Location specific determinants of japanese foreign direct investment in selected asian countries

University of Economics

International Institution of Social Studies

Ho Chi Minh City, Vietnam

Eramus University of Rotterdam,
The Netherlands

VIETNAM – THE NETHERLANDS PROGRAMME
FOR MASTER OF ART IN DEVELOPMENT ECONOMICS

LOCATION SPECIFIC DETERMINANTS OF
JAPANESE FOREIGN DIRECT INVESTMENT
IN SELECTED ASIAN COUNTRIES
BY HUYNH THAO THUY VI

A thesis submitted in partial fulfillment of the requirements for the degree of
Master of Arts in Development Economics

Under the supervision of Dr. Le Cong Tru

HO CHI MINH CITY, 2014


DECLARATION

This is to certify that the thesis entitled “Location-specific determinants of Japanese foreign
direct investment in selected Asian countries”, is submitted by me in fulfillment of the
requirement for the degree of Master of Art in Development Economics to Vietnam –
Netherlands Programme. This thesis comprises only my original work and due supervision and

acknowledgement have been made in the text to all other material used.

Huynh Thao Thuy Vi

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ACKNOWLEDGEMENT

I would not be possible to finish this thesis without the support of people surrounding me.
Firstly, I am really grateful to my supervisor, Dr. Le Cong Tru, for his guidance, comments and
supervisions.
Secondly, I would like to express my gratitude to Dr. Truong Dang Thuy for his econometric
guidance.
Thirdly, I want to acknowledge all lecturers of Vietnam-Netherlands Programme for the wide
knowledge they provided me during the time I studied here.
Next, I would like to express my gratitude to my parents for all of their sacrifice, encouragement
and support for me.
Last but not least, I would like to thank my friends and people, who supported for my thesis but
were not above-mentioned.

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ABBREVIATIONS

FE

Fixed Effect

FDI

Foreign Direct Investment

GDP

Gross Domestic Product

JBIC

Japan Bank for International Cooperation

JFDI

Japanese Foreign Direct Investment

JETRO

Japan External Trade Organization

MNE

Multinational Enterprises

RE

Random Effect

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ABSTRACT
This thesis contributes to examine the location-specific determinants influencing on
Japanese foreign direct investment. This research uses fixed effect method and panel data of ten
selected Asian countries in the period from 1995 to 2012. The determinants are classified into
three groups: policy factor, business facilitation and economic factor. In this study, except for the
variables which belong to policy factor and business facilitation, the others of economic factor
are categorized in accordance with three main motives for Japanese enterprises investing abroad.
Those motives are market-seeking, resource-seeking and efficiency-seeking. The study finds that
market size, natural resource, inflation rate, exchange rate volatility, political risk and
infrastructure development are the significant factors.
Moreover, among ten selected Asian countries, there are the differences between
intercept coefficients of Vietnam and other countries who are Thailand, Indonesia, Vietnam–
Philippines and China. In other words, except for the determinants in the regression model, there
would be other factors making those countries to be more dominant than Vietnam. Finally,
recognizing the need of Japanese foreign direct investment, the policy makers in host countries
should apply the relevant policies to improve the business environment for becoming promising
destinations and attract more Japanese foreign direct investment.

Key words: Japanese foreign direct investment, panel data, location-specific, Asian countries,
fixed effect.

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TABLE OF CONTENT
DECLARATION .......................................................................................................................... 1
ACKNOWLEDGEMENT............................................................................................................ 2
ABBREVIATIONS ....................................................................................................................... 3
ABSTRACT ................................................................................................................................... 4

TABLE OF CONTENT................................................................................................................ 5
LIST OF FIGURES ...................................................................................................................... 7
LIST OF TABLES ........................................................................................................................ 8
CHAPTER 1 INTRODUCTION .............................................................................................. 9
1.1
1.2
1.3
1.4

PROBLEM STATEMENT ........................................................................................................... 9
RESEARCH OBJECTIVES ....................................................................................................... 10
RESEARCH QUESTION ........................................................................................................... 10
THESIS STRUCTURE ............................................................................................................... 11

CHAPTER 2

LITERATURE REVIEW ................................................................................ 12

2.1
THEORETICAL LITERATURE ............................................................................................... 12
2.1.1
Early concepts & studies of determinants of FDI ............................................................... 12
2.1.2
Neoclassical Trade Theory (Heckscher-Ohlin model & MacDougall-Kemp model) ......... 13
2.1.3
Hymer – Kindleberger Paradigm ........................................................................................ 13
2.1.4
Internalization theory .......................................................................................................... 14
2.1.5
The OLI paradigm - Eclectic theory ................................................................................... 15

2.2
EMPIRICAL STUDIES .............................................................................................................. 17
2.3
CONCEPTUAL FRAMEWORK ............................................................................................... 22

CHAPTER 3

RESEARCH METHODOLOGY.................................................................... 25

3.1
VARIABLE DEFINITION AND TESTING HYPOTHESES ................................................... 25
3.1.1
Market size .......................................................................................................................... 25
3.1.2
Natural resource .................................................................................................................. 25
3.1.3
Inflation rate ........................................................................................................................ 25
3.1.4
Exchange rate volatility ...................................................................................................... 26
3.1.5
Trade openness.................................................................................................................... 26
3.1.6
Political risk ........................................................................................................................ 27
3.1.7
Infrastructure development ................................................................................................. 27
3.1.8
Labor cost............................................................................................................................ 28
3.2
DATA AND MODEL SPECIFICATION .................................................................................. 28
3.3

RESEARCH METHODOLOGY ................................................................................................ 31
3.3.1
Descriptive Analysis ........................................................................................................... 31
3.3.2
Regression Analysis ............................................................................................................ 32

CHAPTER 4

DATA ANALYSIS ........................................................................................... 37

4.1
THE OVERVIEW OF JAPANESE FDI IN ASIAN COUNTRIES ........................................... 37
4.1.1
Before the crisis in 1997 ..................................................................................................... 37
4.1.2
After the crisis in 1997 ........................................................................................................ 43
4.1.3
Several remarkable characteristics of recent Japanese FDI in Asia .................................... 45
4.2
EMPIRICAL RESULTS ............................................................................................................. 47
4.2.1
Descriptive analysis and some general tests ....................................................................... 47
4.2.2
Econometric results ............................................................................................................. 52

CHAPTER 5
5.1

CONCLUSION AND POLICY IMPLICATION.......................................... 57

CONCLUSION ........................................................................................................................... 57

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5.2
5.3

POLICY IMPLICATION ........................................................................................................... 58
LIMITATION AND SUGGESTION OF FURTHER RESEARCH .......................................... 59

APPENDIX A: RESULT OF HAUSMAN TEST .................................................................... 60
APPENDIX B: RESULTS OF HETEROSKEDASTICITY & .............................................. 61
SERIAL CORRELATION TEST ............................................................................................. 61
Table B-1: Heteroskedasticity test .......................................................................................................... 61
Table B-2: Serial Correlation test ........................................................................................................... 61

APPENDIX C: REGRESSION RESULTS .............................................................................. 62
REFERENCES............................................................................................................................ 63

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LIST OF FIGURES

Figure 2.1: Conceptual Framework ............................................................................................. 23
Figure 4.1: Japanese FDI by region (billion Yen) ........................................................................ 38
Figure 4.2: Japanese FDI in 10 selected Asian countries (billion Yen)........................................ 40
Figure 4.3: Japanese FDI in NIEs (billion Yen) ........................................................................... 41
Figure 4.4: Japanese FDI in ASEAN4 (billion Yen) .................................................................... 42

Figure 4.5: The correlation between Political Risk (pol) and Trade Openness (TO1) ................. 49
Figure 4.6: The correlation between trade and GDP .................................................................... 50
Figure 4.7: The response of Japanese enterprises considering Vietnam, Thailand, Indonesia,
Philippines and China as the promising countries. ....................................................................... 56

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LIST OF TABLES

Table 2.1: The summaries of some typical theories of FDI .......................................................... 16
Table 3.1: Summary of testing hypotheses ................................................................................... 28
Table 3.2: Summary of expected signs of variables ..................................................................... 30
Table 4.1: Regional distribution of FDI by Japanese firms .......................................................... 39
Table 4.2: Promising countries for overseas business operation over the medium-term in term of
Japanese enterprises ...................................................................................................................... 45
Table 4.3: Summary of variables in the study .............................................................................. 48
Table 4.4: Correlation coefficients of variables in the study ........................................................ 48
Table 4.5: The VIF and TOL factors before excluding trade openness (TO1)............................. 49
Table 4.6: The VIF and TOL factors after excluding trade openness (TO1) ............................... 51
Table 4.7: Summary of Estimation Results .................................................................................. 52

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CHAPTER 1
1.1

INTRODUCTION

PROBLEM STATEMENT
For the time being, because of the immobility and long run profitability, foreign direct

investment (FDI) is one of the important factors contributing to the economic growth of
countries in the world (Nakamura & Oyama, 1998). Through FDI, the financial resources are
transferred to the host countries to set up and expand the production conditions in those
countries. Furthermore, the technological achievements and managerial knowledge are also
transferred from the investing countries to the host countries. Those factors would contribute to
the economic development of the recipients. Moreover, the host countries may also take
advantage of the networks through the sales and distribution networks of foreign investors.
As to the destination of FDI, with the available and potential advantages, Asia has been
still the leading region in attracting FDI with 3,740 projects tracked in 2012, which increases its
global market share to 31.72%. Many countries in Asia have achieved the dominant economic
growth through FDI into many specific industries, such as, business and financial services, ICT,
chemicals, plastics and rubber, etc. As to the source country or home country of FDI, Japan is
still the dominant one all over the world, especially in Asia. In spite of the decreased number of
outward FDI projects from Japan, the ratio of Japanese FDI in Asia still went up from 34.57% in
2011 to 37.37% in 2012 (Fingar, 2013). According to the survey conducted by Japan External
Trade Organization (JETRO) on 3,397 JETRO member firms and 6,403 enterprises using
JETRO services in 2013, 64.9% of firms intend to expand overseas operation by conducting new
investments going with existing operation bases whereas 91.7% set up locations in Asia Pacific.
It would be indicated that because of natural disasters and difficult domestic business
environment in Japan, for example, labor costs, tax burden, domestic regulations, etc, Japan
firms are concentrating on widening their overseas investments (JETRO, 2014). Moreover, as to
the conception of Japanese firms, the countries in Asia have been possessing advantages, which
would promote them to be promising destinations for JFDI. Those advantages can be listed as
current size of local market, inexpensive source of labor, social and political stability, etc.
Despite many motives for Japanese firms to invest in Asia, there are many issues in this
region, which raised concerns for Japanese enterprises. As indicated in the report of Japan Bank

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for International Cooperation (JBIC) in 2013, the rise in salary, difficult searching for the raw
materials, underdeveloped infrastructure, unclear legal system, etc have been the typical issues
existing in Asian countries and possibly preventing them from receiving more investment from
Japan. Combining the pros. and cons. in Asian region, we can examine the determinants
affecting JFDI inflows in Asia. In other words, the study of the important factors determining
JFDI in Asia is necessary for boosting JFDI into this region and should be based on the empirical
studies and the real situations as well. Since then, the relevant policies can be suggested for the
countries in Asia to become more attractive destinations to Japanese investors.
1.2

RESEARCH OBJECTIVES
Up to now, there are some studies about factors affecting FDI inflow in Asian countries.

It can be stated that the empirical papers presented the different and various factors to
demonstrate for the researches and got general findings. A few authors have conducted their
studies by basing on data of FDI inflow into specific sectors of specific countries to find out
what are called sector-specific determinants of FDI.
In this study, the research is concentrated on the total amount of FDI into a specific
location or host country and come to contribute to on-going researches by examining the
location-specific determinants of Japanese FDI in ten Asian countries. As to this general
objective, this study aims at the following specific objectives:
-

To provide the descriptive analysis of the changes in the period of before and after
1997 crisis and some recently remarkable characteristics of JFDI in ten selected Asian
countries.

-

To measure the impacts of location-specific determinants on JFDI in ten selected
Asian countries.

1.3

To suggest some policy implications for attracting JFDI

RESEARCH QUESTION
To conduct research objectives, this study aims to answer the following questions:
-

What are the characteristics of JFDI in the period of before and after 1997 crisis and
the changes in recent JFDI in ten selected Asian countries?

-

What are the significant factors affecting JFDI inflow in selected Asian countries? Is
there any difference between intercept coefficients of ten selected Asian countries?

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-

What are the relevant policies that can be suggested basing on the analysis to attract
JFDI inflow?

1.4

THESIS STRUCTURE
This thesis consists of five chapters. Right after Chapter 1 which aims to present the

introduction of JFDI inflows into Asian countries, Chapter 2 will synthesize the remarkable
theories about determinants of FDI. There are five typical theories presented in this chapter from
the one with the basic concept to the wider one. They are early studies of FDI, Neoclassical trade
theory, Hymer – Kindleberger Paradigm, Internalization theory and OLI paradigm - Eclectic
theory. Moreover, some typically empirical studies will also be reviewed in Chapter 2. By
considering the combination of theories and empirical studies, the analytical framework of this
thesis will be drawn at the end of Chapter 2.
Following Chapter 2, Chapter 3 concentrates on variables definitions and eight testing
hypothesis. Furthermore, going with the introduction of empirical model used in this thesis, the
source for data and the expected signs of eight variables will be summarized in one table. The
final part in Chapter 3 is the research methodology which describes the methods and typical tests
in panel data regression.
In Chapter 4, an overview of JFDI in Asian countries will be presented to describe the
changes in JFDI in the period of before and after the-1997-crisis. Moreover, the recent trends and
characteristics of JFDI in ten selected Asian countries will be also analyzed. The next in this
chapter is the findings obtained from the estimation results, which will provide the answers for
each hypothesis stated in Chapter 2. Since then, the question of significant factors determining
JFDI in selected Asian countries will be also discussed.
Basing on the findings in Chapter 4, some conclusion remarks and policies
recommendations for attracting JFDI into Asian countries will be presented in Chapter 5 which is
the last chapter in this thesis. Moreover, Chapter 5 will also point out some limitations of thesis
and suggest some further research for the study of JFDI.

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CHAPTER 2 LITERATURE REVIEW
This chapter includes three main parts. The first section provides some typical FDI theories
whose combinations will be the theoretical basis for this thesis. The next part contains the
summaries of some empirical studies. Finally, basing on the theories and empirical studies, the
conceptual framework for this thesis will be presented in the last section.
2.1

THEORETICAL LITERATURE
The rise in FDI has led to the extensive research and the development of many theories to

explain the determinants of FDI flow. To study FDI, it should be the combination of many
theories, not just basing on any single one (Faeth, 2009). Therefore, in this study, some theories
will be presented from the early to the latest one. At the end of this section, the Table 2.1 will
provide the summary of these theories.
2.1.1

Early concepts & studies of determinants of FDI

The early researches of determinants of FDI were mostly based on the questionnaires.
The companies in the survey or research were asked to realize and indicate the reasons or factors
which encouraged them investing abroad. Some major researchers contributing to the initially
general building of FDI’s determinants would be mentioned such as Robinson (1961), Behrman
(1963), Basi (1966), etc. (in (Faeth, 2009). In these early studies, a diversification of factors,
indicated as the encouraging ones in multinational enterprises’ investment decisions, included
cost factors, trade openness factors, marketing factors and investment climate. The degree of
significance of those factors were various in every study’s analysis result. In some researches,
marketing factors whose proxies were market size and market growth were the major
determinants of FDI. However, in other studies, the availability of low labor and natural resource
were considered as the important factors. On the other hand, according to the research of Basi
(1966), political stability was the most significant determinant. It would be said that through the

early studies with the researches in specific economies, the initial concepts of FDI’s determinants
have been taken into account.

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2.1.2

Neoclassical Trade Theory (Heckscher-Ohlin model & MacDougall-Kemp
model)
As to the Neoclassical Trade Theory, Heckscher – Ohlin (HO hereafter) model was

considered as the first theory attempting to explain the essence and factors of FDI. Two Swedish
economists, Eli Heckscher and Bertil Ohlin, put the foundation of FDI in HO model through
some basic assumptions: no trade barriers, no transportation cost, perfect competition & full
employment, no specialization, the same constant return to scale production function, the
existence of domestic factor mobility & international factor immobility and the identical
technology between countries. HO model was based on 2x2x2 model, standing for two countries
(home and host country), two factors (capital and labor) and two commodities. In HO model, the
only difference in relative factor endowment would lead to the comparative advantage and
international factor price differentials. The key concept in HO model is that the home country
would export to the host or foreign country the good, which uses the factor that the home country
is relatively abundant. MacDougall-Kemp (MK hereafter) model was one of the earliest theories
of FDI. The assumptions in this model were also the full employment, perfect competition and
constant return to scale. Like HO model, the capital would move from the home country to the
host country that has the higher capital rate of returns. However, as to MK model, the host
country can apply the tax on the capital flow and manage the capital return. It could be said that
the researches in MK model had took into account the barriers toward the trade or the capital
inflow.
2.1.3

Hymer – Kindleberger Paradigm
Besides the Neoclassical Trade Theory, after the World War II, the theory of portfolio
investment, which is one of the oldest theories of FDI, was used to explain for FDI flows. The
basis of this theory is interest rate. Under this concept, the investors will invest where brings
more profits. However, this theory was developed by the assumptions of no risks, uncertainties,
or barriers that cannot exist in the reality. Therefore, Stephen Hymer devoted his 1960
dissertation to develop another clearer theory of FDI. It is called Hymer – Kindleberger
paradigm. As to Hymer’s theory, besides the unrealistic assumptions, in the interest-rate theory
or portfolio investment theory, there is still a theoretical limitation which is called shortage of
explanation of control (Hymer, 1976). As to the portfolio investment theory, the investor would
invest his money in a foreign enterprise whose interest rate is higher than domestic one’s.

13


However, he cannot control the enterprise he invested in. Therefore, Hymer built two types of
direct investment to explain for the reasons why the investors would like to seek the control.
Since then, the theory of direct investment was formed.
In the direct investment of Type 1, Hymer indicated that the investor seeks the control
because they would like to make sure that the capital was used prudently. Because of the
different nationalities, the conflict would happen between the investors about the ratio of
reserves that should be kept in particular currency. Meanwhile, Hymer also emphasized the
difference between international transaction and intra-national one, which would lead to the
distrust and consideration among investors. Generally, although direct investment of Type 1 is
nearly similar to the portfolio investment theory, in which the core concept is interest rate, it
would supplement in portfolio investment theory the concept of the necessity of control in the
case that there is unbelief between investors and the high fear of expropriation and the exchange
rate risk. As a result, direct investment of Type 1 can replace the portfolio investment theory.
As to the direct investment of Type 2, the other reason for operating the foreign
enterprise is the possibility of removal of competition between the firms (Hymer, 1976). It is a

very normal phenomenon that in the same market, the competition between foreign enterprises
would happen. In the case of imperfect market, the combination by gathering the foreign firms
and giving the right of control for one firm would be one of the profitable collusion. In addition,
the ability of enterprise to build the international operation is rather different. It would depend on
the each firm’s specific advantage in particular industry. Furthermore, the firm would have two
choices: the first one is to rent or sell its skills or technologies; the other is setting up the
international operation and undertaking by itself.
2.1.4
Internalization theory
The internalization theory, which was developed by Buckley and Casson in 1976, was
considered as a general paradigm explaining for FDI. Due to the market imperfection, the
internalization would happen. Under this theory, the firm internalizes its globally foreign
businesses to benefit from the internal network and prevent its operation from the disadvantages
of resource allocation (Buckley & Casson, 2009).
In reality, most enterprises have to buy the inputs from independent suppliers, who would
be international ones. In this situation, one question was raised that whether the enterprises
should produce inputs by themselves or not. This kind of question belongs to what is called

14


“make or buy decision” in business management or “backward integration” in economics
studies. This issue also leads to one kind of direct investment, which is called “resource-seeking
investment”. It means that a global company would like to set up the international operations in a
foreign country; and via its subsidiaries in that country, it would use raw materials that could not
be found in any elsewhere to produce intermediate goods. In addition, along with “backward
integration”, “forward integration” issue was also arisen to mention to the question that whether
the enterprise should build its foreign subsidiaries to control the distribution of its goods in
foreign markets or not. By establishing these subsidiaries, instead of using independent
distributors, the enterprise itself can supervise the oversea distribution network.

Moreover, Buckley and Casson emphasized in their studies that the multinational
enterprises (MNEs) specializing in research and development industries would have higher
internalization than the others (Faeth, 2009). On the other hand, MNEs only invested in some
countries with specific characteristics going with MNEs’ investment plans. As to the study of
Buckley and Casson (2009) through literature of development economics, the importance of
encouraging-foreign direct investment factors would be analyzed and classified. It was stated in
the study of Buckley and Casson that as to the MNEs planning to broaden their consuming
market into any country, the factors of local market size and local standard of living were the
important ones. In addition, with the plan of widen markets not only in host country, but also in
host country’s neighboring ones, the infrastructure development was the outweighed factor. Or
with the engagement of constructing focusing-export plants in host country, the MNEs would
pay their attention to the factor of labor cost.
2.1.5
The OLI paradigm - Eclectic theory
By combining and developing from previous theories, Dunning raised the eclectic theory
that is also called OLI paradigm. The OLI paradigm is the combination of three factors: O-L-I
which in turn stands for Ownership advantages, Location advantages and Internalization
advantages.
When entering the abroad location for production, the multinational firms have to face
the additional costs, which are caused by the diversity of legal, cultural, language system, the
lack of knowledge of domestic market; etc, would reduce their benefits. As to the first factor of
OLI paradigm, FDI happens when the multinational enterprises have Ownership advantages or
firm specific advantages that can offset the additional costs. These advantages can be tangible

15


(superior technology, products, economies of scale and scope, etc) or intangible (brand name,
trademark, etc) (Hosseini, 2005).
As to the second factor in OLI paradigm, a particular country’s characteristics, which are

considered as the Location advantages or country specific advantages by foreign firms, would be
the drivers of FDI inflows. The multinational enterprises tend to combine its ownership
advantages and location advantages endowed in host countries to make their investment more
beneficial. Location advantages can be divided into three groups: economic advantages
(including qualitative and quantitative factors related to economics, for example, transport and
communication costs, market size, market growth, etc); political advantages (consisting all
government policies related to FDI inflows, international trade and production, etc) and social &
cultural advantages (including the attitude toward foreign enterprises, the diversity in culture,
etc).
The final factor in OLI paradigm is Internalization advantages that would be exploited
when the multinational enterprises realize the benefit of using Ownership advantages and
investing abroad instead of export or other contractual agreements, such as, licensing, joint
ventures, etc (Hosseini, 2005). This is the third leg of OLI paradigm in making clear the scale
and geography of foreign activities of multinational enterprises (Dunning, 2001) .
Table 2.1: The summaries of some typical theories of FDI
Theoretical approach
Early studies

Determinants/Concepts

Authors

Cost factors, trade openness factors,

Robinson (1961),

marketing factors and investment climate

Behrman (1963),
Basi (1966), etc.

Neoclassical Trade Theory:

Higher return on investment, lower labor

Heckscher & Ohlin

- Heckscher – Ohlin Model

cost

(1933)

Hymer – Kindleberger

Market imperfection, Ownership

Hymer (1976) &

Paradigm

advantages

Kindleberger (1969)

Internalization theory

Market failure

Buckley and Casson

- MacDougall – Kemp Model

(1976)
OLI paradigm - Eclectic

Ownership advantages, Location

Dunning (1977,

theory

advantages, Internalization advantages.

1979)

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2.2

EMPIRICAL STUDIES
Up to now, there are many studies researching about determinants of FDI. The study of

FDI spreads from the FDI inflows to FDI outflows, from locational determinants to sectorial
ones of FDI. Basing on three conceptions of capital imperfection, special ownership advantages
and institutional factors, Buckley et al. (2007) investigated the determinants of foreign direct
investment by Chinese multinational enterprises. The study was based on official data from 1984
– 2001. The authors collected data of forty-nine host countries receiving Chinese FDI, in which,
there are twenty-two countries belonging to Organization for Economic Cooperation and

Development (OECD). Two models were used in this study: pooled ordinary least squares
(POLS) and random effects (RE). Moreover, the authors conducted Lagrangian multiplier (LM)
test to conclude that RE is the better model. Basing on the general and specific theories of FDI,
Buckley et al used fourteen independent variables to be the determinants of Chinese FDI
outflows. These are market size, market size per capita, market growth, natural resource
endowment, host country’s endowment of ownership advantages, political risk, cultural
proximity, policy liberalization, exchange rate, inflation rate, geographic distance from China,
export & import and openness to FDI. Basing on the empirical theories, with the expectation of
nonlinear relationship, the authors transformed data into the natural logarithms. The results of
this study emphasized the important role of host market characteristics, cultural and political
factors on FDI inflows. In host market factors, market size was the only one having significantly
positive influence on Chinese FDI outflow. On the other hand, the exchange rate, geographic
distance and openness to FDI are all insignificant.
In the study of Kinoshita, Campos, and Pankki (2004), the host country’s characteristics,
which would be the drivers of FDI, were analyzed by using 1990 – 1998 panel data of 25
transition countries, which include Central and Eastern European and Baltic (CEEB) countries
and the Commonwealth of Independent States (CIS) consists of all former Soviet Union
countries. These two authors used fixed effects and random effects model to find out the
importance of host country’s factors in FDI inflows. However, the Hausman test rejected random
effects model. They divided the determinants into four groups. Group 1 – Classical Source of
Comparative Advantage – referred to the host country’s advantages considered as the motivation
for FDI inflows. The variables in Group 1 were market size, low labor cost, labor quality and
infrastructure. The second Group included Macroeconomic Policy and Reform variables in

17


which inflation rate was the typical one to emphasize the stability of host country’s economy. As
to the authors, the lower average inflation rate, the more profit can be brought by investment
projects. Next, the third Group emphasized the important role of host country institutions. To

make the investment decisions, the MNEs have to consider not only the economic cost, but also
the non-economic one. The authors used the “Rule of Law” variable whose data was collected
from International Country Risk Guide to measure the corruption of host country. In the last
Group, the variable of agglomeration was used to demonstrate the feedback effect of past FDI on
the current and future FDI. Through the estimation results, the authors found that market size,
labor cost and natural resource were the important FDI’s determinants. In addition, good
institution or lower political risk, higher trade openness were also the drivers of FDI inflow.
Nevertheless, the variable of education and infrastructure were likely to be insignificant.
The same results were also demonstrated in the study of Farrell, Gaston, and Sturm
(2004). These authors used panel data from 1984 to 1995 of 16 countries and applied pooled and
fixed effects model to indicate the important determinants of Japanese FDI. They found that
market size and labor cost of host country were extremely significant. Moreover, the
macroeconomic conditions also highly affected JFDI inflow. As to the variable of exchange rate,
basing on the statistically insignificant results, another finding of the author was that the strength
of Japanese Yen was not likely to be the main determinant of JFDI. According to the authors,
this finding was also similar to other studies.
Using the same type of data from 1979 to 1997 for Japanese FDI and data from 1982 to
1997 for the United States (US) FDI, the research of Nakamura and Oyama (1998) focused on
indicating the macroeconomic determinants of FDI from Japan and US to eight East Asian
countries. They were Taiwan, Korea, Indonesia, Philippines, China, Malaysia, Singapore and
Thailand. The reason that these two Japanese authors chose to investigate Japan and US as the
home countries is that FDI from Japan and US occupied about 50 percent of the total FDI flow
into the above-referred East Asian countries. According to these authors, although there were
many factors influencing on FDI, in their study, they just concentrated on macroeconomic ones,
especially the real exchange rate. Before conducting the regression analysis, eight host countries
were also classified into many different groups basing on their FDI elasticity to macroeconomic
variables. Remarkably, this classification was similar to the countries’ economic characteristics
and development process. The study applied fixed effects and random effects method for the

18

analysis. Like the others, Hausman test was also used to decide which method was better. As to
the regression result, Japanese FDI into eight countries was significantly influenced by the
change of exchange rate whereas US FDI was not. Moreover, as to both Japanese FDI and US
FDI, the coefficient of host country’ GDP was found to be significant in most host countries. On
the other hand, this study also indicated the link between FDI and trade. In other words, FDI
strongly affect the export from host countries to Japan and the import of host countries from
Japan.
Another typical study investigating the factors of Japanese FDI belonged to Urata and
Kawai (2000). By using data of 117 countries that were divided into three groups: developed,
developing and Asian countries, these two authors found out the importance of host country’s
factors in JFDI inflows. The independent variables include exchange rate, wage rate, market size,
macroeconomic stability, labor quality, infrastructure, agglomeration and governance.
Accompanied with the analysis of relationship between those factors and JFDI, the authors also
used SME dummy to indicate the difference between small, medium-sized enterprises (SMEs)
and the large ones in the way of making investment decisions. The results of this analysis
showed that low wage labor, good infrastructure, factors related to local market have the
significant meanings on JFDI inflows. When investing in developing countries, Japanese
multinational enterprises aim the export production that is the reason why they consider much
more about the production conditions. On the other hand, investing in developed countries,
Japanese firms would be interested in the local sales. As a result, market-related factors would be
always the decisive ones. Moreover, industrial agglomeration was found to be very significant in
attracting JFDI. Japanese investors always consider the inter-firm relationship between Japanese
enterprises. As to their conception, this relationship would bring them benefits in procurement
and sales. The other finding referred in the study is the SMEs are more sensitive to the change of
locational conditions than the large ones. Therefore, with the investment tendency from Japanese
SMEs, the countries, who want to attract JFDI inflows, need to build, maintain and enhance local
business environment.
Similarly, with the dataset from 1975 to 2007, Vijayakumar, Sridharan, and Rao (2010)

contributed one more study to the research of FDI’s determinants. In their study, a new term was
generated – BRICS standing for Brazil, Russia, India, China and South Africa. This term
represented for the world’s four continents whose economies were considered significant. The

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FDI inflow into those regions was extremely complex. In this study, the authors used three
methods for analysis: OLS pooled regression, fixed effects and random effects. The fixed effects
method was also rejected by Hausman test. The variables were classified into seven groups. They
were market size, labor cost, trade openness, currency value, infrastructure facilities, gross
capital formation and economic stability & growth prospect. The analysis results showed that
most variables had the important influence on FDI. Nevertheless, the economic stability &
growth prospect measured by inflation rate and trade openness measured by the ratio of total
export plus import to GDP were found to be insignificant determinants of FDI in BRICS
countries.
Basing on the OLI framework of Dunning, Wadhwa and Reddy (2011) conducted the
study about the impact of market-seeking, resource-seeking and efficiency-seeking factors of
host countries on FDI inflows into those countries. The study used panel data from 1991 to 2008
of ten developing countries, which are Bangladesh, China, India, Indonesia, Iran, Malaysia,
Pakistan, Thailand, Turkey and Vietnam. The author classified the determinants into three kinds
of factors. As to market-seeking factor, GDP and population growth were used as the proxies of
market size. In efficiency-seeking factor, the author used inflation rate and exchange rate to be
the variables in this category. Infrastructure indexes including internet users, mobile subscribers
and roads paved were used to demonstrate for the resource-seeking factor. In this study, the
author used fixed effect model with some necessary tests, for instance, Augmented Dickey-Fuller
test checking the stationary of data and multicollinearity test. The regression results showed that
all the factors have the significant impacts on FDI inflows into ten Asian countries referred
above.
Basing on the data sets from 1992 to 2009 of provinces of China, Xin-Zhong (2005) also

conducted panel model to investigate the location determinants affecting to FDI inflow into
provinces in China. The author classified these determinants into three categories. They were
investment environment improving, macro-economic and investment cost factors. The group of
investment environment improving factors included many determinants in which the typical ones
are openness level of economics, policy index and infrastructure level. The factors of macroeconomics included market size, growth rate of economy, economic developing level and human
capital. The final group related to investment cost included labor cost and the exchange rate. The
empirical results indicated that all variables were statistically significant. However, as to the

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wrong signs of the variables of economic developing level and human capital, this author
considered the existence of collinearity among variables. As a result, this author chose the
method of eliminating these two variables and recombining the independent variables to create
more models and remove the collinearity. The derived results showed the good performance of
these two variables and the highly statistic significance of other variables. Basing on the results,
some policy implications were also suggested to attract more FDI inflows. According to this
author, the policy should concentrate on promoting GDP, liberal trade and re-educational
projects. Moreover, besides applying the basic education, it is really important for the
government to pay attention to research and development (R&D) policy to achieve the
productive labor force.
Another research about FDI was conducted by Delaunay and Torrisi (2012). These
authors studied about determinants of FDI in Vietnam by using time-series data which was from
1991 to 2008 and collected from the reliable sources, for instance, IMF, UNCTAD, Vietnamese
GSO, etc. According to these authors, the models of FDI determinants concentrated on two
groups. They are economic and non-economic factors. In this study, the authors classified
political stability, institutional efficiency and corruption indicators into the group of noneconomic factors whereas market size, market growth, trade openness, etc belonged to economic
factors. On the other hand, because the research object was Vietnam whose figures or measures
of these factors were not available, this study just examined the impact of economic factors.
Moreover, the authors used ASIAN dummy variable to measure the impact of Vietnam’s

membership in Asian trading zone on FDI into Vietnam. The results derived were similar with
other studies. GDP, labor cost and exchange rate are predictably significant to FDI in Vietnam
whereas GDP growth rate was not significant. Furthermore, according to the results, the impact
of Vietnam’s membership in Asian trading zone on FDI into Vietnam was not clear. The authors
explained that although the intra-trade increased when Vietnam join Asian, this intra-trade has
been rather low. That is the reason why the re-export from Vietnam to ASIAN market is limited,
which would reduce the attractiveness for FDI inflows. It could be concluded fairly that ASIAN
has not succeeded in being a trade integration mechanism yet.
Different from previous studies, the joint research of Vuong and Yokoyama (2011)
brought the variety and interest in researching FDI’s determinants, especially JFDI’s. In the
study, they used Importance Performance Analysis (IPA) method to investigate the factors that

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stimulating JFDI inflow. Since then, the authors evaluated and compared the attractiveness of
Vietnam with China and Thailand in the process of being the dominant destination of Japanese
enterprises. The study was conducted by IPA method, which has been using not only in
economic planning for strategic management problem, but also in forming framework for
demonstrating changes. Conducting qualitative research methods as referred by Dunning and
Lundan (2008), these two authors carried out the survey and research based on the participation
of 1500 Japanese companies: 900 companies located in 15 districts in Japan and 600 companies
set the operation in Vietnam. Through the research, the attributes whose means were higher than
four (>4), were considered as the determining factors of JFDI in Asia. They were political
stability, availability of skilled labor, infrastructure conditions, labor cost, access to raw material,
etc. Furthermore, the authors also indicated the important difference in between two group
countries in the way that Japanese companies evaluated Vietnamese factors motivating JFDI. As
to the enterprises investing in Vietnam, they paid attention and appreciated the political stability
and the strength of Japanese Yen toward Vietnam Dong. As to the companies not having projects
in Vietnam, they were found to be optimistic about Vietnamese investment environment and the

quality of labor. On the other hand, in making investment decisions, they also considered the
easy access to raw material, infrastructure development and the corruption condition. According
to the findings in this study, Vietnam was considered to be more advantageous than China and
Thailand in production cost and labor characteristics. However, to attract more JFDI, Vietnam
should pay attention to the factors related to macroeconomic conditions and investment
environment.
2.3

CONCEPTUAL FRAMEWORK
Based on the literature review presented in the previous sections, the location-specific

determinants affecting to FDI inflow are classified and described in the following figure:

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Figure 2.1: Conceptual Framework
Location-specific (Host country)
determinants

Policy factors

Economic factors

- Economic, political and
social stability
- Rules regarding entry
and operations
- Trade openness

Type of FDI classified by motives of
Japanese enterprises
1. Market – seeking
2. Resource/Asset – seeking

Business facilitation
- Hassle cost (related to
administrative and
government effectiveness

Principle economic determinants in
host countries
- Market size
- Raw materials, natural resource
- Physical infrastructure (power,
energy, telecommunication)

3. Efficiency - seeking

- Lower labor cost
- Exchange rate
- Inflation rate

Following the World Investment Report (UNCTAD, 1998), the location-specific or host
country determinants of FDI are classified into three groups. They are policy factor, business
facilitation and economic factor. The policy factor refers to the index measuring the stability of
politics and economics, the rules related to the entry and operation of multinational enterprises
and the trade policy related to the trade openness, which is the necessary factor for the host
countries to receive FDI inflows from foreign countries. While the policy factor aims at creating
the framework for the operation of foreign investors, the factors belonging to business

facilitation are considered to facilitate their businesses in host countries. The measures in
business facilitation group are mostly new, in which the reduction of “hassle cost” is really

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important. Demonstrating the reduction of “hassle cost” includes measuring the improvement of
government effectiveness or the reduction of corruption. In this study, in term of policy factor
and business facilitation, we use the variables of trade openness, the average figure of Rule of
Law, Regulatory Quality and Government Effectiveness to be the proxies.
The third group of host country determinant is the economic factor. The economic factor
includes many determinants belonging to the host country’s economic indexes that can have
negative or positive effects on FDI inflow. As indicated in World Investment Report (UNCTAD,
1998), the potential destinations for FDI belong to the host countries which have the advantages
sought by the foreign countries. However, to consider and decide which country is suitable for
investment, the foreign firms from home countries also base on their strategies and motives.
According to the study of Dunning and Lundan (2008), there are three primary motives for the
multinational enterprises to decide investing abroad. They are market-seeking, resource/assetseeking and efficiency-seeking FDI. According to the above conceptual framework, the
economic determinants are divided and classified relatively into each type of FDI motive. As
indicated in the study of Dunning and Lundan (2008), the prerequisite reason for market-seeking
FDI is that a multinational enterprise finds it necessary to set the business operation in the
important markets in which its competitors are serving. When engaging market-seeking FDI, the
foreign firms consider their affiliates to be independent production units rather than a part of
network of cross-border activities. The output will be mostly consumed in host country, so the
market size of host country is top leading determinant that the Japanese firms always appreciate
(JBIC, 2013). Next, the resource-seeking FDI, as it name, would happen when the multinational
enterprises aim to acquire the source of physical infrastructure and raw materials (Buckley et al.,
2007). Furthermore, because Japan is the country with limited natural resource, natural resource
endowment is always considered to be significant determinant (Urata, 1993). The purpose of the
last motive, efficiency-seeking FDI, is the lower cost reduction and the more efficient business

operation. As a result, the lower labor cost is classified in this type of FDI motive. Moreover, in
this group, inflation rate and exchange rate are the determinants highly evaluated. While the
inflation rate implies the macroeconomic stability, the exchange rate is the factor that the foreign
investors would take advantage to reduce the cost of production (Wadhwa & Reddy, 2011).

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