3. Determinants of Direct Investment: A Review of the Literature

A comprehensive review of the literature on direct foreign investment (DFI) invariably becomes a tour d’horizon of the field of International Business. Disciplines from Economics and Finance to Strategic Management, Marketing and Organizational Behaviour have contributed to the present understanding of DFI. This chapter reviews the literature on DFI with focus on determinants of DFI. It considers DFI at different levels of aggregation, including macroeconomic flows of DFI-capital, industry and firm level analysis, as well as individual decisions by firms. Early research analysed DFI as a financial flow. As researchers recognize the specific characteristics of direct, rather than portfolio, investment, they focus on three issues: the location of production, the sources of firm-specific advantages, and the reasons for integrating different business units in one firm. John Dunning’s OLI paradigm incorporates these three issues. It is now the most common analytical tool for the determinants of DFI and it is applied in this study. The limitation of the framework is its ability to explain dynamic processes. Therefore, this review pays special attention to recent advances of economic theory addressing the dynamics of DFI. Dynamic models focus on particular types or aspects of DFI and thus are less general than the OLI paradigm. The most familiar dynamic approach is that of the internationalization process models based on the work of the Uppsala school in the 1970s. Recent advances include the rediscovery of economic geography in the work of Paul Krugman and Michael Porter, the integration of MNE into models of international trade by James Markusen, Elhanan Helpman and, again, Paul Krugman, as well as the game-theoretic analysis by the Leuven school. The appendix presents another dynamic approach to DFI, the developmental model. It relates economic development of a country to the characteristics of DFI outflows. Table 3.1 summarizes economic theories by their level of analysis and whether they focus on static or dynamic analysis. This categorization serves as orientation only. In some cases dynamic theories have developed from static theories, as is the case with the developmental model. In other cases the pairs reflect contrasting views. Internalization and internationalization theories account for some of the most lively encounters at academic conferences. Table 3.2 lists the multitude of theories with their main analytical concepts, original contributors and recent reviews or extensions.