Market Potential, Productivity and Foreign Direct Investment: Some Evidence from Three Case Studies

Abstract

This paper aims at analysing the importance of local determinants to foreign direct investment (FDI) in three European regional case studies. The originality of the approach lies in the use of disaggregated data by sector and by region. The results are three-fold. First, regional demand and productivity are fundamental FDI determinants, confirming most studies with national data. Second, regional FDI inflows are more dependent on regional than national determinants. Finally, the effect of market potential measured with absolute gross domestic product (GDP) on regional FDI diminishes linearly with distance and does not when measured with GDP per capita.

Acknowledgements

We are grateful to the Editor (Ph. Cooke) and two anonymous referees, Isabel Busom and Rosina Moreno for useful suggestions. We thank IDESCAT, Istituto per il Commercio Estero, Secretaría General del Comercio Exterior, Statistiches Landesamt Baden-Württemberg and Ufficio Italiano Cambi for data they provided. Any remaining error is our responsibility. Rosella Nicolini's research is supported by a Ramón y Cajal contract. Financial support from grants 2005SRG00470 and SEJ2005-01427/ECON is acknowledged.

Notes

FDI is the capital transaction that a “direct investor” carries out in a foreign “direct investment enterprise” (affiliate) to obtain a lasting interest in this foreign firm and a significant degree of influence on its management. The threshold of 10%—or more—ownership of a firm's capital is, in general, required to be accounted for as a direct investment. Cross-border mergers and acquisitions have been a growing component of FDI flows in the recent past.

See UNCTAD database: www.unctad.org.

Our exercise is limited to a sample of regions belonging to the European Union that are experiencing a European market integration process. The results should be interpreted by making reference to this specific context.

Source: www.taxpolicycenter.org.

For an extensive review of this literature, see Caves (1996), Chakrabarti (2001) and Blonigen (2005).

Transport costs may exhibit economies of scale for any distance as the quantity to be delivered (over any distance) increases and the transport cost per unit of quantity falls.

Source: Eurostat database.

Absolute GDP can be a misleading measure in developing countries. A large but poor economy can yield a very low demand for certain industries (Chakrabarti, 2001). It is then justified to complement the analysis with GDP per capita. Nevertheless, it can also be interesting to associate both indicators in studies on developed countries.

We are implicitly assuming that firms incur a transport cost to deliver their goods or services.

The composition of the surrounding regions and countries for each home region is given in Table 11.

We compute these by using the Guide Michelin website (http://www.viamichelin.es/viamichelin/esp/tpl/hme/MaHomePage.htm).

Figures 2 and 3 are realized by using regional GDP per capita for the computation of the market potential.

Lombardia, Ufficio Italiano Cambi and Annuario Statistico Lombardia; Catalunya, IDESCAT and Secretaría General del Comercio Exterior and Baden-Württemberg, Statistiches Landesamt Baden-Württemberg.

The office in charge of collecting these data (Ufficio Italiano Cambi) no longer exists and has not yet been replaced.

On specialization versus diversity, see Rosenthal and Strange (2004).

This is the most suitable way to proceed for this kind of exercise, as discussed in Greene (2000) and Wooldridge (2002).

We do not have a sufficient number of variables to run instrumental variables estimations.

The results of the estimations without regional fixed effects are available upon request.

Including fixed effects means that latent regional variables exist that deserve to be considered but the data at hand prevent us from identifying them. Egger (2008) argues that legal, cultural and institutional elements are unobserved factors that can be easily taken into account by applying a fixed effect method.

FDI inflows' fluctuations in a region may reflect booms and busts of the global economy (for instance, economic crises). By including a measure of regional GDP changing over time, we partially consider the effects of these world fluctuations.

There are other factors influencing the attractiveness of FDI towards a specific location, for instance, local institutions, property rights, the environmental policy, fiscal and financial schemes, corruption and bureaucracy as well as the stability of the exchange rate. All these factors may improve or deteriorate the local environment, which may affect FDI inflows (see Blonigen, 1997; Hanson, 2001; Fredriksson et al., 2003; Görg et al. 2009). However, we do not include these factors in our analysis because there are no data or reliable information for our regions.

Catalunya, like other regions (Scotland, for instance), has experienced the diversion effect due to the enlargement process of the European Union. Catalunya has always attracted labour-intensive foreign investments (because of low wages) and now faces the competition of the new Member States within the European Union.