ODI from BRIC Countries: Firm-level Evidence

Introduction

This chapter introduces the reader to the topic addressed in the book. It is structured as follows.

First, we review a number of stylized facts regarding ODI from emerging economies and ODI from BRIC countries in particular.

Second, we detail our research questions, pertaining to the ODI involvement and the ODI-performance nexus of BRIC enterprises.

Third, we discuss the main novelties of our approach and the intended contribution to the existing literature on internationalization and performance.

Forth, we review our main results that can be summarized as follows.

Concerning ODI involvement, our evidence suggests that BRIC firms engaged in ODI are in the minority. Moreover, within the group of BRIC investors, those firms having more than five foreign subsidiaries, investing in developing countries, or operating in joint ventures are in the minority.

Concerning the relationship between ODI involvement and firm-level performance, we show that the best performing BRIC firms are more likely to engage in ODI. Moreover, within the group of BRIC investors, the best performing firms are more likely to rely on a large number of foreign subsidiaries and less likely to invest in developing countries alone, or to operate exclusively in joint ventures.

These results are robust to several econometric models, specifications, measures of performance and to the multiple versus single-country perspective.

 

Chapter 1. BRIC countries and Foreign Direct Investment: from IDI to ODI

In this chapter, we illustrate the transformation of BRIC countries from Inward Direct Investment (IDI) recipients into important sources of ODI and discuss the common patterns as well as the country specific features fostering this transformation.

According to UNCTAD World Investment Report 2017, in 1995 BRIC countries were on the receiving end of 13.5% of world IDI flows, whereas they contributed 1.1% of world ODI flows. In 2016, BRIC countries' share in world IDI and ODI flows were 15.7% and 13.5%, respectively. Despite some fluctuations, over the last two decades sustained growth in ODI flows is common to all BRIC countries.

The outstanding GDP annual growth rates experienced by BRIC countries since 1995 and their unexpected resilience throughout the financial crisis contribute to explain the transformation of BRIC countries from IDI recipients into ODI sources. Moreover, the recent slowdown of these countries' economies had a limited impact on ODI, mostly felt by Brazil and Russia.

A number of country-specific factors-including institutional and regulatory arrangements - also account for the remarkable changes in ODI from BRIC countries. In the following, we summarize for each country the main determinants of aggregate ODI flows.

Brazilian firms have invested abroad since the late 1970s; however, it is only since the early 2000s that improved conditions in the domestic capital market have allowed firms in exporting sectors to raise capital on a large scale and to expand their market share abroad via ODI.[1] As in the past, Brazilian ODI is driven presently by conditions on the domestic capital market. Credit conditions have tightened in the wake of the 2007 financial crisis, which helps to explain why in recent years ODI flows declined. Brazil has not yet developed a policy framework in support of ODI. To date, the only interventions have been loans selectively offered to "national champions" by BNDES-the country major development bank-at an interest rate below market value.

Russia is among the largest investor countries worldwide. In the early 2000s, Russian conglomerates pursued natural and strategic resource-seeking ODI.[2] One decade later, there has been a shift toward investment in knowledge-based sectors and services. A distinctive feature of Russian internationalization is the prevalence of large private companies. Support to ODI by Russian authorities is generally restricted to soft measures and tax exemptions. The tightening of credit conditions on international markets and the economic sanctions imposed in 2014 by the European Union and the US in response to Russian operations in Crimea explain the recent fall in ODI flows.[3]

While small compared with ODI from other BRIC countries, Indian ODI has grown at rates unknown to remaining BRIC. The primary factor behind Indian ODI is a regulatory environment conducive to private firms' participation in global markets. Indian authorities provide debt and equity financing to firms operating abroad as well as insurance against political risk. Because it is primarily directed toward developed countries,[4] Indian market-seeking ODI flows declined over the period of 2009 to 2013 but began to rise once more in 2014.

China is the second largest investor country worldwide. The distinctive feature of Chinese ODI is its careful management by local authorities who have implemented a well-defined regulatory framework since the launch of the so-called "Go out" policy in 2000.[5] The adoption of the 12th Five Year Plan in 2010 imparted further acceleration and favoured a change of target for Chinese ODI. Resources are being shifted away from natural resource-seeking projects and invested instead into advanced technology and high-quality brands. Currently, China supports ODI through a variety of home-country measures.

 

Chapter 2. ODI from BRIC countries: A conceptual framework

In this chapter, we provide the conceptual framework to our study. We believe this is particularly relevant for readers that are not well acquainted with the literature on ODI and performance or readers with a background different from Economics and Management.

ODI from BRIC countries have been studied extensively in the field of International Business. Indeed, ODI from emerging economies have been considered an ideal test for the external validity of the main theories of FDI developed in the field of International Business. In recent years, the availability of firm-level data sparked a lively debate on the internationalization-performance nexus also in the field of International Economics.

The seminal contribution of Bernard and Jensen (1995)[6] started a body of literature on the internationalization-performance nexus at the firm level. No matter the year and the country of the analysis, empirical evidence suggests that internationalized firms are "the happy few",[7] i.e., they are in the minority, but they perform better than domestic enterprises on a number of variables.[8]

From a theoretical point of view, two alternative, although not mutually exclusive, hypotheses explain the positive correlation between internationalization and performance.

According to self-selection (SS), there are ex ante performance differences between firms that become international and firms that keep serving the domestic market. This is because operating abroad involves additional costs that constitute an entry barrier to less successful firms.[9] According to learning-by-internationalization (LI), ex post performance differences depend instead on firms' exposure to the international arena.[10] Indeed, by interacting with foreign competitors and customers, firms are likely to increase their scale, become more efficient and innovate to keep pace with their rivals. In this book, we investigate empirically the internationalization-performance nexus in the spirit of the SS approach. Our testable hypothesis is that there is a positive correlation between the extension and complexity of a firm's ODI involvement and its performance. From an empirical point of view, a vast literature tests the existence of a positive correlation between internationalization and performance.

As for internationalization, the previous literature focuses almost exclusively on trade, whereas the relationship between ODI and performance is addressed only in a few studies.[11]

For the set of countries, it should be mentioned that the earliest contributions dealt with developed countries, due to data limitations. Large firm-level datasets have recently become available for developing countries as well, which has triggered new empirical research on the topic.[12]  However, most studies focus on just one or two countries.

Building on the literature developed within the International Economics framework and filling its gaps, our analyses  for BRIC countries provide new evidence on the ODI and performance nexus consistent with the SS hypothesis. This brings us to consider the nature of the sunk costs associated with investing abroad, on which International Business literature such as the OLI approach and the RBV can shed light.

Chapter 3. ODI from BRIC countries: A multi-country empirical analysis

In this chapter, we present our empirical analysis on the ODI involvement and the ODI-performance nexus of BRIC enterprises. In particular, in (3.1) we introduce the reader to the data and provide some descriptive statistics; in (3.2) we describe the variables and the econometric specifications; and in (3.3) we comment on the results and summarize them in the form of stylized facts. Sections 3.1 and 3.3 are non-technical, and are accessible to a wide audience, whereas Section 3.2 is more suitable to researchers or students with a background in Economics and Management.

 

3.1    Data and descriptive statistics

For the purpose of the present research, we employ firm-level information from Orbis, a commercial dataset issued by Bureau van Dijk and containing administrative data on 130 million firms from more than 100 countries.[13]

Our measures of performance are selected from within the wide array of indicators, real and financial variables present at the firm level. In contrast, our measures of ODI draw on Orbis information regarding subsidiaries.

Our database covers the whole set of industrial companies included in Orbis and headquartered in Brazil, Russia, India and China in 2016, amounting to more than 9,000 firms overall.

From a firm-level point of view, our sample is skewed toward very large (96%), listed (92%) and old (70%) companies that account for the vast majority of firms headquartered in BRIC countries.

At the industry level, 60% of the firms belong to the manufacturing sector, followed by the wholesale and retail trade (10%) and Information and Communication Technologies (7%); other NACE 2-digit sectors, although represented, are quite marginal.

Lastly, from a country-level perspective, most firms are from India (45%) and China (37%), while Russia and Brazil account for a comparatively small 12% and 6%, respectively.

Drawing on these data, we unveil a number of stylized facts regarding ODI and performance in BRIC countries. To this end, we proceed in two steps. First, we characterize our sampled firms' involvement in outward direct investment, introducing a notably rich taxonomy of ODI. Second, we analyze performance by ODI involvement.

Our taxonomy of ODI exploits Orbis data on foreign affiliates. Based on the available information, we distinguish between ODI and noODI firms; namely, those having at least one foreign subsidiary and those having none.

This exercise delivers our first stylized fact:

Fact 1. BRIC firms engaged in ODI are in the minority.

After distinguishing between ODI and noODI firms, we further dissect the former by looking at the number, destination and ownership structure of foreign affiliates. This approach results in a notably rich taxonomy of outward direct investment that groups BRIC firms into mutually exclusive classes of ODI involvement.

As far as the number of foreign subsidiaries is concerned, we distinguish between ODI_1, ODI_2-5 and ODI_>5 firms; namely, those having one, from two to five or more than five foreign affiliates. Our evidence reveals that most of the sample falls under the ODI_1 class with very few firms having more than five foreign subsidiaries.

As far as the destination is concerned, we distinguish between ODI_LDC, ODI_DC and ODI_DCandLDC firms; namely, those with foreign subsidiaries only in Less Developed Countries (LDCs), only in Developed Countries (DCs) and in both LDCs and DCs. Our evidence suggests that developed countries are the favorite destination for BRIC ODI; in contrast, only a few firms invest in LDCs alone.

As far as the ownership structure is concerned, we distinguish between ODI_JV, ODI_WFOE and ODI_JVandWFOE firms; namely, those with only JV-types of foreign affiliates, those with only WFOE-types of foreign affiliates, and those holding both JVs and WFOEs. Our evidence suggests that WFOE is the favorite entry mode of BRIC multinationals, whereas only a handful of firms engage exclusively in JV.

Based on the aforementioned taxonomy of ODI by number, destination and ownership structure of foreign affiliates, we derive a second stylized fact:

Fact 2. Within the group of BRIC investors, firms having more than five foreign subsidiaries, investing in less developed countries, or operating in joint ventures are in the minority.

 

3.2 Variables and specifications

After introducing our taxonomy of ODI, we study performance differentials among firms exhibiting heterogeneous ODI involvement.

For the purpose of the present research, we consider a wide array of performance variables, including sales, profit, number of employees, labor productivity, intangible assets, tangible assets and enterprise value. In selecting these variables, we try to capture different aspects of firms' performance that are related to their economic, innovation and financial strength.

Taking advantage of our rich taxonomy of ODI, we estimate four econometric models, in the spirit of the self-selection hypothesis.

The first model compares ODI versus noODI firms, according to Equation (1):

 

(1)

 

The dependent variable ODI is a dummy equal to 1 for firms having at least one foreign subsidiary. Accordingly, Equation (1) is estimated through the Logit model.

Covariates consist of three main groups: performance is a measure of firm i's performance, according to the economic, innovation and financial variables already delineated above. Adding to performance, firm is a matrix containing firm-level variables that may affect the ODI decision but over which we do not have any specific prior; they include firm's age, a dummy for large companies and a dummy for listed companies. Lastly, industry and country contain industry and country fixed effects.

Our second model focuses on ODI according to the number of foreign affiliates. Equation (2) is set accordingly:

 

 (2)

 

The dependent variable N_subs captures the number of foreign affiliates. Covariates and econometric specifications are the same as before to permit comparisons with our previous results.

Our third model estimates ODI by destination. Equation (3) is set as follows:

 

(3)

 

The only difference, compared with Equations (1) and (2), lays in our choice of the dependent variable. ODI_Dest is a discrete variable that is equal to 0 if the firm has no foreign subsidiaries; 1 if the firm has foreign subsidiaries only in developed countries; 2 if the firm has foreign subsidiaries only in less developed countries; and 3 if the firm has foreign subsidiaries in both developed and less developed countries. ODI_Dest clearly combines the mutually exclusive cases of noODI, ODI_DC, ODI_LDC and ODI_LDCandDC introduced in (3.1). Accordingly, Equation (3) is estimated through the Multinomial Logit model, using noODI as a base group.

Lastly, our forth model focuses on ODI by ownership structure of foreign affiliates:

 

     (4)

 

In Equation (4), the dependent variable ODI_Own captures firm i's involvement in outward direct investment, based on the four mutually exclusive classes-noODI, ODI_WFOE, ODI_JV and ODI_JVandWFOE-introduced in (3.1). In particular, ODI_Own equals 0 if the firm has no foreign subsidiaries, 1 if the firm has only the WFOE-type, 2 if the firm has only the JV-type and 3 if the firm has both WFOE- and JV-types of foreign subsidiaries. Our econometric model is the same as in Equation (3), the only difference being our focus on the ownership structure rather than the destination.

 

3.3    Results and discussion

In this sub-section, we present our main results from estimating Equations 1-4.

Our Logit estimates of Equation (1) suggest that firms exhibiting superior performance are more likely to engage in ODI: Sales, profit, number of employees, labor productivity, intangible assets, tangible assets and enterprise value all turn out to be statistically significant with a positive sign, meaning that better enterprises are more prone to outward direct investment. This delivers our third stylized fact:

Fact 3. The best performing BRIC firms are more likely to engage in ODI.

In our OLS estimates of Equation 2, all coefficients are positive and statistically significant: The larger the firm's sales, profit, number of employees, labor productivity, intangible assets, tangible assets and enterprise value the higher the number of foreign subsidiaries, meaning that the best BRIC firms are more likely to rely on a wide network of foreign affiliates. This finding is robust to firm, industry and country controls, and it holds irrespective of the specifications and the measures of performance.

Based on our Multinomial Logit estimates of Equation 3, we show that BRIC firms exhibiting superior performance tend to choose some ODI involvement rather than none. Sales, profit, number of employees, labor productivity, intangible assets, tangible assets and enterprise value all turn out to be statistically significant with a positive sign, meaning that the best enterprises are more likely to experience some outward direct investment. Looking at the magnitude of the marginal effects, one might push the argument further and infer a performance ranking among ODI types. In particular, the marginal effects for ODI_DC firms tend to be larger than the marginal effects for ODI_LDCandDC firms, which are, in turn, larger than the marginal effects for ODI_LDC firms. This evidence suggests that, within the ODI group, the best BRIC firms are less likely to invest exclusively in LDCs: They rather set subsidiaries in DCs alone or DCs and LDCs. Note that these findings are consistent with the SS hypothesis as firms from BRIC countries face higher entry barriers in DC than LDC countries.

Lastly, our Multinomial Logit estimates of Equation 4 further reveal that, within the ODI group, the best firms are less likely to operate exclusively in joint venture: They rather invest abroad through WFOEs or a combination of full and partial ownership. This is because the marginal effects for ODI_WFOE firms tend to be larger than the marginal effects for ODI_JVandWFOE firms, which, in turn, are larger than the marginal effects for ODI_JV firms. As above, these findings are consistent with the SS hypothesis as more resources are sunk when entering a market via WFOE than JVs.

 

The findings delineated above deliver our fourth stylized fact:

Fact 4. Within the group of BRIC investors, the best performing firms are more likely to rely on a large number of foreign subsidiaries, and less likely to invest in developing countries alone, or to operate exclusively in joint ventures.

               

To conclude, Facts 1-4 provide support to our hypothesis of a positive correlation between the extension and complexity of a firm's ODI involvement and its performance.

 

Chapter 4. ODI from BRIC countries: A single-country empirical analysis

In this chapter, we replicate our empirical analysis on ODI involvement and ODI-performance nexus of chapter 3 allowing for potential differences among BRIC countries. This exercise is intended to provide a robustness check for our previous econometric results and to exploit country-level heterogeneity adding to firm- and industry-level heterogeneity.

Preliminary evidence on China and India confirms our previous findings, suggesting that the stylized facts on ODI involvement and ODI-performance nexus delineated in chapter 3 are robust to the multiple versus single-country perspective. As suggested by the Reviewers, we will provide complementary results on Brazil and Russia.

               

 

Conclusions

This chapter contains some concluding remarks.

It is structured as follows. First, we review our main findings as highlighted previously in the book. Second, we discuss a few limitations that plague our study thus reducing its scope. Third, we derive some policy implications and suggest future lines of research.

Our main prior from previous studies is that globally engaged enterprises are the "happy few." We consistently find that BRIC firms engaged in ODI are in the minority (Fact 1), but they perform better than domestic enterprises (Fact 3). This clearly complements the empirical evidence of a positive correlation between exports and performance in China and India, as reported in the literature.[14] Interestingly, such a correlation emerges also when we identify internationalization with ODI, rather than exports, and we take a cross-country, rather than a single-country, perspective. Fact 2 and Fact 4 further support this evidence; dissecting ODI by number, destination and ownership structure of foreign affiliates, we generate completely original results. First, the "happy few" story survives regardless of the type of ODI. Second, the larger the performance differential compared with the noODI group, the deeper the ODI involvement: The best performing BRIC firms tend to rely on a large number of foreign subsidiaries and to undertake ODI strategies different from operating in developing countries or in joint venture alone. To summarize, we show that the positive correlation between ODI and performance is both a matter of involvement versus non-involvement in ODI and a matter of the type of ODI that a firm undertakes. Being true for Brazil, Russia, India and China, as well as for the entire group of BRIC countries, this is a novel contribution by the present paper. Clearly, it could not be addressed by previous studies based on a more elementary taxonomy of international activities.

Our findings shed some light also on the changing integration of China in the global economy. Facing increasing labor costs, weak external demand and signs of declining return to investment, in 2007-2009 Chinese authorities imparted strength to ODI in view of a change in the country growth model. Our data provide evidence on the characteristics of the firms behind the massive expansion of Chinese ODI ensuing the 2007-2009 liberalization. In particular, we show that ODI involvement by Chinese enterprises shares some common patterns with ODI involvement by firms from the remaining BRIC countries as well as from developed economies. At the same time, we are able to point out some peculiarities, such as the role played by innovation: Innovative Chinese firms are more likely to undertake ODI than innovative firms from the remaining BRIC countries. As increases in labor productivity are unlikely to come from further investments in physical capital, innovation is bound to be vital in promoting growth in China.[15] Our data point in the direction of a possible interplay between innovation and ODI and suggest the importance of further research on the topic.