Foreign direct investment from developing countries: A case study of India

Over the last two decades an increasing number of firms from Less Developed Countries (LDCs) have invested overseas—primarily in other LDCs. A number of theories have been proposed as an explanation for this phenomenon. Dunning's eclectic theory suggests that a combination of firm-specific assets, locational advantages, and contractual risks associated with using market exchanges for intermediate products account for a firm's decision to invest overseas. While locational theorists emphasize locational factors as a determinant of a firm's decision to invest overseas, internalization theorists stress the importance of firm-specific factors. A panel dataset of 469 Indian firms observed from 1980 to 1990 were examined to test the empirical relevance of theories of Foreign Direct Investment (FDI). I find broad support for the eclectic theory for FDI from India. The locational and internalization theories offer only a partial explanation of an Indian firm's decision to invest overseas. Nor do the data provide support for either liquidity theory or Output and Market Size hypotheses as explanations for Indian FDI. This study finds that production experience, managerial skills, conglomerate ownership, and size are the main sources of competitive advantages for Indian firms investing overseas. I confirm that the core competitive advantages of conventional MNCs (from North America and Europe)—technological sophistication, product differentiation and the ability to generate internal sources of finances—do not contribute to an Indian firm's propensity to invest overseas. I do not find corroboration for the traditional hypothesis that firms with relatively labor-intensive technology are more likely to invest overseas. The empirical model supports the proposition that the Indian government's restrictive industrial policy has pushed Indian firms to invest overseas. However, there is no evidence to suggest that restrictive trade policy has influenced Indian firms' decisions to invest overseas. Neither industrial rate of growth at home nor geographical distances from a prospective host country have affected Indian firms' decision to locate overseas. Indian FDI shows an affinity for relatively small, socioculturally contiguous markets. I also find that a potential host country's political risk and inflation rate are negatively related to Indian firm's propensity to invest there.