Robust determinants of OECD FDI in developing countries: Insights from Bayesian model averaging

Abstract

In this paper, we examine the determinants of outward FDI from four major OECD investors, namely, the US, Germany, France, and the Netherlands, to 129 developing countries classified under five regions over the period 1995–2008. Our goal is to distinguish whether the motivation for FDI differs among these investors in developing countries. Rather than relying on specific theories of FDI determinants, we examine them all simultaneously by employing Bayesian model averaging (BMA). This approach permits us to select the most appropriate model (or combination of models) that governs FDI allocation and to distinguish robust FDI determinants. We find that no single theory governs the decision of OECD FDI in developing countries but a combination of theories. In particular, OECD investors search for destinations with whom they have established intensive trade relations and that offer a qualified labor force. Low wages and attractive tax rates are robust investment criteria too, and a considerable share of FDI is still resource-driven. Overall, investors show fairly similar strategies in the five developing regions.

Keywords:

• FDI determinants
• Bayesian model averaging
• OECD
• developing countries
• the US
• Germany
• France
• the Netherlands

AMS Subject Classifications:

• C11
• F0
• F21

Public Interest Statement

The purpose of this study is to shed more light on the determinants of foreign direct investments (FDI) originating from major investors (namely, the US, Germany, France, and the Netherlands) in developing countries (DC) classified under five geographical regions over the period 1995–2008. To achieve that, we employ an approach that is able to identify the most robust determinants among a set of 30 potential determinants, which can be clustered into market size and market dynamics, market development (including labor costs and human capital), resources, openness, bilateral trade relations, geographical and cultural proximity, macroeconomic factors, institutional factors, and infrastructure. Our main findings reveal that: (1) Established bilateral trade relations, market size, high skilled labor force, low wages, and low corporate tax rate are the most robust FDI determinants in DC. (2) No single theory governs the decision of FDI in developing countries, but a combination of theories.

Acknowledgements

The authors wish to thank the editors (Steve Cook, Caroline Elliott, David McMillan, Duncan Watson and Xibin Zhang), two anonymous reviewers, Joseph Francois, Wolfgang Polasek, and ETSG conference participants for very helpful suggestions on a previous version of this paper. The usual disclaimer applies.

Notes

1 The other main OECD investors into DC are the UK, Switzerland, and Japan; unfortunately their FDI statistics for our sample period are incomplete, as discussed below, and thus excluded from this study.

2 Market-seeking FDI typically goes hand in hand with horizontal FDI where the entire production takes place in the host country in order to serve the local market, but not the export market. This type of FDI usually permits firms to operate in markets which are protected by high tariff barriers.

3 However, in our examination below we cannot perform the FDI analysis broken down by industry due to data unavailability.

4 The intermediate or final product needs to be shipped back to the FDI home country, which requires sufficiently low tariffs or free trade arrangements.

5 Li and Resnick (2003) argue, however, that democratic countries limit multinational firms (MNF) in pursuing monopolistic behavior and local governments in offering generous incentives, which may as well result in reduced FDI.

6 BMA techniques have been applied in numerous empirical applications. In the growth context, Fernandez et al. (2001b) apply the BMA with different priors to determine the most robust growth regressors that should be included in linear cross-country growth regressions. León-González and Montolio (2004) extend the BMA to a panel data framework.

7 Since many researchers prefer more parsimonious models, there exists some discussion about the priors on the model space. Nevertheless, regular posterior odds ratios already include a reward for parsimony. Brock and Durlauf (2001), among others, are opposed to uniform model priors because of the implicit assumption that a regressor’s probability is independent of the inclusion of others. They recommend a hierarchical structure for the model prior. However, this requires agreement on which regressors proxy the same theories. As stated in Eicher, Papageorgiou, and Raftery (2011), such a consensus is often not present and, therefore, independent model priors are preferable.

8 In a growth regression context, two recent studies of Ley and Steel (2009) and Eicher et al. (2011) have analyzed the effects of prior choices on the robustness of parameter choices and coefficient estimates.

9 The motivation of the US, France, and the Netherlands to invest in destinations in ECA with low wages which offer a reasonable productivity confirms previous findings by Lansbury et al. (1996) for FDI inflows in Eastern Europe in general.

10 Also, the study of Campos and Kinoshita (2010) could not verify that institutions matter for FDI flows into Eastern Europe.

11 Note that for France, the BMA does not indicate telecommunications and wage interacted with labor productivity as robust factors, but rather small countries that were former colonies.

12 The constraint of low productivity and missing education for FDI inflows into SSA is also found in Azémar and Desbordes (2010) and Suliman and Mollick (2009).

13 As we wish to include the taxation factor the pool excludes several countries in SSA and MENA for which taxation data are unavailable.

Additional information

Funding

Financial support from the OeNB Jubilaeumsfond [number 11701], is gratefully acknowledged.

Notes on contributors

Nikolaos Antonakakis

Nikolaos Antonakakis is an assistant professor at the Vienna University of Economics and Business (WU Wien) in Austria and a senior lecturer in Economics and Finance at the University of Portsmouth. He obtained his PhD in Economics from the University of Strathclyde. He has published articles in widely renowned journals and his research has received a lot of attention from the media.

Gabriele Tondl

Gabriele Tondl is an associate professor and deputy head at the Institute for International Economics at Vienna University of Economics and Business. She has published in the area of regional economic growth and income convergence, foreign direct investment, international business cycles and migration. She held several visiting and deputy professorships. She was fellow at the European University Institute and visitor at the European Central Bank Research Division. She is a member of the editorial board of Empirica and of the European Studies Association (ECSA), Austria.