FDI location choice between North and South in the presence of uncertainty
Date Issued
2009
Date
2009
Author(s)
Hsieh, Che-Hung
Abstract
As an extension for Aw and Lee (2008), this paper tries to provide a more complete picture of the FDI location choice by taking the sovereign risk into account. In our theoretical part, the optimal production location of multinationals headquartered in a middle-income country depends on not only their productivity levels but their individual knowledge about sovereign risks of FDI locations in a setting where fixed set-up costs, labor costs, symmetric transportation costs and the relative market size between North and South are also determinants of FDI location choices. Consistent with other theoretical models, the least productive firms would serve the foreign markets via exporting from the parent country rather than outward FDI. Among the firms engaging in FDI activities, the productivity level is the highest for those investing in both North and South, intermediate for those investing in North and the lowest for those investing in South. Unlike existing theoretical models, we introduce the role of uncertainty into our theoretical framework, which predicts that firms tend to serve not only the local market but the North market via FDI in South as the sovereign risk in South is low. In contrast, firms tend to serve the North market only via exporting from Home while they invest in South where the sovereign risk there is high. Using confidential firm-level data in the year 2005, Taiwanese multinationals are classified into five categories: South firm without export platform, South firm with export platform, North firm, Global firm and others. In order to develop the empirical connection between the observable data and our theoretical model, the outward FDI information of individual firm is merged with its own plant-level data in 2004, and the multinomial logistic model is used in our empirical analysis. The empirical model yields four main conclusions. First, more productive firms prefer locating production in both North and South to investing in South only. Secondly, with the increase of uncertainty in South, firms locating production in South tend to serve the local market only. Thirdly, as the sovereign risk rises, firms would invest in North rather than South resulting from the relatively large North market. Finally, constructing relational networks plays an important role in not only firms’ decisions of FDI locations but the destinations of their goods.
Subjects
FDI
location choice
uncertainty
Type
thesis
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