Locational determinants of foreign direct investment in an emerging market economy: Evidence from Turkey

Multinational Business Review, Spring 2002 by Erdal, Fuat, Tatoglu, Ekrem

Over the past two decades, Turkey has recorded a substantial increase In the level of annual foreign direct Investment (FDI) Inflows. Building on the prior literature, this paper provides an empirical analysis of location-related determinants of FDI. This Is undertaken by means of a co-integration analysis of major locational factors Impacting upon the level of FDI inflows for the period 1980-1998. The evidence from this study supports the contention that while Turkey offers several location advantages to foreign investors in terms of market size, infrastructure, openness of the economy and market attractiveness, the lack of exchange rate and economic stability has hindered its efforts to harbor much higher volume of FDI.

INTRODUCTION

Foreign direct investment (FDI) has innumerable effects on the economy of a host country. It influences the production, employment, income, prices, exports, imports, economic growth, balance of payments, and general welfare of the recipient country. It is also probably one of the most significant factors leading to the globalization of the international economy. Flows of FDI are contributing to build strong economic links between industrialized countries and developing countries, and also among developing countries. The amount of FDI flowing to developing countries increased remarkably in the 1990s and now accounts for about 40 per cent of global FDI. This substantial surge in inward FDI flows to developing countries has been largely due to a rapid pace of liberalization movements in these countries.

Similar trends have also been observed in Turkey. In 1980, the Turkish Government initiated a series of reforms aiming to accomplish the following objectives: (i) mini uing state intervention; (ii) establishing a free market economy; and (iii) integrating the economy with the global economic system. One key progress was in the field of foreign direct investment, which has expanded rapidly following the liberalization program since the early 1980s. The import substitution (IS) strategy of development pursued until the early 1980s was one of the primary cause of the low levels of FDI in Turkey (Balasubramanyam, 1996). The cumulative FDI until 1980 was only $228 million. The major policy shift from the IS strategy towards a more outward oriented economy based on export development has attracted the interest of foreign investors in Turkey. Since the mid-1980s, foreign investors have been taking an increasingly prominent role in the Turkish economy as the recent liberal foreign investment and privatization policies began to show their results. Figure 1 shows this trend in the level of annual inflows of both actual and authorized FDI for the period 1980-1999. As of August 1999, the number of foreign equity venture formations reached a total of 4,817 with the amount of cumulative foreign capital inflows totaling $12,085 million. The authorizations for FDI during this period accumulated to $25,050 million (GDFI, 1999).

Table 1 shows the distribution of cumulative authorized FDI by country of origin. As is reflected in Table 1, European countries take the lead by accounting for over two-third of the total value of FDI. Following the European countries are the USA and Far Eastern countries with having shares of 12.0% and 6.4%, respectively.

In terms of sectoral breakdown of FDI inflows, manufacturing sector accounts for 56.7 per cent of cumulative FDI authorizations with services constituting nearly 41 per cent as of August 1999. Agriculture and mining, however, take very small portion of FDI with both sectors together constituting 2.51 per cent of cumulative FDI authorizations.

Turkey should interest multinational enterprises (MNEs) from several perspectives, specifically as a manufacturing or service provision base from which to supply European, Central Asian and Middle Eastern markets, as a source of raw or processed materials, as a pool of talent and innovation that is readily transferred abroad, as a market for both imports and domestic goods and services, and as a potential joint venture partner anywhere in the world. The US Department of Commerce designated Turkey as one of the ten `Big Emerging Markets' along with China, India, Russia and Brazil, which are expected to offer the greatest commercial opportunities due to their high economic growth and rapidly growing population. Similarly, the UK Government recently labeled Turkey as one of the ten primary developing markets.

To date, however, there have been relatively few empirical studies, which have examined location decisions of MNEs choosing Turkey as an investment location. Previous studies have relied more on collection of survey data using managerial perceptions for measuring the explanatory factors (Erdilek, 1982; Tatoglu and Glaister, 1998), with no studies hitherto been recorded drawing on econometric approaches using secondary data. Given the rapid growth of FDI and its increasing importance, it is critical for both the public and private sectors to have as complete an understanding of the macroeconomic determinants of this phenomenon as possible. Building on the prior literature the focus of this paper is on the location-related determinants of FDI. This is undertaken by means of a time series analysis of major locational factors impacting upon the level of FDI inflows for the period 1980-1998.