International Journal of Social Economics

Macroeconomic determinants of outward foreign direct investment

Dimitrios Kyrkilis, Pantelis Pantelidis,
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Determinants of
Macroeconomic determinants outward FDI
of outward foreign direct
investment 827
Dimitrios Kyrkilis
University of Macedonia, Thessaloniki, Greece
Pantelis Pantelidis
University of Piraeus, Piraeus, Greece
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Keywords Foreign investment, Analysis, Economics

Abstract The aim of this paper is to test the hypothesis that the outward foreign direct
investment (FDI) position of countries may be considered as a function of country specific
characteristics, such as income, exchange rate, technology, human capital and openness of the
economy. The model developed identifies the main determinants of outward FDI using time series
data for five European Union members and four non-European Union countries. The model
indicates that real gross national product is proved the most important determinant of outward
FDI. Developed European countries specialise in human capital intensive FDI, while non-European
Union countries in technology intensive. Overall, the results verify that the outward FDI position of
countries is influenced by national characteristics and that the same type of endowments have
different significance for different countries.

Introduction
Recent contributions to economic theory explaining the outward foreign direct
investment (FDI) position of countries suggest that the mix of ownership (O),
location (L), internalisation (I) advantages of a countrys firms differentiates
along the countrys course of economic development (Dunning, 1993, pp. 76-86;
Dunning and Narula, 1996). If it is accepted that the propensity of a countrys
firms to invest abroad is a function of their ability to acquire and utilise
internally income yielding assets, in the sense that the higher this ability is, the
higher the degree of foreign involvement will be. If in turn this ability of firms
is a function of assets, either natural, e.g. natural resources, unskilled labour or
created, e.g. capital, technology, skilled labour, then the propensity of investing
abroad can be hypothesised to be a function of such endowments, which are
country specific, in the sense that different countries possess different natural
endowments and create different technological and human capital assets
through the adoption of different policies and the following of idiosyncratic
development courses.
In the line of the above argument country specific assets are dynamic in
International Journal of Social
character, evolving along the course of the countrys development, as the result Economics
of the interplay between policies, past levels of developments and actions of Vol. 30 No. 7, 2003
pp. 827-836
economic agents. Firms may draw on the supply of these endowments in order q MCB UP Limited
0306-8293
to organise production efficiently, create their own advantages and be able to DOI 10.1108/03068290310478766
 IJSE supply domestic and foreign markets. As the configuration of country-specific
30,7 endowments change over time the firm specific ability to serve markets also
changes and so does the propensity to invest abroad.
The aim of this paper is to test the hypothesis that the outward FDI position
of countries may be considered as a function of country-specific characteristics,
such as income, exchange rate, technology, human capital and openness of the
828 economy. The model developed identifies the main determinants of outward
FDI using time series data for nine countries. Five European Union (EU)
members, namely France, Germany, Italy, The Netherlands and UK and four
non-EU countries: Brazil, the Republic of Korea, Singapore and Argentina. The
period of investigation is between 1977 and 1997.
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Table I shows that France, Germany, Italy, The Netherlands and the UK
accounted for almost the 80.0 per cent of total EU outward FDI stock in 1997,
the 83.3 per cent in 1990 and 93.0 per cent in 1980[1]. Although Germany
maintained a rather stable share around 20.0 per cent throughout the whole
period, all other countries changed their shares with The Netherlands and the
UK reducing it while France and Italy followed the opposite direction. Brazil,
the Republic of Korea, Singapore and Argentina reduced their share of all
developing countries outward FDI stock from 64.8 per cent in 1980 to 22.2 per
cent in 1997 mainly due to the reduction of the Singapores participation to the
total outward stock of FDI from developing countries[2]. Brazil also lost half of
its share between 1980 and 1997, while Argentina and the Republic of Korea
increased their own considerably in the same period[3].
The model
Dependent variable
Annual FDI outflows.
Independent variables
Income. As the income of a country rises its economic structure changes and so
does the mix of the countrys competitive advantages. A growing share of the
gross national product (GNP) is accounted for by manufacturing and services,
the capital intensity of production increases, demand patterns move towards the
consumption of differentiated products and markets grow. The latter improves
the realisation of economies of scale through specialisation, the introduction of
new technology and greater volumes of output (Chenery et al., 1986).
Firms taking advantage of the country-specific agglomeration advantages
develop their ownership advantages. For example, sophisticated demand patterns
motivate firms, especially in consumer goods and services to differentiate
products and improve their marketing expertise. That in turn may be a
significant competitive advantage in establishing foreign production especially in
markets with demand conditions requiring local product adaptation (Caves, 1971;
Lall, 1980; Grubaugh, 1987). As firms accumulate ownership-specific advantages
their propensity to undertake direct foreign production increases, especially if
 Determinants of
Home country 1980 1990 1997
outward FDI
France 17,985 110,126 189,681
(8.8) (13.9) (12.6)
Germany 43,127 151,581 303,499
(21.0) (19.1) (20.1)
Italy 7,319 56,105 125,074 829
(3.6) (7.1) (8.3)
The Netherlands 42,116 109,092 209,614
(20.5) (13.8) (13.9)
UK 80,434 232,593 374,431
(39.2) (29.4) (24.8)
European Uniona
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205,417 791,625 1,510,714

(100) (100) (100)
Korea 142 2,301 16,750
(1.1) (3.1) (4.9)
Brazil 652 2,397 7,230
(4.9) (3.3) (2.1)
Singapore 7,808 7,808 44,522
(58.3) (10.7) (13.0)
Argentina 70 420 7,616
(0.5) (0.6) (2.2)
Developing countries 13,392 73,069 341,552
(100) (100) (100)
Notes:
Numbers in parentheses are percentage shares of: European countries FDI to total EU FDI; and
developing countries FDI to total developing countries FDI Table I.
a
Austria, Belgium and Luxembourg, Denmark, Finland, France, Germany, Ireland, Italy, The Outward FDI stock
Netherlands, Portugal, Spain, Sweden, the UK by home country
Source: UNCTAD (1999, Annex table B.4, pp. 495-500) (in millions of $)

these advantages are intangible and thus better transferred abroad through the
creation of an internal market rather than via an arms length type of transaction
(internalisation advantages) (Dunning, 1993, pp. 76-86).
The expectation is that higher income levels of a country are associated with
greater outward FDI activity. Real GNP is proposed as the proxy for a
countrys level of income and structural transformation.
Interest rate. Foreign operations require significant commitment in capital,
especially if they are undertaken in capital intensive sectors where
production is characterised by extensive economies of scale, as the case is
for most FDI. The capital abundance of the home country may form the
necessary background for establishing large firms with adequate financial
means and relatively easy access to capital markets. Capital abundance is
associated with relatively low interest rates, which in turn decrease the
opportunity cost of capital. That may prove investments abroad profitable
although there are risks and uncertainties associated with such investments.
The hypothesis is that the lower the interest rate of the home country the
 IJSE higher the countrys propensity for outward FDI (Clegg, 1987; Prugel, 1981;
30,7 Lall, 1980; Grubaugh, 1987).
Exchange rate. Aliber (1970) argued that firms from countries with strong
currencies are able to support financially their foreign investments in better
terms than firms from countries with weak currencies. The appreciation of the
home country currency lowers the capital requirements of foreign investments
830 in domestic currency units enabling the investing abroad firm to raise capital
easier than in the case of a depreciated currency. Besides, the home currency
appreciation reduces the nominal competitiveness of exports, increasing that
way the motive for choosing FDI as the mode of servicing foreign markets. A
positive correlation between exchange rate and outward FDI is hypothesised
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and the effective exchange rate index of the home country is proposed as an
approximation of the variable.
Technology. The hypothesis that technological capability is positively
related with FDI has received extensive theoretical and empirical support (Lall,
1980; Prugel, 1981; Grubaugh, 1987; Clegg, 1987; Cantwell, 1981; Cantwell,
1987; Pearce, 1989; Kogut and Chang, 1991; Dunning, 1993). The ability to
organise and undertake the production of technological inputs is a critical
ownership competitive advantage yielding income for the possessing firm.
Markets fail to optimise the returns on technological input transactions,
especially if technology is information intensive (Buckley and Casson, 1976,
1985; Dunning, 1993). In that case the exploitation of technological intermediate
goods across national boundaries is internalised by firms via FDI.
The ability of firms to organise and produce technological inputs varies
across countries according to characteristics such as the legal and patent
systems, availability of inputs and skills necessary for the production of
technology, market structure, government policies and incentives in education,
scientific research, etc. The number of patents issued in a country is expected to
approximate the ability of firms to generate technological inputs and thus it is
positively related to the outward FDI propensity of the country.
Human capital. Human skills is another powerful ownership advantage the
possession of which gives the ability for acquiring competitive advantages of
another type. R&D, marketing, management and organisation activities and
foreign operations require competent and skilled labour. Empirical research has
proved that FDI is more likely in skill-intensive sectors (Juhl, 1979; Lall, 1980;
Prugel, 1981; Clegg, 1987). Again, the human capital supply varies across
countries according to education and training systems, government policies, etc.
The approximation proposed for this variable is the number of higher
education R&D personnel. Because these data are not available for non-EU
countries, the third level education students are suggested as a substitute. The
higher the number of third level education graduates, the higher the skill
content in employment is expected to be, and so a positive relation is suggested
between the variable and FDI.
 The openness of the economy. The liberalisation of a countrys foreign Determinants of
economic transactions is expected to influence positively the outward FDI outward FDI
activities of its firms. First, the absence of capital controls allows the unrestricted
funding of investments abroad (Scaperlanda and Mauer, 1973; Scaperlanda and
Balough, 1983; Scaperlanda, 1992). Second, an export-oriented economy permits
firms to acquire information about foreign markets, knowledge and skills about
organising foreign operations and marketing their products internationally. All 831
these may form the background for changing the mode of internationalisation
from exporting to FDI (Kogut, 1983). Third, firms may choose to combat import
competition via increasing their involvement in the home markets of the import
producing companies and a certain mode of retaliation is FDI. Overall, a higher
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degree of openness is expected to be associated with a higher level of outward

FDI activity. The exports plus imports level of a country is proposed as an
approximation of its openness.
Dummy variable. The unification of Germany is expected to act negatively
on the level of German outward FDI, shifting investments towards Eastern
Germany for modernising its economy. The dummy variable takes the value of
0 for the years up to 1990 and the value of 1 for the years afterwards.

Methodology and data

The model function can be summarised as it follows:
FDI FY ; I ; ER; TE; HC; OP; D
+ + + + +
where:
FDI = Outward flows of FDI.
Y = Home country real GNP.
I = Home country interest rate.
ER = Home country effective exchange rate index.
TE = Technology variable. It is approximated by the number of patents
issued in the home country.
HC = Human capital variable. It is approximated by the number of higher
education R&D personnel for the three EU countries and by the
number of third level education students for non-EU countries.
OP = Openness of the economy. It is approximated by the level of exports
plus imports.
D = Dummy variable applicable in the case of Germany and measuring
the impact of German unification: it takes the value 0 for the years
between 1977 and 1990 and the value 1 for the years between 1991
and 1997.
 IJSE The signs underneath the variables indicate the expected type of correlation
30,7 (negative or positive) between the independent variables and FDI outflows. The
loglinear form of the equation is estimated using OLS for each country
separately with annual data for the period 1977-1997. The equation has a
loglinear form because under this specification elasticities given by the
estimated coefficients are constant.
832 The FDI, real GNP, exchange rate, interest rate, export and import variables
have been taken from IMF International Financial Statistics. The source of the
technology and human capital variables in the case of the EU countries is the
OECD Main Science and Technology Indicators and in the case of non-EU
countries is the United Nations Statistical Yearbook.
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The stationarity of all used data series has been tested by applying the
Plillips-Perron unit root test (Phillips and Person, 1988). It was found that
France, Germany, Italy, the UK, the Republic of Korea and Argentina series are
of level zero, while The Netherlands, Brazil and Singapore series are of level
one[4]. The result of all unit root test are reported in Table II. The
Durbin-Watson statistic indicates the absence of autocorrelation in most
cases[5].

Results
The results are presented in Table III. The constant term is significant in all
cases, with the exception of Singapore and Argentina indicating that a part of
outward FDI is due to strategic considerations of firms in an increasingly
globalised business environment.
In the case of France the statistically significant variables and with the
expected signs are: income, technology, at the 10 per cent level, and human
capital. Exchange rate is significant, but its correlation with FDI outflows is

The
France Germany Italy Netherlands UK Korea Brazil Singapore Argentina

FDI 2 4.8* 2 4.6* 211.5* 24.9* 2 3.2** 25.9* 2 4.9* 29.3* 2 4.1*
Y 2 3.1* 2 2.6** 2 2.6** 23.1** 2 3.4* 28.6* 2 3.6* 22.8** 2 3.5*
I 2 3.1* 2 3.3* 2 2.6** 23.5** 2 3.7* 23.1* 4.0* 23.0* 2 3.6*
ER 2 2.6** 2 5.1* 2 3.8* 23.5** 2 4.0* 22.6** 2 6.9* 23.0* 2 2.8**
TE 2 3.9* 2 3.9* 2 2.7** 24.4* 2 8.4* 23.9* 2 4.2* 23.3* 2 4.5*
HC 2 3.2* 2 2.6** 2 3.1* 24.2* 2 8.1* 22.7** 220.3* 23.3* 2 4.0*
OP 2 6.6* 2 3.6* 2 2.9** 29.7* 2 3.1* 22.9** 2 2.67** 22.7** 2 2.8**
D 2 4.3*
Notes:
The Phillips-Perron unit root test is conducted in level zero for France, Germany, Italy, the UK,
Argentina and the Republic of Korea and in first difference for The Netherlands, Brazil and
Table II. Singapore
Phillips-Perron unit * Means significant at 5 per cent level
root test (t-statistic) ** Means significant at 10 per cent level
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France Germany Italy The Netherlands UK Korea Brazil Singapore Argentina

Const 283.0* 227.2* 2 52.2* 212.4** 234.4* 214.7** 248.5** 214.1 2 69.4
(4.1) (6.8) (2.91) (1.7) (3.4) (1.9) (1.8) (0.9) (0.7)
Y 10.2* 9.2* 11.5* 7.5** 8.0* 2 0.3 5.2 ** 28.8 15.4
(2.5) (4.7) (2.2) (1.9) (3.2) (1.4) (1.8) (0.7) (0.6)
I 0.2 0.2 2 0.5** 2 0.7** 20.6 21.6* 0.05 20.5 2 0.09
(0.6) (0.8) (1.8) (1.8) (0.7) (2.3) (0.5) (0.6) (0.09)
ER 2 3.6* 0.1** 1.0 1.4 2.5** 0.8 20.1** 28.4** 0.05**
(2.7) (1.8) (0.6) (0.2) (2.0) (0.9) (1.8) (1.8) (2.1)
TE 3.9** 2 0.004 0.05 0.6 20.07 20.3 1.08* 3.2* 0.8
(1.8) (0.04) (0.2) (0.7) (1.01) (0.9) (2.2) (2.6) (0.4)
HC 5.5* 4.11* 2.7** 1.7* 0.46** 0.01 20.3 4.6 0.7
(3.4) (3.5) (1.8) (2.2) (1.99) (0.06) (1.2) (0.9) (0.8)
OP 2 0.5 0.6** 0.5 1.6 20.69 2.3* 0.3 0.6 6.6*
(1.1) (1.82) (0.5) (1.5) (1.05) (3.3) (0.2) (0.2) (3.3)
D 2 0.45**
(1.82)
R2 0.96 0.95 0.92 0.75 0.87 0.94 0.63 0.88 0.66
F statistic 63.4 51.1 23.8 6.1 16.0 46.1 3.8 18.5 4.6
DW 2.07 2.04 2.05 2.32 1.79 1.89 2.12 2.31 1.95
Notes:
* Means significant at 5 per cent level
** Means significant at 10 per cent level
The values in parentheses are t-statistics

period 1977-1997
OLS estimates of
outward FDI

outward FDI for

Table III.
833
Determinants of
 IJSE negative. If the devaluation of the French franc is made in order to adjust for
30,7 losses in competitiveness in terms of productivity or labour cost or inflation,
then French firms may take the option of transferring abroad the less
sophisticated and more vulnerable of increases in labour costs parts of their
production processes, thus securing their shares in both the domestic and
exporting markets through rationalised FDI where strategic rather than capital
834 considerations are taken into account. This argument is similar to the export
platform motive for FDI in the case of decreasing national competitiveness in
certain sectors (Kojima, 1978; Kojima and Ozawa, 1985).
German outward FDI is best explained by: income, exchange rate, at the 10
per cent level, human capital and the openness of the economy. These variables
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also have the expected sign. The dummy variable is significant at the 10 per
cent level and has the expected negative sign explaining perhaps the stability
of the German share in total EU FDI stock in recent years (see Table I). The
shift of investments towards the Eastern part of the country lowered the rate of
increase of FDI outflows relatively to other European countries.
Income, interest rate and human capital are the statistically significant with
the expected signs determinants for the outward FDI in the cases of Italy and
The Netherlands. Income, exchange rate and human capital are the statistically
significant with the expected signs determinants for the UK outward FDI.
Interest rate and openness are the only significant and with the expected signs
explanatory variables in the case of Korea, while only one variable, i.e. technology,
being the significant and positively correlated with outward FDI determinant for
both Brazil and Singapore. Income is significant at the 10 per cent level and has
the expected positive relation with FDI outflows in the case of Brazil.
The exchange rate is statistically significant at the 10 per cent level with a
negative sign for both Brazil and Singapore. That means that if domestic
currency depreciates, outward FDI increases. If currency depreciation
compensates for deteriorating productivity and labour cost, export-oriented
FDI may be used as a long-term effective measure for securing market shares
abroad. This type of FDI is directed towards countries of more favourable cost
structures, mainly other developing countries. Indeed, locations in developing
countries accounted for almost the 46.0 per cent of outward Brazilian FDI stock
in 1993 and the same applies to Singapore, whose FDI locations concentrate to
a significant degree in other Asian, particularly ASEAN countries and China
(Dunning et al., 1996; UNCTAD, 1995, 1996). In the case of Singapore perhaps
50.0 per cent of its outward FDI is undertaken by foreign subsidiaries located
there (UNCTAD, 1996). It is plausible to assume that if their main motive for
establishing in Singapore is exporting, then any increase in labour cost drives
them to invest in other countries in the region in order to take advantage of cost
differentials and continuing that way their exporting activity.
Exchange rate and openness are the only significant variables with the
expected sign in the case of Argentina.
 Conclusion Determinants of
The model has a good explanatory ability relatively better in the case of the outward FDI
developed European countries than non-EU ones.
Real GNP is proved the most important determinant of outward FDI.
Exchange rate is also one of the main factors influencing outward FDI. It seems
though that in some cases it is rather indirectly connected with FDI revealing
changes of national competitiveness (cases of France, Brazil and Singapore). 835
Developed European countries specialise in human capital intensive FDI,
while non-EU countries in the technology intensive one.
Overall, the results verify that the outward FDI position of countries is
influenced by national characteristics and that the same type of endowments
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have different significance for different countries.

Notes
1. Calculations are made on the basis of the following 13 EU countries for all years for reasons
of comparability: Austria, Belgium and Luxembourg, Denmark, Finland, France, Germany,
Ireland, Italy, The Netherlands, Portugal, Spain, Sweden, the UK.
2. Korea and Singapore actually belong to the newly industrialised countries and are
conventionally included in the developing countries group.
3. It should be noted that the reduction of the share of both Singapore and Brazil was
accompanied by an enormous increase of the absolute amount of their outward FDI stock by
almost 6 and 11 times respectively between 1980 and 1997.
4. That means that all equations using series of level one are estimated by using the first
difference of each variable.
5. In the cases of Germany, Italy and The Netherlands autocorrelation was detected. The
Cochrane-Orcutt technique was used for correction.

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