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Why and how FDI stocks are a biased measure of MNE affiliate activity

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Abstract

Many international business (IB) studies have used foreign direct investment (FDI) stocks to measure the aggregate value-adding activity of multinational enterprises (MNE) affiliates in host countries. We argue that FDI stocks are a biased measure of that activity, because the degree to which they overestimate or underestimate affiliate activity varies systematically with host-country characteristics. First, most FDI into countries that serve as tax havens generate no actual productive activity; thus FDI stocks in such countries overestimate affiliate activity. Second, FDI stocks do not include locally raised external funds, funds widely used in countries with well-developed financial markets or volatile exchange rates, resulting in an underestimation of affiliate activity in such countries. Finally, the extent to which FDI translates into affiliate activity increases with affiliate labor productivity, so in countries where labor is more productive, FDI stocks also result in an underestimation of affiliate activity. We test these hypotheses by first regressing affiliate value-added and affiliate sales on FDI stocks to calculate a country-specific mismatch, and then by regressing this mismatch on a host country's tax haven status, level of financial market development, exchange rate volatility, and affiliate labor productivity. All hypotheses are supported, implying that FDI stocks are a biased measure of MNE affiliate activity, and hence that the results of FDI-data-based studies of such activity need to be reconsidered.

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Notes

  1. This possibility was suggested to us by the editor.

  2. In total we found 44 studies of the cross-country distribution, country-level determinants, and host-country consequences of MNE affiliate activity that have measured that activity by FDI stocks and its change by FDI flows. A list of these studies is available from us upon request.

  3. Hence the term “FDI” is somewhat misleading, because reinvested affiliate earnings do not involve a cross-border transfer of capital (Root, 1994). Note that FDI figures for some countries, such as Denmark, France, Japan, Spain, Singapore and Thailand, exclude reinvested earnings.

  4. UNCTAD (2006: 12) estimates that from 25% up to 50% of all FDI into China is undertaken by Chinese firms that are sending back to China funds initially sent from there to the Virgin Islands and other tax havens.

  5. As pointed out by an anonymous referee, this option is available only to affiliates with revenues in the host market. This was indeed the case for most US foreign affiliates, with about 65% of their sales over the 1983–2004 period being local (Beugelsdijk, Pedersen, & Petersen, 2009; Lehmann et al., 2004).

  6. The BEA defines a US foreign affiliate as “a foreign business enterprise in which there is US direct investment; that is, it is a foreign business enterprise that is directly or indirectly owned or controlled by one US person to the extent of 10% or more of the voting securities for an incorporated business enterprise or an equivalent interest for an unincorporated business enterprise” (US Bureau of Economic Analysis, 2004: M5-M6).

  7. The fact that affiliate value-added is available only for non-bank affiliates in which non-bank US parents have a majority ownership stake should not pose serious problems. Data from the 1999 US direct investment abroad benchmark survey show that majority-owned non-bank affiliates of non-bank US parents account for 85.0% of the sales of all non-bank affiliates of non-bank US parents (US Bureau of Economic Analysis, 2004: M-29, Table 7). The percentages for total assets and employment are 87.6% and 84.2%, respectively, suggesting that the percentage for value-added is likely to be in the same range.

  8. A formal econometric presentation of these arguments is available from the authors upon request.

  9. We thank an anonymous reviewer for bringing this point to our attention.

  10. This unexpected effect is driven by the inclusion of Hong Kong and Singapore in the non-OECD subsample. Both of these countries are well-known tax havens, and at the same time have relatively high scores on our sales-based mismatch measure (see Table 1). When we excluded these two countries from the non-OECD subsample, we obtained the expected significantly negative coefficient of the tax haven dummy on the sales-based mismatch measure.

  11. In the interests of space, we do not report here the results of these regressions or the measurement details of these determinants. They are available from us upon request.

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Acknowledgements

We thank Area Editor Sea-Jin Chang and three anonymous reviewers for their valuable comments and suggestions. We also received useful comments from participants at sessions at AIB 2007 and at EIBA 2009, as well as at seminars at the Center for Strategic Management and Globalization at Copenhagen Business School, at Maastricht University, at the University of Reading, at the University of Sydney, at Auckland University of Technology, at Vienna University of Economics and Business, and at the Netherlands Network for Quantitative Economics. We thank Iman van Lelyveld of the Dutch Central Bank (DNB) for providing the interest rate data. The first author thanks the Netherlands Organization for Scientific Research (NWO) for financial support.

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Authors and Affiliations

  1. Department of International Business & Management, University of Groningen, The Netherlands

    Sjoerd Beugelsdijk

  2. CentER and Department of Organization & Strategy, Tilburg University, The Netherlands

    Jean-François Hennart

  3. International Strategy & Marketing Section, University of Amsterdam, The Netherlands

    Arjen Slangen

  4. CPB Netherlands Bureau for Economic Policy Analysis & Department of International Economics and Business, University of Groningen, The Netherlands

    Roger Smeets

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  1. Sjoerd Beugelsdijk
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  2. Jean-François Hennart
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Correspondence to Sjoerd Beugelsdijk.

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Accepted by Sea-Jin Chang, Area Editor, 25 April 2010. This paper has been with the authors for three revisions.

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Beugelsdijk, S., Hennart, JF., Slangen, A. et al. Why and how FDI stocks are a biased measure of MNE affiliate activity. J Int Bus Stud 41, 1444–1459 (2010). https://doi.org/10.1057/jibs.2010.29

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