Location theory: Economic Environment
Features of a country’s economic environment are also important determinants of FDI location. Capital, and human and natural resource endowments such as labor in China and oil in Nigeria, continue to be significant influences on FDI location choices. The importance of neoclassical factors of production (e.g., land, labor, capital, raw materials) to MNCs’ FDI location choices is consistent with the predictions of location theory.
Factors of production can be intrinsic or created. The Silicon Valley area receives large inflows of FDI due in part to the quality of its human capital. The geographically concentrated pool of specialized human capital arose, in part, from the presence of leading-edge domestic companies and the entry of foreign companies. Hence, specialized labor in Silicon Valley can be viewed as a created and dynamic factor of production: created in the sense that hightech workers developed their knowledge through their experience working at different Silicon Valley firms, dynamic in the sense that the entry of more firms into the area expanded the skill set and enlarged the pool of specialized labor.
The size of a country’s economy is another important economic influence on FDI location decisions. Market size can be viewed as an indirect measure of transportation costs, since it reflects the ability of a firm to reach many consumers at a relatively lowcost. The attractiveness of large countries is particularly true when an economy is both large in terms of absolute size (GDP) andwealthy in terms of GDP per capita. Brainard (1997) finds that proximity to customers is an important factor in an MNC’s FDI location choices.
Finally, like political risk discussed above, economic risk is also an important influence on FDI location decisions. Countries that have experienced very high rates of inflation or currency exchange rate shocksmay have difficulty attracting FDI. Similarly, other things being equal, highly indebted countries and countries with periodic fiscal crises are typically not recipients of large FDI inflows.