1. The determinants of FDI inflows
Introduction: Benefits of FDI
The advance of the globalization process and the progress of science and technologies have brought
the world closer together than ever before, facilitating the movement and spread of information,
capitals, goods and products, raw materials and human capital from countries around the world. On
one hand, transnational companies are quick to realize these new potential investment destinations
and markets and start moving their resources to even the furthest corners on Earth to capitalize on
these new opportunities. Directly investing in these locations helps companies gain easy access to
the local markets, reduce transportation costs, and take advantage of the local workforce and
On the other hand, countries, especially developing ones, also recognize the importance and
contribution of FDI inflows to their economic growth. FDI inflows increase the existing pool of
capitals and speed up the transfer of new technologies and knowhow to host countries. Also, the
presence of FDI enterprises increases competition in the host countries' business environment,
forcing domestic enterprises to innovate and catch up with their foreign competitors and creates
other positive spillover effects.
Trends in FDI flow in recent years
In recent years, the prospects for overall global FDI flows have been very positive. According to the
statistics of UNCTAD, after falling from the height of $2 trillion in 2007 due to the world economic
recession, the global FDI inflow showed signs of recovery. In 2013, it increased by nearly 9 percent
to reach more than $1.45 trillion, and the increasing trend was observed across all 3 categories of
the economy - developed, developing and transitional economies. Many experts predicted that this
rising trend would continue for the next 3 years.
2. Among all global destinations, with the exception of the year 2009, FDI inflow to developing
countries kept increasing, making up for more than 54% of the total global inflows in 2013 ($778
billion), among which, emerging Asian economies accounted for nearly one third of the total global
share ($426 billion), significantly higher than that of African economies ($57 billion). China arose as
the most attractive developing-economy destination, ranking 2nd among the top host economies for
FDI and receiving a total of $124 billion in 2013, up 2.5% compared with 2012. As for developed
countries, after reaching a peak of $1.3 trillion in 2007, the total amount of FDI inflow to the region
deteriorated and stood at $566 billion in 2012, only slightly greater than that of 2012 ($517 billion).
North America attracted $250 billion while the European countries received $246 billion.
In terms of FDI outflows, developed countries maintained their lead, contributing more than $857
billion or more than 60% of the total global outflows. The United States and Japan were the most
active investors, investing $338 billion and $126 billion abroad respectively.
Determinants of FDI inflows
As the role of FDI in economic development has been increasingly acknowledged and emphasized,
competition among countries and regions to attract the global FDI inflows to their locations has also
intensified, leading to the big question as to which factors encourages or discourages foreign
investors from investing in a location. According to various researches, these followings factors are
identified as crucial in influencing investors' location decisions.
3. Market size
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Market size, which is usually decided by the host country's population, GDP and per capita income,
is one of the most important factors in FDI location decision. Market size gives investors an idea
about the host location's general economic and demographic conditions, the potential demand for
their products, local sales and profitability. Zheng (2009) argued that foreign investors who are
seeking new markets for their output are most likely to be interested in market size, customers'
potential purchasing power and growth. In addition, Scaperlanda and Mauer (1969) pointed out that
market size would positively affect the level of FDI if it was large enough to allow the companies to
take advantage of economies of scale and effectively allocated resources. It is no coincidence that
China and the United States, the two biggest economies in the world, are also the two largest FDI
recipients, accounting for approximately 13% and 9% respectively of global FDI inflows in 2013.
It is generally believed that openness and market freedom encourages FDI and economic growth.
Many studies show that trade openness promotes export-oriented FDI inflow into an economy in
general and companies often prefer host countries that are close to their export markets, have
policies supporting import-export activities and participate actively in many regional or global trade
agreements. Countries that undergo trade liberalization are expected to receive more FDI. For
instance, after Vietnam officially joined the World Trade Organization, signing various agreements to
open its economy and loosen the state's control in many areas, the country witnessed the largest
wave of FDI companies flocking to the country with a peak in 2008 with 1,171 new FDI projects and
a total registered capital of $71 billion.
Although researches have demonstrated that tax incentives are not the deciding factors in drawing
foreign investors' attention, it does prove to have some impacts on investors' decision, especially
when they compare among locations with relatively similar investment conditions. For example, from
1985 to 1994, as Caribbean and South Pacific countries amended their tax policies, making them
become tax havens, total foreign direct investment to these locations increased more than five times.
Similarly, countries and territories such as Hong Kong, British Virgin Islands etc. with lucrative
effective corporate tax rates are also able to attract a steady stream of foreign investments.
Moreover, tax incentives enable the host government to influence the structure of FDI inflow. In
fact, most governments give more incentives to a certain type of investment or a certain sector to
encourage investors satisfying specific conditions.
Labor cost has always been identified as a major FDI determinant and many developing countries
claim low labor cost as their competitive advantage in attracting foreign companies. Labor is one
component of the total production cost; therefore, labor-intensive industries and companies which
have labor costs constitute a large proportion of their total costs are most appealed to cheap labor.
Besides, export-oriented FDI companies are even more sensitive to labor cost and they tend to move
their production to the place offering low tax rates and cheap inputs including labor, raw materials
and energies to cut down on production cost. A study by Wheeler and Mody (1992) found out that for
4. US firms, labor cost played an important role in their global investment location decisions and lower
labor cost associated with higher level of FDI inflow. According to a research by Baskaran, Nasrin,
and Muchie (2010), low labor cost is the most significant determinant of FDI inflow to Bangladesh
and 71% of the foreign investors surveyed indicated that cheap labor was the main factor motivating
their investment decisions.
Economic and political stability
Foreign investors pursuing long-term and sustainable investment take economic and political
stability of the host country into serious consideration before making investment decision. A stable
and reasonably sound economic and political climate enhances the certainty and predictability of
future events or changes, increases investors' trust and makes them feel more secure about the
outcome of their investment. In addition, perception of stability adds to investor's perception of risk
and the greater level of instability drives away risk-averse investors, thus reducing the incoming FDI
flow. A report by OECD (2002) cited macroeconomic instability, nonenforceability of contracts, and
armed conflicts as the biggest risks of capital loss of foreign investors when investing in Africa,
which ultimately discourages them from investing in this region despite the high potential rate of
return on investment. Another example is the China - Japan's political dispute over islands in South
China Sea which caused much tensions and hostile attitudes towards Japanese investors in China,
forcing many Japanese companies to redirect their investments from China to other surrounding
countries in recent years.
In addition to the above-mentioned factors, there are other factors that are potentially the
determinants of FDI inflow such as natural resource availability, investment regulation, institution,
cultural traits, ease of doing business, infrastructure and so on. Each country has its own
comparative advantages in FDI attraction and pursues different goals in order to maximize benefits
and minimize risks from FDI. As the competition among countries in attracting FDI becomes fiercer,
there will be more factors that companies will take into account before deciding where they would
like to invest.
Baskaran A, Nasrin S, and Muchie M. (2010), "A Study of Major Determinants and Hindrances of
FDI inflow in Bangladesh", DIR Department of Culture and Global Studies, Aalborg University.
OECD (2002), "Foreign Direct Investment for Development: Maximizing benefits, Minimizing costs"
Scaperlanda A, Mauer L. (1969), "The Determinants of US Direct Investment in the EEC", American
Economic Review 59, 558-568.
Wheeler, D and A. Mody (1992), "International Investment Location Decisions: The Case of US
Firms," Journal of International Economics, Vol. 33.
5. Zheng P. (2009), "A Comparison of FDI Determinants in China and India," Thunderbird International
Business Review, Vol. 51, No. 3, p. 263-279.