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Direct private foreign investment : a survey and reconsideration of traditional theory Chua, Joon Eng

Abstract

The purpose of this study is, first, to outline the neo-classical investment theory and the main competing hypotheses which seem to form the bases of the policy measures adopted by governments of capital-importing and capital-exporting countries to stimulate the flow of direct private foreign investments (DPFIs), and, second, to re-examine and reconsider a few of the assumptions and implications of the theory and the hypotheses in the light of certain reported investigations of direct foreign investment decisions of firms. A review of the neo-classical investment theory shows that the theory assumes that firms aim at profit maximization, that firms systematically scan domestic and foreign environments for investment opportunities and that firms undertake direct investments, whether domestic or foreign, to maximize their profits. According to this theory, when firms make investment decisions, they have before them a number of investment propositions, both domestic and foreign. They then carefully appraise these propositions in terms of costs, benefits and risks and decide in favour of those propositions which promise them high returns and low risks. This theory therefore implicitly suggests that it is possible to provide considerable stimulation to the flow of DPFIs by merely affecting firms' expectations of returns and risks of such investments. Disagreements over the validity and usefulness of the neo-classical investment theory as an explanation of the flow of DPFIs lead to a formidable number of alternative explanations or hypotheses. Some of t hese are: (1) the higher profit rate abroad hypothesis, (2) the lower costs abroad hypothesis, (3) the monopolistic competition hypothesis, (4) the growth of the firm hypothesis, (5) the marketing considerations hypothesis, (6) the market size hypothesis, (7) the maintenance of market hypothesis, and (8) the product cycle hypothesis. Each of these hypotheses is based on a number of assumptions, most of which seem similar to those made by the neo-classical investment theory for most of them implicitly assume that: (1) firms normally look across their national boundaries for investment opportunities, (2) firms possess financial and suitable managerial resources to undertake direct investments abroad, (3) firms are generally prepared to use their resources to investigate direct foreign investment projects, and that (4) firms make cross country comparisons of projects to determine which project or projects they should undertake. Some reported investigations of the foreign investment decisions of firms, however, suggest that firms do not, in fact, systematically scan the globe for areas to make an investment and that most firms do not normally consider the possibilities of investing abroad. The reasons why firms do not normally look abroad for investment opportunities can probably be found in: (1) organization traditions and attitudes, (2) generally held beliefs of firms, (3) limitation of company resources, (4) departmental structures, (5) complexities of investing abroad, and (6) information and investigation costs. These investigations also suggest that: (1) generally firms consider direct investments abroad only when they are "pressured" (or "threatened") or "persuaded" (or "instigated") to do so, (2) when firms consider direct foreign investment projects, they agree in principle right from the beginning to accept them, (3) firms evaluate direct foreign investment projects sequentially and do not weigh them alongside each other, (4) different firms use different criteria to determine the acceptability of foreign investment projects. This study accepts the conclusions of these investigations and suggests that any theory of DPFIs has to recognize that direct foreign investment alternatives are not given to firms and that there is a need to incorporate the "initiating forces" into the theory. It also suggests that it is probably not possible for countries to provide considerable stimulation to the flow of DPFIs without first devising some policy measures to initiate firms to consider investment opportunities across their national boundaries.

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