significant degree of influence on its management. The threshold of 10%-or more-ownership of a
firm’s capital is in general required to be accounted for as a direct investment.
FDI implies a long-term relationship between a host economy and a foreign resident who wants
to invest in this host economy. Two important issues may be raised when FDI is to be studied. One
question is to know whether the host economy benefits from the capital import. The other question is
about the motivations and the expectations that led the foreign resident to invest in that host economy.
This paper addresses the latter by carrying out an econometric analysis on the FDI determinants in
three European regions: Baden-Württemberg in Germany, Catalunya in Spain and Lombardia in Italy
(see map in Annex).
1.2 The determinants of FDI
What attracts FDI? What are the benefits that foreign firms search by investing in host
countries? Shatz and Venables (2000) distinguish two main reasons why a firm would like to make
direct investments in foreign countries. The first one is to better serve the local market. This type of
FDI is called “horizontal” or “market seeking” since it implies a duplication of production plants. The
main motivation is to economize on tariffs and transport costs. The second reason is to have access to
lower-cost inputs. This type of FDI is called “vertical” or “production cost-minimizing” since there is
fragmentation. The motivation is to economize on production factors to maximize the profits on each
part of the good production. Most of the world’s FDI is horizontal in nature and, hence, are driven by
market size.
The great variety of FDI determinants observed in investor surveys (e.g. A.T. Kearney, 2003)
emerges in the form of a lack of consensus in the econometric studies. This can be explained by the
lack of data, the different variables as FDI determinants used by the empirical literature and, possibly,
by the use of aggregate data.
In the literature a few FDI determinants are regularly cited:
- Market Size as measured by GDP or GDP per capita seems to be the most robust FDI determinant
in econometric studies. This is the main determinant for horizontal FDI. It is irrelevant for vertical
FDI. (Shatz and Venables 2000, Billington 1999, Branard 1997, Wheeler and Mody 1992, Kravis
and Lipsey 1982).
- Transport costs will be determinant for horizontal FDI. However it can also be decisive for
vertical FDI since this is often an investment with the objective to export the goods produced.
Branard (1997) finds a positive correlation between FDI and transport costs.
- Production factor cost: This is the main criterion motivating vertical FDI. Lower cost is also
favorable to horizontal FDI. Feenstra and Hanson (1997) find that labor cost is positive and
significant for US FDI in Mexico. A similar result is obtained by Wheeler and Mody (1992) for
US FDI in electronics.
- Agglomeration effects signal high quality of infrastructure, human capital, high productivity and
specialization. These affect both horizontal and vertical FDI are found to be highly significant for
US FDI by Wheeler and Mody (1992).
- Fiscal incentives tend to affect more vertical FDI since it is cost-sensitive. Many countries have
tax incentives to attract FDI.