An empirical examination of the determinants of Foreign Direct Investment: A firm-level analysis for the Colombian economy
Analise empirica dos determinantes da inversao estrangeira direta na Colombia: Evidencia ao nivel de firma
During the last three decades or so, economic integration among countries have deepened through increased participation in world markets for capital, goods and services. In this context, transnational corporate investments have played a key role in financing new economic structures both at the regional and country levels. In particular, foreign direct investment (FDI) is essential to an economy as a source of external funding and, given the effect it can have on a country's balance of payments, long-term economic growth and productivity. Moreover, FDI helps increase the transfer of technology, capital formation, competitiveness and qualification of the local labor force, in addition to reducing a firm's costs. Taking the above considerations into account, it is relevant to analyze the economic features that make firms attractive to foreign investors.
In recent years, Colombia, like many other emerging market economies, has been a recipient of increasing inflows in the form of FDI. It has been argued that investment inflows to the various sectors of the Colombian economy have been partly the result of a regulatory framework favorable to foreign investors, as it has been designed to provide them with both stability and certainty in legal terms. (1)
Literature on FDI in Colombia has examined numerous subjects both at the macro and the micro levels. Focusing on the latter, topics such as the effectiveness of the regulatory framework designed to attract FDI, the relationship among foreign investment, exports and innovation, as well as among FDI, growth and productivity have been the subject of attention (see, inter alia, Steiner and Giedion (1995), Echavarria and Zodrow (2005), Atallah (2006), Kugler (2006), Kalin (2009), De Lombaerde and Garay (2009)). However, to the best of our knowledge the study of the factors that make firms more likely to receive FDI has not received enough attention. Moreover, it appears that the scarcity of this strand of the literature is not exclusive to Colombia, as it applies to other emerging economies as well.
In an attempt to contribute to the literature, the aim of this paper is to study the determinants of FDI in Colombia, for which we take advantage of a unique and large dataset at the firm level. The dataset, which has been collected by the authors, consists of annual observations over the period 2000 to 2010, and comprises more than 5.300 firms from a large spectrum of economic sectors, some of which of strategic importance for the economy as a whole (such as petroleum and electricity, gas and water). An interesting feature of the dataset is that the level of disaggregation is such that we are able to examine firms of different sizes. Moreover, the dataset lends itself to analyze the characteristics of the firms that received FDI and compare them to those which did not receive it. To accomplish this objective, we perform two econometric exercises: the first one involves the specification and estimation of a model to find the factors that determine the probability that a firm is recipient of FDI; the second one focuses on a model to help explain the foreign share of the firm's capital.
Our findings suggest that firms that are more likely to attract FDI are capital intensive ones, of greater size, with well-established business structures, and that are involved in activities related to foreign trade. Interestingly, the results also show that the probability of a firm receiving FDI decreases for companies operating in economic sectors different from petroleum.
The paper is divided into four sections, in addition to the introduction. The second one reviews the economic literature on FDI. In the third section, we characterize the firms that receive FDI and compared them to those that do not receive this type of investment. In the fourth section, the results of the econometric estimations are presented. The final section offers some concluding remarks.
2 Literature Review on FDI
The economic literature on FDI determinants has concentrated mainly on analyzing why firms invest abroad. Some authors have studied the determinants of FDI at the macroeconomic level. They found that FDI is mainly determined by relative real wages, the relative exchange rate, economic integration, market size, cultural differences, infrastructure, credit access and economic stability. (2) Another strand of the literature, where studies are scarcer and more relevant to the present study, analyses the determinants of FDI at industry or firm level. For example, for the firms in the manufacturing and services sectors in Sweden, Karpaty and Poldahl (2006) found that the factors associated with firms' ownership and variables such as human capital, capital intensity and the intensity in the use of energy positively affect a firm's decision to invest in such sectors. Also, for the case of the food processing industry in the United Kingdom, Giulietti, Mccorriston and Osborne (2004) showed that the property of the firm and the market structure are important variables foreign companies considered when deciding to invest in this sector.
Buch, Kleinert, Lipponer and Toubal (2005) found that German multinationals companies mainly moved overseas to gain better access to international markets. Moreover Todo (2009) found evidence that the cost of entry into foreign markets plays an important role in the decision to invest abroad by Japanese firms.
Bellak, Leibrecht and Stehrer (2008) analyzed public policies to attract FDI, using a sample of countries, at the manufacturing industry level. The results showed that expenditure on research and development, unit labor costs, worker's ability, institutional environment and tax policy contribute to closing the gap between estimated FDI and its potential.
Alfaro and Charlton (2009) used a detailed database to characterize global patterns of multinational activity; they found that GDP is one of the main determinants of vertical FDI. On the contrary, bilateral distance, as a proxy for costs, and the increase in the level of skills in the subsidiary country have a negative effect on the multinational activity.
Finally, other studies have used surveys to ask entrepreneurs what reasons influence their decision to invest abroad. Hogenbirk (2002) conducted a survey among eighty six foreign electronics firms in the Netherlands. The survey asked the companies the reason why they set up business in the country. According to the results, factors associated with the ownership of the firms, location, and the benefits of internationalization affect the decision to locate in the Netherlands. Moreover, Ali and Guo (2005) analyzed the response of twenty two foreign firms operating in China on what they perceive as the most important factors for investing in that country. The survey results show market size is the main motivation for American firms, while low labor costs are the key determinant for Asian companies.
In summary, it's difficult to identify the most important factors affecting a firm's decision to invest abroad given that there is a wide range of methodologies and databases that include different samples of countries and time periods. However, from the literature review it is possible to establish that from a macroeconomic perspective market size, economic growth, the exchange rate, the tax structure, trade agreements, financial costs and macroeconomic stability are the most relevant factors. Moreover, from a microeconomic point of view the ownership structure of the firm, product differentiation, economies of scale and the firm's size are the most important aspects.
In Colombia, the determinants of FDI at the firm level have not been studied in depth. (3) The literature has focused on FDI regulations (Steiner and Giedion, 1995; Corral and Anzola, 1998), the role of taxes to attract FDI (Echavarria and Zodrow, 2005) and the government policies to attract FDI (Kalin, 2009; De Lombaerde and Garay, 2009).
Another subject examined is the relationship between foreign investment, manufacturing exports and innovation (Fatat, 1998). In turn, Echavarria and Esguerra (1990) and Kalin (2009) examined the impact the presence of foreign companies in the country has on employment, wages, production and exports. Other authors have studied the relationship between FDI, productivity, externalities and technology diffusion in the manufacturing sector (i.e. Atallah, 2006; Kugler, 2006; De Lombaerde and Pedraza, 2004; Pedraza, 2003; Kugler, 1998 and Steiner and Giedion, 1995).
Finally, among the few studies that have used firm level data, Rowland (2006) compared foreign and domestic firms in terms of sales, the evolution in earnings, leverage, exports, imports and foreign debt. In addition, Pedraza (2003) explored how FDI flows directed to the Colombian industrial sector affected the productive performance of recipient firms and compared the productive performance of firms with foreign investment to the productivity achieved by local firms.
3 Characterization of Firms Receiving FDI
We analyze whether firms receiving FDI differ from those that do not receive this type of investment. (4) To perform this analysis, we use a database consisting of 5,364 firms, mainly in the manufacturing sector (28%), trade (26%) and financial services (19%), during the 2000-2010 period. (5) 30% of the firms in the entire sample have FDI. It is important to point out that 96% of the firms in the petroleum sector and 41% in mining receive FDI (table 1). The development of petroleum and mining projects in particular requires the involvement of foreign firms that can afford the high capital investment, technology and risks associated with this type of business.
In the electricity, gas and water sector,...