The Effects of Project Scale on FDI Location Choices: Evidence from Emerging Economies.

VerfasserLoncan, Tiago
PostenRESEARCH ARTICLE - Foreign direct investment

1 Introduction

FDI (Foreign Direct Investment) is a strategic source of finance for emerging economies, exerting beneficial impacts on employment, technological upgrading, productivity and economic growth (Alfaro 2017; Wei and Liu 2006). Given its importance for both private sector development and public policies, research analysing the factors affecting FDI location choices gained prominence in the international business literature. While a voluminous body of research has uncovered a number of country and firm-level attributes affecting FDI attractiveness, studies emphasising a micro-based approach, as to consider project heterogeneous characteristics, are much scarcer (Blonigen 2005).

In this paper, we examine the effects of project scale on multinational enterprises' (MNEs) location choice sensitivity to four important determinants of FDI: market size, labour costs, corporate taxes and institutional quality. Our choice for these determinants is motivated by recent comprehensive review articles summarising the extensive literature on location choice by Jain et al. (2016), Kim and Aguilera (2016), Nielsen et al. (2017) which show that these country attributes are among the key determinants of MNEs' location selection. In broad lines, these four locational traits are purely economic or institutional factors exerting direct impacts on foreign revenues, costs and on investment risk, thus affecting FDI location decisions. However, a gap exists in the extant international business literature in linking country locational factors to project characteristics.

As well noted by Nielsen et al. (2017), most studies treat country locational determinants in a somewhat atomistic way, paying limited attention to how they interact with other factors driving firms to a particular host market. In synergy with this view, Kim and Aguilera (2016) also remark the importance of digging deeper into MNEs' operations, as to allow for a more birds-eye view of MNEs' FDI decisions. Moreover, Nielsen et al. (2017) also highlight a paucity of location studies which have considered the role of investment scale. For instance, a recent theoretical model presented by Jain et al. (2016) provides clear predictions regarding how firm and industry characteristics might interact with country determinants of FDI location. However, the role of project scale, which is a crucial characteristic of any FDI project, remains under-researched. Therefore, the main contribution of our paper is to derive and empirically test hypotheses predicting interactive effects between project scale and several important country-level determinants of FDI location. In doing so, we shed light on how the salience of country locational factors might change contingent on micro-level determinants, such as it is the case of the scale of FDI projects.

Our analysis employs a large project-level dataset with over 15,000 greenfield manufacturing investments from 5182 multinational enterprises. These FDIs are originated in 20 industrialised countries and are located in 25 emerging economies, covering a time period from 2003 until 2014. We empirically estimate FDI location models employing conditional logistic regressions. By including interactions between project scale (measured in financial terms by Capex and in labour terms by Employment) and market size, labour costs, taxation and institutional distance, we analyse if project scale and country attributes jointly affect MNEs' FDI location decisions.

Our sample includes top FDI destinations in the emerging world, like China, India, Brazil, Mexico and Russia, as well as Asian fast-growing economies like Singapore, Thailand, Malaysia, Indonesia and Vietnam. We also cover transition economies, like Poland, Czech Republic, Hungary and Romania (among others). As to the senders of FDI, all the major developed economies are present in our sample: the US and Canada, Japan, Western European countries and Australia. Our empirical study boasts great diversity in terms of numbers of recipients and senders of FDI. However, it is important to clearly set up the boundaries of our examination. Our sample does not cover M&As, nor technological and knowledge-intensive FDI, further being restricted to location choice and not covering other entry modes and internationalisation decisions.

While taking stock of the boundaries of our work, our empirical design adds valuable insights nevertheless. The most common design in the location literature analyses outward FDI from one sender country going to a limited number of recipient countries, typically within a geographic region, or from multiple senders going to one recipient country. For example, reviewing 153 studies, Nielsen et al. (2017) find a considerable bias towards studies based on US and Japan as senders of FDI, and towards China as main FDI recipient. We offer empirical evidence that considerably expands extant studies by analysing FDI location choices of MNEs from multiple sender countries in industrialised economies investing in multiple recipient countries in emerging economies. This gives a good scope for generalisation of our results in the context of emerging economies.

Although studies focussing on investment scale are scarce, a lew papers have examined the issue. For instance, larger projects involving more capital are considered to be inherently riskier than smaller projects (Chadee et al. 2003). In line with this view, some evidence suggests MNEs are more likely to locate subsidiaries with larger scale in countries characterised by lower risk (Duanmu 2014; Pak and Park 2005). However, this research stream remains somewhat fragmented, with the role of investment scale yet to be streamlined into a more coherent theoretical framework. Our work differs from and contributes to these studies in many ways. First, building on insights from the economics literature (Chen and Moore 2010; Defever 2012; Halvorsen 2012; Tomiura 2007), we establish a pathway linking micro-level factors, such as project scale heterogeneity, to country-level locational factors. The main insight we borrow from this literature is that investment (project) heterogeneity can shift the salience of FDI location to country-level determinants. Second, our empirical examination goes beyond country risk, as we analyse the interplay between scale and a wider set of country-level locational factors potentially affecting expected revenues and costs. Third, regarding the role of scale, Duanmu (2014) analyses how expropriation risk influences the scale of Chinese outward FDI. While, like Duanmu (2014), we use Capex as a proxy for the investment's scale, our analysis differs from the former in that by examining the impact of country expropriation risk on Capex directly, Duanmu (2014) seems to embed the location and the capital commitment decision as jointly determined. We examine whether the scale of the investment affects location sensitivity to country determinants, instead, analysing a cross-country sample of FDI senders and not only a single sender. Fourth, the locations] role of scale was analysed in the context of joint-ventures (Chadee et al. 2003), whereas we look into greenfield FDI.

Furthermore, our study is important from theoretical and conceptual perspectives, adding a more granular view on how location decisions are made by MNEs. Most of FDI location studies, for being unable to account for project scale in the empirical design (usually due to data restrictions), intrinsically assume that firms pick their target locations either neglecting the scale of the project, or assuming that the scale (how much capital is to be committed) will be determined sequentially after the target market is selected. But it is very likely that the capital budgeting process of strategically relevant ventures, like FDI, occurs either before or concomitantly with foreign market choice. Our paper provides evidence that this is exactly the case: Projects with different scales might end up located in target countries with different economic and institutional characteristics.

The paper continues as follows. In Sect. 2, the literature is reviewed and empirically testable hypotheses are proposed. Section 3 describes the dataset employed in the empirical test and the empirical methods. In Sect. 4 the main empirical results are presented and discussed, followed by sensitivity checks in Sect. 5. Section 6 discusses our findings with the extant international business literature, whereas Sect. 7 concludes.

2 Literature Review and Hypotheses Development

This section discusses the literature and proposes testable hypotheses. We begin by discussing the extant International Business (IB) literature on FDI location choices. Building on recent valuable and comprehensive reviews, we discuss the current boundaries in the literature and propose the need to dig deeper into investment-specific characteristics, like scale, as to further expand location choice theory. In doing so, we propose ways to integrate the micro-level approach typically employed in the economics literature into IB. We then streamline project scale in a cohesive theoretical framework, where the size of the investment might interplay with important locational factors well established in the field. We propose hypotheses linking project scale, market size, labour costs, taxation and institutional quality distance with FDI location attractiveness.

2.1 An Overview of Location Studies in the International Business (IB) Literature

FDI location choice has been a subject of vigorous research in many disciplines, such as international economics, economic geography, international business, and strategic management. The field was initially rooted in the economics discipline, mostly led by the early seminal works by Buckley and Casson (1976), Coase (1937) and Hymer (1960). The core concepts from these studies are that multinational firms explore foreign investment opportunities as to arbitrage...

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