Effects of Outward Foreign Direct Investment on Home Country Exports: The Case of Korean Firms

Abstract

In this paper, empirical analysis has been conducted at the firm level in terms of foreign direct investment (FDI) directions, subsidiary ages, and industry's life cycle, to examine the relationship between a country's FDI activities and its exports, using the data of Korean firms. Empirical result supports that outward FDI would have a more positive effect on home country exports if the subsidiaries are located in less developed countries than in developed countries; if they are relatively new; if the is in a declining stage in the firm's home country. INTRODUCTION This paper examines the relationship between a country's foreign direct investment (FDI) activities and its export, i.e., substitutes or complements, focusing on multinational corporations' (MNCs) subsidiary types in terms of the location of subsidiaries, the duration of subsidiaries, and the industry's life cycle in the firm's home country. The question of whether a firm should go abroad or not is very important to both policymakers and business people. Policymakers are often concerned about the possibility that trade deficits and the industry hollowing effect may be related to a domestic firm's outward FDI. However, from the firm's perspective, domestically oriented strategies may result in severe damage to the firm's international competitiveness. If the firm's business is positioned in a declining or faces trade protectionism that hinders its access to existing export markets, the firm will have difficulties to grow further and even to survive. The approach in this paper leads to a wider scope of choices as a strategic means for policymakers and business people. In fact, according to subsidiary conditions, factors such as the location in developed or less developed countries, newly established or long-standing subsidiaries, and the declining or growing in the firm's home country, can make the differences in the relationship between FDI activities and its export. In order to prove our argument we will review related theories, formulate hypotheses, and then conduct statistical analysis in cases such as the location of FDI, the duration of subsidiaries, and the business environment of parent firm. LITERATURE REVIEW AND HYPOTHESES How can we explain the relationship between MNC activities and trade? Home exports can either replace or promote MNCs' foreign production. To determine this relationship, researchers have empirically tested the effects of overseas production on home country exports. These studies have focused on two fundamental aspects of the effect of outward FDI on home exports - whether FDI substitutes or complements home country exports. Lipsey and Weiss (1981), Helpman (1984), Grossman and Helpman (1989), Lin (1995), and Pfaffermayr (1996) suggested that outward FDI had a positive effect on home exports. In contrast, Mundell (1975) and Svensson (1996) argued that in some cases FDI caused negative effect on exports. From a theoretical point of view there is no clear assertion concerning the relationship between FDI and net exports (Pfaffermayr, 1996), and the relationship is essentially an empirical one (Lin, 1995). However we can logically infer that relationships will differ according to differences in subsidiaries' situations, such as location, duration and industry's life cycle. We first argue that outward FDI is more effective on home country exports when the subsidiaries are in less developed countries (LDCs), as opposed to more developed countries (DCs). MNCs from DCs go abroad to exploit ownership advantage. This type of FDI has been addressed by many conventional FDI theorists from Hymer (1976), Buckley and Casson (1976), Rugman (1981) to Dunning (1988). In contrast, firms from less developed countries (LDCs), also invest in developed countries for strategic motivations such as market seeking, exploration (market proximity), learning, compensating for disadvantages (Moon and Roehl, 1993). …