Outward Foreign Direct Investment from Developing Countries

Transcription

1 Master Thesis Public Administration Outward Foreign Direct Investment from Developing Countries A study on the economic and institutional factors that can have an influence on the occurrence of outward FDI from India and Brazil Bruna Consiglio de Souza Student ID: s b.consiglio.de.souza@umail.leidenuniv.nl Supervisor: Dr. N. A.J. van der Zwan Second Reader: Dr. S.N. Giest MSc Public Administration Governing Markets: Market Competition and Regulation Leiden University January 13 th, 2016

2 Abstract This research has been conducted to investigate a relatively new phenomenon, which is the increasing occurrence of outward foreign direct investments (OFDI) from developing countries. To better understand which factors might influence the increasing occurrence of this activity in the developing world, this study has focused on different economic and governmental institutional factors. The economic factors observed are framed by the theoretical framework provided by the IDP hypothesis, and the institutional factors are mainly based on findings from previous studies in this field. The developing countries that have been observed are Brazil and India, which are two countries that have experienced substantial increases in their levels of OFDI over the past decades. Based on the findings obtained through this study, it seems that both economic and institutional factors might have a relation with the occurrence of OFDI in the two countries observed. The empirical observations included in this study indicates that institutional factors such as the relaxation of capital controls for OFDI and the presence of pro-market policy-makers in key institutions might contribute to the occurrence of OFDI in India and possibly in Brazil as well. To confirm whether or not these factors indeed have a possible relation with Brazilian OFDI, however, further research is necessary, including other factors that have not been observed in this research (e.g. indicators of economic stability). In addition to the findings mentioned above, this study also suggests that economic factors such as expenditures on research and development and increases in inward FDI might also have a relation with the levels of OFDI from both countries. 1

3 Contents 1. Introduction Literature review Brief historical overview of OFDI from developing countries The pros and cons of OFDI Economic development and OFDI National institutions and policies as determinants of OFDI The purpose of this research and its methodology Methodology The choice of Brazil and India Data selection and hypotheses Considerations about replicability Case study: India Introduction: Indian economy and OFDI Economic factors that could have an influence Indian OFDI Institutional factors that could influence Indian OFDI Background information on the Indian political system Indian policies easing capital controls for OFDI Indian policy-makers and Indian outward FDI The provision of financial incentives to Indian firms investing abroad through lowinterest rates loans The international dimension: Policy Prescriptions by the IMF and/or World Bank Final reflections on institutional factors and Indian OFDI Case study: Brazil Introduction: Brazilian economy and OFDI Economic factors that could influence Brazilian OFDI Institutional factors that could influence Brazilian OFDI Background information on the Brazilian political system Brazilian policies easing capital controls for OFDI Brazilian policy-makers and Brazilian outward FDI

4 The provision of financial incentives to Brazilian firms investing abroad through low-interest rates loans The international dimension: Policy Prescriptions by the IMF and/or World Bank Final reflections on institutional factors and Brazilian OFDI Analysis and discussion Hypotheses based on the Investment Development Path (IDP) Hypotheses based on institutional factors Conclusion and suggestions for further research Bibliography Annex 1: Brazilian OFDI (Host countries, 2014)

5 1. Introduction Outward foreign direct investment 1 (OFDI) is an economic activity that has been predominantly practiced by developed countries. In other words, OFDI has consisted mainly of firms from developed countries investing overseas. Interestingly, however, in the past decades, an increasing number of firms from developing countries have engaged in OFDI activities as well, constituting a relatively new phenomenon (Saad et al, 2014; Luo et al, 2010). An analysis on the evolution of OFDI from developing countries indicates that up until the 1980s, outflows of FDI from developing countries took place moderately, without substantial increases. From the 1980s onwards, however, it is possible to see that more substantial increases began to take place. For example, in 1980 outflows of FDI from developing countries totaled approximately USD 3 billion, and one decade later these outflows were significantly higher, totaling USD 13 billion in Following this trend of substantial increases, more recently, in 2014, this number has risen to USD 468 billion (UNCTAD, 2014). This phenomenon has gained the attention of many scholars, who want to understand which factors could possibly explain this increase in OFDI from developing countries. As the next chapter will explain, most authors have conducted analyses on the occurrence of OFDI as a result of economic development. This type of analysis is framed by the Investment Development Path hypothesis (hereinafter IDP hypothesis), which suggests that OFDI occurs as a natural consequence of economic growth in a country (Liu et al, 2005). Over the years, however, especially from the mid- 2000s onwards, a small group of scholars began to criticize the theoretical approach offered by the IDP hypothesis. According to these scholars (e.g. Stoian, 2013; Khoon & Wong, 2011), the IDP hypothesis cannot fully explain the occurrence of OFDI in developing countries because it neglects other factors that could play important roles influencing this activity. These authors were referring 1 The definition of OFDI being used in this research is as follows: OFDI is a business strategy where a domestic firm expands its operations to a foreign country either via a green field investment, merger/acquisition and/or expansion of an existing foreign facility. Source: Investopedia ( retrieved in Dec

6 to governmental factors. That is, they believed that certain public institutions and policies could also have an effect on the occurrence of this economic activity in developing countries. Based on that, many of these authors have combined economic and institutional factors to find out whether or not they could possibly have a relation with OFDI (e.g. Stoian, 2013; Khoon & Wong, 2011). The methodology used by these scholars was to conduct regression analyses to investigate whether or not the variation of numerical variables indicating economic and institutional factors could have a relation with the variation of OFDI for the countries analyzed. The idea of integrating both economic and institutional factors in a study on the possible determinants of OFDI seems to be plausible, and this study will also follow this line of research. Nevertheless, in this research I argue that this type of study should be carried out in a different way. To find out whether or not certain institutional factors could have an effect on OFDI, I suggest that a research should not take place through linear regressions since such approach only attempts at finding out whether or not a possible relation between variables exists. More importantly, in my view, a study should also attempt to find out how that relation could have taken place, and who the actors enhancing this relation are. Thus, because I want to present a more informative analysis on the factors that could contribute to the occurrence of OFDI, I will combine quantitative and qualitative data to test both theories (i.e. economic and institutional). In this research I will focus on two developing countries, namely Brazil and India, with the goal of answering the following question: To what extent are economic and governmental institutional factors associated with the occurrence of OFDI for Brazil and India? This study is theoretically relevant because, differently from the previous studies carried out in this area, it will include both a quantitative and a qualitative analyses on different factors that could have an influence on OFDI. The findings included in this study should be more informative because they will not only address some of the public policies and institutions that can have an effect on OFDI in India and Brazil, but they will also include observations on the policy-makers driving these institutions and policies, including their motivations in terms of OFDI governance. When it comes to the societal relevance of this study, I suggest that this research can be of relevance to policy makers in other developing countries. This is because, through the findings enclosed in this study, it will be possible for other policy makers to find out whether certain policies and institutional arrangements seem to be effective in enhancing and/or promoting OFDI in 5

7 developing countries. Or, on the contrary, this research can also be informative to policy-makers in case it shows that in Brazil and India OFDI seems to be associated mainly with economic development, and not so much with institutional factors. In sum, policy-makers interested in enhancing OFDI in their countries can learn more about the governance of this activity based on the Indian and Brazilian experience. The remainder of this thesis will proceed as follows: The next chapter will offer an overview on previous studies in this area, providing a theoretical background for this research. The following chapter will then elaborate on the design and methodology of this research. In that chapter I will specify which factors are going to be framed as economic factors, and which ones will be the institutional factors for this research. The fourth and fifth chapters present the case studies on India and Brazil. There I will include my observations on the economic and institutional factors that I have selected to observe in this research for India and Brazil. The following chapter will present an analysis on the findings enclosed in the case studies, with the purpose of highlighting those factors that seem to be the most applicable to explain the occurrence of OFDI in Brazil and in India. Finally, in the conclusion I will present the answer to the research question of this study, and will give suggestions for further research. 6

8 2. Literature review This chapter will present an overview of previous academic studies in the field of OFDI in order to provide some background information about this economic activity in developing countries. For the purpose of this research, this chapter will be divided as follows: the first sub-section will offer a brief historical overview of OFDI in developing countries, and the second one will present some of the pros and cons of OFDI for the economy of the investing country; the third and fourth sub-sections will then follow by elaborating more on the economic and institutional factors that, according to the literature, can have an influence on OFDI. These last two sub-sections will be used here as a theoretical framework for this research. 2.1 Brief historical overview of OFDI from developing countries By examining the literature on the evolution of OFDI from developing countries, it is possible to see that many authors divide this evolution in two waves to explain how this process has taken place (Narula & Nguyen, 2011; Saad et al. 2014). Based on the observations of these authors, the first wave emerged in the 1980s. During this wave, firms from developing countries sought to expand their operations across borders mainly with the purpose of acquiring more natural assets (Narula & Nguyen, 2011). Due to their lack of international experience, however, these firms did not expand their activities into different parts of the globe. Instead, they concentrated their investments in neighboring countries, which in most cases were at an earlier or similar stage of development. In other words, this means that firms from developing countries were mainly investing in other developing countries during this first wave. Some exceptions, however, existed, meaning that certain firms from developing countries were already expanding their operations into developed economies as well. Examples of such developing countries are Brazil, China, and Mexico. During this first wave, economies such as Argentina, Korea, Taiwan, Brazil, Singapore, and Mexico extended their investments across borders significantly (Dunning, 1998; Narula & Nguyen, 2011), and in general, outflows of FDI from developing countries increased substantially from USD 3 billion in 1980 to USD 16 billion 7

9 in 1989 (UNCTAD, 2014). This first wave lasted until the late 1980s, when a shift in OFDI practices began to occur. By the early 1990s, the second wave of OFDI was taking place. During this wave, an increasing number of firms from developing countries had gained more international experience and began to extend their investments substantially into developed economies. These firms were mainly interested in acquiring natural resources, expanding their markets, exploiting new assets, and augmenting their own assets abroad. Interestingly, many of the economies that were active during the first wave of OFDI did not play a prominent role during this second wave. In fact, the economies that led this second wave were mainly the newly industrialized Asian economies, such as Taiwan, Korea, Hong Kong and Singapore, which were indicating the increased competitiveness of their firms and dynamism of their economies (Narula & Nguyen, 2011; Saad et al. 2014; Dunning, 1998). As a consequence of their expansions, these newly industrialized Asian economies had their share of all developing country OFDI stock increased from 21% in the 1980s to 66% by 1993 (Narula & Nguyen, 2011). By analyzing these waves of OFDI, one question that arises is: what explains the occurrence of these two waves? One hypothesis is that the waves of OFDI could be a reflection of the different development paths that developing countries have followed. For example, the substantial increase in OFDI experienced by newly industrialized Asian economies could be a reflection of the development model that these economies have adopted decades earlier. For instance, as Haggard (1990 p. 25) explains in his book entitled Pathways from the Periphery, since the 1970s a number of Asian economies (led mainly by Korea, Taiwan, Singapore and Hong Kong) have adopted a model of development based mainly on export-led growth. Governments in many of these economies have promoted this growth by, for instance, providing financial and fiscal support to industries focusing on exports, targeting industrial policies, and liberalizing trade and investment. Possibly, by expanding their export activities, these economies have become more internationalized and open to foreign markets, and this could have led to the significant increase in OFDI that these economies experienced during the first and mainly during the second waves of OFDI. Latin American countries, on the other hand, have followed a model of economic development based mainly on import substitution. This model has taken place at least since the early 1990s, and 8

10 it focused on enhancing self-sufficiency in Latin American economies so they would be less dependent on imports (Haggard, 1990, p. 25). With that been said, it could be possible to suggest here that this economic model that has been adopted in Latin American economies restricted their economic transactions mainly to the home country and to the Latin American region, and this could possibly explain why these countries have not extended their OFDI activities to the same extend as their Asian counterparts during the second wave in the 1990s. Currently, however, from the 2000s onwards, it is possible to see that an increasing number of developing countries from different regions (e.g. Asia, Latin America, and Eastern Europe) have in general increased their OFDI activities substantially, with investments in both developing and developed economies. As a result of this growth, between 2009 and 2010 outflows of FDI from developing economies increased by 20.9 percent (from USD billion in 2009 to USD billion in 2010), indicating the significant increase in competitiveness and internationalization of these economies (Saad et al. 2013, p. 238). 2.2 The pros and cons of OFDI The aforementioned growth in OFDI indicates that developing countries are becoming increasingly attracted to the possible benefits that they can obtain by extending the operations of their firms abroad. The literature on OFDI points out several benefits that can be associated with this economic activity. For instance, authors such as Saad et al. (2013) and Sauvant (2005) argue that firms investing overseas will benefit by entering new markets as they will gain new customers in different states. Moreover, by operating in other states, these firms will have more access to foreign technology, and they will also benefit from being able to import intermediate products at lower prices in case the prices in their home countries are higher than those in host countries (Saad et al. 2013). In addition to firms, consumers in the home country can also benefit from OFDI. For instance, if the relocation of production facilities to other countries results in a more efficient use of resources, the costs of production will be lower, which can result in lower prices for consumers at home (Saad et al. 2013; Sauvant, 2005). OFDI can also lead to benefits to the workforce in the home country. For instance, in case the relocation of production activities leads to a concentration of skilled-labor intensive activities at home, there would be more incentives in the home country to educate 9

11 workers so they can become highly skilled to meet the growing demand for skilled labor in the labor market (Berman et al. 1994). There are, however, other aspects of OFDI that are not as positive for the home country as the ones mentioned above. For instance, OFDI is often associated with skills transfer and job losses in the home country (Saad et al. 2013, p.239). The debate about these negative consequences of OFDI, however, leads to mixed conclusions. For instance, Saad et al (2013) argue that in certain instances OFDI could also create jobs in the home country. According to them, if foreign production takes place complementing domestic production, the foreign subsidiary will then use inputs from the home country to produce outputs. If, in this case, the relocation of production processes take place as to use resources in a more efficient way, marginal costs of production could possibly become lower. As marginal costs of production decrease, outputs tend to increase. As a result, the creation of more outputs would require the creation of more inputs, consequently leading to job creation in the home country (Saad et al. 2013, p. 239). It is important to stress, however, that this case described by Saad et al. illustrates a scenario in which the entire production process takes place in an efficient manner, and foreign production complements domestic production. In other cases (e.g. when foreign production does not complement home production), OFDI might not occur as the authors describe, and job losses in the home country can indeed become an issue to be considered. According to Saad et al. (2013, p.239), however, most scholars seem to agree that OFDI end up strengthening the remaining economic activities at home. This claim is mainly based on arguments that OFDI can lead to more efficient production processes, lower prices for consumers, more competitive firms, and more specialized division of labor (Saad et al. 2013; Sauvant, 2005). As a conclusion, based on the analysis of the literature in this field, it is possible to argue here that OFDI can lead to many gains for the economy of a country; however, less positive consequences such as job losses in the home country can also occur and should not be neglected as a possible risk that OFDI entails. 2.3 Economic development and OFDI Given the increasing attention that OFDI has received in developing countries over the past decades, one question that arises is: What are the factors that determine OFDI for developing countries? Throughout the past decades, most scholars conducting research on the determinants of OFDI have focused exclusively on OFDI as an achievement from economic development. The 10

12 rationale used by these scholars is that as the economy of a country develops, that country will develop as well (e.g. that country might experience more technological innovations as a result of increased investments on technology that were enabled due to economic growth). The firms from that country will also benefit from such developments if they incorporate them into their operations. As a consequence of such incorporations, these firms will become more competitive (i.e. more able to exploit their newly acquired advantages against their competitors). Thus, because these firms are more competitive, they will be more likely to expand their operations abroad so they can reach new markets, acquire new resources, and consequently increase their sources of profit. Thus, in sum, according to this rationale the levels of economic development in a country can have an effect on that country s levels of OFDI (Dunning et al, 2001). The classic work that has influenced a substantial number of researches in this field in the past decades is the study by Dunning (1981), entitled Explaining the International Direct Investment Position of Countries: Towards a Dynamic Development Approach. Originally, Dunning investigated the variations in a state s outflows of FDI with the variations of that state s economic development. This investigation took place mainly by measuring variations of levels of OFDI and variations of levels of GDP per capita in an economy. This analysis is commonly known as the IDP hypothesis (standing for Dunning s Investment Development Path Hypothesis). This hypothesis has been tested over the years by many scholars, and it was often supported by their empirical analyses (e.g. Buckley & Castro, 1998; Barry et al., 2003; Bellak 2001). Over the years, however, many scholars argued that investigating only GDP per capita in an analysis is incomplete. They affirmed that many other economic factors could also be indicators of economic development and, consequently, they could also have an influence on a state s levels of OFDI. As a result, most recent research testing the IDP hypothesis began to include other variables in addition to GDP per capita. For instance, Durán & Ubeda (2001) have used national resources and development mode as complementary variables, and Liu et al. (2005) have used investments in human capital, levels of exports, and levels of inward FDI as complementary to GDP per capita. By that time, Dunning also recognized the limitations of his original IDP hypothesis and also started to use complementary variables in his analyses. For instance, in 2001 he conducted an analysis together with other scholars where he combined the variables foreign 11

13 trade and GDP per capita as indicators of economic development to test the IDP hypothesis (Dunning et al, 2001). Even though Dunning admits that other variables should be used together with the variable GDP per capita, he makes it clear that the variation of GDP per capita is still paramount in the analysis of economic development. For instance, in 2001 Dunning et al. published a reviewed elaboration on the process of the investment development path (Dunning et al. 2001). By analyzing their elaboration on this process, it is possible to conclude that GDP per capita still plays a significant role in the IDP analysis. According to the authors, the process of investment development path (IDP) takes place through the following four stages (Dunning et al. 2001): The first stage corresponds to a pre-industrial phase in the investment development path. Economies at this stage should have a GDP per capita bellow USD 1000 (at 1994 prices), and in general they only receive a small volume of inward FDI. This small volume is mainly a consequence of the economy s underdevelopment and weak locational advantages (e.g. a poorly educated labor force) which makes the economy less attractive to foreign investors. In addition to that, the underdevelopment of these economies lead them to have smaller market sizes, which again makes these economies less attractive to foreign investors due to limited purchasing power. OFDI in these economies is insignificant due to their poor locational advantages (e.g. poorly educated labor, low investment in innovation, etc.), and for this reason, economies at this first stage are mainly net recipients of FDI. The second stage comprises economies that enjoy better locational advantages and, for that reason, attract larger volumes of FDI. Economies at this stage are characterized as those possessing a GDP per capita between USD (at 1994 prices). These economies enjoy a rapid economic growth and consequently experience a growth in the sizes of their markets, which attracts both resource-seeking and market-seeking investments from foreign investors. At this stage, elements of OFDI begin to emerge. This is mainly because local firms are starting to incorporate some of the locational advantages of their home countries into their operations (e.g. they could be incorporating developments such as technology and other innovations into their operations). Thus, as these companies develop, they tend to extend their operations across borders in order to reach 12

14 new markets and acquire more resources. OFDI in these economies, however, is still small. Therefore these economies are still mainly net recipients of OFDI. At the third stage, economies enjoy a higher GDP per capita (between USD ,000 at 1994 prices). Economies at this stage experience continuous improvements in their locational advantages, which eventually end up becoming ownership advantages to their firms (e.g. locational advantages such as an increase in investments in technology becomes an ownership advantage to firms as these firms begin to gain technological knowledge as a result of these investments). At this stage economies experience increasing outflows of FDI. The firms in these economies are more prepared to enter international markets and compete internationally, seeking possibilities to start exploiting their own assets across borders. These economies, however, remain net recipients of FDI. The fourth, and final, stage, corresponds to those economies enjoying a GDP per capita above USD 10,000 (at 1994 prices). At this stage, economies are net outward investors due to the ownership advantages enjoyed by their firms. These economies see their outward FDI growing faster than inward FDI. If these economies keep developing they will go beyond stage four, which means that they will finally become major exporters, enjoying highly advanced technologies and higher living standards. This rationale of the investment development path has been widely adopted by scholars in the past three decades. As new variables were being added to complement the variable GDP per capita, the IDP hypothesis acquired more acceptance until it became widely used by researchers (Liu et al., 2005). It is important to note, however, that even though the IDP hypothesis gained significant acceptance, it did not escape criticism. For instance, Kuada & Sorensen (2000) conducted an analysis on the economic development of Ghana, and what they found is that even though Ghana has moved through stages of economic development, it did not experience an increase in OFDI as the IDP hypothesis suggests. Similarly, Erdilek (2003) has obtained the same findings for Turkey. The IDP hypothesis has also been criticized because, according to some scholars (e.g. Stoian, 2013; Kalotay & Sulstarova, 2010), this paradigm neglects the role that institutions play as determinants of OFDI. In fact, by analyzing researches framed by the IDP hypothesis, it is possible to conclude that many authors using that paradigm indeed see the emergence and growth of OFDI 13

15 simply as an automatic consequence of economic development, without considering the possible effects that institutions and policies can have on the occurrence of OFDI. A good example here is the study that Liu et al. (2005) conducted on Chinese OFDI. According to Liu et al. (2005, pp ), the emergence and growth of Chinese OFDI is consistent with the IDP hypothesis. They conclude that, for that reason, there is no need to look into the Chinese institutional framework to understand the origins and evolution of Chinese OFDI. In fact, these authors suggest that policies designed to directly promote OFDI in a country might be unnecessary, and this is because OFDI can evolve simply as a result of economic growth (Liu et al. 2005, pp. 113). Those scholars who criticize the IDP hypothesis on the grounds that it neglects the power of institutions, claim that the IDP hypothesis should be further extended to include institutional variables (e.g. Stoian, 2013; Kalotay & Sulstarova, 2010). Especially in the context of OFDI from developing countries, these scholars argue that analyzing institutional factors can be of relevance. For instance, according to Stoian (2013), developing countries (especially emerging markets and transition economies), often have particular institutional characteristics that have been put in place in order to enhance and drive their economic development so they can catch up with developed economies in a globalized world. These institutional characteristics, according to Stoian (2013), deserve the attention of researchers conducting analyses on the determinants of OFDI in these economies since they might have an influence on OFDI. This kind of argument has gained the support of an increasing number of scholars from the 2000s onwards. As a consequence, by the mid-2000s, it is possible to see that several researchers focusing on OFDI from developing countries began to give more attention to institutional variables in their analyses on the determinants of OFDI (e.g. Stoian, 2013; Khoon & Wong, 2011; Wang et al., 2012). The next sub-section will elaborate on these scholarly works. 2.4 National institutions and policies as determinants of OFDI As mentioned in the previous sub-section, many recent studies on the determinants of OFDI from developing countries are focusing not only on the economic determinants of OFDI, but also on the possible institutional factors that can influence OFDI as well (e.g. Khoon & Wong, 2011; Stoian, 2013). Next to that, some other studies have focused solely on the institutional determinants of 14

16 OFDI, excluding possible economic determinants (e.g. Wang et al. 2012; Luo et al. 2010). What these studies have in common, however, is that they all recognize that national institutions and policies can have an impact on the occurrence of OFDI. Most of these researches focus on two specific groups of developing countries, namely emerging markets (Khoon & Wong, 2011; Wang et al. 2012; Luo et al. 2010), and transition economies (Stoian, 2013; Blanke-Ławniczak, 2009) 2. The reason why these groups of developing countries have gained increasing attention by scholars is because they are the ones experiencing the most substantial increases in OFDI (Stoian, 2013). According to Luo et al. (2010), including national institutional factors in the analysis of the determinants of OFDI in developing economies is of great importance. They justify this claim by explaining that, in this type of economy, enterprises often face competitive disadvantages such as, for instance, lack of international experience and/or lack of capital. Thus, for that reason, governments in these countries often step in to coordinate the functioning of institutions and policies in order to offset these competitive disadvantages. In the context of outward FDI, this means that governments can coordinate the functioning of institutions and policies in order to promote OFDI (e.g. governments can design programs aimed at assisting firms to expand their operations across borders - more specific examples of such programs can be found further in this sub-section). Institutional factors, in fact, seem to have an influence on the occurrence of OFDI. For instance, Stoian (2013) has conducted an analysis on the determinants of OFDI from twenty Central and Eastern European states. The analysis conducted by Stoian was an extended version of the IDP hypothesis (using linear regression), in which not only economic, but institutional numerical variables were also included as possible determinants of OFDI. What Stoian has found is that one particular institutional variable can be considered as a significant determinant of OFDI from Central and Eastern European states. This factor is overall institutional reforms, which includes, for instance, privatization, price liberalization, and banking reforms. According to Stoian (2013, p.623), overall institutional reforms comprise a wide mix of institutional reforms that have been 2 To clarify the difference between these two groups of developing countries, emerging markets can be defined as economies that present certain characteristics of a developed economy, but still do not meet all the economic standards (e.g. such as sustainability of economic development) to be considered a developed economy (MSCI, 2014, p. 1). Transition economies, on the other hand, are those economies that are transitioning from a centrally planned economy (e.g. post-communist economies) towards a market economy (Feige, 1994). 15

17 implemented in post-communist economies with the purpose of ensuring their transition from centrally planned to market economies. The author explains that these overall institutional reforms reflect an economy s level of competitiveness and development. That means that the more advanced these overall institutional reforms are, the more competitive and developed an economy is. As a consequence of this increased development and competitiveness, the author suggests, firms in these economies gain more entrepreneurial confidence and increase their investments both inside and outside their home country (Stoian, 2013, p. 623). Other authors have conducted similar studies and their findings also supported the idea that institutional factors can have an effect on OFDI. For instance, Khoon & Wong (2011) have found that the liberation of capital outflows can lead to an increase in OFDI for Malaysia, and Salehizadeh (2007) has found that the deregulation of financial and capital markets, and the maintenance of sound monetary and fiscal policies can enhance OFDI in both emerging markets and transition economies. The studies mentioned above present the role that broad institutional reforms can play in enhancing OFDI in developing countries. In other words, they focus on outcomes of institutional reforms and operations, and on whether or not these outcomes can possibly have an impact on OFDI. For instance, the deregulation of financial markets allows firms to invest abroad more easily. If firms can carry out investments abroad more easily, they can take part in OFDI activities more easily as well. Thus, deregulation of financial markets might lead to an increase in OFDI. These studies, however, are limited to such broad conclusions. Possibly because they have been conducted mainly through quantitative analyses (e.g. regression analyses), they fail to investigate in depth the possible relationships between institutional operations and the occurrence of OFDI. For instance, these researches do not investigate in depth which actors (i.e. policy-makers) are involved in these institutional operations, and which specific tools they use in order to facilitate OFDI. Moreover, questions such as what are the specific motivations of these actors? And what are the main institutions that seem to have a direct influence on outward FDI? are left unanswered in such studies. This means that even though these studies further contribute to the theoretical knowledge on possible institutional determinants of OFDI, they still do not address in depth how and which institutions could possibly have an impact on OFDI in a country. This does not mean that there are no qualitative studies analyzing the roles of different institutions in the promotion of OFDI in developing countries. However, this type of study is still rare, and it 16

18 often focuses only on the national government as an actor that can have an influence on the occurrence of OFDI. This means that such studies neglect possible economic and international institutional factors that could possibly have an influence on OFDI. One such study, for instance, is the one conducted by Luo et al. (2010) on government determinants of OFDI from China. What Luo et al. suggest in their study is that the Chinese strategy which is commonly known as going global strategy seems to contribute significantly to the country s levels of OFDI. Luo et al. present in their study an in-depth analysis of many domestic institutions that are involved in the Chinese going global strategy. According to the authors, this strategy comprises a set of policies and institutional reforms such as: (1) the creation of incentives for OFDI (e.g. the provision of fiscal incentives such as tax incentives and low-interest loans to firms that want to invest abroad), (2) easing capital controls for OFDI by designing more liberal policies, and (3) providing information and guidance to firms with regards to possible investment opportunities abroad (Luo et al. 2010, p. 70). Similarly, a study conducted by Sauvant (2005) also mentions that similar policies have been adopted in developed countries, and, as the author suggests, they might have contributed to the high levels of OFDI that these countries enjoy. Such policies include, for instance, the provision of low interest loans to support the direct investments of domestic firms abroad, and also the provision of information and technical assistance to firms investing overseas (ibid. p.642). These government initiatives that are more specifically aimed at promoting OFDI present certain similarities with what Johnson (1982) termed as the developmental state. According to Johnson, one of the characteristics of a developmental state is that the government not only creates a favorable environment for economic activities. Instead, governments in developmental states have clear goals for the development of the economy, and they therefore create policies and drive institutional changes with the intention of supporting and achieving those goals. It is, however, important to mention that in a developmental state the government suppresses democracy in a way that it can have more control and autonomy over its development plans. Thus, I do not refer to this characteristic of a developmental state when I mention some of the similarities between this type of economic governance and the ones mentioned above. The only characteristic that I emphasize due to its relevance for this study - is that both of them have an economic governance that focuses on achieving a particular economic goal. In this case, the goal being the promotion of OFDI. In 17

19 sum, thus, it is possible to infer here that OFDI has been recognized by different governments in both the developed and the developing world as an important strategy to achieve economic development. For that reason, many of these governments have created incentives specifically targeted at promoting OFDI. Given that institutional arrangements and policies seem to play a role in the occurrence of OFDI, this study will follow this line of research to find out in depth how some of these institutional factors can have an effect on this economic activity for developing countries. In order to add to existing studies in this field, this research will be conducted through two case studies on two developing countries, namely Brazil and India. The focus on two case studies will enable this research to elaborate more thoroughly on two developing countries that have presented substantial increases in their levels of OFDI over the past decades. To present a more informative analysis on the different factors that might influence OFDI in these countries, this research will not only focus on institutional factors, but it will focus on economic factors as well. 18

20 3. The purpose of this research and its methodology As previously mentioned in the literature review, through this research I want to conduct a more informative analysis on some of the economic and institutional factors that could have an influence on OFDI in developing countries. What will make this study different from previous ones is that this study will not be restricted to a more superficial analysis on the government institutions and policies that can have an influence on OFDI. Instead, this research will go more in depth and will include an analysis on the policy-makers that participate in the governance of those institutions, with observations on their economic motivations and policy preferences. In addition to that, in this research I will not only observe national policies and institutions, but also international ones, such as the International Monetary Fund (IMF) and the World Bank. My goal here is to carry out these observations in order to offer more context to the role that public institutions can play in the occurrence of OFDI in developing countries. In my view, these observations, combined with observations on economic factors, will result in a more holistic analysis of the different factors that could have an influence on OFDI Methodology Because the goal of this study is to provide a deeper understanding on the possible determinants of OFDI in developing countries, I have chosen to conduct this research in the form of a multiple case study. For this research, two developing countries will be analyzed, namely Brazil and India. The reason why I have chosen to conduct two case studies is: 1- A case study design will allow me to investigate in depth how a phenomenon in this case OFDI is taking place in two different developing countries. 2- By conducting case studies on two developing countries, this research will be more informative than it would be in case only one country was being observed. For instance, through this research, it will be possible to see whether these two developing countries located in different continents have any similarities in the way they see and address OFDI. Similarities in these two countries could be possible indicators of similar paths that developing economies or more specifically emerging markets are taking. For instance, 19

21 similar policies to enhance OFDI could indicate that these countries have similar motivations to promote this economic activity. Thus, in sum, by analyzing two countries a greater contribution to the current knowledge on the possible determinants of OFDI in developing countries can be provided The choice of Brazil and India For this research I have selected one specific group of developing countries to focus my analysis on, namely emerging markets. The reason why I have chosen to focus on emerging markets is because, as mentioned in the literature review (e.g. by Luo et al and Sauvant, 2005), they have experienced some of the most substantial increases in OFDI among developing countries in the past decades. Thus, because they are experiencing such significant increases, it would be informative to understand more in depth how and why these increases have taken place. To clarify, it is first important to define what the term emerging markets means in this study. In sum, emerging markets could be defined here as those developing countries or economies that are experiencing rapid economic development, and therefore present certain characteristics similar to those of a developed economy. More formally, according to the definition by the Morgan Stanley Capital International s Market Classification Framework, emerging markets are economies that present certain characteristics of a developed economy, but still do not meet all the economic standards (e.g. such as sustainability of economic development) to be considered a developed economy (MSCI, 2014, p. 1). To narrow down my selection of countries to observe, I have chosen to focus on countries belonging to the BRICS (which comprises Brazil, Russia, India, China and South Africa). I have chosen the BRICS because this is an internationally known group of emerging economies. Thus there is an international consensus that these countries are emerging markets. To select the countries for my analysis, I have looked closely into the evolution of OFDI from the BRICS countries. The graph below illustrates this evolution. 20

22 OFDI stock (USD millions) Outward Foreign Direct Investment from Developing Countries January 13, OFDI Evolution from BRICS countries ( ) Brazil India South Africa China Russia 0 Year Figure Evolution of OFDI from BRICS countries (UNCTAD, 2014) By analyzing the graph above, it is possible to see that Brazil presented the highest rates of OFDI until the 2000s. By the 2000s, Russia s OFDI skyrocketed, followed by China that also experienced substantial increases by the mid-2000s. In comparison to these three countries, South Africa and India present more modest outflows of FDI, with India presenting the lowest rates during most of the years from 1980 until Based on these observations, I have decided to focus my analyses on two countries that have presented significantly different levels of OFDI over the years. I have chosen India because this country presents the lowest rates, and Brazil because it presents high rates of OFDI since the 1980s. The reason why I have not chosen China or Russia instead of Brazil is mainly due to language barriers. While conducting a qualitative analysis on the institutional factors that might influence OFDI from these countries, I will have to analyse many documents, including policy documents and transcriptions of public speeches. Thus, due to the fact that I do not speak the local languages spoken in Russia and China, I believe I will be limited in my analysis if I select these countries. In the case of India and Brazil, however, documents are issued in Portuguese and English, and these are languages that I have a good command of. 21

23 My motivation to select countries presenting different rates of OFDI is mainly because both of them have experienced significant increases in economic development; however, whereas one presents high rates of OFDI over the years, the other presents somewhat more modest increases since the 1980s. My goal, therefore, is to find out whether some institutional and economic factors could possibly explain the historical variation of OFDI between these two countries. To summarize, in terms of unit of observation and unit of analysis, it can be said that the units of analysis of this research are Brazil and India. The unit of observation refers to the time-space element for which my observations will be conducted. In this case the units of observation will be country-by-year. This is because in this research I will carry out observations on Brazilian and Indian OFDI within the timeframe between 1980 and This timeframe has been chosen because of data availability. For instance, variables indicating variations of OFDI are only available from 1980 until Data selection and hypotheses For this research data referring to the variables will be collected in two different ways. Firstly, quantitative data will be collected for the analysis of the economic factors that could possibly have a relation with OFDI. Secondly, qualitative data will be collected for the analysis of the institutional factors that might possibly affect the occurrence of OFDI from Brazil and India Data indicating economic factors that could have a relation with OFDI The first part of the case studies on Brazil and India will elaborate on the possible economic factors that can be related with their levels of OFDI. This part of the case studies will be similar to those studies conducted by scholars testing the extended version of the IDP hypothesis. The dependent variable that I will use is OFDI stock. This variable has been used in many studies testing the IDP hypothesis (e.g. Liu et al 2005; Stoian, 2013). The source of this variable is the UNCTAD. According to the UNCTAD s definition, OFDI stock is the value of the share of capital and reserves (including retained profits) attributable to the parent enterprise investing abroad, plus the net indebtedness of affiliates to the parent enterprises (UNCTAD, 2014). The first independent variable being used in this part of the analysis will be GDP per capita. This variable will be used in this research because it is the main and original - variable that must be 22