International business strategy expert Alvaro Cuervo-Cazurra shares insight on the implications of outward foreign direct investment in emerging economies.
Q: Is government support important for a firm that is considering transforming to multinational?
Government support is not a requirement for expanding abroad but can be useful. It can help the company deal with the challenges inherent in foreign expansion, especially at the beginning when managers and employees may have limited knowledge on how to operate in other countries.
Q: Can outward foreign direct investment of emerging economies help build economic performance?
Outward foreign direct investment in emerging economies can help companies improve their competitiveness by exposing them to new ideas abroad that can lead to innovation at home. It can also help them obtain more sophisticated capabilities from alliances with and acquisitions of companies that have advanced technologies. All this has positive spillovers in the home country as firms with foreign direct investment, i.e., multinationals, transfer their capabilities directly to their suppliers and distributors via training and indirectly to other competitors that copy their actions, ultimately helping the country upgrade and develop.
Q: What are some of the potential negative consequences of outward foreign direct investment?
There is a view that outward foreign direct investment may lead to the hollowing out of the home country as firms move operations to other countries in search of lower costs of production. However, in most cases there is a positive impact on the home country with foreign investments complementing domestic investments by becoming a sales channel or providing better inputs.
Governments in emerging economies are supporting the transformation of their firms into multinationals. This policy has generated a debate because, unlike related policies such as export promotion or the attraction of inward foreign direct investment, which have direct influences on employment and investment in the home country, the support of outward foreign direct investment (OFDI) in some cases is seen as supporting investment and employment abroad. Nevertheless, it appears that outward foreign direct investment has positive spillovers in the home economy.
In this report we take a different approach from the traditional analysis of spillovers and instead analyze the relationship between multinationalization and performance to understand under which conditions firms need for government support to become multinationals. We propose that if managers find it profitable to expand their firms abroad, the government may not need to provide support as managers already have incentives in place and the spillovers would happen. Thus, government support for OFDI can be directed at helping firms become multinationals by reducing constraints on and facilitating the process of OFDI rather than at directly subsidizing the investments.
We analyze this relationship in a panel of publicly traded Thai firms in the period 1990- 2012. We find that internationalization appears to have a positive impact on profitability and may follow a curvilinear relationship. We also find that there is no clear relationship between the location of international expansion and profitability, except for investments in offshore financial centers that appear to have a positive relationship.
From these arguments and findings we recommend caution on public support for OFDI. Managers appear to have the incentive to engage in foreign investment and thus may not need government support to continue expanding their firms abroad. Government policy can be directed at lifting constraints to investments in the home country and in host countries that will reduce the cost of expanding, allowing managers to choose the destination countries they consider to be better for the success of their firms.
Access the full report here.