Elsevier

Emerging Markets Review

Volume 34, March 2018, Pages 175-191
Emerging Markets Review

Does quality of innovation, culture and governance drive FDI?: Evidence from emerging markets

https://doi.org/10.1016/j.ememar.2017.11.007Get rights and content

Highlights

  • We examine how technology, culture and governance drive inward FDI in emerging economies.

  • Better the governance of a country, greater the impact of technology, innovation, corporate governance and culture in attracting FDI.

  • More than country governance, the interaction between corporate governance and culture ensures greater flow of FDI. Societies with high level of power distance, strict social norms and individualistic approach attract more FDI.

  • Emerging economies need to focus on enhancing technological adoption and innovative capacity to drive more FDI.

Abstract

This study examines how technology, culture and corporate governance drive inward FDI in emerging economies. A study of 22 emerging economies shows that technology is the major attractive factor influencing inward FDI. Further, FDI increases as technology absorption and innovation capacity increase. The greater the quality of country governance, the greater the influence of corporate governance on FDI. Cultural dimensions such as individualism, masculinity and uncertainty avoidance exhibit a weaker influence on inward FDI, while power distance and indulgence have a stronger influence on inward FDI. Our results support the leapfrogging approach of emerging economies towards promoting innovation and enhancing technology adoption to drive FDI. Interaction effect of country governance further highlighted that the better the governance of a country the impact of technology, innovation, corporate governance and culture in attracting inward FDI also increases.

Introduction

According to the UNCTAD global investment trends monitor report 2016, global FDI has risen by 36% in 20151. Regardless of economic and financial crisis, emerging economies outperformed other economies mostly because of their sustainability even during the crisis period2. Prior studies focused on the relationship between country-specific economic growth and the inflow of FDI and find that GDP growth Awokuse and Yin, 2010, Daniele and Marani, 2011, Perez et al., 2012, Gomes Neto and Veiga, 2013, Kudina and Pitelis, 2014, Paniagua and Sapena, 2014, Dreher et al., 2015, inflation Bengoa and Sanchez-Robles, 2003, Li and Liu, 2005, Busse and Hefeker, 2007, Straub, 2008, Eduardo et al., 2014, and trade openness Addison, 2003, Ang, 2008, Asiedu and Lien, 2011, Blanc-Brude et al., 2014, Hsu and Tiao, 2015 impacts FDI inflow. However, macroeconomic factors fail to justify the increased flow of inward FDI to emerging economies and the primary focus of researchers has shifted to country governance factors Gani, 2007, Buchanan et al., 2012. While better economic environment and country governance may induce more FDI, the distinctive factors that attract FDI in emerging economies is largely dependent on institutional environment. In the context of emerging economies, it is the institutional environment that determines the level of technological growth and innovation more than country governance. This distinction is crucial in the context of inward FDI. Firm level corporate governance and country culture may also play a significant role in the success of FDI investment. Hence, a plausible conjecture is that factors such as the ability to adopt technology, capacity of innovation, quality of corporate governance and dynamic cultural factors may be associated with a country's competitiveness and increasing inflow of FDI in emerging economies.

With technological developments, the capacity to sustain the benefits of FDI becomes easy. As a result, technology may be the important driving force of inward FDI in emerging economies since they benefit from technology transfers through FDI inflow (Borensztein et al., 1998). A favourable investment environment for technology transfers positively influences FDI (Hsu and Tiao, 2015). This argument supports the leapfrogging technological growth pattern in emerging economies. In pursuance of advancement, emerging economies recognize the need to reduce the technology gap and stimulate innovative capacity. The ability to adopt technology and innovative capacity increases the capability to survive new challenges in the business environment. Moreover, the political connections of multinational enterprises that make investments influence the quality of investment in innovation (Cumming and Zhang, 2016) and increase the accessibility of foreign markets (Sojli and Tham, 2017). The extent to which the strength of the institutional environment enhances technology and innovation in emerging economies may be a key feature in attracting FDI. Therefore, the opportunities for growth from inward FDI in emerging economies may not be just a function of good country governance, but also depend on the level of technology adoption and the capacity for innovation.

Emerging economies with identical economic and country governance structures fail to attract a similar level of inward FDI due to inefficient business environment. Emerging economies, which had hitherto been incompetent in governing countries, began to overcome their inefficiencies through improved firm-specific advantages. Along similar lines, a better corporate governance structure improves operating performance, which then increases financial performance and thereby partially compensates the weak support from the governments of emerging economies. The firm-level operating performance improves the efficiency of the business environment, and corporate governance practices in emerging economies strongly influence the operating environment (Klapper and Love, 2004). Thus, better corporate governance in the presence of higher institutional quality may lead to a greater flow of inward FDI in emerging economies.

Over the years, emerging economies have also witnessed a change in cultural preferences due to globalization. Firms under any situation do not work in isolation, and their performance is dependent on cultural adaptability. In this context, the challenge in investing in an economy with a high level of cultural difference magnifies uncertainty and risk. The cultural difference between the host and the home country significantly affects inward FDI (Liu et al., 1997). The existence of high level of uncertainty and the risk level of culturally sensitive economies deter FDI flow, but economies with a specific cultural characteristic, such as uncertainty avoidance, prefer FDI investment (Bhardwaj et al., 2007). Collectivism and the futuristic dimension of culture promote regulatory, political and economic institutional factors (Holmes et al., 2013). Therefore, emerging economies need to recognize the moderating effect of culture and adapt the values and belief system that best influence firm performance. Thus, the degree of inward FDI flow into emerging economies may also depend on the link between country governance with culture.

Hence, this study starts from the premise that the influence of trade-linked technology, innovation, corporate governance and cultural factors are likely to be associated with inward FDI in emerging economies. We propose that the quality of country governance in an emerging economy would improve the investment environment and provide an additional effect in combination with the extent of technology, capacity for innovation, quality of corporate governance and adaptability of culture. We examine the interaction effect of country governance with technology, innovation, corporate governance and cultural factors to enhance FDI in emerging economies.

The empirical results indicate that technology is the major attractive factor influencing inward FDI. Further, FDI increases as technology absorption and innovation capacity increase. Simultaneously, good corporate governance practices and cultural dimensions such as power distance and individualism also drive inward FDI. The interaction analysis also further highlights that the better the governance of a country, the greater the impact of technology, innovation, corporate governance and culture in attracting inward FDI.

Section snippets

Literature review and hypotheses development

Over the past decade, researchers and practitioners have examined the need for attracting FDI. Borensztein et al. (1998) estimate a relatively greater effect on economic growth from FDI than domestic investment. Prior studies that examine the link between macroeconomic factors and inward FDI find that it signals stability and sustainability in an economy Addison, 2003, Bevan and Estrin, 2004, Alfaro et al., 2004, Li and Liu, 2005, Awokuse and Yin, 2010, Daniele and Marani, 2011, Perez et al.,

Data

Our panel data includes 22 economies that are advanced and secondary emerging economies. Based on FTSE 2015 country classification as of September 2015, the emerging economies considered are as follows: Brazil, Chile, China, China Macao SAR, China Taiwan, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, the Russian Federation, South Africa, Thailand, Turkey, and the United Arab Emirates. The sample comprises data from the World

Descriptive statistics

Table 1 shows the summary statistics of all the variables used in the study. The correlation matrix in Table 1 shows that the six governance variables exhibit high correlation among themselves, and hence, a country governance index is developed. In the case of culture variables, the mean score for power distance (0.7095) shows that the emerging economies we considered in the study exhibit a high degree of power distance and inequality in each society. The sample also shows a high score for

Conclusion

This paper addresses the magnitude and direction of the determinants of inward FDI in emerging economies by exploring a panel data from 22 emerging economies. The results provide new insights on the distinctive features of emerging economies that attract FDI. Macroeconomic factors are the primary drivers of inward FDI, however this study identifies that the significance of these determinants lessens and provides enough evidence for exploring other drivers exclusively for emerging economies. The

Acknowledgements

We gratefully acknowledge the anonymous reviewers and participants of the Journal of International Financial Markets, Institutions and Money (JIFMIM) Special Issue Symposium held in Shanxi, China and the JIFMIM Special Issue Conference held in Pu’er, China for their valuable feedback to improve and refine this paper. We also thank the participants of the 11th Annual Conference of Knowledge Forum, whose comments and reviews substantially improved the paper.

References (47)

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This paper was presented at the 2016 Cross Country Perspectives of Finance conferences held in Taiyuan and Pu’er, China.

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