How investment promotion affects attracting foreign direct investment: Analytical argument and empirical analyses

ARTICLE IN PRESS international business review International Business Review 17 (2008) 39–53 www.elsevier.com/locate/ibusrev

How investment promotion affects attracting foreign direct investment: Analytical argument and empirical analyses Sung-Hoon Lim Department of International Trade, Konkuk University, 1 Hwayang-dong, Gwangjin-Gu, Seoul 143-701, Republic of Korea Received 13 January 2007; received in revised form 28 April 2007, 16 July 2007; accepted 4 September 2007

Abstract This paper examines that how a host government’s promotional effort, through the establishment of investment promotion agency (IPA), can influence foreign direct investment (FDI) inflows. This paper conducts structural equation analyses with maximum-likelihood estimations focusing upon the effectiveness of investment promotion as a mediator between the host country’s FDI environment and FDI inflows. The empirical results show that the effectiveness of investment promotion, measured by IPA age, IPA’s overseas staff intensity, and number of IPA staff, positively affects the attraction of FDI. From the results, we infer that enhancing investment promotion can be a tool for attracting FDI through the mediation effect that coordinates other determinants of FDI such as market size, market growth, and low labor costs. r 2007 Elsevier Ltd. All rights reserved. Keywords: Investment promotion agency; Foreign direct investment inflows; FDI determinants; Mediation effect; Structural equation model

1. Introduction There is some view that national strategic marketing management is needed to create or increase economic development (Kotler, Jatusripitak, & Maesincee, 1997). That means, in other words, a government can market a country in the same way as a company’s products and services in order to attract foreign direct investment (FDI). Most governments have increasingly adopted measures such as liberalizing the legal and regulatory framework for FDI and establishing mechanisms for the settlement of investment disputes to attract FDI, as a means to achieve their economic development goals. According to UNCTAD (1998, p. 91), the determinants of FDI include not only economic determinants (e.g., market size, low-cost unskilled labor, raw materials, and strategic assets and technology) but also business facilitation (e.g., investment promotion activities, investment incentives, and administrative services). As for determinants of FDI, even if the literature argued that business facilitation plays a less crucial role than economic determinants (Guisinger, 1992; Shah, 1995; UNCTAD, 1996, 1998; Wells & Wint, 1990), most Tel.: +82 2 450 3559, mobile: +82 18 283 0684; fax: +82 2 3436 6610.

E-mail address: [email protected] 0969-5931/$ - see front matter r 2007 Elsevier Ltd. All rights reserved. doi:10.1016/j.ibusrev.2007.09.001

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governments regard business facilitation as a significant policy instrument (Bergsman, 1999; Lim, 2005; Morisset & Pirnia 2000; Wells & Wint, 1990). Promotion activities by investment promotion agencies (IPAs) have been considered to be a major part of business facilitation (UNCTAD, 1995, 1998). However, the role of IPA in attracting FDI has been the subject of only a few studies (Morisset & Andrews-Johnson, 2003; Wells & Wint, 1990) and the literature has never been clearly argued as to how IPA activity affects FDI inflows. There are some exceptions: Wells and Wint (1990) and Wint and Williams (2002) tested whether the existence of IPA, measured by a dummy variable and four-category scale, has affected a host country’s FDI inflows or not; Morisset and Andrews-Johnson (2003) showed recently that spending by IPAs was positively associated with attracting FDI. Regarding empirical tests in previous studies, they have developed in two directions: first, how to select proxies for the effectiveness of investment promotion affecting FDI inflows in large-sample analysis; second, which role of an IPA is the most important among various promotion activities, i.e., image-building activity, investment-generating activity, and investment service (after care service) with case analysis. The main line of inquiry of this paper is how and to what extent a host government’s promotional effort, through an IPA, can influence FDI inflows. I regard an IPA as acting in the role of a mediator between the host country’s FDI environment and FDI inflows, while the previous paper regards it as one of the determinants of FDI. That is, an IPA can function as a catalyst between the FDI environment and FDIattraction performance of the host country. This view puts the IPA’s role apart from other determinants affecting FDI inducement in this paper. Accordingly, this paper has three main contributions in developing the previous approach: first, various proxy of effectiveness of investment promotion is adopted even though it is an analysis of a relatively large set of countries in these kinds of studies; second, the functions of IPA, as a FDI promotion factor, is regarded not as a normal independent factor but a mediator between the host country’s FDI environment and FDI inflows; third, related theories, such as the transaction cost economy approach and information searching cost are adopted to make a link between the hypothesis and empirical tests. 2. Literature reviews and hypotheses 2.1. Investment promotion and FDI determinants Dunning (1996, p. 56) identified four types of motive behind the FDI activities of multinational corporations (MNCs): resource seeking, market seeking, efficiency seeking, and strategic asset or capability seeking. UNCTAD (1998, p. 91) defines these motives as economic determinants with two other FDI determinants, i.e., host country’s policy framework and business facilitation. Policy framework refers to social and political stability, regulations regarding entry and operations, fair competition between foreign and domestic firms, and international agreements on FDI. Business facilitation refers to providing facilitation services for foreign investors such as investment incentives, government promotional activities, and administrative support for foreign investors. Among those determinants, the importance of IPA promotion activities such as image-building activities, investment-generating activities, and investment-service activities have become more important (UNCTAD, 1995). Because investment promotion activities can be taken to shorten the delayed reactions of investors to emerging investment opportunities’ or to help investors, especially those small and medium-sized firms, to discover new opportunities that they would not find on their own (UNCTAD, 1998, pp. 99–100). 2.2. Information dissemination activities and market imperfection If there is to be an optimal allocation of resources through market mechanisms, participants should have free access to information. However, instead of circulating freely, information is concentrated and transaction costs occur, resulting in some investment decision makers possessing it and some who do not. This type of ‘information impactedness’ usually occurs from uncertainty and opportunism (Williamson, 1975, 1985). The asymmetry of information tends to change the bargaining power between the supplier and the demander and the side which posses less information will be at a disadvantage. Therefore, in order to overcome this

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asymmetry of bargaining power, harmonization of information possession should be achieved. In other words, those who posses less information should pay an information searching cost to even-up their bargaining power position. This logic can be applied for the site-selection decision process of MNCs. When making a decision on where to locate, the information base of MNCs is far from perfect, and the decision-making process can be subjective and biased (UNCTAD, 1999). Countering market imperfections in the location decision-making process, literatures (Morisset & Andrews-Johnson, 2003; Wells & Wint, 1990) found that investment promotion was most effective when it overcame informational asymmetries (Loewendahl, 2001). Regarding the information searching cost for foreign investors, Mariotti and Piscitello (1995) argue that, ceteris paribus, foreign investors experience substantial information asymmetry compared with indigenous investors. As a result, the spatial distribution of inward FDIs is governed by information costs, rather than by production and transport costs, which, on the other hand, are more influential on the choices of the physical location of plants (Mariotti & Piscitello, 1995, p. 816). They also state that the information that an investor needs is divided into ‘low-cost information’ and ‘high-cost information’. Some information regarding traditional location factors such as manpower, raw materials, market areas, and transport cost, can be acquired at zero (or very low) cost since extensive statistical data are available. In contrast, high-cost information is needed to reduce uncertainty in the quality of available location factors, the workings of the local market in terms of consumer behavior, institutional framework, and so on. IPA promotion activities concern not only reducing low-cost information searching but also the high-cost information searching. According to a survey by the Foreign Investment Advisory Service (FIAS) of Latin American IPAs, all 14 agencies maintain an informational database for potential investors, to respond to questions by potential investors across a wide range of topics such as current macro-economic data, domestic laws and regulations, the local costs of land, labor, energy and other factors of production, and information pertaining to specific business sectors (FIAS, 1999). Brossard (1998) demonstrated that IPA services for reducing the level of market uncertainty are considered to be the most important factor among 15 surveyed services provided to investors. (It was strongly supported in the feasibility study stage). Literature addresses that a main role of the IPA is to gather and distribute the information that prospective investors need to evaluate the attractiveness of a country as an investment site. In other words, IPA could play a role in influencing FDI decisions by compensating for market failure due to information or perception gaps about investment opportunities or country of the investment climate. 2.3. Literature on investment promotion The neoclassical view is largely based on the premise that if governments work hard to build good investment climates, then investors will automatically seek out the best investment opportunities (Morisset & Andrews-Johnson, 2003). However, despite the fact that greater promotional effort is associated with more FDI, there is a lack of research on the subject of investment promotion of IPAs (Loewendahl, 2001; Wells & Wint, 1990). As a matter of fact, IPA studies have been developed from Wells & Wint’s original book entitled ‘Marketing a Country’. The classification of techniques proposed in this book has become the standard terminology for describing what IPAs do (Wells, 1999). Many researchers cite Wells & Wint’s classification (i.e., is image-building activity, investment-generating activity, and investment service techniques) studding an investment promotion (Wint & Williams, 2002). Major studies on role of IPA’s from 1990 to now by chronologically are summarized in Table 1. Other research on the role of the IPA in FDI policy, that of Young et al. (1994), stated that a number of functions might be performed by IPA, i.e., policy formulation, investment promotion and attraction, investment approvals, granting of incentives, providing assistance, and monitoring clients (i.e., providing after-care) to eventually act as a player in establishing FDI policy. Comparing the view of Wells and Wint (1990) on the role of the IPA, they emphasize more the policy-advisor function than an IPA’s direct promotion activities. They also point that monitoring and after-care functions are bound to grow substantially in importance during the 1990s although these functions are underdevelopment (Young et al., 1994, p. 145). Wells (1999) added a fourth category, policy advocacy, to the previous three categories and gave the example of Mozambique, i.e., the role of the Mozambique CPI (Centro de Promoc- a´o de Investimentos), in improving the investment climate by reducing bureaucratic red tape that investors faced. He also broke down

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Table 1 Summary of previous studies on the effectiveness of IPA activities Categories of IPA roles

Empirical methodologies and samples

Empirical or major findings

Wells and Wint (1990)

Image building, investment generating, and investment services (pre-investment decision, post-investment service)

Positive relationship between IPA’ existence and FDI inflows

Wint (1992)

The same as that of Wells and Wint (1990)

Wint (1993)

After sales or post-approval services

Young et al. (1994)

Policy formulation, investment promotion and attraction, investment approvals, providing assistance, and monitoring (after-care) Disseminating information to potential investors

Regression analysis using a proxy for the effectiveness of investment promotion as a dichotomous variable 50 cases Case study analysis through interviewing 20 investment promotion officials 11 cases Case study analysis through interviewing government officials in 10 selected countries 10 cases No empirical test

Head, Ries, and Swenson (1999)

Wells (1999)

MIGA (2000)

Loewendahl (2001)

Image building, investment-generating, investment services (pre-investmentdecision, implementation, postinvestment service), and policy advocacy Preparing for the site visit (managing the visit program), managing the post-visit, and providing follow-up and aftercare Strategy and organization, lead generation, facilitation, and investment services

Wint and Williams (2002)

Not mentioned directly

Morisset and AndrewsJohnson (2003)

The same as that of Wells (1999)

Regression analysis using a dummy variable indicating USA states with investment promotion office(s) in Japan 225 cases of investment No empirical test

No empirical test

No empirical test

Regression analysis using the four-category scale of investment promotion effectiveness derived from Delphi-type poll of experts 36 cases Regression analysis using IPA budget, IPA staff, and two control variables (e.g., investment climate, GDP per capita) 58 cases

The stand-alone office as overseas network type is more successful in promoting investment The most effective post-approval services are provided by powerful investment authorities The policy-advisor function is most important among IPA roles

The Japan office dummy is a positive sign to FDI, but it is not statistically insignificant

The weight of assigned IPA role should reflect the task that a country faces in marketing itself to investors -

To maximize the long-term benefits from inward FDI, aftercare activity should form a major component of investment promotion activities The effectiveness of promotional activity records positive sign to FDI flows, but it is statistically insignificant Positive relationship between IPA’s promotional spending and FDI inflows

investor services into three categories: aiding pre-investment-decision (providing information services about procedures required of investors), aiding implementation (legal or accounting services necessary in the process of supporting FDI projects), and post-investment services (services to assist investors overcome problems they encounter once they are operating). MIGA (2000) also categorized IPA investor services into three phases of investment: preparing for a site visit, managing post-visit inquiries and procedures, and providing follow-up and aftercare. In case studies on the effectiveness of investment promotion, the most effective post-approval services are provided by powerful investment authorities (Wint, 1993) and stand-alone offices as overseas network type are

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more successful in promoting investment (Wint, 1992). Loewendahl (2001) divided investment promotion into four main areas (strategy and organization, lead generation, facilitation, and investment services) and explained IPA activities by stage (from the stage of ‘setting the national policy context’ to stage of ‘monitoring and evaluation’). However, he did not conduct empirical tests but rather based his explanations upon cases studies of certain countries. Regarding empirical tests on the effectiveness of investment promotion, Wells and Wint (1990) is classified as one of the earlier studies, which used as a proxy for the effectiveness of investment promotion a dichotomous (dummy) variable based upon whether or not the country had overseas promotional representation in the USA. Wint and Williams (2002) developed a proxy of IPA in the same manner that Wells and Wint (1990) conducted their research. The effectiveness of investment promotion activity was proxied through a promotional variable calculated based on questionnaire sent to 10 promotional experts around the world in a Delphi-like research process. The empirical result showed that it had not a statistically significant impact on FDI flows. Empirical tests with relatively large samples as to the extent investment promotion helps explain crosscountry variations in FDI flows were conducted by Morisset and Andrews-Johnson (2003) using data from a survey of 58 IPAs. The results showed that, on average, spending by IPAs was positively associated with attracting FDI, along with the influence of key factors such as the quality of the investment climate and the country’s market size. They distinguished four key functions: policy advocacy, image building, investment generation, and investor services following Wells (1999) and found that policy advocacy was most associated with attracting investment, followed by image building and investor services from the empirical results. Another large-sample empirical approach was conducted by Head et al. (1999). However, the study was not directly focused on analyzing the relationship between FDI inflows and the role of various IPAs. Their regressions take into consideration the influence of the presence of an investment promotion office in Japan on attracting prospective Japanese investors to the respective states of the US, based on the 225 investments made in the US by Japanese manufacturers. From the result of empirical analyses with a dummy variable indicating which American states had representative offices in Japan, the findings did not show a significant effect from the investment promotion offices in Japan. 2.4. Hypothesis Wells and Wint (2001, p. 4) define investment promotion as ‘‘activities that disseminate information about, or attempt to create an image of the investment site and provide investment services for prospective investors.’’ Morisset and Andrews-Johnson (2003) interpret that this definition encapsulates the two most important analytical justifications for IPAs. The first is its role in communicating and disseminating information and the second is that the IPA can play a role in coordinating most activities aimed at improving the business environment in the host country. These justifications imply that the role of IPA can be a mediator between host country’s FDI environment and FDI inflows as well as one of determinant of FDI. Foreign investors usually face difficulties in acquiring trustable and accurate information for evaluating a host country’s FDI attractiveness, as well as in defraying the cost of information searching when they enter a local market (Mariotti & Piscitello, 1995). The provision of high-cost information (e.g., consumer behavior pattern, institutional framework and so on) by IPAs especially reduces the uncertainties related to the quality of the investment destination or the market. IPAs can play the role of a coordinator in influencing FDI decisions by compensating for market failure resulting from asymmetric information on the investment opportunities or the investment climate of the host country. IPAs can also function as a bridge between the FDI environment and FDI-attraction performance of the host country. In sum, an IPA can play the role of a mediator between a host country’s FDI climate and FDI inflows. In other words, the FDI climate influences FDI inflows through IPA’s activities. Therefore, hypotheses can be established as follows. Hypothesis: IPA promotion activity has a positive influence on FDI inflows by its mediation effect between a host country’s FDI environment and FDI inflows.

 

The FDI environment of host country directly affects FDI inflows. The FDI environment of host country indirectly affects FDI inflows through the IPA promotion activity.

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3. Research methodology 3.1. The data Primary and secondary data were used in this paper. IPA-related data were based mainly on questionnaires while macro economic data were based on published sources. Questionnaires collected from the person responsible for investment policy in each of the 68 countries where the Korea Trade-Investment Promotion Agency (KOTRA) maintains an overseas office. ‘One empirical datum per one country’ was the principle employed, but in some European countries and in North America, more than one set of empirical data were collected in consideration of a country’s characteristics, such as its level of regional autonomy and degree of separation between politics and economics. For example within the United Kingdom, IPAs in England, Scotland, Wales and Northern Ireland, are operated independently of the political and economic system. In the case of the USA, data were collected on a regional basis in acknowledgement of the fact that state governments are responsible for investment promotion and the associated legislation. Twenty-five regions1 in the USA provided separate information, together with four in the UK, four in Germany, plus two each in Ukraine and Belgium. In this paper, empirical tests will be conducted at the country level. Therefore data on characteristics of regional IPAs (e.g., the number of staff and the year an IPA was established) were transformed into country level data by the averaging method. Lastly, 68 items of data by country were employed that were collected from 22 countries in Europe, 15 in the Middle East and Africa, two in North America, and 12 in Central and South America and 17 in Asia. The period of data collection was from 1 to 31 August 1999 (see Table 2). 3.2. Models and variables Earlier I proposed that an IPA might be a mediator between a host country’s FDI environment and FDI inflows. To test for the impact of mediation, I conducted a series of path analyses with Amos 4 (Arbuckle & Wothke, 1999) with maximum-likelihood estimation. Tests of mediation generally can be conducted following causal steps (Baron & Kenny, 1986; Judd & Kenny, 1981). The steps require that: (1) The total effect of the independent variable on the dependent variable must be significant; (2) The path from the independent variable to the mediator must be significant; (3) The path from the mediator to the dependent variable must be significant; and (4) If the independent variable no longer has any effect on the dependent variable when the mediator has been controlled, then complete mediation has occurred. Partial mediation is the case in which the path from an independent variable to a dependent variable is reduced in absolute size but is still different from zero when the mediator is controlled. According to above four-step approach, I propose following four structural equation models that posited an IPA’s existence as a mediator-cum-coordinator between the host country’s environment and its FDI inducement performance. Each model was designed to correspond with above steps as Baron and Kenny (1986) and Judd and Kenny (1981) suggested (see Fig. 1). The structural equation model that examines the relationship between FDI inflows and a host country’s FDI attraction environment, two observed variables, NETFDI and TOFDI, were included to measure FDI inflows. Also, five observable variables, GRGDP, PERGDP, LBCOST, OPEN, and INCENT, were employed to gauged the environmental attractiveness in respect of its impact on FDI inducement. NETFDI measures FDI inflows on a net basis (credits of capital transactions less debits between direct investors and their foreign affiliates) in balance of payments, while TOTFDI is the volume of FDI inflows into a host country. That is, NETFDI takes account of the amount of withdrawn FDI. NETFDI is added as observed variable for FDI performance because one of the roles of an IPA is providing a good after care service that enhances the longevity of a foreign firm in a host country.

1 Real and financial constraint prevented me gathering a half the USA sample including Alabama, Arizona, Arkansas, California, Florida, Idaho, Louisiana, Maryland, Massachusetts, Michigan, Mississippi, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Carolina, Oklahoma, Oregon, Rhode Island, Tennessee, Texas, Virginia, Washington, and West Virginia.

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Table 2 Current status of data collection by country (68 countries) Europe (22 countries)

Middle East and Africa (15 countries)

Asia and Oceania (17 countries)

America (14 countries)

Austria Belgium Czech Denmark Finland France Germany Greece Hungary Ireland Italy Netherlands Norway Poland Portugal Rumania Slovenia Spain Sweden Switzerland UK Ukraine

Coˆte D’ivoire Egypt Israel Jordan Kenya Lebanon Libya Morocco Nigeria Oman Saudi Arabia South Africa United Arab Emirates Turkey Zimbabwe

Australia Bangladesh China India Indonesia Japan Korea Malaysia Myanmar New Zealand Pakistan Philippines Singapore Sri Lanka Taiwan Thailand Vietnam

Argentina Brazil Canada Chile Colombia Dominican Republic Guatemala Mexico Panama Paraguay Peru Uruguay USA Venezuela

The host country’s per-capita Gross Domestic Product (GDP) and GDP growth rate are chosen as measures of host market attractiveness. Host country market size and growth is one of the most influential factors governing inward FDI (Bennell, 1997; Dunning, 1973). This is supported by many empirical studies (Jun & Singh, 1996; Nigh, 1985; Root & Ahmed, 1979; Schneider & Frey, 1985; Wheeler & Mody, 1992). Nigh (1985), in an empirical analysis using pooled aggregated data on US manufacturing investment in 24 countries, found per-capita GDP of the host country to be an important factor determining FDI. Tsai (1994), in an econometric analysis of a non-linear simultaneous equations model using 62 countries over the period 1975–1978 and for 51 countries over the period 1983–1986, also demonstrated that larger market-size measured by per-capita GDP is associated with a higher level of inward FDI.2 The difference between GDP size and GDP growth rate those are the most commonly used in the literature as a proxy of market attractiveness. Clegg (1995) argues that the former is more likely to be associated with new investment while the latter is more relevant to expansionary FDI. The GDP growth hypothesis maintains that a rapidly growing market provides relatively better opportunities for making profits than the ones growing slowly or not growing at all (Lim, 1983). Previous studies such as Schneider and Frey (1985), Nigh (1985), Tsai (1994), and Billington (1999) observed a significantly positive effect of growth on inward FDI. Other studies, however, have found a negative relationship between GDP growth and per capita FDI flows to developing countries (Reuber, 1973; Wells & Wint, 1990; Wint & Williams, 2002). Accordingly, this study was agnostic with respect to expectations on the sign for change in GDP growth rate. Dunning (1996) and UNCTAD (1998) argue that a host country’s low labor cost platforms satisfy a MNC’s motivation to seek greater efficiency. Accepting their argument, this paper employs a country’s low labor cost as a condition of locational efficiency. However, the results of empirical research do not support the findings explicitly. The host country’s labor cost condition was indicated as a statistically significant variable in the 2

According to Chakrabarti (2001), per-capita GDP is more preferred as a proxy of market attractiveness compared with absolute GDP and per-capita GNP. Absolute GDP is a relatively poor indicator of market potential for the products of a foreign investor. GNP also under-estimates the market for the products of MNCs located in the host country by excluding the earnings of foreigners located in the home country.

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e1

GRGDP

e2

PERGDP

e3

LBCOST

0.29*

0.82 a

Model 1

NETFDI

e7

TOTFDI

e8

AGE

e7

FSTAFF

e8

TSTAFF

e9

NETFDI

e5

TOTFDI

e6

NETFDI

e7

TOTFDI

e8

1.01** 0.50**

0.86a

FDIENV

FDISUM

0.52**

e4

OPEN

e5

INCENT

e1

GRGDP

e2

PERGDP

e3

LBCOST

0.99**

e6

0.31**

Model 2

0.33*

0.56 **

1.05** 0.54**

0.82 a

IPA

FDIENV

0.70**

0.48**

e4

OPEN

e5

INCENT

e1

AGE

e2

FSTAFF

Model 3

0.67**

0.57**

TSTAFF

e1

GRGDP

e2

PERGDP

e3

LBCOST

FDISUM

OPEN

e5

INCENT

0.89**

e4 Model 4

0.33*

0.87 a

1.05** 0.83 a

FDIENV

0.27*

FDISUM

0.47**

e4

0.91 a

0.56**

IPA

0.75a

e3

0.67a

e6

0.30**

0.30**

0.52**

0.59**

0.94**

0.44*

e9

IPA

e6

0.69a

0.67**

AGE

FSTAFF

TSTAFF

e10

e11

e12

Fig. 1. The empirical results on the path diagram. ** Significant at 1 percent level, * significant at 5 percent level, and a shows the variable whose regression weight was set to 1.

works of Owen (1982) and Gupta (1983). In contrast, it was not significant in those of Flamm (1984), Schneider and Frey (1985), Lucas (1993), and Wheeler and Mody (1992). The sign for this variable can be hypothesized to be negative. According to AMOS requirement that a single l-path for each construct be set to one, however, this variable was set to 1.00 in models. The ratio of trade to GDP (trade/GDP), as a proxy of economy openness is one of the critical determinants of FDI in literature (Asiedu, 2002; Chakrabarti, 2001; Edwards, 1990; Kravis & Lipsey, 1982; Wheeler & Mody, 1992). In particular, a host country’s trade restrictions can directly affluence market seeking or exported-oriented foreign investors (Asiedu, 2002). Investors in a less-opened economy can face additional transactions cost. Direct investment is a way to avoid local trade barriers and reduce transaction costs (i.e., tariff and quotas) for MNCs that intend to cultivate the local market and export/import their products from/ to the host country. Kravis and Lipsey (1982), Culem (1988), Pistoresi (2000), and Asiedu (2002) reported a positive effect of openness on FDI while Schmitz & Bieri (1972) and Chakrabarti (2001) discerned a weak link between them. Accordingly, this variable had a hypothesized positive sign. The provision of incentives to foreign investors is a business-facilitation measure to reduce the ‘hassle costs’ of doing business in a host country as is the provision of amenities that contribute to the quality of life for

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expatriate personnel (UNCTAD, 1998). However, Walker (1965) noted that investment incentives are less important in investment location selection by MNCs when compared with variables such as political and nonpolitical factors. Also, many studies (Contractor, 1990; Shah, 1995; Wells, 1986) agree with the concept that incentives are secondary to fundamental determinants. Despite the fact that investment incentives play a less crucial role in determining FDI inflows than fundamental determinants do (Guisinger, 1992; Shah, 1995; UNCTAD, 1996; Zhang, 2001), they maintain their significance as an investment policy instrument. The range and extent of incentives can be quickly changed and easily adjusted by government comparing to variables such as economic factors. For these reasons, investment experts, view incentives as important policy variables in their strategies to attract FDI (UNCTAD, 2000). In this paper, the importance of incentive regime is measured by each subject country’s investment officials on a five-point scale according to responses to the question, ‘Indicate the level of support given to each incentive (both fiscal incentives and financial incentives)3 by your government: (1 ¼ weak, 5 ¼ strong)’. The providing incentive negotiation and approval belongs to the range of services offered by most IPAs (Loewendahl, 2001; Young et al., 1994). The sign for this variable was also hypothesized to be positive. In the structural equation model that examines the mediating effect of an IPA’s promotion effectiveness, three observed variables, AGE (establish year of IPA), FSTAFF (overseas staff intensity), and TSTAFF (total staff), were employed to measure the IPA’s existing capabilities. Organization age is usually regarded as a measurement of an organization’s experience in literature, which examines the relationship between export capability and organizational performance (Bilkey, 1982; Fenwick & Amine, 1979). This paper selects the age of an IPA as one of the IPA’s existing capabilities in assuming that the IPAs could gain promotional experience and learning skills through conducting IPA-type roles, i.e., image building, investment generating, and investment service. Two observed variables, total number of staff members and overseas staff, are also inserted as measures of organizational capability. Wells and Wint (1990) and Young et al. (1994), address that generating overseas investment leads are most important for IPAs to increase their FDI inducement potential. Accordingly, overseas staff intensity, i.e., ratio of overseas staff to total staff, is employed in the model with number of total IPA staff. Morisset and Andrews-Johnson (2003), in an empirical analysis using an IPA’s promotion effectiveness effort measured by the level of human resources on FDI inflows in 58 countries during 2001, found the relationship was positive, but not statistically significant. The sign for these variables as proxy for the effectiveness of IPA’s promotion was hypothesized to be positive—overseas staff intensity was also set to 1.00 in models. The variables to be included in the model, the measures, the data source, and the expected signs are summarized in Table 3. 3.3. Results Structural equation modeling was used to estimate parameters of the four structural models in Fig. 1, and the completely standardized solutions computed by the AMOS 4 maximum-likelihood method are reported in Table 4. Goodness-of-fit statistics, indications of the overall acceptability of the structural model analyzed such as w2, GFI, CFI, TLI, NFI, RMSEA, were satisfied with maximum acceptable levels in all models. All path coefficients between latent variables and all loadings on the latent constructs (l-paths) were significant (po0.05). The goodness-of-fit statistics of Models 1 and 3 are more acceptable than those of Models 2 and 4. Model 1 indicated good fit with a w2 of 20.28 (12 df) and a non-significant p-value (40.05). Absolute and relative fit indices also supported the structural model (GFI ¼ 0.92, CFI ¼ 0.99, TLI ¼ 0.97, NFI ¼ 0.97, and RMSEA ¼ 0.01).4 In Model 2, w2 of 41.2 (18 df) was significant (po0.01) while most indices of fit, GFI ¼ 0.87, CFI ¼ 0.96, TLI ¼ 0.92, and NFI ¼ 0.93, presented support for the measurement model. In 3

Fiscal incentives involve a reduction of the standard corporate tax rate, tax holidays, accelerated depreciation, and exemption of import duties. In contrast, financial incentives include government grants, subsidized credits, and government insurance at preferential rates. 4 If the model fit perfectly, the fit indices such as GFI, CFI, TLI, and NFI should have the value 1.00. Usually, a value of at least 0.90 is required to accept a model, while a value of at least 0.95 is required to judge the model fit as ‘good’ (Bentler & Bonett, 1980; Hox & Bechger, 1995; Jreskog & Srbom, 1989; Tucker & Lewis, 1973). In contrast, a RMSEA of less than 0.05 is generally required (Byrne, 2001; Hox & Bechger, 1995).

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Table 3 Summary of variables and hypothesized signs Observed variables

Description

Data source (publisher)

Hypothesized sign

NETFDI

PERGDP LBCOST OPEN INCENT AGE FSTAFF TSAFF

Per-capita GDP in US dollars Hourly average wage of manufacturing sector measured in US dollars Ratio of exports and imports to GDP Level of support to attract FDI (5-point rating scale) IPA age (current year minus established year of IPA) Overseas staff intensity, ratio of overseas staff to total staff Number of IPA staff

WIR (UNCTAD), IFS (IMF) WIR, local data EIU Report (EIU), WDI EIU, WDI EIU IFS Survey (KOTRA) Survey (KOTRA) Survey (KOTRA) Survey (KOTRA)

–

TOTFDI GRGDP

Net FDI inflows in balance of payment (amount of inward FDI minus withdrawal FDI amount) measured in US dollar Amount of FDI inflows in US dollars Annual percentage change in gross domestic product

Positive Positive/ negative Positive – Positive Positive Positive – Positive

WIR, IFS, IMF, EIU, and WDI mean World Investment Report, International Financial Statistics Yearbook, International Monetary Fund, The Economist Intelligence Unit, and World Development Indicators (the World Bank, 1999), respectively.

Table 4 Estimates and model fit in full samples Variables

Model 1

Model 2

Model 3

Model 4

Standard Critical p-value Standard Critical p-value Standard Critical p-value Standard Critical p-value estimate ratio estimate ratio estimate ratio estimate ratio FDISUM’FDIENV IPA’FDIENV FDISUM’IPA GRGDP’FDIENV PERGDP’FDIENV LBCOST’FDIENV OPEN’FDIENV INCENT’FDIENV AGE’IPA FSTAFF’IPA TSTAFF’IPA NETFDI’FDISUM TOTFD’FDISUM w2 (df) GFI CFI TLI NFI RMSEA

0.5 0.29 1.01 0.86 0.52 0.31 0.82 0.99

3.65 2.14 9.78 – 4.77 2.65 – 5.95

20.28 (12), p ¼ 0.06 0.92 0.99 0.97 0.97 0.01

0.01 0.03 0.01 – 0.01 0.01 – 0.01

0.54 0.33 1.05 0.82 0.48 0.3 0.56 0.7 0.67

3.49 2.31 8.75 – 4.43 2.72 3.44 3.79 –

41.2 (18), p ¼ 0.01 0.87 0.96 0.92 0.93 0.07

0.01 0.02 0.01 – 0.01 0.01 0.01 0.01 –

0.56 0.67 0.57 0.75 0.91 0.89

3.33 3.94 3.62 – – 5.78

5.35 (4), p ¼ 0.25 0.97 0.99 0.98 0.98 0.01

0.01 0.01 0.01 – – 0.01

0.27 0.52 0.44 0.33 1.05 0.83 0.47 0.3 0.59 0.67 0.69 0.87 0.94 56.2 (31), 0.86 0.96 0.94 0.93 0.05

2.03 3.54 2.41 2.42 9.4 – 4.38 2.67 3.69 4 – – 7.3 p ¼ 0.01

0.04 0.01 0.02 0.02 0.01 – 0.01 0.01 0.01 0.01 – – 0.01

AMOS requires that a single l-path for each construct be set to 1. Therefore regression weights of LBCOST, TSTAFF, and NETFDI were set to 1.00, respectively in models.

addition, RMSEA reached the maximum acceptable value of 0.07 (Byrne, 2001). All Model 3 indices were most excellent with a chi-square of 5.35 (df ¼ 4, p ¼ 0.25), GFI ¼ 0.97, CFI ¼ 0.99, TLI ¼ 0.98, and RMSEA ¼ 0.01. Model 4 had a maximum acceptable value of fit; with GFI ¼ 0.86, CFI ¼ 0.96, TLI ¼ 0.94, NFI ¼ 0.93, and an RMSEA estimate of 0.05 that fell within the acceptable range. Regarding path coefficient, latent variables were statistically significant as well as the observed variables. All standardized estimates of observed variables were more than 0.29 and at 5 percent significant level in modes. The proxy for FDI environments, i.e., FDI, GRGDP, PERGDP, LBCOST, OPEN, and INCENT, in Models

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1, 2, and 4, were supported in statistics. Other proxies, i.e., AGE, FSTAFF, TSTAFF and NETFDI, TOTFDI for IPAs, and FDISUM, respectively, were also supported in related models. As a next step for testing the mediation effect, I examined the relationship between latent variables, FDIENV, IPA, and FDISUM. The three pre-required conditions were satisfied, namely: (1) The estimate of FDIENV on FDISUM was positive and significant in Model 1 (standardized estimate ¼ 0.50, CR ¼ 3.65, po0.01); (2) The effect of FDIENV on IPA was positive and significant in Model 2 (standardized estimate ¼ 0.54, CR ¼ 3.49, po0.01); and (3) The path estimate of IPA on FDISUM was positive and significant in Model 3 (standardized estimate ¼ 0.56, CR ¼ 3.33, po0.01). However, the relationship between FDIENV and FDISUM was not zero when IPA inserted in model (Model 4). The effect of FDIENV on FDISUM was still significant while absolute size of path estimate was reduced from 0.50 in Model 1 to 0.27 in Model 4. From the results, we conclude that partial mediation was indicated. The amount of mediation is 0.23, which was computed as a difference between the coefficients of FDIENV on FDISUM in Models 1 and 4, i.e., 0.50–0.27 ¼ 0.23. These differences can be shown to equal exactly the product of the effect of FDIENV on an IPA times the effect of IPA on FDISUM, i.e., 0.52  0.44 ¼ 0.23 (Baron & Kenny, 1986; Hoyle & Kenny, 1999). Total effect of FDIENV on FDISUM was 0.50 (0.27 of direct effect+0.23 of indirect effect) in Model 4. In addition, the result of Sobel test that provides a more direct test of the mediation hypothesis was also supported at 5 percent significant level (p ¼ 0.05).5 Therefore, the results indicated support for the hypotheses that IPA activity acts as a mediator between a host country’s FDI environment and FDI inflows. In regional analyses, the effect of IPA on FDISUM is significant at a level of 0.01 percent in the American region while other regions are not satisfied with statistically significant level. In two categorized regions such as Europe/America and Middle East/Africa/Asia/Oceania, the goodness-of-fit statistics of the Europe/America samples are more acceptable than those of Middle East/Africa/Asia/Oceania. The indirect effect of FDIENV on FDISUM through IPA is 0.256 in the Europe/America region. The analyses were also conducted between two groups, samples from most developed countries (MDCs) and samples from less developed countries (LDCs). Within this paper, MDC was proxied by the member country of the organization for economic cooperation and development (OECD) plus Singapore and LDC was proxied by non-OECD members. The reasons that Singapore was regarded as a MDC sample are that Singapore ranked second to none in national competitiveness evaluation by IMD in population less than 20 million countries and that it also ranked second in the overall top 10 ranking in the world. Singapore was the only country that ranked in the overall top 10 rankings among non-OECD members consecutively from 2002 to 2004 (IMD, 2004). The result of an analysis showed that the statistical model fit met better in OECD+Singapore than non-OECD and the coefficient of IPA on FDISUM was 0.51 at 5 percent statistical level (Table 5). 4. Concluding remarks MNCs are exposed to uncertainty when they enter a foreign market. They face information costs and risks on entering host countries. Uncertainty stems from a lack of knowledge of an unfamiliar environment (UNCTAD, 1998). IPAs can counter these factors by providing potential investors with information and investor servicing. The marketing potential of IPAs gained through experience, a well-structured, well-staffed overseas network is particularly important since investors are more likely to visit a country after making initial contact at an overseas office. Previous studies on the role of IPAs (Morisset & Andrews-Johnson, 2003; Wells & Wint, 1990) regarded IPA activities as one of the determinants affecting FDI inflows and conducted empirical tests accordingly. However, an IPA can also be more of mediating factor between the host country’s FDI environment and FDI inflows than any other FDI environmental factor. This view led to structural analyses on the mediating effect of IPA activities as conducted in this paper. The empirical results proved the hypothesis that IPA promotion effectiveness, measured by IPA age, IPA overseas staff intensity, and number of IPA staff, has a 5 Sobel test equation is ‘z-value ¼ a  b/SQRT (b2  sa2+a2  sb2)’ where a: regression coefficient for the association between X and mediator, sa: standard error of a, b: raw coefficient for the association between the mediator and the Y (when the X is also a predictor of the Y), and sb: standard error of b (Baron & Kenny, 1986; Sobel, 1982).

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Table 5 Estimates and model fit in regional samples Variables

Areas Europe

Middle East and Africa

Asia and Oceania

America

Standard Critical p-value Standard Critical p-value Standard Critical p-value Standard Critical p-value estimate ratio estimate ratio estimate ratio estimate ratio FDISUM’FDIENV IPA’FDIENV FDISUM’IPA GRGDP’FDIENV PERGDP’FDIENV LBCOST’FDIENV OPEN’FDIENV INCENT’FDIENV AGE’IPA FSTAFF’IPA TSTAFF’IPA NETFDI’FDISUM TOTFD’FDISUM w2 (df) GFI CFI TLI NFI RMSEA

FDISUM’FDIENV IPA’FDIENV FDISUM’IPA GRGDP’FDIENV PERGDP’FDIENV LBCOST’FDIENV OPEN’FDIENV INCENT’FDIENV AGE’IPA FSTAFF’IPA TSTAFF’IPA NETFDI’FDISUM TOTFD’FDISUM w2 (df) GFI CFI TLI NFI RMSEA

0.69 0.17 0.75 0.31 0.95 0.98 0.61 0.18 0.53 0.86 0.39 0.52 0.62 43.00 (31), 0.75 0.86 0.79 0.67 0.13

2.37 0.63 1.44 1.51 9.1 – 3.46 0.85 1.46 1.56 – – 2.33 p ¼ 0.07

0.02 0.53 0.15 0.13 0.01 – 0.01 0.4 0.14 0.12 – – 0.02

8.8 0.98 8.63 0.21 0.95 1 0.06 0.58 0.07 0.67 0.64 0.22 1.32 54.55 (31), 0.65 0.76 0.66 0.62 0.21

0.15 3.47 0.14 0.88 12.96 – 0.24 2.89 0.37 2.87 – – 0.58 p ¼ 0.01

0.88 0.01 0.89 0.38 0.01 – 0.81 0.01 0.71 0.01 – – 0.56

0.9 0.57 1.44 0.59 2.41 0.05 0.34 0.1 0.23 0.07 0.13 1.35 0.41 57.54 (31), 0.67 0.61 0.43 0.49 0.26

0.1 1.15 0.09 0.31 0.34 – 1.41 1.52 1.6 1.56 – – 1.18 p ¼ 0.01

Europe and America

Middle East, Africa, Asia and Oceania

OECD+Singapore

0.26 0.32 0.8 0.43 1.02 0.9 0.61 0.25 0.8 0.53 0.68 0.88 0.95 55.38 (31), 0.79 0.88 0.83 0.78 0.15

1.68 1.65 0.83 3.29 1.16 1.2 0.33 1.57 0.92 4.16 0.69 – 0.1 0.56 0.4 2.2 0.59 2.99 0.73 3.67 0.74 – 0.48 – 0.66 2.08 42.24 (31), p ¼ 0.09 0.8 0.85 0.79 0.65 0.24

0.07 0.11 0.51 0.07 0.4 2.04 0.17 0.08 0.91 0.39 0.7 1.01 0.78 48.97 (31), 0.76 0.82 0.74 0.66 0.15

2.06 1.68 3.65 2.52 9.85 – 4.45 1.61 23.99 2.82 – – 7.83 p ¼ 0.01

0.04 0.09 0.01 0.01 0.01 – 0.01 0.11 0.01 0.01 – – 0.01

0.1 0.01 0.23 0.12 0.01 – 0.57 0.03 0.01 0.01 – – 0.04

0.48 0.49 2.39 0.47 0.6 – 0.51 0.48 2.88 1.84 – – 3.71 p ¼ 0.02

0.92 0.25 0.93 0.75 0.74 – 0.16 0.13 0.11 0.12 – – 0.24

0.01 0.04 0.76 2.9 0.99 11.98 0.68 3.02 1.18 1.93 0.62 – 0.54 2.52 0.07 1.25 0.89 6.47 0.8 4.69 0.98 – 1 – 0.99 29.09 56.95 (31), p ¼ 0.01 0.6 0.89 0.83 0.79 0.25

0.97 0.01 0.01 0.01 0.05 – 0.01 0.21 0.01 0.01 – – 0.01

Non-OECD

0.63 0.62 0.02 0.64 0.55 – 0.61 0.63 0.01 0.07 – – 0.01

0.04 0.29 0.05 0.6 0.09 0.29 0.29 0.28 1.82 0.33 0.24 – 0.17 1.68 0.03 0.45 0.99 1.53 0.42 2.11 0.44 – 0.4 – 1.81 0.34 35.80 (31), p ¼ 0.25 0.86 0.91 0.87 0.64 0.06

0.78 0.55 0.77 0.78 0.74 – 0.09 0.65 0.13 0.04 – – 0.73

AMOS requires that a single l-path for each construct be set to 1. Therefore regression weights of LBCOST, TSTAFF, and NETFDI were set to 1.00, respectively in models.

positive influence on attracting FDI by mediation effect between a host country’s FDI environment and FDI inflows. From the result of analysis, we infer that establishing and enhancing an IPA’s promotion activities can be a FDI policy instrument for improving the FDI attracting environment of the host countries. Furthermore, the investment promotion function is more easily implemented in comparison with changes to the economic factors (e.g., market size or labor cost) that influence the overall attractiveness of a particular FDI destination,

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which may be difficult and time consuming, or even entirely beyond government control. The point to be understood carefully from the result is that simply increasing the resources of an IPA will not automatically lead to an impact on FDI inflows. Only with efficient IPA coordination function will FDI inflows increase. In other words, enhancing an IPA promotion activity is not the only road to inducing FDI, but should be undertaken along with measures to develop other determinants of a location’s attractiveness. That policy implication cannot usually be derived from previous studies assuming that the role of the IPA as a factor of the FDI attraction environment is located in same layer as other independent variables of FDI. This paper should be viewed as an initial attempt to examine empirically the mediating effectiveness of investment promotion agencies. Despite the contributions, weak points in this paper where improvement is required remain. In measuring the effectiveness of IPA promotion, this paper does not reflect the impact of various characteristics of IPA activities such as after-care services and policy advocacy services (i.e., problem-solving capability, sectoral targeting, and activities to reduce bureaucratic barriers, etc.) nor IPA structures such as government and/or quasi-government. It also cannot be completely objective since it relies in part on qualitative data derived from the survey questionnaire. Therefore, three directions would be proposed for future research. The first direction should consider a more various proxy of promotional techniques and the structure of IPAs. The evaluation of an IPA’s techniques and structure should add considerably to the evidence on the influence of promotion on FDI inflows. The second direction should also consider various proxy of FDI performance, i.e., quality of FDI, as dependent variables. This is certainly true for sophisticated IPAs that focus on job creation, spillover effects of technology transfer to host country. The third direction would consist of supplementing the data collected in this survey by extending the coverage period over a longer period of time. Future research, depending on the data availability, should carefully explore the time lag between overall investment promotion and the decision of foreign investors to invest in a country.

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