The Determinants of Foreign Direct Investment in the Business Services Industry

Abstract

This report aims to identify the determinant factors of FDI in the business services industry by examining 20 variables and their impacts on attracting foreign investment in 33 sample countries plus Hong Kong. The results of this study indicate that system-related factor conditions and demand conditions have a strong correlation to FDI. Among the variables under system-related factor conditions, four (bribery and corruption, transparency, intellectual property rights (IPR), and ease of doing business) greatly influence the amount of FDI in the business services industry. Among the variables under demand conditions, three (the cost of living index, office rent, and GDP) are key. At the same time, this paper concludes that the aforementioned factors influence not only the business services sector, but the manufacturing industry's FDI as well. Another main finding of this paper is that the FDI in the business services industry is more frequently found in more developed economies. For the market seeking and efficiency-seeking FDI, the quality of system-related factor conditions and the size of GDP are of particular importance for FDI in the business services industry.

Key Words:

• business service
• foreign direct investment

JEL Classifications:

• C10
• F21

Notes

¹According to the OECD (1999), advancement in the business services industry contributes to a service-oriented economy, knowledge-based economy, flexibility within the organization, professionalism, and division of labor.

²Principal Component Analysis (PCA) has been called one of the most valuable results from applied linear algebra. PCA is used in all forms of analysis, because it is a simple, non-parametric method of extracting relevant information from confusing data sets. For more details, refer to Jolliffe (2002).

³The interested reader is referred to one of the many books on the factor analysis such as Cattell (1978), Lawley and Maxwell (1971), Lewis-Beck (1994) or Rummel (1970) for further details. Factor analysis is one member of the class of latent variable models, which have been the subject of much recent research.

⁴ISIC (International Standard Industrial Classification of All Economic Activities) is a classification of industries developed by the United Nations.

⁵The factors influencing FDI in the business services industry are classified as: factor condition, demand condition, competitiveness of related industry, and system-related variables based on the preceding study. However, sub-variables of factor condition, demand condition, etc., are not verified theoretically and/or statistically.

⁶At the end of every February, the IMD conducts an Executive Opinion Survey. The survey questionnaire asks 106 questions, which are constructed as a Likert scale with a range of 1 to 10. Two-thirds of the IMD World Competitiveness Index data are based on the statistical data and the rest on survey data. The survey data are weighed so that the survey accounts for one-third in the determination of the overall ranking. Most of the criteria in the IMD data are scaled differently, so standardized values of each criterion are calculated based on the standard deviation method. The survey responses are transformed into their standard deviation values, from which the rankings are calculated.

⁷See Barro and Lee (2000).

⁸IMF, International Financial Statistics (Online), available at: http://www.elibrary.imf.org/, accessed 2 November 2013.

⁹There is a limit to causal inference, since the result is observed without controlling other variables that may influence FDI in the business services industry.

¹⁰Cost factors tend to be high in countries with high gross national income (GNI) per capita. Careful interpretation of cost factor is needed.