Analysis of Motives and Prospects Within the Oli Framework a Case Study of German FDI in china (Research Paper Sample)

ANALYSIS OF MOTIVES AND PROSPECTS WITHIN THE OLI FRAMEWORK: A CASE STUDY OF GERMAN FDI IN CHINA
By Student Name
Instructor
Course
Date
Introduction
Various sources (EAC. 2008 Liegsalz 2010, Peng 2010, Neuhaus 2006) show that FDI in China has been growing steadily over the years. This should not be surprising at all because China has a huge population as well as other resources that remain unexploited. In addition, the country has been pursuing open market policies for the last three decades. Additionally, the country’s efforts to woo investors have contributed to the rise in FDI (EAC. 2008 Liegsalz 2010, Peng 2010, Neuhaus 2006). Indeed, this development has also seen a rise in the number of FDI studies on China being undertaken in the last two decades. Further economic growth in China will continue to rely heavily on FDI and policy-making initiatives that will propel inward investments.
FDI has numerous benefits, both for the host country and the MNE (EAC. 2008 Liegsalz 2010, Peng 2010). FDI as well as the development of given industrial sectors is associated with a growth in infrastructure that support the modern market economy. This paper looks at the motives and prospects that have led German companies to enter into the Chinese market. The study will focus on the OLI (Ownership, Location and Internalisation) framework prosed by Dunning (1980) in understanding the motives and prospects that drive Germany companies to invest in China. Based on the analysis, a set of policy implications will be outlined to guide future efforts by German MNEs wishing to enter the Chinese market.
The Importance of FDI to China
China has greatly benefited from Germany in terms of the large foreign direct investments (EAC. 2008 Liegsalz 2010, Peng 2010, Neuhaus 2006). This has enabled it to be foremost in the development of industries such as the automotive sector as evidenced by German companies operating in China. According to the EAC (2008) report, German is ranked seventh in terms of the European firms that have invested in the country. German has invested about 8 billion Euros in China through its companies. Most of the firms from Germany are in the manufacturing industry, dealing with automobiles, chemical and electrical engineering. Most of these companies, because of their expertise and technical expertise, find their way in china easily than if they would have been in their home countries. In terms of investments, the Germany contribution is 1.2 % of the total foreign direct investments.
Empirical evidence point out that FDI plays an important role in the economic growth of a country as opposed to domestic investment (DeGregorio 1992). DeGregorio (1992) shows that FDI contributes as much as three times to the growth of a country compared to domestic investment. Blomstrom et al. (1992) also identified a strong link between FDI and economic growth in developing countries. Further Findlay (1978), argued that FDI increases technical knowhow and growth in the host country. This is achieved through the contagion effect as countries with advanced technologies bring it into the host country. Therefore, China gains a lot from FDI through transfers of technology, overall contribution to the countries economy provided by MNE as well as increase in manpower capabilities. For instance, Luo and Tan (1997) note that during the period 1979-1995, the Chinese government approved over 200,000 projects with total worth of about US$393.04 billion in foreign capital. These colossal amounts of money have been analysed by various researchers (Chen et al 1995) who argued that such investments played a significant role in augmenting the available resources for capital formation (Sanyal & Guvenli 2000). With increased FDI ventures, domestic manufacturers have been forced into a new era where competition, occasioned by the international players, is intense. Therefore, domestic firms have to do all they can to compete with multinationals. Therefore, china has seen numerous benefits of FDI into the countries economy.
Foreign Direct Investment: A Review of the Literature
Theoretical Approaches for Evaluating FDI
MNEs have become important drivers of economic development in many countries. Indeed, several models have ben put forward to explain the level of multinational enterprises activities. These foundational frameworks range from economic frameworks (Hymer 1960, Caves 1971) and internalisation models (Buckley and Casson 1976, Rugman 1981) to the eclectic model (Dunning 1988). The reason for venturing into foreign countries can be summarized by the model put forth by Behrman (1972). This framework considers several types of MNEs, which include companies that go to foreign markets seeking resources, markets, efficiency, or capacity. Resource seeking enterprises are motivated by the fact that cheaper resources are available in the foreign country. These resources include cheap labour, cheap technology and any other resource that the company requires in its production processes.
Market driven companies are those that go abroad to protect or gain new markets (Sanyal & Guvenli 2000). The rationale is to chase the prospects of growth and gain more share in the market by establishing operations in a foreign country. Market-seeking companies aim to counteract the strategies of competitors or gain first mover advantages. On the other hand, efficiency-seeking MNEs take advantages of economies of scale, policies, and market structures to undertake production on a limited number of locations. Finally, strategic-focused MNEs engage in FDI to sustain or enhance their international competitiveness.
Hymer (1960) opposed the perfect model of competition. The arguments put forth by Homer dealt with the firms’ capacity to bar competitors into the market, which formed a good background for future research on theories of FDI. It was on Hymers’ work that other researchers developed models to explain MNEs activities. For instance, Kindleberger (1969) developed the ‘market imperfections model’, which stated that specific advantages in the foreign market are critical for thriving of the MNE. Without such advantages, it would be impossible for a company to venture abroad. Some of the advantages as proposed by Kindleberger (1969) include knowledge, economies of scale, and differentiation among others. This explains why international operations are organized in a hierarchical manner (FDI) instead of market forces as explained by classical models. The internalisation model, which is the reason why companies go abroad (Kindleberger 1969), are occasioned by market failures arising from transaction costs. The transaction costs make direct investment in subsidiaries more practicable than market contracting (Buckley 1988)
The internalisation model was further refined by the eclectic model o Dunning (1980). Dunning tried to analyse the factors and determinants of FDI in terms of the OLI framework. The OLI framework stipulates that “ the choice of entry mode during international expansion is influenced by three types of determinants (OLI advantages), ownership advantages of a firm, location advantages of a market, and internationalization advantages of integrating transactions within the firm” (Luo 2000, p. 103). Ownership advantages are those that accrue to the MNE and which enable the company to take advantages for investing in the foreign country. Location advantages accrue to the company by investing in a certain country or location within the host country. On the other hand, internalisation benefits determine the market vis-à-vis hierarchy (FDI) organisation of production.
Empirical Surveys on MNEs Activity and FDI Determinants
The major focus in the empirical studies concerning FDI is based on the motives and prospects presented by a given country as well as the methods that companies employ in entering a new country (Sanyal & Guvenli 2000). The OLI (Ownership, Location, and Internalisation) is an important framework for categorising much of the empirical research on FDI. This section will summarize the OLI paradigm and use it as a lens through which to understand some of the highlights in this paper.
Ownership Advantages
As noted by Neuhaus (2006) “ownership advantages derive from knowledge-based, firm-specific assets which constitute cost advantages and lead to market power” (p. 142). For instance, a firm can have advantages resulting from patents, trade secrets, managerial expertise, and trademarks among others. Peng (2010) sees ownerships as the “possession and leveraging of certain valuable, rare, hard-to-imitate, and organizationally embedded (VRIO) assets overseas” (p. 185). Based on these definitions, ownership advantages can be explained as those benefits that are exclusive to the investing company (Zhang and Bulcke 2000, Zhang, & Felmingham 2001). Such benefits can be transferred from the home country to the host country at a low cost, thus making the investor outsmart competitors in the market.
Location
Location advantages that those benefits that a firm can enjoy by doing business in a certain place instead of another location (Peng 2010). Several features help a company identify a given location for its business. Some of these might include the availability of raw materials and proximity to a market for the company’s products (Peng 2010). In dealing with the location aspect, numerous studies have explored such issues as the choice of the country to invest in and the location within a given country (Agarwal & Ramaswami 1992). The attractiveness of a market is based on the potential that the country has to offer to the investor. Additional considerations involve the investment risks and the availability of resources in a given location. Zhao and Zhu (1998) discovered that foreign business agglomera...