Pattern of Foreign Direct Investment in Emerging Economies: An Exploration

Until recently major part of FDI flows had been among developed economies with similar relative factor endowments, income levels and market institutions such as property rights regimes. Consequently, major theoretical streams of FDI in economics could simplify FDI as a substitute for intra-industry trade by incorporating transportation costs and economies of scale (multi-plants). In the recent years, developing economies have increased their share of FDI inflows significantly (40%). Explanation of magnitude and pattern of FDI into developing economies requires a complex ray of factors. This is because these economies differ significantly from developed economies and also among each other in economic development levels and endowment of market institutions. This paper attempts to develop a conceptual framework to explain pattern of FDI in developing economies by identifying the determinants on the supply and demand side and market institutional conditions. Differences in the endowment of the factors in a set determine the pattern of FDI in these economies. This paper illustrates this by taking the case study of China and India.

Introduction: Since 1950 till the early part of the nineties, major portion of foreign direct investment flows had been among the developed (OECD) economies. As a natural outcome, the leading theoretical streams of foreign direct investment are envisaged to explain FDI flows among developed economies. As in intra-industry trade models, similarity in income levels and factor endowments and market institutions are the underlying explanations for FDI flows among the developed countries. This facilitates theoretical simplification of FDI flows as a substitute for intra-industry trade in differentiated goods by incorporating transportation costs and multi-plant operations into the analysis. The theories could afford to ignore or give
a marginal treatment to market institutional and political factors because the OECD countries can be observed to be similar in these conditions. Although market institutions such as financial markets, and corporate governance are significantly different among the U.S., Japan and Western European Countries, these economies are similar in the institutions of the private property rights, protection of intellectual property2 and democratic institutions such as independent judiciary.

Author: Murali Patibandla

Source: Copenhagen Business School

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