Cultural, Political, and Economic Factors in the Inbound Foreign Direct Investment Process

2016Cambridge Business & Economics ConferenceISBN : 9780974211428

CULTURAL, POLITICAL, AND ECONOMIC FACTORS IN THE INBOUND FOREIGN DIRECT INVESTMENT PROCESS: NEW CONCEPTS AND MEASURES

Kylie M. Bos

Kelsie L. Hutter

George M. Puia*

Saginaw Valley State University

7400 Bay Road

University Center, MI 48710

Phone: +1989.964.6074

Fax: =1989.964.4699

*Corresponding author

Key Words: FDI, Culture, Diversity, Regulation

CULTURAL, POLITICAL, AND ECONOMIC FACTORS IN THE INBOUND FOREIGN DIRECT INVESTMENT PROCESS: NEW CONCEPTS AND MEASURES

ABSTRACT

Purpose- The purpose of this paper is to research the effects of national culture, within-country diversity, and the political-economic factors of corruption, and regulatory quality on inbound foreign direct investment.

Design/methodology/approach- The researchers modeled a series of publicly available measures on inbound FDI to explore the net effects of culture, cultural diversity and public policy. New variables in this model include within-country diversity and the recently developedHofstede dimension of indulgence/restraint.

Findings/Implications-Cultural and economic independent variables were statistically significant in helping explain national levels of inbound foreign direct investment (R^2 = 0.415; overall model significant 0.000). The model found that culture, cultural diversity and political-economicvariables were significant in their contribution to FDI. The results are important to policy makersin that they offer areas where host nations might attractmore inbound FDI.

Originality/value- Most prior studies have looked at culture without considering within-cultural diversity or more recent cultural constructs. This paper remedies that shortcoming.

INTRODUCTION

Many scholars have written on the barriers to foreign direct investment (FDI) (Davidson, 1980; Bhardwaj, Dietz, and Beamish, 2007; Dunning, 1994). Traditionally, three academic domains have influenced the FDI literature: political, economic, and national-cultural (Habib and Zurawicki, 2002; Asiedu, 2006; Puia andMinnis, 2007). Each stream has focused on specific metrics from within their domain, e.g., political researchers explored topics like government corruption and political instability (Habib and Zurawicki, 2002) as well as quality of government regulation, (Kaufmann et al., 2008); while economists identified effects of financial regulations and market size (Asiedu, 2006). Investors must also take into consideration the national culture and the implicated cultural barriers of investing in a new and culturally distant country (Dattaand Puia, 1995). Potential cultural barriers include dissimilarities between countries regarding their deeply held local values (Hofstedeet al, 2008). Unfortunately, the literature on foreign direct investment does not seem to reflect the most recent research on national cultures. Our paper attempts to close that gap by exploring two cultural dimensions not previously considered by other scholars, indulgence and within-country diversity.

Much of the previous research on cultural differences relied on Hofstede’s four original constructs of national culture- individualism, power distance, uncertainty avoidance, and masculinity (Hofstede, 1980). This paper will assess the importance of the connection between inbound foreign direct investment and Hofstede’s more recent construct, indulgence (Hofstede andMinkov, 2011). Additionally, international business research has identified an important link between cultural diversity within nations and national levels of innovation (Puia and Ofori-Dankwa, 2013). Since innovation and investment share a known linkage, we felt it was important to explore this dimension by analyzing measures of within-nation cultural diversity.Lastly, to keep this paper comparable to prior research we used political and economic covariates common to prior research.

This research has the potential to contribute to the FDI literature in two important ways. First, an empirical study of indulgence and restraint further clarifies the role of culture in FDI decisions.Additionally, while countries have central cultural tendencies, they can vary greatly from one another in the extent to which values are moderated by within country diversity. This paper adds to the literature by exploring effects of within-countrydiversity in addition to culture on FDI. The use of these metrics may also provide practitioners with a practical way of quantifying cultural differences in their FDI decision process.

THEORETICAL BACKGROUND

FDI Outcomes

Policy makers are deeply interested in FDI for its ability to spur economic growth and job creation. According to Moran (2012), FDI occurs when a “corporation in one country establishes a business operation in another country, through setting up a new wholly-owned affiliate, acquiring a local company, or forming a joint venture in the host economy.” De Mello (1999) also suggests that FDI can include agreements such as licensing, leasing and franchising.Lipsey (2001) states that FDI can be subdivided into two categories - a macro and a micro view. The macro view focuses on the international finance decisions related to FDI, such as the flows of capital and the value of stock while the micro aspect of FDI focuses on the investor’s motivations to invest in a particular country (Lipsey, 2001). With the growth of global business, technology and international trade, enterprises and scholars have been researching the benefits of FDI and its effects on the source country, as well as the host country (Dunning and Narula, 2003; Hermes &Lensik, 2003; Lipsey, 2004).

Dunning was one of the first scholars to systematically analyze the process of inbound foreign direct investment, using the United States’ investment in the British manufacturing industry as the subject of his research (Dunning, 1958). Dunning’s initial findings on inbound FDI has since spurred similar investigations in numerous countries (Dunning, 1994).More recent findings by Dunning have suggested that FDI is not only a complementary aspect of trade in today’s global economy, but it is also important in regards to economic integration as a whole (Dunning, 2013). In our research, the dependent variable is inbound FDI.

Hofstede’s Cultural Value Dimensions

There have been numerous contributions in regards to Hofstede’s original five constructs of culture and the effect these values have on an enterprise’s desire to invest in a foreign market. In 2012, Tang analyzed four of Hofstede’s dimensions- individualism, power distance, uncertainty avoidance and masculinity- and whether the differences in cultural distance make FDI attractive or undesirable. Additionally, Shane (1994) researched the effects of national culture on a firm’s willingness to select either licensing or foreign direct investment. Dimensions, such as individualism, are broadly represented in the literature; however, Hofstede’s most recent dimension- indulgence versus restraint- is not currently represented. The lack of representation in literature in regards to indulgence versus restraint and its potential effect on inbound FDI helped prompt this paper.

Indulgence v. Restraint

Hofstede’s sixth dimension of national culture is a recent addition to his research, added in 2010 (Hofstede, 2011).Indulgence versus restraint is identified as the social acceptance of acting to fill one’s human desires rather than society holding social norms that encourages one to restrain from these desires (Hofstede, 2011). Indulgence tends to be prevalent in North and South America, Western Europe and parts of Sub-Sahara Africa. Highly restrained societies often have a perception of helplessness contrary to the indulgent view of being in control of one’s life, and are also less likely to remember positive emotions,which in some countries results in lower birthrates and fewer obese people. Restrained societies can be found in Eastern Europe, Asia and in the Muslim world (Hofstede, 2011). As of this writing, there have not been any indexed articles on the relationship between indulgence and inbound FDI.

H.1. Indulgence will be positively associated with inbound FDI

Individualism

According to Hofstede (2001), individualistic countries provide loosely framed societies where individual interests supersede those of the group. As a result, individuals are allowed to pursue personal goals and interests (Hofstede, 2001). Shane’s seminar work (1992) found a significant positive relationship between individualism and business-led economic growth. Puia and Ofori-Dankwa (2013) found significant positive effects of individualism and the generation of both patents and trademarks. The literature does clearly suggest that in individualistic cultures, success is earned rather than attributed, therefore in individualistic cultures there is greater pressure on the individual to perform (Hofstede, 2001). Given this propensity of performance driven individuals, one would anticipate FDI would flow first to individualistic cultures.

H.2. Individualism will be positively associated with inbound FDI

Within-Country Diversity

Some scholars believe it important to move beyond a traditional emphasis on national cultures to embrace within-nation diversity or intra-cultural variation (ICV) – the extent to which there is variation or cultural diversity within a nation’s culture (e.g. Au, 1997, 1999; Morris &Schindehutte, 2005; Tayeb, 2001;Puia and Ofori-Dankwa, 2013). Au (1997, 1999) makes an unambiguous case for within-nation diversity to supplement aggregated measures of culture, like those of Hofstede, due to differences in spoken language and ethnic composition, among other factors. Kluckhohn and Strodtbeck (1961) were among the first to recognize the significance in the difference in cultures within a single country. West and Graham (1998) observed that measures of linguistic diversity are available from a wide range of culture. Most studies investigating the national culture –foreign direct investment relationship have simply not taken within-country cultural variations into account. This research explores a dominant factor in within-country diversity, the presence of ethnic and linguistic differences.

Active Languages

One of the key dimensions of within-country diversity is ethnic difference, particularly when different languages are involved (Lieberson, et al., 1981). The number of active languages in a country or society can be also used as an indicator of cultural diversity. In their research, Puia and Ofori-Dankwa (2013) uncovered a correlation between ethnolinguistic diversity and innovation. The data selected for active languages was acquired fromEthnologue, and indicates the total count of living languages used as a first language in a given country (Lewis et al., 2015; Studer, 1998). As is common, a log transformation of the index was conducted to improve its linearity (Puia and Ofori-Dankwa, 2013). Currently, any effect or correlation between the number of active languages and inbound FDI is not represented in literature.

H.3. Countries with a higher amount of active languages will be positively associated with inbound FDI

Control of Corruption

Corruption is an important focus of study for those analyzing FDI, as it has the ability to render an investment target untrustworthy. In the simplest sense, corruption adds both cost and uncertainty, reducing the number of potentially profitable investment projects. Furthermore, corruption has the capacity to provide an advantage to local investors who already understand how the system works and how to manage the corruption in their favor (Zurawicki and Habib, 2010). This creates a greater challenge for outside investors to operate in a corrupt country.Given these issues, a country that better controls corruption will be a more desirable target for investment.

H.4. Control of Corruption will be positively associated with inbound FDI

Regulatory Quality

Regulatory quality describes governmental ability to establish and enforce regulations and policies that dictate a business’s ability to operate and develop (Kaufmann, 2008). Regulatory quality affects both existing firms and entrepreneurs (Reger et al., 1992; Puia et al., 2015). For example, in regulating market entry, it only takes two days to begin operation in Canada, and the compliance with two procedures; however, in Italy it takes 62 business days, and compliance with 16 procedures (Djankovet al. 2002).Clearly these regulations differ from country to country, causing them to be an extremely important factor for investors to address when looking to enter a new country. There are two opposing views on regulatory quality. One side views regulation to be implemented solely to benefit government, whereas, the other side views the positive relationship between government regulation and industry success due to an industry’s desire to adapt beneficial regulations (Stigler, 1971).

H. 5. Poor regulatory quality will be negatively associated with inbound FDI

METHODS

The population that we began to analyze was limited tothe Hofstede’s national values dataset - Hofstede’s construct of indulgenceprovided data for only88 countries. The other data sets that we used, such as the Ethnologue dataset of active languages within a country included a much larger list of countries. Although, the Hofstede dataset limited our ability to analyze data from a larger population ofcountries, we found the dataset useful as thecountries included in the list offeredsubstantial cultural diversity.The use of Hofstede’s dataset also allowed us compare results to prior FDI studies that indicated correlated investment levels with culture.

Given that this research exploredthe potential relationship between one dependent variable, a categorical variable denoting the target country, and multiple covariates, the authors selected the univariate version of the General Linear Model as the primary analytical tool.

RESULTS

The cultural and economic independent variables were statistically significant in helping explain national levels of inbound foreign direct investment (R^2 = 0.415; overall model significant F=10.62; P=0.000). (See Table 1: Univariate Analysis of Variance). The model found that culture, cultural diversity, and political-economic factors were significant in their contribution to FDI. The results are important at the policy level in that they offer areas where host governments can make countries more attractive to inbound FDI.(See Table 2: Descriptive statistics and correlations). As anticipated, individualism, the number of active languages (diversity), regulatory quality, and control of corruption were significant.

Not all results were as anticipated. While prior measures of culture (e.g. individualism, uncertainty avoidance) had previously been correlated with investment decisions, there was a slight lack of statistical support for the new metric of indulgence. This might be explained in part by the strong correlation between indulgence, control of corruption, and regulatory quality. (When regressed without these variables, indulgence is significant with p=0.000). As this study compared the inbound FDI data from only four countries, it limited the sample size. We anticipate a large sample size would also validate indulgence versus restraint as a significant construct.

DISCUSSION

As we have seen in the literature, there are multiple factors that influence inbound foreign direct investment. Given the significance of FDI to employment-related economic growth and job creation, policy makers need to understand the obstacles and enablers of FDI.

Undeniably, the control of corruption is an issue. All foreign direct investment requires a certain level of trust, and corruptionhas a tendency to disrupt the basic framework of trust. Similarly, there is less incentive for investors to place bets in markets that lack an effective regulatory environment. Further, it may well be that there are other equally important political and economic factors that also influence FDI. Further research may wish to explore alternative measures of government policy and institutional frameworks. Governments often have limited resources politically as well as economically; they may not be able to adjust all of their policy variables at one time. These results seem to suggest that the control of corruption and regulatory quality may need to be the first steps; certainly additional research on the sequence of policy enhancements is justifiable. Additionally, this paper offered a static analysis of the role of government. It may be that given more lag time, government policies may have larger effects. Further research might wish to explore the question of government policy in a time series framework.

Within-country diversity was significant, indicating that ethno-linguistic diversity influences inbound FDI. From a policy perspective, countries are seldom ableto change their own cultures without a multi-generational time commitment. However, diversitycan be changed through immigration policy or other measures. In a time when the concept of open borders is under challenge, it is important to recognize the economic role of diversity in foreign direct investment models.

There are many unanswered research questions in regards to diversity. We do not know if there is a sufficient level of diversity. Additionally, research has yet to be conducted on FDI using constructs like linguistic fragmentation. We hope the findings in this paper continue to spur a scholarly dialogue on the relationship between culture, diversity, government policy and inbound foreign direct investment.

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