Academic journal article The European Journal of Comparative Economics

Emerging Countries' Multinational Companies Investing in Developed Countries: At Odds with the HOS Paradigm?

Academic journal article The European Journal of Comparative Economics

Emerging Countries' Multinational Companies Investing in Developed Countries: At Odds with the HOS Paradigm?

Article excerpt

Abstract

The paper analyses the new trend of outward foreign direct investment (FDI) by multinational companies from emerging countries, in particular the BRICs, in developed countries to question the applicability of the traditional HOS theoretical framework to this trend. A literature review shows that labour costs do not play any significant role in the first attempts to provide an analytical explanation of this new trend. A HOS equation, amended in order to encompass FDI, is elaborated in order to explain outward FDI from developed to developing and emerging countries based on differences in labour endowment and therefore in wage rates. Step by step, the equation introduces the technological gap, institutions and government policies. Then it is shown that such equation when reversed to explain outward FDI from emerging to developed countries is at odds with the traditional HOS framework. Turning the HOS theory upside down does not help to explain reverse FDI outflows from emerging to developed countries. An alternative approach is called for, in which a labour cost advantage (a lower wage rate than abroad) is a home market advantage for emerging countries to invest abroad. A final section provides some empirical examples that labour matters and a lower home wage rate is a decisive comparative advantage for Indian and Chinese multinationals investing in developed countries. Additional evidence shows that the technological gap and the home country's institutions and government policy matter as well.

JEL: F21, F23, O53

Keywords: emerging countries'multinationals, outward foreign direct investment, China, India, HOS theorem, labour costs, wage differentials, skilled and unskilled labour, technological gap, government policies

(ProQuest: ... denotes formulae omitted.)

Introduction

The growth of outward foreign direct investment (FDI) from emerging countries has accelerated in the first decade of the 2000s and has been less markedly affected by the 2008-2012 economic crises in the BRICs3 than overall FDI in the rest of the world. Moreover, multinational companies (MNCs) from emerging countries have developed various strategies; one of the most striking is to invest abroad in developed countries. The latter is the focus of this paper, since it is not common that less-developed countries undertake significant outward FDI in more-developed countries. The existing economic literature is more used to analysing FDI flows that go the other way round from developed to less-developed countries. However, in the recent years, a series of articles have provided analyses about the determinants of outward FDIs from emerging to developed countries, primarily focusing on a technological catching-up process. We have found that none of them has clearly demonstrated so far that such a "reverse" FDI outflow - compared with the flow explained by the standard theory - is, together with technological catching-up, basically due to lower labour costs in home countries such as India, China and other emerging countries. When such an assumption is mentioned, it is just as a brief remark (Milleli et al., 2010). Why is this so?

Our guess is that outward FDI by MNCs from emerging to developed countries is so deeply at odds with the analytical framework of the standard international trade and foreign investment theory that no one has attempted to go to the logical conclusion of this "reverse" FDI outflow, i.e. explaining this "reverse" flow requires reversing and finally rejecting the standard theory itself. Such is the major contention of the present paper.

The paper is organized as follows. A brief coverage of the most recent empirical evidence regarding outward FDI from emerging countries and in particular the BRICs (1) is followed by a survey of the literature that has attempted to explain or interpret this new trend (2). Then, starting from a very simplified standard Heckscher-Ohlin-Stolper-Samuelson (HOS) framework, amended in such a way as to integrate FDI, it is demonstrated first that labour cost matters as a determinant of outward FDI from emerging to developed countries and, second, that the standard model is incorrect / inconsistent with its usual assumptions about international capital flows between developed and less developed (emerging) countries, thus calling for an alternative approach which this article paves the way for (3). …

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