FDI location choice of Chinese multinationals in East and Southeast Asia: Traditional economic factors and institutional perspective

Journal of World Business 47 (2012) 45–53

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FDI location choice of Chinese multinationals in East and Southeast Asia: Traditional economic factors and institutional perspective Yuanfei Kang a,*, Fuming Jiang b,1 a b

School of Management, Massey University, Auckland, New Zealand Centre for Asian Business, International Graduate School of Business, University of South Australia, Adelaide, Australia

A R T I C L E I N F O

A B S T R A C T

Keywords: Outward foreign direct investment Location choice Institutional perspective Economic factors Chinese multinationals

This paper investigates the factors determining foreign direct investment (FDI) location choices of Chinese multinational firms. We developed a conceptual framework that synthesizes traditional economic factors and institutional perspective. Then several hypotheses were developed in line with the framework and empirically tested using panel data of Chinese outward FDI to eight economies in East and Southeast Asia across a time period of thirteen years. Our findings suggest that institutional factors demonstrate a higher level of significance, complexity and diversity in determining FDI location choice in comparison with economic factors, while both types of factors influence the FDI location choice of Chinese multinational firms. We also found that the FDI location choices of Chinese firms have a dynamic nature, as statistical evidence indicates a heterogeneous response of Chinese FDI towards different economic groups and during different time periods. ß 2010 Elsevier Inc. All rights reserved.

1. Introduction The dramatic growth in recent years and anticipated future prospects of China’s outward foreign direct investment (FDI) has attracted considerable attention from international business scholars. A number of studies have examined a series of issues regarding China’s outward FDI, including the trend and driving forces of China’s outward FDI (e.g. Morck, Yeung, & Zhao, 2008; Rui & Yip, 2008), the determinants and motivations of Chinese firms’ involvement in overseas investment activities (e.g. Buckley et al., 2007), and FDI entry mode decisions of Chinese multinational enterprises (MNEs) (e.g. Cui & Jiang, 2009). However, another important issue, namely, the FDI location choice of Chinese firms, has not received a great deal of research attention. To our knowledge, this issue has not been empirically examined in the literature. The current research is designed to address this theoretical gap. Existing literature has suggested that FDI made by MNEs from emerging economies presents characteristics different with that made by multinationals from developed countries, so that extensions of FDI theories are needed in order to understand and explain internationalization of firms from emerging economies (Buckley et al., 2007; Child & Rodriguez, 2005; Mathews, 2006). More

* Corresponding author. Tel.: +64 9 4140800x9577; fax: +64 9 4418106. E-mail addresses: [email protected] (Y. Kang), [email protected] (F. Jiang). 1 Tel: +61 8 8302 5796; fax: +61 8 8302 0709. 1090-9516/$ – see front matter ß 2010 Elsevier Inc. All rights reserved. doi:10.1016/j.jwb.2010.10.019

particularly, it has been argued that in comparison to other theoretical perspectives, such as transaction cost theory, resourcebased theory, and agency theory, the institutional approach is the most useful theory when studying business strategy in emerging economies (Wight, Fliatotchev, Hoskisson, & Peng, 2005). However, while acknowledging the importance of institutions is important, it is more important to understand how institutions affect FDI behaviour. Logically, researchers call for more research on how institutional factors matter when determining FDI strategy of MNEs from emerging economies (Peng, Wang, & Jiang, 2008). In responding to this call, we endeavour to address this ‘‘how’’ issue by focusing on the impact of institutional forces, together with traditional economic factors, on FDI location choice of Chinese MNEs. This study aims to make contributions to the literature in three ways. First, it develops an integrated theoretical framework that incorporates an institutional perspective (Scott, 2001) along with traditional economic factors (Buckley, Cross, Tan, Liu, & Voss, 2008; Dunning, 1993) to provide a more comprehensive framework for empirical investigation on the location choice issue. Second, with empirical evidence, this study provides explicit insights explaining the factors influencing FDI location choice of Chinese firms and revealing the divergent and dynamic impacts of various institutional factors on FDI location choice. Third, it enriches the extant research by distinguishing between two subgroups (i.e., the Asian developed and developing economy subgroups) and two time periods (i.e., 1995–2000 and 2001–2007), exposing the different patterns of FDI location choice of Chinese firms for different economy groups and over different time periods.

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Y. Kang, F. Jiang / Journal of World Business 47 (2012) 45–53

The rationale for a focus on the East and Southeast Asian region is based on three aspects. First, theory suggests that internationalization of firms is an incremental process achieved mainly through regional expansion rather than global expansion (Johanson & Vahlne, 1977), and most existing MNEs are regional rather than global players (Qian, Li, Li, & Qian, 2008; Rugman, 2005). It is even argued that a lack of firm-specific advantages for Chinese firms will lead to a trend that Chinese FDI flows mainly intra-regionally rather than globally in the foreseeable future (Rugman & Li, 2007). Second, geographically, FDI from China has mainly flowed into this region. A calculation based on Chinese official data source of outward FDI (MOFCOM, 2008) demonstrates that by the end of 2007, 67% of Chinese FDI stock was located in the Asian region, of which 93% went to eight Asian economies, including Hong Kong, Korea, Japan, Indonesia, Malaysia, Philippines, Singapore and Thailand. Therefore, this region as FDI location for Chinese firms deserves a special research attention. Third, this study aims to investigate different patterns of FDI location choice at a subregional level. Most prior studies have debated on the issue at global and/or regional levels (e.g. Rugman, 2005), but little attention is given to a sub-regional level perspective. The heterogeneity among Asia economies with respect to their political and legal systems, socio-cultural differences, development stages, and degree of economic dynamics, are expected to affect the location choice of Chinese FDI. The empirical findings reported in this paper have given weight to this argument. Such investigation benefits from a relatively small sample size and from splitting the full sample into different subgroups. The rationale for such an intra-group split comes from the literature that acknowledges the influential role of distinctive institutional regimes and economic development levels in different countries on business strategy (Meyer, Estrin, Bhaumik, & Peng, 2009; Peng et al., 2008). 2. Theoretical background The eclectic paradigm developed by Dunning (1977, 1993) provides a holistic approach to explain FDI activities. It elaborates that firms’ FDI behaviour is determined by ownership, location and internalization advantages. Location advantages can be investigated through host country specific variables, while both ownership and internalization advantages are examined by firm specific factors. Arising from the business environment associated with a particular geographical location, these location specific advantages define the degree of attractiveness of a host economy to the investing MNEs. Focusing on the rationale of economic efficiency, the eclectic paradigm suggests that foreign firms are motivated to exploit location specific advantages provided by the host country through internalizing their firm specific advantages. Firms with different motivations choose locations with different sets of location advantages. The mainstream theory on location issue identified four primary motivations for FDI, namely marketseeking, nature resource-seeking, efficiency-seeking and strategic asset-seeking (Dunning, 1977, 1993). Recent studies have demonstrated that these motivations are also relevant to the FDI location choice of Chinese MNEs (Buckley et al., 2007, 2008). Economic efficiency however can provide only a partial explanation for FDI location choice of MNEs, as investing firms also require institutional legitimacy in order to survive and succeed in a challenging foreign environment (Kostova & Zaheer, 1999). The crucial difference between the eclectic paradigm and the institutional approach in addressing the issue of FDI location choice lies in the primary criterion for selecting a location. The eclectic paradigm focuses on economic efficiency as the ultimate determinant of location choice. From this perspective, the intersection of MNE investment strategy and the institutional environment is an analysis of the ability of institutions to reduce

the transaction costs associated with FDI that result from an uncertain environment (Hoskisson, Eden, Lau, & Wright, 2000). On the other hand, the institutional approach regards institutional legitimacy as the primary criterion. The central premise of institutional theory is that organizations are embedded in, and must adapt to their institutional environment to attain legitimacy (Zukin & DiMaggio, 1990). MNEs are therefore motivated to enhance their legitimacy by becoming isomorphic with their environment, even in the absence of evidence that such actions increase efficiency (Yiu & Makino, 2002). It is even argued that the need to integrate institutional factors into FDI theory can hardly be over-emphasized (Sethi, Guisinger, Ford, & Phelan, 2002). Noticing a lack of institutional content in the eclectic paradigm, Dunning (2006) pointed out that it is important to incorporate institutional factors in an extension of the model. More recently, it is further suggested that institutions affect all three components of the paradigm (Dunning & Lundan, 2008). Incorporating an institutionbased view into FDI theory is even more important for the case of emerging countries. Traditional FDI theory was established on the experience of MNEs from western countries, where fully developed market-based institutions provide background conditions for business activities, although these institutions are almost invisible. On the contrary, the absence of formal market-based institutions is conspicuous in emerging countries (Peng et al., 2008) and thus firms are constrained by institutional context, characterized by highly visible state interference. In the case of China, the significant influence of government has been identified as a striking feature of FDI by Chinese MNEs. The biggest sources of outward FDI are from state-controlled companies and the largest FDI players highly overlap with the most profitable state-owned-enterprises (Morck et al., 2008). The government stance on outward FDI regulations has also continuously been evolving during the past three decades from tight control to actively sponsoring and even to direct funding (Buckley et al., 2007; Zhang, 2003). In more recent years, the domestic institutions provided strong support to Chinese MNEs, facilitating their desire to accelerate the internationalization process and to catch up with MNEs from developed countries (Voss, Buckley, & Cross, 2009). As a result of these observations, it may be fair to argue that a failure to consider the influence of China’s unique institutions will undermine the robustness of any meaningful attempt in seeking to understand the FDI behaviour of Chinese MNEs. More specifically for the FDI location issue, recent studies have also suggested that the decisions made by Chinese MNEs about their FDI location choice are likely to be shaped by institutional forces in their home country (China) (Buckley et al., 2008) and their host countries (Globerman & Shapiro, 2002). Based on this theoretical background, we developed a conceptual framework for this study by incorporating the institutional perspective along with the traditional economic factors that are derived from the eclectic paradigm. Regulative, normative and cognitive systems are identified as three pillars of the institutional environment. Each of them provides a basis for legitimacy. The regulative pillar involves the capacity to establish rules, to ensure conformity with the rules, and to manipulate sanctions for influencing future behaviour. The normative system imposes constraints on social behaviour through prescriptive and obligatory values and norms. The cognitive pillar refers to the established structures in society that are taken for granted (Scott, 2001). Realizing that most existing studies from an institutional perspective examined only the regulative dimension of institutions, leaving the other two institutional dimensions untouched (Trevino, Thomas, & Cullen, 2008), our study included all three institutional pillars with the aim to capture the influence of institutional forces on the FDI location choice of Chinese firms.

Y. Kang, F. Jiang / Journal of World Business 47 (2012) 45–53

3. Hypothesis development 3.1. Market-seeking Factors related to the host country market are the most widely tested variables influencing FDI location decisions. Empirical research has revealed a strong positive relationship between the market size of the host country and FDI inflows (Bevan & Estrin, 2004). A large market size offers increased opportunities for investors to reach cost effectiveness and to realize economies of scale through local production (Braunerhjelm & Svenson, 1996; Venables, 1999). Thus, the larger the market size, the more attractive the host country is. Moreover, a fast growing economy provides more profit-making opportunities than those economies that are growing slowly or stagnant. Rapid economic growth in the host economy leads to a high level of aggregate demand for product and stimulates greater demand for FDI inflows. Thus, the higher the economic growth rates, the more FDI that is attracted to the host country. In the case of China’s outward FDI, recent studies suggest that market seeking is one of the major driving forces for Chinese firms (Buckley et al., 2007, 2008; Deng, 2004). Increased competitive pressure in the home market and Chinese firms’ ambitions to develop new markets and brand awareness abroad have been responsible for a large proportion of Chinese marketseeking outward FDI. When a Chinese firm is motivated to pursue and penetrate new markets through FDI, it will take an interest in the market size and economic growth of the host market. Chinese market-seeking FDI is also related to the market openness of a host economy. International business theory suggests that when the economic orientation in a host country fits more easily into the patterns of global production and trade, the country is more attractive to foreign investors (Vernon, 1966). It has been pointed out that the rise of tariff and non-tariff trade barriers, such as export quotas and other ‘anti-dumping’ measures against Chinese exporters, has prompted some Chinese firms to establish offshore manufacturing plants in order to ensure access to foreign markets (Taylor, 2002; UNCTAD, 2003). In most cases, this type of FDI has been used as a springboard to serve developed markets such as the US and EU countries. Thus, the exporting capability of a host economy becomes an important factor in attracting Chinese FDI. Market openness reflects the competitiveness and export orientation of an economy and is used as a variable to accommodate the market-seeking motive of Chinese investing firms. Hypothesis 1a. The choice of a Chinese firm’s FDI location is positively associated with the market size of the host economy.

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has been regarded as one of the key strategic considerations for Chinese outward FDI. This motivation has been highlighted by a number of high-profile resource-based Chinese acquisitions in the world (Deng, 2004). Therefore, locations that have rich natural resources are likely to be more attractive for Chinese FDI. Hypothesis 2. The choice of a Chinese firm’s FDI location is positively associated with the richness of natural resource endowment of the host economy. 3.3. Efficiency-seeking The Chinese domestic markets provide ample supplies of relatively low-cost labour, land and other factor inputs. Chinese firms axiomatically enjoy a comparative advantage in low-cost labour and labour-intensive production domestically. It is unlikely that greater efficiency is currently a major driver for Chinese firms investing overseas (Buckley et al., 2008). While the efficiencyseeking aspect has been applied mainly to explain why firms invest in overseas markets, dealing with the choice between home and overseas markets (Vernon, 1966), the focal point of this study deals with the FDI location choice among overseas markets. Locations that have a lower cost of labour can attract more FDI flows (Sethi, Guisinger, Phelan, & Berg, 2003). Therefore, variations in factor endowments in those overseas markets are expected to have an impact on the flow of Chinese FDI into those locations. Hypothesis 3. The choice of a Chinese firm’s FDI location is negatively associated with the labour cost in the host economy. 3.4. Strategic asset-seeking Recent studies have revealed that one of the major forces that drove Chinese firms to conduct FDI is to compensate for their competitive disadvantages in terms of proprietary technology, management know-how, product brands, and distribution networks, while competing with multinationals from developed countries (Buckley et al., 2008; Luo & Tung, 2007). The underlying rationale for such asset-seeking FDI is the strategic need to compete at a global level (Deng, 2007). By resorting to FDI, Chinese firms can acquire strategic assets from mature multinationals to compensate for their competitive weaknesses. Therefore, locations that have more strategic assets are likely to be attractive for FDI flows from Chinese firms.

Hypothesis 1b. The choice of a Chinese firm’s FDI location is positively associated with the market growth of the host economy.

Hypothesis 4. The choice of a Chinese firm’s FDI location is positively associated with the availability of strategic assets in the host economy.

Hypothesis 1c. The choice of a Chinese firm’s FDI is positively associated with the market openness of the host economy.

3.5. Regulative institutions

3.2. Natural resource-seeking Acquiring and securing a continual supply of natural resources is one of the major motives for FDI activity (Dunning, 1993). It is the central argument for backward vertical FDI. The objective for resource-seeking FDI is to provide inputs to downstream operations of the investing firms. Internalization theory emphasizes the importance of equity-based control in the exploitation of scarce natural resources (Buckley & Casson, 1976). It is common for MNEs both from developed and developing countries that FDI is induced by the need to gain access to foreign natural resources. As per capita availability of natural resources is low in China, particularly in the areas of minerals, petroleum, timber and fisheries, resource-seeking

The regulative dimension of the institutional environment establishes the rules of the game that structure interactions as well as ensure stability and order in societies (North, 1990). Organizational action is bounded by these rules. When deciding whether or not to enter a particular foreign market, the most appealing concern for an investing firm is its ability to gain market legitimacy. Through emphasizing conformity to rules, regulative institutions provide such required legitimacy to organizations. Legitimate organizations are those established by, and operating in accordance with, relevant legal and quasi-legal requirements (Scott, 2001). From the regulative institutional perspective, a decision on location choice for MNEs is to determine favourable locations where regulative institutional constraints are less repressive to FDI activity so that MNEs can more readily conform

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to the regulative constituents of the host countries. Prior empirical studies have confirmed that regulative institutions in host countries have a strong influence on FDI inflows and that institutions ‘‘friendly’’ towards FDI, such as stable economic policy, security of property rights, less ownership restriction, and non-corrupt bureaucracy, are conducive to attracting FDI from MNEs (Bevan, Estrin, & Meyer, 2004; Grosse & Trevino, 2005; Pajunen, 2008). Regulative institutions are measured in three dimensions in this study as: economic regime, political and legal regime, and institutional regime directly regulating FDI activities. From the perspective of institutional embeddedness, the institutional environment in the home country is also a major shaping force for firms’ FDI behaviour. It has been well suggested that the institutional environment facing Chinese firms in their home country is significantly different from their Western counterparts (Meyer et al., 2009; Peng et al., 2008). A distinctive and highly dynamic home country institutional environment also contributes to the uniqueness of Chinese outward FDI. In spite of the three-decade market-oriented economic reform, the Chinese economy is still heavily regulated (Heritage Foundation, 2008; Scott, 2002). A higher level of difference in regulative regimes between China and a host economy implies that the regulative institutional environment in a host economy is less repressive but friendly towards FDI activity. Therefore, it can be suggested that Chinese firms are more likely to locate their FDI in economies where the differences in economic regulative regime and institutional regime directly regulating FDI activities are bigger between the home and host countries. However, there may be a different picture for FDI location choice while considering political regulative regime. It is suggested that Chinese MNEs tended to disregard political risks in the host countries in their attempt to catch up with MNEs from developed countries (Ge & Ding, 2009). Furthermore, probably because Chinese MNEs were able to gain a strong support from domestic institutions (Voss et al., 2009), they demonstrated a perverse tendency towards risk management in comparison with their counterparts from developed countries, in order to exploit opportunities in countries where MNEs from developed countries might regard as too risky (Buckley et al., 2007, 2008). Home country embeddedness in terms of political institutions may act as a type of ownership advantage possessed by Chinese MNEs in their overseas investment. Hypothesis 5a. The choice of a Chinese firm’s FDI location is positively associated with the degree of differences in economic regimes between China and the host economy. Hypothesis 5b. The choice of a Chinese firm’s FDI location is negatively associated with the degree of differences in political and legal regimes between China and the host economy. Hypothesis 5c. The choice of a Chinese firm’s FDI location is positively associated with the degree of difference in FDI restriction between China and the host economy.

3.6. Normative institutions The normative dimension of institutions emphasizes the stabilising influence of social values and norms, which imposes constraints on interpersonal and inter-organizational behaviour. While operating in foreign countries, MNEs need to establish social legitimacy, as in comparison to their local counterparts, they are more vulnerable to attacks from local interest groups, and face more stereotypes and different standards (Kostova & Zaheer, 1999). Establishment of social legitimacy could also be more difficult than the case for regulative legitimacy, as normative controls stress a deeper moral base and are more likely to be

internalized than regulative controls (Scott, 2001). Cultural distance is identified as a major barrier for MNEs gaining normative legitimacy in host countries (Yiu & Makino, 2002), and has been found to be a strong influence on FDI location choice (Bhardwaj, Diets, & Beamish, 2007). The bigger the cultural distance between the host and home countries, the more difficult it is for MNEs to gain normative legitimacy in the host country. MNEs would prefer to invest in the countries where cultural proximity exists with the home country. Thus, Chinese firms are more likely to locate their FDI in economies where cultural differences between China and the host economy are smaller. Hypothesis 6. The choice of a Chinese firm’s FDI location is negatively associated with the cultural distance between China and the host economy. 3.7. Cognitive institutions The cognitive dimension of institutions recognizes that internal interpretive processes are shaped by external stimuli, as mediating between the external world of stimuli and the response of the individual organism is a collection of internalized symbolic representations of the world (D’Andrade, 1984). Based on cognitive institutional theory, compliance occurs in many circumstances because other types of behaviour are inconceivable and routines are followed because they are taken for granted (Scott, 2001). If a particular type of practice is repeated by many organizations in high frequency, it will be routinized as a behavioural stereotype and accepted as a cognitive structure. This behaviour pattern is named mimetic isomorphism (DiMaggio & Powell, 1983). Although a mimetic behavioural pattern does not provide a guarantee of reaching the expected high efficiency, it does help organizations to gain cognitive legitimacy. In the case of FDI location choice, empirical evidence demonstrates a bandwagon effect that is resulted from a follow-the-leader approach of decision-making (Sethi et al., 2002). Frequency in business dealings between host and home country firms is reflected by the intensity of economic relations between the two countries, which can be proxyed by the bilateral trade value of the two countries. A large trade volume represents a high frequency of business transactions conducted by firms of the home economy in a host economy. This repetitive pattern of business dealings in trade relations can become habitualized and objectified. By imitating this location pattern in trade relations, investing firms may expand the business transaction pattern to another similar area—FDI, especially for those motivated by market-seeking where the motivation of FDI is to facilitate trade (Buckley et al., 2008). A high frequency of business dealings resulting from trade relations can also influence FDI location choice through a cognitive mechanism named external legitimacy spillover (Kostova & Zaheer, 1999). If firms in the home country have had intensive trade relations with firms in a host country, a good reputation for trading firms may spillover to investing firms, thus facilitating attainment of legitimacy. Hypothesis 7. The choice of a Chinese firm’s FDI location is positively associated with the intensity of business transaction between firms of the host and home economies. 4. Data and methods 4.1. Variable measurement 4.1.1. FDI stock FDI stock from Chinese firms in each of the eight host Asian economies, rather than FDI flows to these economies, is used as the

Y. Kang, F. Jiang / Journal of World Business 47 (2012) 45–53

dependent variable, as the stock variable is a more accurate measure of FDI location distribution (Filippaios, Papanastassiou, & Pearce, 2003). Data for the dependent variable were obtained from official Chinese sources (MOFCOM), Almanac of China’s Foreign Economic Relations and Trade (Volumes, 1996–2008), renamed as China Commercial Yearbook since 2004. GDP per capita (GDPP) captures the market size of a host economy. GDP growth (GDPG) captures the market potential of a host economy and is measured by the annual growth rate of the economy. Market openness (OPEN) is used as a proxy accommodating export-substituting FDI and is measured as a ratio of an economy’s exports over its total foreign trade. Resource (RESO) captures the resource-seeking motive of the investing firms and is measured as ratio of ore and metal exports to merchandise exports in the host economy. Data for these four variables were taken from ‘‘World Development Indicators (WDI) 2008’’ published by the World Bank. Unit labour cost (ULC) captures investing firms’ efficiency-seeking motive and is measured by the average wage in the manufacturing industry of the host economy. Data for ULC were collected from Labour Statistics, published by International Labour Organisation (2008). Patent (PATENT) applications in the host economy are used as a proxy of development level for technology and management know-how to accommodate strategic asset-seeking motivation of the investing firms, and data were taken from Statistics on Patents, a database published by WIPO (2008). Economic freedom (EFREE) represents the economic regulative regime in the institutional environment. Five component items in the domain of economic regulative institutions were used to conceptualize this variable, including (1) business freedom, (2) monetary freedom, (3) financial freedom, (4) property rights and (5) freedom from corruption. These five items were derived from the Economic Freedom Index 1996–2008, developed by the Heritage Foundation, which provides time series data for most of the countries in the world. An internal reliability test generated the Cronbach’s alpha of 0.893 for these five measurement items and a correlation test found that scores for these five items were highly correlated for the eight economies under study. Thus, these five items were merged into a composite variable of economic freedom. As suggested in Hypothesis 5a, relative differences of regulatory institutions between China and the host economy, rather than the regulatory institutions of the host economy, are to be investigated as a variable influencing FDI location choice of Chinese firms. Using mean score data taken from the Economic Freedom Index, the variable of difference in economic freedom between China and the host economy was measured and operated. Political influence (POLITIC) represents the political and legal regulative regime in the institutional environment. Six component items including political system, bureaucracy, legal and regulatory framework, government economic policies, corporate tax, and

OFDIit

protectionism were adopted to configure this variable. Data for these six component items were obtained from the World Competitiveness Yearbook (WCY) 1995–2008, which is a data collection of annual surveys published by IMD International and the World Economic Forum. After an internal reliability test (with the Cronbach’s alpha index of 0.948) and a correlation test, the six component items were merged into a composite variable of political influence, and the mean scores of the six items were used to measure this variable. Following the method used in measuring the variable of difference in economic freedom, the variable was

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measured as the difference in political influence between China and the host economy. FDI restriction (RESTR) is used as the variable presenting the institutional regime directly regulating FDI activities. It measures the extent to which foreign firms experience difficulties in acquiring control over a domestic firm in a host country. Following the same method in the case for the two variables of economic freedom and political influence, FDI restriction is measured by the relative difference between China and the host economy, and data were obtained from WCY 1995 to 2008. Cultural distance (CULTR) measures the extent to which normative forces influence FDI activities. In this study, cultural distance is defined as the difference between the national culture of the home country (China) and those of the eight host economies. It is measured through the four cultural dimensions of power distance, uncertainty avoidance, individualism and masculinity, as identified by Hofstede (1983). Using the scores for individual countries provided by Hofstede (2005) and following the method developed by Kogut and Singh (1988), culture distance was measured by using a composite variable consisting of the four cultural dimensions. A low score on this measurement represents cultural proximity and a high score means culturally more distant between China and a host economy. Bilateral trade (TRADE) between China and a host economy is used to measure the influence of cognitive institutions on Chinese FDI flows. The variable of trade has been widely used as an economic variable (e.g. Bevan & Estrin, 2004; Buckley et al., 2007), which reflects the economic relationship between host and home countries. From the perspective of institutional approach, the variable of bilateral trade indicates the intensity of transactional dealings and choice in terms of exporting destinations, and importing sources by firms from the home country. If a particular destination choice for trade is repeated in high frequency over time so that it is institutionalized in managers’ mindsets, expanding trade destination choice to FDI location choice will become a way to gain legitimacy. Thus, the variable of bilateral trade between China and a host economy was used as a proxy for mimic pattern of FDI location choice. Data for this variable were sourced from the State Statistical Bureau of China (SSBC). A control variable of inflation (INFLA) was included to reveal the impacts of the main variables. As inflation imposes a high risk to firms operating in the economy, a negative relationship between inflation in the host economy and the location choice of Chinese FDI is expected. This variable is measured by the annual inflation rate and data were taken from WDI 2008. 4.2. Estimation method Following discussion on variables used in the current study, we formulated the regression model as follows:

¼ ait þ b1 GDPPit þ b2 GDPGit þ b3 OPENit þ b4 RESOit þ b5 ULCit þb6 PATENTit þ b7 EFREEit þ b8 POLITICit þ b9 RESTRit þ b10 CULTRit þb11 TRADEit þ b12 INFLit þ uit where i = 1, . . ., 8 represents host country i and t = 1995, . . ., 2007 indicates the time period. This regression model was adopted for empirical estimation of FDI location choice by Chinese firms and the panel data estimation method was adopted, pooling together the cross-section data of eight Asian economies over the period 1995–2007. After conducting a Lagrangian multiplier test, the random-effects model was selected as the model specification. Table 1 presents the descriptive statistics and correlation matrix for independent variables. The variance inflation factor (VIF) was also checked

Y. Kang, F. Jiang / Journal of World Business 47 (2012) 45–53

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Table 1 Descriptive statistics and correlation matrix for independent variables. Variables

Mean

S.D.

1

2

3

4

5

6

7

8

9

10

11

1. GDPP 2. GDPG 3. OPEN 4. RESO 5. ULC 6. EFREE 7. POLITIC 8. RESTR 9. CULTR 10. TRADE 11. INFL

16,260.130 2.788 0.479 2.192 942.390 2.426 1.570 2.548 1.421 4,078,789.51 3.854

12,753.790 3.968 0.180 1.866 986.185 1.933 1.468 2.948 1.400 5,123,689.50 6.562

1.000 0.095 0.451 0.338 0.781 0.766 0.457 0.642 0.151 0.598 0.432

1.000 0.010 0.061 0.069 0.005 0.073 0.103 0.027 0.080 0.415

1.000 0.037 0.370 0.641 0.374 0.665 0.378 0.272 0.156

1.000 0.231 0.297 0.078 0.103 0.287 0.060 0.403

1.000 0.631 0.347 0.359 0.100 0.546 0.381

1.000 0.620 0.592 0.080 0.257 0.337

1.000 0.390 0.356 0.062 0.160

1.000 0.251 0.298 0.292

1.000 0.430 0.176

1.000 0.286

1.000

when performing the regression analysis (see Table 2), and the results indicate that no serious multicolinearity exist between the independent variables. In our empirical estimations, a structural break method was used to investigate heterogeneity within the data. First, the eight economies were separated into two groups of developed economies (Hong Kong, Japan, Korea and Singapore) and developing economies (Indonesia, Malaysia, Philippines, and Thailand). Second, the full sample was split into two time periods (1995– 2000 and 2001–2007). The year 2001 was selected as a cut-off point as it marked a milestone in outward FDI from China, when the Chinese government formalized the ‘‘Go Global’’ strategy in its five-year plan to encourage outward FDI and the country became a formal member of WTO. To statistically support the two-way split of the full sample, structure break tests (Chow test) were performed. The results from Chow tests were highly significant for the selected break points of both cases, showing that H0 (the subsamples along the two breaking lines are statistically similar)

was rejected at p < .00 level. Thus, the estimation of four subsamples after two-way splits of the full sample is statistically justified. 5. Modelling results and discussions Table 2 provides the summary of estimation results. 5.1. Results from full sample testing The preliminary regression testing indicated that the variable patent never gained significance. The correlation tests showed that this variable was highly correlated with several other independent variables. Thus, the variable patent was dropped from the final model estimation and we did not statistically test the hypothesis related to strategic asset-seeking (Hypothesis 4) in this paper. The results from the full sample estimation provided limited support for the hypotheses for traditional economic variables. Among the

Table 2 Results for VIF test and model estimation. Full model

Developed economies

Developing economies

Period one (1995–2000)

Period two (2001–2007)

(1)

(2)

(3)

(4)

(5)

Independent variables (traditional economic factors) GDPP 7.8956 0.1267 0.4410 (0.2827) GDPG 1.5630 0.6399 0.1650 (0.1168) OPEN 3.5037 0.2854 0.1745 (0.1642) RESO 1.6381 0.6104 0.2435 (0.2207) ULC 3.561 0.2808 0.8104** (0.2507)

0.2917 (0.3002) 0.0218 (0.0788) 1.858*** (0.2899) 0.3970 (0.0917) 0.2026* (0.0897)

0.5934 (0.5234) 0.1295 (0.1578) 0.1915y (0.1040) 0.7657*** (0.2054) 0.5019 (0.4572)

0.0054 (0.3218) 0.0218 (0.0446) 0.0499 (0.1087) 0.1392 (0.1080) 0.0102 (0.2704)

0.3149 (0.3467) 0.2528y (0.1339) 0.9562** (0.2671) 0.1589 (0.2634) 0.5772** (0.2034)

Independent variables (institutional perspective) EFREE 4.9368 0.2026 0.6326*** (0.1785) POLITIC 2.2427 0.4459 0.3124** (0.1091) RESTR 3.1746 0.3150 0.1252 (0.1624) CULTR 2.6824 0.3728 0.3518y (0.1959) TRADE 3.3010 0.3029 0.6785*** (0.1614)

0.4669** (0.1337) 0.1384 (0.0860) 0.1404 (0.1483) 1.7129 (1.2043) 0.5018* (0.2074)

0.1816* (0.1042) 0.1931 (0.1310) 0.0129 (0.0972) 0.6566*** (0.1154) 0.6848* (0.2563)

0.1111 (0.1160) 0.0863 (0.0732) 0.2869*** (0.0694) 0.3550 (0.4685) 0.0933 (0.2214)

0.0250y (0.3653) 0.0849 (0.1454) 0.5755* (0.2464) 0.3240 (0.2148) 0.6679** (0.2182)

0.1688* (0.0820) 52 0.8388

0.0038 (0.0954) 52 0.7501

0.0128 (0.0503) 48 0.5014

0.1772 (0.2154) 56 0.8255

Variable

VIF

Control variable INFL 2.0430

Tolerance

0.4895

Obs. Adj.R2 Standard errors are in parentheses. y p < .10. * p < .05. ** p < .01. *** p < .001.

0.1074 (0.1007) 104 0.5118

Y. Kang, F. Jiang / Journal of World Business 47 (2012) 45–53

tested four economic variables, only unit labour cost (ULC) was significant. Hypothesis 3 is supported, as a negative impact of variable ULC was expected and found, indicating that a higher labour cost in a host Asian economy served as a deterrent for Chinese FDI. Given the fact that China has the largest pool of cheap labour, this result is conventional. This result suggests that FDI activities by Chinese firms are becoming more conscious of profitmaximising. Empirical results demonstrate that institutional systems had a strong influence on the location choice of Chinese FDI. Four of the five institutional variables are statistically significant. Two of the three regulative variables were found to have a significant effect. A highly significant and positive effect of variable economic freedom (EFREE) confirms Hypothesis 5a. This result suggests that Chinese firms would prefer FDI locations where a big difference in levels of economic freedom existed between the home and host economies. This result indicates that Chinese FDI tended to locate in a host economy with a higher orientation towards a market economy regime so that the investing firms could more readily conform to the economic regulative constituents of the host economy. Variable political influence (POLITIC) is also significant and bears a negative sign as expected, confirming Hypothesis 5b. This result suggests that the smaller the difference in the political and legal regulative regime between China and a host economy, the more attractive it was for Chinese firms to locate their FDI there. Data from the World Competitiveness Yearbook (IMD, 1995–2008) suggest that the Chinese economy scored relatively low on this variable when compared to the eight host economies. A lower score value means that the regulative regime of the political and legal dimension in an economy is more repressive and centrally controlled thus more risky, and vice versa. The result for this variable suggests that Chinese firms prefer to locate their FDI in relatively higher risky locations. A possible explanation could be that by operating in a politically unstable and risky environment in their home country, Chinese firms may find that they can more readily gain institutional legitimacy in a similar political environment when competing with developed country MNEs in FDI activity. The political embeddedness in a home country could be internalized as firm specific advantages, which provide them with expertise in adaptation to a similar institutional environment, characterized by high volatility and bureaucratic intervention. An interesting and important finding regarding the regulative institutional influence is the opposite impact directions for the two variables of economic freedom and political influence. This finding suggests that Chinese MNEs tended to locate their FDI to those locations, which have a high level of economic freedom but are politically repressive and risky. This tendency clearly reflects the influence from regulative institutions in the home country on FDI location choice. Hypothesis 6 regarding normative institutions gained some support, since a negative influence from variable cultural distance is predicted and confirmed with a marginal significance level at 10%. This result suggests that Chinese firms tended to locate FDI operations in economies with which China had a smaller cultural distance. Full sample estimation provided a strong supportive result to Hypothesis 7, as the variable of bilateral trade (TRADE) had a positive and highly significant impact on Chinese FDI, suggesting that frequent business transactions of bilateral trade by Chinese firms with the firms from a host economy indeed have an impact on the mindset of Chinese managers while making decisions regarding FDI location choice. 5.2. Results of two economy groups Estimation results justified the initial intent to split the full sample into two economy groups. Empirical results for the two

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economy groups were sharply different with those generated from full sample testing and also between the two groups, especially for variables drawn from the institutional approach, suggesting that FDI from Chinese firms followed different location patterns when flowing to different economy groups. For the developed economy group of Hong Kong, Japan, Korea, and Singapore, two economic variables (openness and ULC) and two institutional variables (economic freedom and trade) were significant, and all of them carried the predicted signs. The positive and highly significant impact of variable OPEN suggests that a strong exporting orientation of the host economy facilitated Chinese FDI for the Asian developed economies. This result may help to provide an explanation for the insignificance of conventional market-seeking variables. While seeking market expansion in Asian developed economies through FDI, Chinese firms may aim to serve broader foreign markets, rather than the domestic market in the host economy. Thus, the market-seeking motive is mainly realized through facilitating export expansion to other foreign markets from overseas FDI bases. Hong Kong has been most evident for this case. The negative effect from the variable of unit labour cost (ULC) is consistent with the result from the full sample testing, suggesting that the high labour cost in Asian developed economies served as a deterrent for Chinese FDI to flow into this economy group. Two institutional variables – economic freedom (EFREE) and trade (TRADE) – were significant. Consistent with the case in the full sample testing, the significant and positive impact of variable economic freedom reflects the fact that Chinese firms preferred a FDI location which had a stronger market orientation. Similar to the full sample result, variable TRADE had a positive relationship with Chinese FDI for developed Asian economies, although at a less significant level (5%), suggesting China’s trade pattern had a positive impact on the FDI location choice of Chinese firms. For the developing economy group of Indonesia, Malaysia, Philippines, and Thailand, two (openness and resource) of the five traditional economic variables were significant. Variable openness carried a positive sign as expected, and was significant at a marginal (10%) level, suggesting that market-seeking Chinese FDI was facilitated by an export orientation of the host Asian developing economy, rather than their absolute market size. Different with the cases both in the full sample and developed economy group, variable resource (RESO) gained strong significance and carried a positive sign as expected, suggesting that Chinese FDI flows were attracted to natural resources in these Asian developing economies. Turning to the institutional variables, three of the five institutional variables were significant. The variable of economic freedom was significant, but different to the results from both the full sample and the developed economy group, this variable carried a negative sign here, suggesting that a smaller difference between China and the developing Asian economies, in terms of economic regulative regime, served as an attraction for Chinese firms. Cultural distance (CULTURE) was statistically significant, but contrary to the case in the full sample testing as it carried a positive sign here, suggesting that Chinese FDI was flowing into the Asian developing economies that were culturally distant from China. The variable of bilateral trade is positive and significant here Consistent with the results from both the full sample and the developed economies group. 5.3. Results for two time periods Modelling results changed again when the full sample was split along the time dimension, indicating the dynamic nature of FDI location choice by Chinese firms. For the 1995–2000 period, only one institutional variable (FDI restriction) was statistically significant and had a positive sign as predicted. The highly

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Y. Kang, F. Jiang / Journal of World Business 47 (2012) 45–53

significant and positive influence of the variable FDI restriction (RESTRI) suggests that a difference between China and the host economy in the FDI regulating regime acted as a strong attraction for Chinese FDI flows. Considering that China had a rather rigid regime in restricting foreign ownership for this period, this result demonstrates that Chinese firms did prefer a friendly regulative regime directly linked to FDI activity, while not paying much attention to the broad regulative environment in a host economy. For the more recent 2001–2007 period, the model estimation generated quite interesting results. Three economic variables (GDPG, OPEN, and RESO) were significant. Variable GDP growth gained significance for the first time throughout all the model estimations and carried a positive sign as expected in H1b. This result may suggest that the eventual return to the normal track of economic growth for the East and Southeast Asian economies acted as an attraction for Chinese FDI flows to this region, after a severe recession during the Asian financial crisis. Variable OPEN had a significant and positive impact, and this result is similar to the case for the developed economy group. A positive impact of this variable indicates that Chinese FDI outflows preferred economies with a strong export orientation, demonstrating that the Chinese FDI stock was used to serve other foreign markets. This result may explain the insignificance of the more conventional market-seeking variables (GDP growth and GDP per capita). Variable ULC had a significant and negative influence, and this result is similar to the result from the full sample testing. A negative influence here from variable ULC suggests that it is in this time period when Chinese firms became more profitdriven and conscious of cost reduction while involving FDI activity. Regarding results for institutional variables, a surprising finding is that the significant impact of FDI restriction (RESTRIC) changed from positive for period one (1995–2000) to negative for period two (2001–2007), suggesting that Chinese firms tended to locate their overseas operations in economies with which China had a smaller difference in institutions directly regulating FDI activities. This result may be taken as a reflection of a positive change in China’s regulative regime directly related to FDI activities towards market-oriented direction in the new century, after China became a formal member of WTO in 2001. 6. Conclusions This study has sought to contribute to the understanding of the location choices of FDI by Chinese MNEs by examining the traditional economic variables derived from the eclectic paradigm and variables representing the three pillars of the institutional regime. Two important implications can be drawn from the empirical findings. First, empirical evidence suggests that while traditional economic factors have a major role to play in affecting Chinese MNEs’ decisions on FDI location, institutional factors may matter more and demonstrate a higher level of complexity and diversity. An assessment of findings from the full sample, as well as cross-section sub-samples, reveals that in comparison to traditional economic factors, institutional variables are more likely to impact on the FDI location choice of Chinese firms, and also demonstrate more complex relationships with FDI location choice. The impact directions for the five economic variables are fixed across all the five full and sub-sample estimations, if they are significant. On the other hand, the impact directions have changed for three (economic freedom, FDI restriction and cultural distance) of the five institutional variables across estimations for the full and/or sub-samples. The same institutional variables can influence the location choice of Chinese firms towards different directions, while crossing different full and sub-sample sections. Thus, it can be inferred that institutional variables play a more dynamic and also more significant role in the FDI location choices of Chinese firms, and that location choices by Chinese MNEs tended to have

different patterns, both for different regional economy groups and across different time periods. Second, the findings suggest that while the mainstream FDI theories and frameworks regarding FDI location choice, which were generated mainly from studies on developed economies, are still applicable in the case of Chinese FDI outflows, some important theoretical modifications and extensions are needed in explaining location choices by Chinese firms. Some empirical findings from this study are quite unconventional, such as findings regarding the contrasting impacts from two regulative institutional variables (economic freedom and political influence), and regarding changes in impact directions for variables of economic freedom, FDI restriction and cultural distance. These findings clearly demonstrate the impact of institutional forces in the home country on FDI location choice and provide strong support for the notion that the distinctive and highly dynamic institutional forces in China contribute to the FDI location choice decisions of Chinese firms. 6.1. Managerial relevance The findings of this study offer several managerial implications. First, this study reveals that FDI location choice of MNEs from China as an emerging economy is determined by a joint influence of both economic and institutional factors, and thus mangers should not view these factors in isolation from each other when making FDI location decisions. Chinese FDI to the East and Southeast Asian region is motivated to fulfil certain economic imperatives, such as gaining access to supply of natural resources and developing overseas market. However, managers should keep in mind that the institutional factors of host country in relation to those of home country play an even more significant and important role in determining their FDI locations in the region. Second, the finding regarding opposite impacts from the variables of economic freedom and political influence demonstrates an influence of institutional embeddedness from operating in home country on FDI location choice by the MNEs from an emerging market. This finding suggests that Chinese MNEs are targeting FDI location where it has political and economic institutions more or less similar to those found in their home country—with relatively market-oriented economic institutions and more restrained political institutions. Important managerial implication for FDI location can be drawn from this finding. Our data suggest that MNEs from developing countries are able to turn their disadvantage of operating in a politically oppressive institutional environment into an advantage when competing overseas with MNEs from developed countries. Managers from emerging markets like China should be aware that their experiences and expertise in adapting to oppressive institutions could probably make them be more capable in comparison to their counterparts from developed countries in dealing with the political and institutional impediments that MNEs may face in developing country markets. 6.2. Limitations and future research directions Several limitations of this study need to be noted, leading to avenues for further investigation. Firstly, some variables used in this study may not provide an accurate measurement of the institutional forces in play. A major issue here is the measurement of the cognitive regimes. Bilateral trade between the host and home economies was used as variable of cognitive institutions, capturing the institutionalized behaviour pattern of managers in the home country. However, the trade variable is more commonly used as an economic variable, and this study may suffer from measurement errors. It is difficult to measure the behavioural pattern of investing firms using aggregate statistical data. Thus,

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