is the ownership specific one which includes the advantage that the firm has over its rivals in terms of its brand name, patent or companionship of technology and marketing. This allows firms to compete with the different firms in the markets it serves regardless of the disadvantages of beingness foreign. The stake is the transnationalisation advantage, that is why a bundled FDI approach is preferred to unbundled product licensing, capital lending or technical assistance (Wheeler and Mody, 1992).The location-specific advantages relate to the importance for the firm to operate and invest in the host country and are those advantages that m ake the chosen foreign country a more move inive come out for FDI than the others. For instance firms may invest in production facilities in foreign markets because transportation costs are excessively high to serve these markets through exports. This could either be directly related to the actual nature of the good, either being a high bulk item or a service that needs to be provided on site, or due to policy factors such(prenominal) as tariff rates, import restrictions, or issues of market access that makes physical investment advantageous over serving the market through exports. Location advantage also embodies other characteristic (economic, institutional and political) such as large domestic markets, accessibility of internal resources, an educated labour party force, low labor cost, good institutions (the clarity of countrys law, efficiency of bureaucracy and the absence of corruption), political stability, corporate and other tax rates among others.Bende-Nabende and S later (1998) inquire both the short-run and long-run locational determinants of FDI under the broad categories of cost-related, investment surround improving and other macroeconomic factors. The short-run dynamics indicate that European investment in the Thai manufacturing sector has been more responsive to the macroeconomic factors. The long-run dynamics on the other hand suggest that European investment has been more responsive to the investment environment improving factors. In particular, there is turn up to suggest that the Thai manufacturing sector is losing its cost-related comparative advantage.Dar, Presley and Malik (2004) analyze the causality and long-term kinship between Foreign Dirct Investment (FDI), economic growth and other socio-political determinants. Although a con eventfacerable literature gives the evidence of relationship between FDI and economic growth. Their paper considers economic growth, exchange rate and direct of interest rates, unemployment, and po litical stability as determinants of the level of FDI inflows for Pakistan over the current 1970-2002. Almost all changeables are found to have the theoretically expected signs with two-way causality relationship. The present study also estimates an error bailiwick model by ordinary least squares, based on cointegrating var (2).Nunnenen (2002) argues that there is a startling gap between, allegedly, globalization-induced changes in international competition for foreign direct investment (FDI) and recent empirical evidence on the relative importance of determinants of FDI in developing countries. He shows that surprisingly humble has changed since the late 1980s. Traditional market-related determinants are still dominant factors. Among non- handed-down FDI determinants, only the availability of local skills has clearly gained importance. As concerns the interface between trade policy and FDI, he finds that the tariff jumping motive for FDI had lost much of its relevance well bef ore globalization became a hotly debated issue.Artige and Nicolini (2005) analyse the determinants of FDI (foreign direct investment) inflows for a root of European spheres. The originality of their approach lies in the use of disaggregated regional data. First, they develop a qualitative description of their database and discuss the importance of the macroeconomic determinants in attracting FDI. Then, they provide an econometric exercise to identify the potential determinants of FDI. In spite of choosing regions presenting economic similarities, they show that regional FDI inflows rely on a combination of factors that differs from one region to another.Bnassy-Qur, Coupet and Mayer (2007) re- analyse the piece of institutions in the host and in the source country by estimating a gravity equation for bilateral FDI stocks that includes governance indicators for the two countries. Second, they tackle multicollinearity and endogeneity influence by implementing a three-stage procedur e for instrumentation and orthogonalisation. Third, they look further into the breaker point of institutions by using a new database constructed by the French Ministry of pay network in 52 foreign countries. This database is use to point out in some detail the relevant institutional features. Its country coverage, which focuses on developing countries, is very helpful for studying the push of the institutional environment of the host country. It does not allow, however, going deeply into the dissemble of the institutional environment in the source country as well as into the violation of institutional distance. Hence they complement our synopsis with estimations based on the Fraser database, which provides few details on institutions, albeit on a more balanced country coverage between industrial and developing countries. Finally, they study the stupor of institutional distance on bilateral FDI.Onyeiwu and Shrestha (2004) argues that despite economic and institutional crysta llise in Africa during the past decade, the flow of Foreign Direct Investment (FDI) to the region continues to be disappointing and uneven. In their study they use the fixed and ergodic effects models to explore whether the stylized determinants of FDI affect FDI flows to Africa in conventional ways. establish on a panel dataset for 29 African countries over the menstruum 1975 to 1999, their paper identifies the following factors as significant for FDI flows to Africa economic growth, splashiness, openness of the economy, international reserves, and natural resource availability. Contrary to conventional wisdom, political rights and infrastructures were found to be un in-chief(postnominal) for FDI flows to Africa. The significance of a variable for FDI flows to Africa was found to be dependant on whether country- and time-specific effects are fixed or stochastic.Nakamura and Oyama (1998) studied the macroeconomic determinants of FDI from lacquer and the United States into eins teinium Asian countries, and the linkage between FDI and trade, and other macroeconomic variables. Their outline focuses on the structural differences among East Asian counties and classifies them based on statistical tests of fixed effects models using panel data. This tryout helps to clarify how Nipponese and American multinational firms position their production bases in East Asian countries within their world marketing strategies. In mark to avoid the problem of simultaneity among variables, they examine simultaneous equation models to get the validity of panel regression results. In their study they find that East Asian countries can be classified into four groups depending on FDI from Japan and other elasticities to macroeconomic variables, and this grouping almost coincides with their economic development stages. Moreover, they get that FDI from Japan into all the groups are strongly affected by changes in real bilateral exchange rates, but this is not always the elusi on for FDI from the United States. Among varied country groups, FDI into group 1 (mainland China and Korea) responds positively to the Japanese capacity utilization, indicating their industries integration with the Japanese economy. Group 3 (Indonesia and the Philippines) shows that Japanese FDI is buoyed up by the yens appreciation against the U.S. dollar. FDI into group 4 (China and Malaysia) and, to a lesser extent, group 2 (Singapore and Thailand) is oriented more toward capturing local markets compared to the other groups. They also find that Japanese FDI has strong trade expansion effects, which is rarely seen for U.S. FDI.With regards to research on the determinants of FDI to Africa there appears to be a dearth of literature. A Search on the Econlit database using Foreign Direct Investment and Africa as keywords yielded the other two reffered journal articles on the Determinants of FDI to Africa. One of the papers, Schoeman et al (2000), analyses how political sympathies p olicy (mainly deficits and taxes) affects FDI. However, their analysis focuses on one country, South Africa. The Second paper , Asiedu (2002) examines whether the factors that drive FDI in developing countries have a different impact on for countries in Sub Sahara Africa (SSA). However, the analysis focuses only on three variables the return on investment, infrastructure availability and openness to trade, and does not take into bank bill the natural resource availability , which is an serious determinant of FDI to Africa. some other paper that focuses altogether on Africa is Morisset (2000). Unlike Asiedu (2002), Morisset (2000) controls for natural resource availability , measured by the sum of primary and secondary sectors , minus manufacturing. However, this measure of natural resources is too broad and does not accurately capture the availability of minerals and oil, the most important types of natural resources relevant for FDI to SSA. In addition none of the studies exam ine the impact of some of the important variables that feature predominantly in investor surveys, such as corruption and regulatory framework in the host country.This research extends the special to empirical literature on the determinants of FDI to Africa by examining the extent to which the economic, political, institutional characteristics of a country, as well as the policy environment affect FDI flows.Nunnekamp (2002) sought-after(a) to assess whether determinants of FDI have changed with globalisation i.e whether traditional determinants are losing importance whilst non traditional ones are increasingly gaining importance. Two approaches were adopted, namely survey data from European Round Table of Industrialists ( ERT 2000) and simple correlation for 28 developing countries. grocery size (proxied by host countrys population and level of gross domestic product ) as a traditional determinant of FDI is said to have declined in importance over time. Other factors such as locatio n, cost differences, qualities of infrastructure, ease of doing railway line and the availability of skills measured by average years of schooling have become increasingly important as non-traditional determinants of FDI (Nunnekamp 200216)The survey results were supplemented by earth Bank Data on variables that are considered important FDI determinants. Results show that traditional market related determinants still dominate determinants of FDI distribution among the countries considered (Nunnekamp 200224). Non traditional determinants such as cost factors, and trade openness , measured by ratio of exports plus imports to gross domestic product, have typically not become more important with globalisation. Of importance is the availability of skills which is proxied by average years of schooling, which has become a relevant pull factor of FDI in the process of globalisation (Nunnekamp 200235).An analysis of a developing country by (Tsai 1991) focused on Taiwan by providing demand s ize determinants of FDI using time series data. Tsai (1991279) utilise OLS method using equations in logarithm form. Two equations were specified, i.e first on the demand size determinants and the second using variables as ratio of GDP to eliminate possible side of influences. A dummy variable was used to assess the impact of government incentive polices on FDI in different periods.Tsai (1991276) suggests that for Taiwan only labour cost, market size and government incentive policies are important demand size determinants. Although FDI is seen to exploit cheap labour in developing countries, the case of Taiwan seems to show that growth in FDI with rising labour costs indicates the cheap labour may not be as important as expected.No clear evidence was found to support the expectation that government incentive policies were effective in attracting FDI to Taiwan. An interesting finding in Tsai (1991279) is that Taiwans relatively outstanding economic performance as reflected in the ex panding domestic market and ever increasing per capita GDP during 1965-1985 was not particularly attractive to foreign investors. As Tsai argues, this could be attributed to FDI being used supply side determined rather than demand side or perhaps non- economic factors outweigh the investment incentives.It is generally believed that factors determine FDI inflow in developing countries could have a different impact on SSA countries in particular . This is because developing countries outside Africa seem to attract huge FDI inflow while SSA attracts low levels of FDI as discussed by Asiedu (2002).Another study in Africa by Obwona (2001) investigated the FDI-growth linkage for Uganda. Obwona used the investor surveys approach and econometric tests. Using investor surveys, both local and foreign investors were directly questioned regarding their decisions and decision reservation processes when investing in Uganda (Obwona 200155). The focus was on productive investment, as such purely c ommercial and consulting activities were excluded. For econometric tests , time series data was used for the period 1975-1991to estimate the determinants of FDI and growth.Findings from the survey showed that increased foreign investment was a result of a conducive investment environment provided by government though its policies and institutions (Obwona 200156). The author concludes that from the investors surveyed, foreign investors are primarily concerned with heavy factors, i.e a stable macroeconomic and political situation and credible policy reforms.For Uganda , Obwona considered pull factors such as growth factors , liberalised exchange rate, low inflation and fiscal discipline. The major determinants are availability and cost of natural and humanity resources, adequacy of infrastructure , market size, trade policies, macro stability, economic growth and political stability (Obwona 200162). The importance of each of these variables , however depends on the type of investmen t and motivations or strategy of investors. Obwona (200162) agrees with other researchers, such as Nunnekamp (2002) that given the shifts in the type of investment, the availability of low cost un masterly labour in location decisions has declined over time. This has meant more emphasis on skilled labour or the trainability of workers.Furthermore, two notable studies by Moolman et al (2006) and Fedderke and Romm (2004) have focused on determinants of Inward FDI to South Africa.Moolman et al (2006) sought to examine the macroeconomic link between FDI in South Africa and its resultant impact on output for the period 1970-2003. In so doing, they initially identify supply side determinants of FDI before analysing their impact on output. Their research method follows the supply side macro econometric framework, which does not take into account the demand side determinants that are equally important as well. On Model specification , five variables were explored as explanatory variables fo r FDI in the empirical estimation, namely, market size measured by real GDP, exchange rate proxied by the rand-dollar exchange rate , infrastructure, openness and a dummy variable for sanctions.The empirical results of Moolman et al (20063) indicate that market size, openness, infrastructure and the nominal exchange rate are factors which South African policy makers should focus on when seeking to attract FDI. The FDI output link does not take other factors such as increased employment , improved skills and new management techniques into account (Moolman et al 200629).After thorough investigation and studies, it was found out that only market size and openness are common factor determining FDI. The role of exchange rate is an important determinant of foreign investment in most countries. Particularly for South Africa, it should be considered whether it could be an important FDI determinant. Studies from developing countries have also identified other factors that should be considere d as in the case of South Africa as those of Loots (2000) and Ahmed et al (2005).