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AN INVESTMENT PERSPECTIVE ON GLOBAL VALUE CHAINS
BOX 2.1 Motivations for and modes of foreign direct investment Dunning’s framework In 1977, Dunning first established the OLI (ownership, location, internalization) paradigm of why (ownership advantages), where (location advantages), and how (internalization advantages) a firm decides to invest abroad. He identified four types of foreign direct investment (FDI) motives: resource seeking, efficiency seeking, strategic asset seeking, and market seeking. These types are cross-cutting with horizontal and vertical FDI. The potential limitation of this widely accepted taxonomy is that this theory was established before the rapid rise of global value chains (GVCs), and thus tended to pay little attention to the role of GVC network coordination on firms’ outward investment motivation. In addition to Dunning’s framework, FDI is commonly categorized as being horizontal or vertical. Horizontal FDI Horizontal FDI occurs when multinationals undertake the same production activities in multiple countries. Horizontal FDI with a market-seeking motive is one of the earliest and most established types of FDI. This type of FDI is often associated with trade, that is, investment substitution. The reasons behind horizontal FDI include, among others, proximity to consumers, adaptation to local needs, tax planning, and sometimes tariff jumping. Japanese firms have been very active in using this strategy in the auto industry and electronics in US and European Union markets (Belderbos and Sleuwaegen 1998; Head and Ries 2003). Greenfield FDI and mergers and acquisitions are both common modes of horizontal FDI. Vertical FDI Vertical FDI takes place when firms fragment production processes and locate each stage in the country where it can be performed at the least cost. The conventional interpretation for the motivation is factor cost differences, that is, efficiency-seeking FDI (Aizenman and Marion 2004). An increasing portion of the literature also suggests that vertical FDI also entails the strategic asset–seeking motivation to augment firm capacities. Strategic assets can include technology, production processes, management skills, networks, and more (Amann and Virmani 2015; Driffield and Love 2003). In addition, vertical FDI is used as an organizational format to minimize transaction costs. In a GVC network, market-based cross-border transactions may suffer from high transaction costs because of the absence of strong legal systems. Also, the increasing organizational complexity and growing length and layers of GVCs create additional transaction costs. Firms are therefore motivated to vertically integrate to avoid contract hazards and deficiencies (Antràs 2019; World Bank et al. 2017). Agglomeration FDI FDI might also be attracted by location-specific spillovers. Production-unbundling costs associated with cross-border management, coordination, and logistics might outweigh the benefits of reduced factor costs. In such case, a firm may choose to move along with its GVC partners to new locations against its own comparative advantage (Baldwin and Venables 2010). For firms hoping to join new value chains through outward investment, location-specific externalities, such as pooled markets of skilled labor, availability of specialized inputs and services, and benefits of technological spillovers, become attractive conditions. For example, Japanese firms tend to be in proximity to other Japanese firms in the United States to access trained Japanese workers in the cluster (Head, Ries, and Swenson 1995). Also, outward investors from Belgium, Germany, Italy, Japan, the Netherlands, Switzerland, the Continued on next page ›
