Foreign Direct Investment

Introduction

This essay will be discussing the factors driving investments into Southeast Asian countries like Thailand, Malaysia, Vietnam, Cambodia and Indonesia with references to Dunning's ownership, location and internalization advantage theory which is also known as the eclectic paradigm.

Foreign direct investment (FDI) is a growing global phenomenon. According to international guidelines based on the recommendations by the IMF , FDI is defined as inter-national investment that reflects the objective of a resident entity in one economy (foreign direct investor or parent enter-prise) obtaining a "lasting interest" and control in an enterprise resident in an economy other than that of the foreign direct investor." Lasting interest" implies the existence of a long-term relationship between a direct investor and the enterprise and influence on the management of the enterprise.

However, it is important to take note that portfolio investment is different compared to FDI. Portfolio investments are found in the markets for bank loans, government securities, and traded company bonds and equity. One way to distinguish FDI from portfolio investment is control. Investor for portfolio investment don't involve in the management of the enterprise, while FDI do (Lipsey, 1999).

Foreign investments during colonial times were largely meant to exploit the ASEAN region's abundant natural resources. With political independence in the 1940s and 1950s and the rise of economic nationalism, foreign investment into natural resource were restricted, the major exception being oil and gas where the financial and technological requirement were beyond domestic capabilities. However, the post- interdependence focuses on attracting FDI to promote industrialisation, for example, the Malaysian government provide market-seeking incentive and it adopts outward-oriented policies, for example, by providing tax exemption (Goh & Wong, 2011), because FDI can provides many positive contributions. Borensztein, Gregorio and Lee (1998) found out that FDI can create a larger impact than investments by domestic firms besides stimulates economic growth.

FDI takes place in response to home country push factors and host country as well as firm specific factors. With reference to Dunning's eclectic paradigm, an argument that combining location- specific assets or resource endowments and the firm's own unique assets often requires FDI; it requires the firm to establish production facilities where those foreign assets or resource endowment are located (Hill, Cronk & Wickramasekera, 2011), this theory which developed by professor Dunning is a mix of three different theories of direct foreign investments (O-L-I).

"O" from Ownership advantages

Ownership factor is also known as firm specific factors. This refer to intangible assets, which are, at least for a while exclusive possesses of the company and may be transferred within transnational companies at low costs, leading either to higher incomes or reduced costs.

Thereby to successfully enter a foreign market, a company must have certain characteristics that would triumph over operating costs on a foreign market. These advantages are the property competences or the specific benefits of the company. The firm has a monopoly over its own specific advantages and using them abroad leads to higher marginal profitability or lower marginal cost than other competitors. (Dunning, 1998).

There are three types of specific advantages:

a) Monopoly advantages in the form of privileged access to markets through ownership of natural limited resources, patents, trademarks;

b) Technology, knowledge broadly defined so as to contain all forms of innovation activities

c) Economies of large size such as economies of learning, economies of scale and scope, greater access to financial capital;

"L" from Location

When the first condition is satisfied, it must be more beneficial for the company that owns them to use them itself rather than sell them or rent them to foreign firms. Location advantages (Country specific factors) of different countries are the key factors to determining who will become host countries for the activities of the transnational corporations. The specific advantages of each country can be divided into three categories:

a) The economic benefits consist of quantitative and qualitative factors of production, costs of transport, telecommunications, market size etc.

b) Political advantages: common and specific government policies that affect FDI flows.

c) Social advantages: includes distance between the home and home countries, cultural diversity, attitude towards strangers etc.

"I" from Internalisation:

If the first two conditions are met, it will be profitable for the company the use of these advantages, in collaboration with at least some factors outside the country of origin (Dunning, 1998). This third characteristic of the eclectic paradigm OLI offers a framework for assessing different ways in which the company will exploit its powers from the sale of goods and services to various agreements that might be signed between the companies.

As cross-border market Internalisation benefits is higher the more the firm will want to engage in foreign production rather than offering this right under license, franchise.

Advantages and Limitations of Dunning's Eclectic Paradigm

The eclectic paradigm offers a holistic framework to investigate the significance of factors influencing both the initial expansion of MNEs by foreign production and the subsequent growth of their activities (Dunning & Robson, 1987). The framework facilitates comparison between different theories by establishing the common ground between various approaches and by clarifying the specific questions theorists have posed, as well as the different levels of analysis (Cantwell & Narula, 2001).

Besides, the eclectic paradigm is able to anticipate what is internally needed from a firm's standpoint to transition operations across borders and counter the foreignness disadvantage. It does also explain the value adding FDI moves into a country in some instances.

But, the eclectic paradigm does not state what should specifically be analysed and what priority should be given to each factor, and on the other hand its explanatory variables are so broad that its predictive value is small.