Development and Finance from issue 2011/1

Kornél Halmos

Economic Theories on Foreign Direct Investment

- Abstract -

Among FDI theories one cannot identify a single dominant, widely accepted view that is able to explain each form and aspect of FDI flows. The neoclassical condition of perfect competition was criticized in several empirical works. Dunning’s eclectic theory integrating ownership, location and internalisation advantages created a more precise framework for analysing FDI, than neoclassical attempts. In empirical studies R+D expenditure, technology intensity, company size, market size, factor costs, transport costs, political stability and development level of infrastructure were mentioned as important factors of FDI inflow.

Between countries with the same development level FDI flow is caused by ownership, technology and country specific advantages, according to research results. Horizontal capital flows were explained by the size of a country, the endowment with skilled and unskilled labour and transport costs. As regards vertical capital flows factor endowment received also some empirical backing, but it was much weaker than the horizontal model and the knowledge capital model of Markusen.

Risk diversification that was not included into the above models as an important motivating factor for multinational corporations became more and more important from the nineties. The major motivator in this case is the exchange rate risk, interest rate risk and in general the market risk that can be mitigated by international diversification in order to stabilise profits of MNS’s at acceptable level of business risk.

In recent decades research was focused on the interaction between target countries and MNCs and the competition between countries for FDI. Game theory approaches stressed the importance of FDI incentives of recipient countries. Empirical studies gave evidence to the significant role tax incentives play in attracting FDI.

During the past decades several FDI theories were elaborated and due to the extensive research on them, mostly they were verified by empirical evidences, but none of the theories can be seen as the perfect approach touching every aspect of FDI flows. In economic research the selection of adequate theory to the given situation can be the best tool to create suitable framework for analysis.

Kornél Halmos, PhD student (BME, Doctoral School of Technical Management, Business and Organisational Science)
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