Foreign Direct Investment Determinants Economics Essay

This paper provides a research proposal investigating the question of determinants of FDI in the ASEAN and the SAARC. significant relationships and differentials between potential Macro-economic, country specific and Transnational company specific determinants of Foreign Direct Investment in the ASEAN (Indonesia, Malaysia, the Philippines, Singapore, Vietnam and Thailand) and select SAARC countries (Sri Lanka and India) using data sets from 1990-2011 are identified. The paper ascertained all objectives of the study and conducted a literature review where 32 variables and 32 hypotheses were identified to test the research question. The proposal was critically centred on research design and research method but also the research conducted time frames, weaknesses and bibliographic references which are to be proposed for future research in to the author’s research topic. Finding of the study are to be conducted as per the time frame. Furthermore the Author provides definitions of all variables in the annexure 2.

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Abstract

This study aims at analyzing the determinants of foreign direct investment inflows for a

group of European regions. The originality of this approach lies in the use of

disaggregated regional data. First, we develop a qualitative description of our database

and discuss the importance of the macroeconomic determinants in attracting FDI. Then,

we provide an econometric exercise to identify the potential determinants of FDI inflows.

In spite of choosing regions presenting economic similarities, we show that regional FDI

inflows rely on a combination of factors that differs from one region to another.

Design/Methodology/Approach

A mixed method approach to research is conducted gathering secondary data from the World Bank Statistics, International Financial Statistics (IFS) of the International Monetary Fund (IMF) and the Global Market Information Database (GMID). Global Market Information Database (GMID), the database of Department of Statistics for each country (Malaysia, Indonesia, Thailand, Singapore and Philippines) and the Bloomberg database. Central bank annual reports of all countries. Furthermore primary data analysis will be conducted post testing where interviews with specialists in the field of Finance and economics will help make meaning to the results.

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The paper proposes to use a multiple regression analysis method where robustness of results and hypothesis are proven/disproven using ANOVA, Correlations and Model significance. This data will be tested using various statistical packages such as SPPS and visually will be shown to the reader via MS project. Then based on the variables ascertained from literature the hypothesis will be proven or disproven. Furthermore to stimulate the interest of the reader the data will be displayed as much as possible in the research report stage using graphical software such as MS project, Microsoft visio, Mind Mapping software and Matlab.

Findings:

The following paper is a research proposal and no findings have been ascertained.

Research limitations and implications:

Certain variables lacked time series data and may prove to have some level of significance on FDI. Certain countries did not have the required data to test Hypothesis.

Practical Implications:

The finding will be a guideline so that policy planners in emerging markets can use prior to making any type of investment decision related to the markets concerned. Also the paper after the finding will have section on the lessons learnt for each country or region in terms of FDI and it will be catalyst paper for future research and academia.

Originality/value

The paper extends and expands the knowledge of international capital flows and provides a more nuanced understanding of the importance of internal market dynamism in attracting FDI in the ASEAN and SAARC.

Paper type: Research

Chapter 1: Introduction

1.0 Background

One of the remarkable features of globalization in the 1990s was the flow of private capital in the form of foreign direct investment. FDI is an important source of development financing, and contributes to productivity gains by providing new investment, better technology, management expertise and export markets (Sahoor, 2004). Domestic investment still accounts for the majority of the total investment in developing economies. Foreign investment can only complement this. However, each form of foreign investment plays a distinct and important role in promoting growth and sustainable development, boosting countries’ competitiveness, generating employment, and reducing social and income disparities. Non-FDI flows may work either in association with FDI, or separately from it. As no single type of flow alone can meet investment needs, it is vital to leverage their combinations to maximize their development impact (UNCTRAD, 2011) Foreign investors are also expected to transfer intangible assets such as technology and managerial skills to the host country and provide a source of new technologies, processors, products, organizational technologies and management skills as a strong impetus to economic development (Dr Catherine S.F. et .al, 2011)

As per the Ernst & young report six factors will shape our world including, Emerging markets increase their global power, Cleantech becomes a competitive advantage, Global banking seeks recovery through transformation, Governments enhance ties with the private sector, Rapid technology innovation creates a smart, mobile world and Demographic shifts transform the global workforce. If we Identify the key emerging markets globally as per a study conducted by Ernst and Young suggests “Estimates show that 70% of world growth over the next few years will come from emerging markets, with China and India accounting for 40% of that growth. Adjusted for variations in purchasing power parity, the ascent of emerging markets is even more impressive: the International Monetary Fund (IMF) forecasts that the total GDP of emerging markets could overtake that of the developed economies as early as 2014” also other emerging markets were identified such as . “The emerging markets already attract almost 50% of foreign direct investment (FDI) global inflows and account for 25% of FDI outflows. In fact the largest The brightest spots for FDI continue to be Africa, the Middle East, and Brazil, Russia, India and China (the BRIC’s), with Asian markets(Thailand, Indonesia, Malaysia, the Philippines, Singapore and Thailand) of particular interest at the moment. By 2020, the BRICs are expected to account for nearly 50% of all global GDP growth” (Ernst & Young,2011). In fact from the top 20 FDI inflow host countries as depicted in figure 3 China, Hong Kong, Singapore, India and Indonesia are among the top recipients in the world. In fact as per the UNCTAD’s World Investment Prospectus Survey(WIPS) confirms that developing and transition economies are becoming important investors, and this trend Is likely to continue in the near future (UNCTAD, 2011) “Therefore Securing a strong base in these countries will be critical for investors seeking growth beyond them” (Ernst & Young, 2011). As depicted below in figure 2 shows the FDI inflows both global and group of economies, and it is estimated that in 2014 share of GDP growth in developing countries will surpass that of developed cuntries as shows bellow in figure 2, furthermore as Krugell, 2009 Suggets The spatial distribution of FDI depends firstly on interregional differences in factor and resource endowments. When foreign firms can choose between different regions, cities or towns, they locate in favourably endowed places. Investors also prefer to locate where other firms cluster together. Agglomeration creates a large local market and ensures diverse intermediate inputs and a thick labour market. This generates positive externalities which reduce costs and increase competitiveness and hence attracts investors.

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Figure 1 : Top 20, Host recipients of FDI (Source: UNCTAD, based on annex table I.1 and the FDI/TNC database (www.unctad.org/fdistatistics).

a Ranked on the basis of the magnitude of 2010 FDI inflows. Note: The number in bracket after the name of the country refers to the ranking in 2009. British Virgin Islands, which ranked 12th in 2010, is excluded from the list)

Figure 2: World GDP forecast (World Economic Outlook, Business Source Monitor, 2010)

To secure strong base as advised by Ernst & Young for investors require an understanding on the history, policy, trends, important lessons learnt from a global context with an emphasis in the South, East and South East Asian regions to understand its investment environment prior to understanding FDI determinants, which will be covered in section 1 of the report. Then the essay will conduct a literature review looking at various benchmark indices that measure FDI performance together with other literature which will help in understanding the location or regional FDI determinant factors at a country specific and regional level. Then the determinants will be tested by model creation for its significance by using data from a variety of reputed sources and testing panel data using OLS regression and a unit root equation using panel data from 1xxx-2010. Then the findings will be done both for a country specific angle and at a regional level. Then a TOPSIS analysis will be conducted to see if FDI promotes competitiveness. Then the findings will be interpreted and finally the dissertation will be concluded with some considerations for investors/Policy Makers.

1.0.1 History, policy, Trends and Lessons learnt through Global FDI and FDI in the ASEAN and SAARC

1.0.1.1 Global trends and directions in FDI

As stimulus packages and other public fiscal policies fade, sustained economic development fade, sustained economic recovery becomes more dependent on private investment, at present Trans National Corporations (TNC) have taken a customary role as private investors (UNCTRAD, 2011). Global FDI rose to $ 1.24 Billion in 2010 from $1.185 Billion, but were 15% below pre-crisis averages. This in contrast global industrial output and trade, which were back to pre-crisis levels. UNCTAD estimates that Global FDI, will recover to pre-crisis level in 2011, increasingly to $1.4 Trillion-1.6 Trillion, approaching its 2007 peak(as per UNCTAD econometric model), this is baring any global economic shocks, that may arise due to a number of risk factors (UNCTRAD, 2011) risk factors especially for TNC’s have become critical as unpredictability of global economic governance, possible widespread sovereign debt crisis, fiscal & financial sector imbalances, rising inflation, apparent signs of overheating certain economies; might derail global FDI. Therefore investors have changed there preferences as the global FDI trends depict below:

Developing (including ASEAN and SAARC) and transition economies contributed more than half(52%) of Global FDI flows while its outward flows were also the highest, while intra-regional flows of FDI between developing countries plus TNC were also high. Figure 3 depicts the transition of FDI flows over 3 decades from developed to developing and transition economies (UNCTRAD, 2011). TNC are actively in those countries due to its cost effectiveness and to remain competitive in the global production networks and also since the consumption patterns in the world are shifting (UNCTAD, 2011).

52% to developed and transition countries

figure 3: World FDI inflows, global and by group of economies(Source: UNCTAD, based on annex table I.1 and the FDI/TNC database (www.unctad.org/fdistatistics)

In the South, East and South East Asia inflows rose in the region by 24% in 2010, reaching $300 Bn, as a result of economic growth, good macro-economic fundamentals and higher commodity prices spurred FDI, figure 4 depicts FDI inflows to the developing economies in the region and it is clear that most FDI flows are flowing to South, East and South East Asia.

Figure 4: FDi inflows to developing and transition economies, by region, average of 2005-2007 and 2008 to 2010 (Source: UNCTAD, FDI/TNC database (www.unctad.org/fdistatistics).

International production expansion in foreign sales, assets and employment TNC’s account for 1/10 of global GDP and 1/3 of world exports. TNC contribute largely as global presence sustains price advantage, cost effectiveness and make them remain competitive with global production networks. Furthermore state owned TNC’s account(650 in number) with its affiliate network (8500 in number), their outward investments account for 11% of global FDI flows. Therefore the governance of state owned TNC’s have raised concerns of late, the level playing field, national security, regulatory implications for international expansion becomes important for these companies. Understanding their incentives for capital flows is important to understand FDI flows.

In 2010, 70% projects(Cross border merger and acquisition (M&A) and Greenfield FDI projects) from these were invested in these regions. Mainly FDI’s were inherited by BRIC countries in which China and India have gained ground In recent years following rapid economic development in home countries, abundant financial resources are strong motivations to acquire resources and strategic assets abroad. Infact Chinese and Indian companies saw large capital investment beyond their own regions. In fact in 2010, there were seven mega deals(12% of the total inward FDI came from these deals as shown below in table 1 in appendix 2 of this report were done by Chinese companies mainly to the Latin American Region.

TNC ROI on FDI is approximately 7.3%, where leverage has shown decline, as proxy by outward FDI stock over foreign assets.

Sales over foreign affiliates increased by 9.1%, reflecting strong revenue in developing and transition economies, employment continued to expand, as efficiency seeking investments increased.

A new recent development is that TNC’s account for nearly 80% of global FDI and TNC’s are in the developing world account for 70% of global FDI flows.

Strong profits of TNC’s in emerging markets were incentives for further investments. Infact 100 of the largest TNC companies of Anglo-American origins gained 93% of their profits from these economies, this includes high EBIT positions for Coca-Cola, Toyota Motor, Unilever, SABMiller, Nestle, Barrick gold, Holcim, British American Tobacco, Nissan Motor, BASF, Honda Motor and Bayer.

Even state owned TNC’s became important to global FDI contributing largely to global FDI inflows and outflows, the 15 largest state owned TNC’s account for large chunk of global FDI. Geographically 56% of State owned TNC’s are located in China (50), Malaysia (50) and India (20) are among some top participants. Among them include Volkvagen group, GDF suez, General Motors, CITI group, Tata steel to just name a few.

If we consider FDI by sector wise classification, FDI towards manufacturing sector increased while services and primary sector saw declines. Within manufacturing business cycle sensitive industries such as metal and metal products, electronics and wood products saw declines while chemicals, food, beverages & tobacco, textile, automobiles showed rapid increases in emerging economies. In fact manufacturing related FDI rose to 23% in 2009 to $554 Billion, this as seen made TNC’s more receptive to restructuring in to more profitable and productive units FDI in the primary sector decreased in 2010 despite growing demand for raw materials and energy resources, and high commodity prices. FDI projects (including cross-border M&A and Greenfield investments) amounted to $254 billion in 2010, raising the share of the primary sector to 22 per cent, up from 14 per cent in the pre-crisis period(UNCTAD, 2011).

Natural resource-based companies with sound financial positions, mainly from developing and transition economies, made some large acquisitions in the primary sector. Examples include the purchase of Repsol (Brazil) by China’s Sinopec Group for $7 billion, and the purchase of the Carabobo block in the Bolivarian Republic of Venezuela by a group of investors from India for $4.8 billion. The value of FDI projects in the services sector continued to decline sharply in 2010, with respect to both 2009 and the pre-crisis level of activity. All main service industries (business services, finance, transport and communications and utilities) fell, although at different speeds(UNCTAD, 2011).

Business services declined by 8 per cent compared to the precrisis level, as TNCs are outsourcing a growing share of their business support functions to external providers, seeking to cut internal costs by externalizing non-core business activities Transportation and telecommunication services suffered equally in 2010 as the industry’s restructuring is more or less completed after the round of large M&A deals before the crisis particularly in developed countries (UNCTAD, 2011).

Figure 5 depicts the breakdown of Sectoral distribution of FDI projects during the 2009-2010 period.

Figure 5: Sectoral Distribution of FDI projects (Source: UNCTAD. a Comprises cross-border M&As and Greenfield investments. The latter refers to the estimated amounts of capital investment.)

In terms of mode of entry Greenfield investment has become much larger that cross-border M& A, however TNC’s. Recovery of FDI flows in 2011 reliant on the rise of both Greenfield and M&A. as depicted in figure 6 M&A and Greenfield projects have increased by 36% to $ 339 Bn as a result of higher stock prices increased the purchasing power of investors to invest abroad, the higher the values of corporate assets in 2010 raised the leverage of investors to undertake M&A by using shares in part payment. At the same time the ongoing corporate and industrial restructuring is creating new oppertunies for for cash rich TNC’s including those from emerging markets. However the total project value of Greenfield Investments over M&A is not surprising as varying conditionality has tilted the favor towards Greenfield projects

Figure 6: Greenfield Vs Mergers and Acquisitions (Source: UNCTAD, based on UNCTAD cross-border M&A database and information from the Financial Times

Ltd, FDI Markets (www.fDimarkets.com).

Note: Data for value of Greenfield FDI projects refer to estimated amounts of capital investment.

If we consider FDI by component; reinvested earnings grew fast, while equity capital investments and intra-company loans declined, cash reserves of foreign affiliates grew substantially. For example the profits to sales ratio of the United States S&P 500 firms, Japanese Firms, Korean firms and developing country firms rose in 2010.

However the rise in reinvested earning brought a decline in equity capital, intra-company loans declined as loans were paid back and capital was held for future investments. Given the fact the foreign affiliates hold large retained earning’s on their balance sheet, repatriation to their parents become important role in determining the investment flows. Here government policymakers need to take steps.

FDI flows in developing economies and transition economies should be treated with caution due to containing some short-term volatile flows, “hot money”, stabilization of capital flows represents an important challenge to many developing countries.

As private foreign capital flows-portfolio investment, bank loans and FDI all contribute to development. But due to the nature of the crisis, official development assistance (ODA) is less prone to fluctuations and is as important to developing countries. But there effectiveness has been questioned on actual development.

Private equity sponsored FDI has regained momentum, although it fell of its pre-crisis level. It is directed more towards developing and transition economies as secondary buyouts and smaller acquisitions.

Sovereign Wealth Funds FDI declined substantially because of severely reduced investment from the Gulf region. However its long term potential as a source of investment remains.

Poorest countries saw declines in FDI flows such as landlocked countries, small island developing countries or certain regions in south Asia.

(UNCTRAD, 2011)

Figure 5: FDI inflows by component (Source: UNCTAD, based on data from FDI/TNC database (www/unctad.org/fdistatistics).

a Based on 106 countries that account for 85 per cent of total FDI inflows during the period 2007-2010.

1.0.1.2 Policy reform in terms of FDI and Macro-economic reform in East, South, South-East Asia

The People’s Republic of China (PRC) and East/Southeast Asian countries have made rapid enhancement in their macroeconomic situations, investment, exports and employment over the decade of 1980s and 1990s through the use of large amounts of Foreign Direct Investment. Similarly private capital, which was long seen with concern and suspicion, is now regarded as source of investment and economic growth in South Asia. Like other developing countries, South Asian economies focus their investment incentives exclusively on foreign firms. Over the last twenty years, market reforms, trade liberalization and intense competition for FDI have led to reduced restrictions on foreign investment and expanded the scope for FDI in most sectors. However, the South Asian countries have been largely unsuccessful in attracting FDI. These countries, jointly and also individually, receive low FDI compared to PRC, Brazil, Singapore and other East/Southeast Asian countries. South Asia received the smallest FDI flows among developing Asian countries, accounting for around 3 percent of the total FDI inflows to developing countries in the region. All the countries in the South Asian region except India have received very little attention and negligible FDI inflows. South Asian policymakers realize that credible efforts for economic reforms in South Asia must involve an upgrading of technology, scale of production and linkages to an increasingly integrated globalise production system chiefly through the participation of Multi National Corporations (MNCs). South Asian countries have many advantages to offer to potential investors, including high and steady economic growth, single-digit inflation, vast domestic markets, a growing number of skilled personnel, an increasing entrepreneurial class and constantly improving financial systems, including expanding capital markets. On top of these advantages, South Asian countries have been designing policies and giving incentives to foreign direct investment in several ways (Sahoor, 2006)

Till the late 1960s, most of the developing economies, including those of East Asia, adopted closed macroeconomic policies with import substitution industrialization policies, under which self-reliance and indigenous efforts were encouraged. At the same time, a dominant role was assigned to the state in the development process. These import substitution strategies, coupled with the large public sectors, resulted in rent seeking activities and uncompetitive production processes (Bhagawati and Srinivasan, 1975). Therefore, export-led industrialization and liberalization was advocated to make the production process efficient and competitive. Following the export-oriented growth argument (Bhagawati and Srinivasan, 1975 and Kruger, 1975), and the success of East Asian countries with higher exports and economic growth during the period from the early seventies to mid nineties, most of the South Asian countries started opening up their economies from the early eighties. The South Asian economies are currently enjoying the benefits of economic reforms, particularly reforms related to trade and investment. These countries undertook reform processes and opened up their economies after having experienced sluggish growth rates throughout the seventies and eighties (Sahoor, 2006 ). Please see appendix 1 for the types of reforms undertaken by SAARC countries.

1.0.1.3 Current trends in the ASEAN and SAARC

* to understand the Policy, policy framework or related public institutions for FDI then foreign policy in terms of its automatic routes, government approval, FDI in attractive zones, repatriation of profit, labour regulations applicable to the South, East and South-East Asian Countries have been shown in appendix 1 of this report.

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Figure 6: Various Tables and Graphs (Source UNCTAD, 2011)

In 2010, FDI inflows to South, East and South- East Asia increased by 24 per cent, to $300 billion (Figure A of Figure 6). inflows to the ASEAN countries more than doubled; those to China and Hong Kong (China) enjoyed double-digit growth; while those to India, the Republic of Korea and Taiwan Province of China showed decline (table B of figure 6). FDI to ASEAN increased to $79 billion in 2010 breaking 2007’s previous record of $76 billion recorded at pre-crisis level times. The boost was driven by large magnitude of FDI inflows to Malaysia (537 per cent), Indonesia (173 per cent) and Singapore (153 per cent) (table A ; annex table I.1). Positive policy at country level fuelled good performance within region, and seem likely to continue to do so: in 2010, Cambodia, Indonesia and the Philippines liberalized more industries; Indonesia improved its FDI-related administrative procedures; and the Philippines strengthened the supportive services for public private partnerships.

Singapore the global financial centre and a regional hub of TNC headquarters, has benefited greatly from increasing investment in developing Asia, this accounted for half of ASEAN’s FDI, recorded record FDI levels of $39 billion in 2010. Due to rising production costs in China, some ASEAN countries, such as Indonesia and Viet Nam, have gained ground as low-cost production locations, especially for low end manufacturing.

FDI to East Asia rose to $188 billion, thanks to growing inflows to Hong Kong (China) (32 per cent) and China (11 per cent) (table A). Benefiting greatly from its close economic relationship with mainland China, Hong Kong (China) quickly recovered from the shock of the global financial crisis, and FDI inflows recorded a historic high of $69 billion in 2010. However, inflows to the other two newly industrializing economies, namely the Republic of Korea and Taiwan Province of China, declined by 8 per cent and 11 per cent, respectively.

China continues to experience rising wages and production costs, so the widespread offshoring of low-cost manufacturing to that country has been slowing down and divestments are occurring from the coastal areas.

Meanwhile China has seen structural transformation shifting FDI inflows towards high technology sectors and services. For instance, FDI in real estate alone accounted for more than 20 per cent of total inflows to China in 2010, and the share was almost 50 per cent in early 2011. Mirroring similar arrangements in some developed countries, China established a joint ministerial committee in 2011 to review the national security implications of certain foreign acquisitions.

FDI to South Asia declined to $32 billion, reflecting a 31 per cent slide in inflows to India and a 14 percent drop in Pakistan, the two largest recipients of FDI in the subcontinent. In India, the setback in attracting FDI was partly due to macroeconomic concerns, such as a high current account deficit and inflation, as well as to delays in the approval of large FDI projects;10 these factors are hindering the Indian Government’s efforts to boost investment, including the planned $1.5 trillion investment in infrastructure between 2007 and 2017. In contrast, inflows to Bangladesh increased by nearly 30 percent to $913 million; the country is becoming a major low-cost production location in South Asia.

Cross-border M&As in the region declined by about 8 per cent to $32 billion in 2010. M&As in manufacturing rose slightly while they declined by 8 per cent in services. Within manufacturing, the value of deals surged in industries such as chemical products ($6.0 billion), motor vehicles ($4.2 billion) and metal products ($1.6 billion), but dropped in industries such as food and beverages ($2.9 billion) and electronics ($920 million) (table D). Greenfield investment remained stable in 2010, after a significant slowdown due to widespread divestments and project cancellations in 2009 (annex table I.8).

FDI inflows to East Asia should continue to grow in the near future, and those to South Asia are likely to regain momentum. The competitiveness of South- East Asian countries in low-cost production will be strengthened, and further FDI increases can be expected. Prospects for inflows to the LDCs in the region are promising, thanks to intensified South-South economic cooperation, fortified by surging intraregional FDI. Indeed, countries in the region have made significant progress in their regional economic integration efforts (within Greater China, and between China and ASEAN, for example), which will translate into a more favourable investment climate for intraregional FDI flows. To get a closer picture of the emerging trends in terms of its industrial patterns please refer appendix 2 of this report.

(UNCTAD, 2011)

1.2 Problem Statement

However despite recent improvements FDI flows have declined in 2012, for the first time Developed nations and nations in transition received more FDI than there Asian counterparts during the recent period which has primarily been as a result of volatility in the markets. The capital surge is exposing developing countries to greater unstability, putting direct pressure on their exchange rate and the low interest rate environment will be hard sustain in the long term (UNCTRAD, 2011). While FDI recovery resumes unevenly, the world wide demand for private productive investment is increasing as public investment, which rescued the global economy from declines in FDI in one country after another. With unsustainable level of debt in many countries, with nervous capital markets, governments must now rein in their deficits and let private investment take over the lead role in generating and supporting recovery. Infact responses by TNC’s indicate increasing awareness to invest, and clear priority in opportunistic area’s but TNC’s feel that increased protectionism coupled by regulatory risks have put a brake on capital expenditures. Infact many developed nations require private investment rather than public investment, but TNC’s are reluctant to invest due to past FDI performance would seem to warrant(UNCTRAD, 2011). Taking in to consideration the volatility in the markets, TNC investments directed towards the right countries, sectors and the understanding of the current investment environment is pivotal. However current indicies are full of limitations and thus building an index to both understand the current investment environment and reduce the limitations in other indicies is the main problem trying to be solved by this report.

1.3 Objective

This study aims to provide an investigation of the determinants significantly affecting FDI flows in to key emerging markets in in East, South and South East Asia. The investigation builds on previous research both from literature & conference proceedings and focuses on a variety of determinants including the policy framework of FDI, economic determinants and FDI determinants in relation to business facilitation for FDI. This is a important consideration in the global context for investors. To construct the variables 3 sets of macroeconomic, country specific and transnational company specific determinants of FDI will be used. The empirical assessment will consider econometric models such as Improved Inward FDI Potent