3 - Determinants of Inward Foreign Direct Investment in Emerging Asian Countries

Summary

Foreign direct investment (FDI) inflow in emerging Asian economies has risen noticeably over the past three decades, with interruptions arising from the dot-com bubble crunch (2001–2) and the global financial crisis (2008–9) (see Figure 3.1). FDI not only directly provides additional capital funds to a host country, but also the superior technology associated with multinational enterprise (MNE) affiliates which can spill over to the local non-affiliated firms (Caves 1974; Sjöholm 1999; Wang and Blomstrom 1992). FDI is potentially able to both increase market competition and influence the performance of incumbent firms. It can also create linkages to upstream and downstream industries. Identifying the factors determining FDI inflows has become crucial and has received considerable attention from policymakers in emerging Asian countries. This chapter aims to examine such determinants of inward FDI in selected Asian countries.

Interestingly, along with an increase in FDI in the region, the crossborder dispersion of component production/assembly within vertically integrated production processes, or so-called international product fragmentation, has become an important feature of the structural interdependence of the world economy. Rapid advances in production technology and technological innovations in transportation and communication have allowed companies to “unbundle” the stages of production so that different tasks can be performed in different places. This dynamic has resulted in a shift in the composition of trade towards intermediate (parts and components) goods. Although production sharing is now a global phenomenon, there is evidence that it is far more important for emerging Asian countries than elsewhere (Athukorala 2008). The share of the parts and components trade in the region has generally increased over the past two decades, although countries in South Asia still remain a minor player in global production networks. Figure 3.2 shows that the share of parts and components in manufacturing imports emanating from emerging Asian countries increased from less than 30 per cent in 1992 to 40 per cent in 2014, while on the export side, the share of parts and components in manufacturing exports rose to 32 per cent from less than 20 per cent during the same period. MNEs from the US, Europe, Japan and recently foreign investors from East Asian newly industrialized economies (NIEs) have played a pivotal role in linking countries in the region to regional and global production networks.