Foreign Direct Investment in a Developing Country with Economic Reform

61 Pages Posted: 27 Mar 1998

See all articles by Gyoung-Gyu Choi

Gyoung-Gyu Choi

affiliation not provided to SSRN

Date Written: August 1997

Abstract

This paper formalizes the foreign investors' investment decision in the economic reform projects of developing countries with political instability. Although foreign direct investment (FDI) increases capital and advanced technology flows to developing countries, relatively high concentration of FDI on developed countries and on a few advanced developing countries implies bleak prospects for industrialization in the majority of developing countries. This paper explains why a majority of developing countries are seriously neglected by foreign investors. A model is developed to link the complementarity among projects to the investment responses under various information structures. For given parameter values, two main factors dampen FDI flows into developing countries: The first is the combined effect of private information and the possibility of foregone positive spillover, which lowers the incentive for FDI flows into developing countries. The second is the combined effect of the existence of multiple equilibria due to complementarity and the coordination failure arising from pessimistic expectation, which induces investors to choose a Pareto-inefficient equilibrium. While the former effect arises from the interaction of private information and complementarity, the latter effect arises from the complementarity of the reform projects regardless of the presence of private information. In the absence of project complementarity, however, the presence of private information does not make any difference in the investment decision. The paper's analysis gives the rationale for the recent institutional development in Asia of subregional economic zones and special economic zones.

JEL Classification: F00, F36

Suggested Citation

Choi, Gyoung-Gyu, Foreign Direct Investment in a Developing Country with Economic Reform (August 1997). Available at SSRN: https://ssrn.com/abstract=71248 or http://dx.doi.org/10.2139/ssrn.71248

Gyoung-Gyu Choi (Contact Author)

affiliation not provided to SSRN

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