Trends in Foreign Direct Investment

Abstract

From a theoretical point of view, firms generally have three possibilities to supply foreign markets with goods and services: exports, foreign direct investment (FDI) and licensing. According to the OLI paradigm introduced by Dunning (1977), a firm will engage in FDI if ownership, locational and internalisation advantages coincide. Particularly, FDI is the first choice of means to supply a foreign market with services, which are often considered as non-tradable goods. In this case, FDI can replace the exports that are not possible because of the necessary double coincidence, which means that transactions of services in most cases require the spatial and temporal proximity of buyers and sellers simultaneously. For principally tradable goods, there can be trade barriers or high transport costs (generally spoken: very high transaction costs that discourage exports) which prompt firms to substitute exports by FDI. On the other hand, a complementary relationship can also exist between FDI and exports.¹ Thus subsidiaries can be established abroad that provide direct contacts with the customers and additional services while the digitalized basic services, such as databases or software, can be provided by the firm headquarters. Furthermore, FDI can be a driving force of the fragmentation of production, which means the splitting-up of the value added chain allowing for a more in-depth specialisation. The reason therefore is that different stages of production correspond to different production functions so that a country may have a comparative advantage in one stage of production and a comparative disadvantage in other stages.