South Korea’s outward direct investment and its dyadic determinants: Foreign aid, bilateral treaty and economic diplomacy

• DOI: http://doi.org/10.1111/twec.13012
• Published date: 01 December 2020
• Date: 01 December 2020
• Author: Heon Joo Jung,Geonwoo Park

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wileyonlinelibrary.com/journal/twec World Econ. 2020;43:3296–3313.

© 2020 John Wiley & Sons Ltd

Received: 27 January 2019

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Revised: 13 July 2020

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Accepted: 20 July 2020

DOI: 10.1111/twec.13012

ORIGINAL ARTICLE

South Korea’s outward direct investment and its

dyadic determinants: Foreign aid, bilateral treaty

and economic diplomacy

GeonwooPark

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Heon JooJung

Department of Public Administration, Yonsei University, Seoul, Korea

Funding information

National Research Foundation of Korea (NRF-2018S1A3A2075117).

KEYWORDS

aid, economic diplomacy, foreign, foreign direct investment, international investment agreement

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INTRODUCTION

In 1996, Renato Ruggiero, then Director-General of the World Trade Organization, stated “there can

be no doubt that foreign direct investment has joined international trade as a primary motor of global-

ization”.1 Since then, many have argued that foreign direct investment (FDI) has become even more

important than international trade because it deepens economic integration not just via the transfer of

capital but also through the transfer of knowledge. Specifically, FDI plays a growing role in the global

economy as it benefits both investing firms and host countries. Among other things, it provides firms

with new markets, cheaper labour force, new technologies, and lower regulations and restrictions. As

these firms bring capital, job opportunities, advanced technologies, and management skills, FDI also

contributes positively to the national and local economic development of the host countries. In fact,

according to a report by the United Nations Conference on Trade and Development (UNCTAD), FDI

has increased substantially since the end of the Cold War. While the total amount of FDI around the

globe was approximately 241billion USD in 1990, it grew to 1.2trillion USD in 2018.2

In terms of FDI, South Korea is not an exception. During its developmental period in the 1970s and

1980s, FDI played a very limited role in the Korean economy because the government preferred loans

to FDI inflows and tightly controlled FDI outflows due to the strong domestic need for capital. As

state control over FDI inflows and outflows was deregulated in the late 1990s and the 2000s, the role

of FDI in the Korean economy grew rapidly. Specifically, outward direct investment (ODI) greatly

increased from 5.4billion USD in 1995 to 49.7billion USD in 2011 because Korean firms began to

invest in foreign countries as they strived to be competitive in the global market.

1WTO News, Foreign direct investment seen as primary motor of globalisation, says WTO Director-General: https://www.

wto.org/engli sh/news_e/pres96_e/pr042_e.htm.

2UNCTAD Statistics, https://unctad.org/en/Publi catio nsLib rary/diaei ainf2 019d1_en.pdf.

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PARK And JUnG

Due to the growing significance of ODI in the Korean economy, many researchers have examined

what affects Korean firms’ investment decisions, such as FDI destinations. There is a significant body

of literature examining various factors influencing outward FDI (Kim & Jun,2018; Kim, Kim, &

Wang,1998; Seong & Jung,2017). Most of these studies focus on the investment environment of the

host countries, such as socio-economic and political factors, but fail to explain growing ODI in some

developing countries where economic and political conditions are supposedly unfavourable to it. For

example, Peru's geographic distance, governance and economic conditions were unfavourable for FDI

but it ranked 4th among Korea's FDI destinations in 2013. Similarly, South Korean firms invested

387.8 million USD in Panama in 2012, ranked 8th in terms of FDI amount that year, even though

Panama's market size was much smaller than that of countries that received similar amounts. This

raises the question of why South Korean entrepreneurs invest in these unlikely destinations.

This study aims to address this question by considering interstate factors such as investment trea-

ties, foreign aid and economic diplomacy, which have been largely underexplored in the existing

literature. For example, it is argued that although there have been many studies on the impact of eco-

nomic diplomacy and networks on trade, the FDI issue remains unexplored (Moons,2017). To fill this

research gap, the current study examines what factors influence the foreign investment decisions of

South Korean firms with a focus on the bilateral relationship between South Korea and host countries,

especially developing countries where political and economic conditions are not as favourable as those

in developed countries.

Empirical analyses of South Korea's ODI in developing countries from 1995 to 2016 reveal that in-

terstate factors along with political-economic and geographic factors stressed in previous studies have

positive effects on South Korea's FDI in these countries. In particular, international investment agree-

ments (IIAs) and foreign aid have statistically significant effects on South Korea's FDI to developing

countries, while presidential visits have significant effects on FDI in developing countries located only

in non-Asian regions, especially the African continent. These results indicate that the effects of bilat-

eral relations on South Korea's FDI vary depending on the geographic location of the host country.

The remainder of this paper is organised as follows. First, a review of existing works on FDI

that prioritise politico-economic and geographic factors in explaining firms’ choice of investment

destinations are presented in Section 2. Section 3 provides an overview and discussion of the key

characteristics of South Korea's FDI. The research design and hypotheses are discussed in Section 4,

while statistical analyses and discussion are presented in Section 5. Finally, Section 6 summarises the

findings and concludes with some policy implications.

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LITERATURE REVIEW

Due to the impact of FDI on both investing firms and host countries, there is a large body of research

on the determinants of FDI destinations. One of the most important studies is Dunning’s (1980) eclec-

tic theory of FDI, which is a mix of three theories emphasising ownership advantage (O), location (L)

and internalisation (I).3 More specifically, regardless of their disciplinary fields, most studies stress

3As one of the most prominent scholars in studies of FDI, John Dunning suggests an eclectic theory of FDI flows, usually

called an OLI framework. According to this framework, a firm chooses to invest in foreign countries and become a

multinational corporation (MNC) if each of three advantages is satisfied. The ownership advantage (O) refers to firm-specific

advantages that allow certain firms to overcome the challenges and costs of running a business in a foreign country. The

location advantage (L) relates to which country a firm or MNC decides to invest in. The internalisation advantage (I) refers to

a firm's strategy in a case when the MNC intends to make more profits and cut costs by directly investing in a foreign country

or internalising their investment instead of other options such as joint ventures, exports and licensing.