Academic journal article Contemporary Economic Policy

The Determinants of Korea's Foreign Direct Investment from the United States, 1980-2001: An Empirical Investigation of Firm-Level Data

Academic journal article Contemporary Economic Policy

The Determinants of Korea's Foreign Direct Investment from the United States, 1980-2001: An Empirical Investigation of Firm-Level Data

Article excerpt

I. INTRODUCTION

Foreign direct investment (FDI) has been one of the main driving forces of rapid economic growth in Korea in recent years. FDI inflows into Korea have grown at a rapid pace over the last two decades, especially since the 1997 financial crisis. Inward FDI flows in Korea accounted for almost 4% of the gross domestic product (GDP) in 2000, and inward FDI stocks accounted for more than 12% of GDP in 2005. According to the Ministry of Commerce, Industry and Energy (MOCIE), the number of companies in which foreign ownership exceeded 10% totaled only 3,877 in 1996 but rose to 9,423 by the end of 2000. Moreover, the combined FDI inflow into Korea during the 8-yr period of 1997-2005 was $98.9 billion, more than quadruple the $24.6 billion accumulated over the previous 35-yr period of 1962-1996. FDI inflows to Korea were reported to have hit an all-time high of $15.7 billion during 2000 and maintained at the annual level of $7-$13 billion during 2001-2005. The figure for 2000 is the 12th highest level in the world and the second highest in Asia after China, which is a substantial enhancement from its previous position below the Top 40 countries. (1)

Despite the crucial role played by FDI in the Korean economic development, the available empirical evidence on the major determinants of Korea's FDI inflows, especially at the firm level and the industry level, is rather scant in the literature and, at best, only under preliminary discussion. A drastic increase in the influx of foreign investment into Korea after November 1997, when the International Monetary Fund (IMF) stepped in to bail Korea out from its currency crisis, also provides a unique case to look into the possibility of changes in the major determinants of foreign investment in Korea. (2)

The purpose of this paper is threefold: first, to identify the major determinants of firm-level FDI inflows into Korea from the United States during the last 20 yr; second, to provide empirical evidence of structural changes in FDI determinants since the 1997 Asian financial crisis; and third, to investigate the important, but changing, roles of the level as well as the variability of foreign exchange rates in determining the firm-level and industry-specific FDI flows from the United States to Korea before and after the November 1997 foreign exchange crisis in Korea.

The rest of the paper is organized as follows. In Section II, we present an empirical model and describe the data which are employed in the study. Section III presents the empirical results of the whole sample period and subsample period estimations, industry-specific analysis, and panel data analysis. Finally, Section IV draws the main conclusions and policy implications of the paper.

II. EMPIRICAL MODEL AND DATA

The mainstream literature of FDI in the early tradition of Kindleberger (1969), Caves (1971), and Hymer (1976) focuses on strategic or locational variables, such as relative production costs, the technology gap, and trade barriers, to explain FDI flows. In this view, FDI takes place as a result of a multinational corporation's (MNC) attempts to exploit its oligopolistic advantages, relative to indigenous firms, by internalizing transactions within a firm. With the criticisms of Dunning's (1980, 1981) eclectic theory of FDI, which suggested internalization as an important precondition for FDI decisions by an MNC, for lack of financial consideration, financial variables, such as exchange rates, relative cost of capital, and corporate wealth, were also proposed to be included within a paradigm of the internalization theory of FDI in a world of imperfect or incomplete international financial markets. (3)

Froot and Stein (1991) examined the relation between exchange rates and U.S. FDI for the period of 1973-1988 and found that exchange rates add some explanatory power. Klein and Rosengren (1994) and Cushman (1988) also found that U.S. inward FDI was significantly negatively correlated with the value of the dollar. …

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