Academic journal article Management International Review

The Impact of Regional Integration on Insider and Outsider FDI

Academic journal article Management International Review

The Impact of Regional Integration on Insider and Outsider FDI

Article excerpt

Abstract:

* We develop hypotheses for the implications of regional economic integration on foreign direct investment (FDI) from insider and outsider countries contingent on member nations' country-specific characteristics.

* We find that following regional integration (1) on average there is an increase in inward FDI, and (2) structural determinants such as the host country's market size, cultural and geographic distances, and institutional efficiency have a significantly different impact than when the host nation was outside the integrated area. Common economic area membership is associated with greater FDI flows, with the larger members gaining more; furthermore, insider FDI is less sensitive to labor cost, whereas the host country's institutional efficiency is an even more positive determinant of insider FDI.

Keywords: Regional economic integration * RIA * Foreign direct investment * FDI * OECD

Introduction

The centrality of foreign direct investment (FDI) in the modern economy cannot be overemphasized. The United Nations Conference on Trade and Development (UNCTAD) estimates that by 2005 there were about 77,000 multinational corporations (MNCs) with approximately 770,000 foreign affiliates world-wide (UNCTAD 2006, p. 10). Global FDI inflows reached a peak of nearly $1.5 trillion in 2000, before dropping to $ 558 billion in 2003, and subsequently recovering to $ 916 billion in 2005, and the share of value added by affiliates of MNCs now account for roughly 10% of world GDP. As countries liberalize their policy regimes to attract inward FDI, they may consider regional economic integration to serve as an additional location-specific advantage (Ethier 1998); in fact, the UN observes that "international investment rules are increasingly adopted as an essential part of free trade agreements and other treaties on economic cooperation" (UNCTAD 2006, p. 27). In addition, in recent years, the international business (IB) literature has drawn renewed attention to the regional nature of much of MNC activity (see, for example, Rugman and Verbeke 2004), thus the investigation of the relationship between regional integration and FDI flows is particularly apt.

A regionally integrated area (RIA) may attract more inward FDI for various reasons such as access to a larger market, defensive investments by firms from non-member countries to obtain similar treatment as firms from within the RIA, the lessening of the liability of foreignness within the RIA, and gains in economic efficiency. However, individual RIA members may not all observe gains (and indeed, some may even see losses) in FDI inflows, depending on the interaction between the motivations of the firms making the FDI and the variation in the location-specific advantages among the RIA members (Dunning 1997; Eden 2002; Ethier 1998; Feils and Rahman 2008; Rugman and Verbeke 2007). At present, "[t]he role of increasing regional integration" represents "a rich avenue for further research into the globalization/regionalisation debate" (Dunning et al. 2007, p. 187) in the IB literature using macro-level data, as is done in the present study.

We first develop hypotheses that explain which countries are expected to benefit most in terms of inward FDI from regional economic integration by examining the manner in which an RIA member's country-specific characteristics may materially affect firms' FDI decisions following integration. We then test these hypotheses by examining the aggregate FDI inflows into 24 OECD countries between 1980 and 2003. Our paper contributes to the globalization/regionalization debate in two ways: first, we provide evidence on which country characteristics are most important to attract FDI following accession to an RIA; second, we provide evidence on the country characteristics that attract FDI from inside the integrated region.

Our study extends the scope of existing studies by studying multiple RIAs and by examining the interaction effects of country characteristics and RIA membership. …

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