There are six sections in this chapter:
• The first section focuses on the nature of FDI, distinguishing it from international portfolio investment.
• In the second section the main implications of a home country bias in investment decisions are set out.
• The third concentrates on the definition and measurement of home country bias.
• Section four examines the arguments for home country bias and the relative immobility of capital.
• The fifth section reviews possible causes of a home country bias.
• The last section briefly explores a relationship between risk, notably country risk, and home country bias.
no investment is possible without a matching savings decision, made by someone somewhere, not necessarily in the same country. Foreign investment often involves savings and investment decisions made in different countries.
Ownership is a matter of who directly owns the productive assets created by the investment, often a large multinational corporation which can own directly, through subsidiaries or even joint enterprises.
The ownership chain might be long. A corporate legal entity holds the assets on behalf of the ultimate owners, the shareholders, who may be many, various and highly dispersed, even globally.
Operation involves the appropriate organisation and integration of the relevant resources in the process of creating something of value to a market. It is also the control part of ownership and control. Any pro- ductive assets can stand alone, being managed separately, be linked to a network of suppliers and purchasers in the host economy, or be part of a genuinely international value chain of linked producing units.
The second source of ambiguity is that each of the terms in the expression, foreign direct investment, lacks a precise meaning.
For which function does foreignness apply – saving, ownership, control, or all three? The term international production is often used carelessly. In theory, a subsidiary of a multinational corporation might raise capital on the market of the host country or borrow from a local bank; all the funding, and therefore the saving, is domestic, coming from the host country.1This might imply a dilution of foreign ownership of the relevant organisation. Such a flow of capital is usually excluded from an estimate of foreign direct investment and the use of the term foreign is taken as requiring the actual import of funds from abroad, except where the subsidiary of a foreign enterprise is using retained profits. If the corporation is taken to be the foreign investor – which is commonly the case, how is it possible to deter- mine the nationality of a multinational corporation which raises capital from a multitude of different sources and has to a varying degree severed its links with the home country? Is the nationality simply defined by the location of its headquarters? Next, what does direct mean? Usually, it is taken as indicating both a long-term com- mitment to the project and control of the relevant production facility.
Ownership and control do not necessarily go together. A corporation can hire all the necessary resources, thereby controlling but not owning, or it can rent out resources it owns, thereby owning but not controlling. Finally, in what does the investment consist? Is it the financial flow generated by the investment, as is often assumed, or is Home Country Bias in Foreign Direct Investment 43
it a ‘real’ movement of resources? If the latter, does the term comprise just production goods, or include associated entrepreneurial expertise and technical knowledge, a package of related resources transferred with the production goods?
Thirdly ambiguity arises because the analysis of foreign direct investment requires a multidisciplinary approach, involving:
• the financial theory relating to capital markets, a sophisticated body of theory, which includes a burgeoning literature on risk manage- ment and capital budgeting, and various attempts to apply the theory relating to financial options to real options,2
• the management theory relating to strategy, particularly that which has developed to explain competitive advantage through the resources possessed by an enterprise (Wernerfelt 1984), and also the mode of entry into international business transactions,
• the theory of the firm, including the recent literature on capitalist organisation in general, sometimes referred to as institutional econ- omics.3Related is the growing body of economic theory relating to informational economics,
• political theory which explains the causes, characteristics and consequences of political change.
• neoclassical economics relating to production and to trade (Krugman and Obstfeld 2003),
• game theory, applied to strategic problems.
There should be a clear distinction between foreign direct investment and portfolio investment. The two distinguishing criteria are control and a link to a specific increase in productive capacity, not just a change of ownership. The intent to control is the key defining feature of direct investment, but actual control can reflect different levels of ownership.
The US Department of Commerce defined foreign direct investment as:
‘the movement of long-term capital to finance business activities abroad, whereby investors control at least 10% of the enterprise’ (see Meyer, S. and Qu, T. 1995: 1). After careful consideration, the OECD concurred with this view. The World Investment Report adopts the same position, as have most relevant international organisations. An investment of anything less than 10% is deemed a portfolio investment.
While 10% might give control, if another organisation holds 51%, even 49% is not necessarily a controlling interest.
Any addition to productive capacity can be achieved by the move- ment of production goods but it does not have to. On the one hand,
an increase in productive capacity may reflect the reorganisation of an enterprise acquired (Lee and Caves 1998). It is possible for foreign debenture holding to support an extension of productive capacity through the transfer of consumption goods. The sale of debentures involves abstention from consumption in the home country, followed by the export of consumer goods to the host country and their con- sumption by workers constructing the enlarged productive capacity.
Portfolio investment can indirectly support an increase in productive capacity, provided an effective transfer of the relevant goods can be made. The economic circuit is indirect. The distinction between port- folio and direct investment is a difficult one to fully sustain and in the main literature is deliberately not sustained.
Following usual statistical practice, the present book recognises the simplifying assumptions made to avoid these ambiguities. FDI includes three main elements: the transfer of equity funds, any lending by headquarters to subsidiaries abroad and the investment of retained profits by those subsidiaries. The first is critical since FDI only occurs if there has been a transfer of ownership abroad of at least 10% of the capital of an enterprise.