Foreign direct investment (FDI) is a crucial source of financing for emerging markets and developing economies (EMDEs). When foreign firms invest in a particular economy, there are several spillover effects related to productivity levels, higher wages, and R&D opportunities. As such, policy makers are always on the lookout to identify factors that motivate multinational corporations to invest in EMDEs. As our world strives to achieve higher levels of global integration, there has been a concomitant rise in cross-border foreign direct investment (FDI) flows and global value chain linkages. GVCs tend to be increasingly associated with FDI flows with subsidiaries supplying inputs to their parent firms. Thus, higher flows of FDI have occurred in tandem with a greater degree of participation of countries in GVCs across the world (see chart below).
Can EMDEs with scarce endowments seeking greater FDI inflows stand to benefit from further GVC integration? While there is a growing academic interest in quantifying the potential development benefits of GVCs, there are hardly any studies attempting to systematically examine the relationship between FDI flows and GVCs, focusing on a large panel of EMDEs. This is where ACI’s recent research steps in to fill the gap.
The ACI paper titled “Do Global Value Chains Pull Greenfield FDI Inflows into Emerging Markets? Theory and Evidence” explores GVC linkages with regards to greenfield FDI. Through Greenfield FDI, the parent company establishes a subsidiary in a new country, building its operations from ground up. Our research states that if a country is already embedded in the international production network, foreign investors are more inclined to invest in those nations. This is because it is easier for investors to build their operations from ground up with regards to hiring suppliers, conducting transactions, and managing bureaucratic procedures. The theoretical model in the paper further elaborates on this.
The research contribution of this paper is two-fold. The first being the development of a theoretical model that shows how the transmission mechanism works from GVC linkages to the deciding criteria for a firm to invest in a particular country. The second is testing the theoretical model propositions using a large panel dataset on bilateral Greenfield FDI flows for 143 source countries and 109 host countries covering 2003 to 2019. The researchers find strong evidence that GVC participation is a significant determinant of FDI inflows to EMDEs. They also find that a country’s positioning in the global value chain matters with downstream specialization attracting significant FDI inflows.
By Ammu GEORGE and Sunena GUPTA