International Conference on the Modern Development of Humanities and Social Science (MDHSS 2013)

Reversal of Fortune
Solving the Puzzle of Emerging Economy ODI

Philip C. Chang Juanjuan Xie

Haskayne School of Business School of Economics
University of Calgary Nankai University
Calgary, Canada Tianjin, China

Abstract—Since the surge of the outbound direct investment (ODI) their overseas investments, especially the outpouring of
of the emerging economies, the limitations of the traditional Chinese outbound foreign direct investment (ODI) in the 21st
Ownership-Location-Internalization (OLI) paradigm of foreign century, the limitations of the OLI paradigms were exposed.
direct investment were exposed. The main puzzle is how to
interpret emerging economy ODI when the fundamental The main puzzle that academicians have been struggling
buildingblock of OLI, firm specific ownership advantages, barely with is how to interpret emerging economy ODI when the
existed. Focusing on the case of China, an integrated theory based fundamental buildingblock of OLI, firm specific ownership
on the reversal of fortune of China and the reversal of the role of advantages, barely existed within their MNEs. Many scholars
ownership advantages is proposed. The new framework adds such as Buckley et al [10], Huang and Wang [11], Sun et al
home advantage and institutional support to OLI while reversing [12], and Andreff and Balcet [13], to name just a few, have
the role of the “O”, generalizing the “L”, and strategizing the “I”. attempted to address this question from various angles but so
far there is no generally accepted answer.
Keywords-China, the eclectic theory, emerging economies,
foreign direct investment, institutional support, outbound direct The purpose of this paper is to propose an integrated theory
investment for emerging economy ODI to solve the puzzle. Given China’s
dominating role in emerging country ODI, our illustration and
I. INTRODUCTION analysis will be based on the case of China.The new framework
Foreign direct investment (FDI) has been an important topic may be applicable to other emerging economies.
in international business during the past five decades [1]. As The solution to the puzzle lies in the “reversal of fortune”
multinational enterprises (MNEs) and globalization evolved, (Figure. 1) of China – from a relatively poor country short in
scholars continued to wonder about the future of FDI [2]. foreign exchange, to the world’s second largest economy with a
A widely accepted theory of FDI is Dunning’s Eclectic thriving domestic market (deep market) and long in foreign
Theory [3][4][5]. While it has five versions as summarized by exchange reserves (deep pocket). And decades of FDI pouring
Eden and Dai [6], it has been crystalized as the Ownership, into China was indeed an important contributor to the
Location, and Internalization Paradigm (OLI). It provides a economic miracle. The deep market and deep pocket enabled
framework for understanding FDI: MNEs doing FDI must have Chinese MNEs to acquire desired FSA through ODI; the “O”
firm specific Ownership advantages (technology, brand and in OLI was skipped!
management) that they can transfer abroad; they will choose an
attractive Location (seeking natural resources, market,
efficiency and strategic assets); and when FDI is chosen as the
preferred entry mode, it is because Internalization of the above
advantages incur lower transaction costs than alternative modes.
While OLI has been criticized for the interdependent nature
of O, L, and I [7], it is still a popular analytical tool for FDI.
We may interpret OLI as an attempt to answer the following
three FDI questions:
• What frim specific advantages (FSA) does the firm own? FIGURE I. THE REVERSAL OF FORTUNE
• Which location is the best place to go?
• Why is FDI the best entry mode? II. AN INTEGRATED CHINESE ODI FRAMEWORK
A thorough analysis of the Chinese ODI trends and patterns
OLI evolved and matured during the age of globalization is beyond the scope of this conceptual paper. But it might be
when the developed world expanded their businesses all over useful to note that KPMG and China International Contractors
the world through FDI. It has long been recognized that the Association [14] reported recently that while Asia is still the
ownership of FSA is a necessary condition for FDI [8][9].But leading destination of Chinese ODI, Europe andNorth America
since the rise of the emerging economies and with the surge of have enjoyed significant growth during the past few years.
Chinese investments in Europe have been growing at an annual

© 2013. The authors - Published by Atlantis Press 25

rate of 111% between 2008 and 2011, and those in North well documented by Luo et al [15], proved to be very powerful
America at 90%. The key sectors for Chinese ODI have been in launching Chinese firms onto the global stage.
overseas engineering and contracting projects, energy and
mining, household appliances, automotive, and financial C. Reversal of Roles of Chinese MNEs: Acquisition of
services. Ownership Advantage
Equipped with home country advantages and institutional
They also reported that in 2012, the total value of ODI support, Chinese MNEs were able to go on a global “shopping
made by Chinese non-financial enterprise reached $77.2 billion spree” to compensate for their weaknesses in competitiveness.
– a 44% compounded annual growth rate since 2003. As well, They skipped the “O” in OLI and acquired the FSA of foreign
overseasacquisitions have risen at an annul growth rate of 31% firms through M&A and other modes. Understanding such a
between 2005 and 2012. reversal of roles, from a recipient of foreign FAS through FDI
With the rapidly expanding Chinese ODI in mind, the to a buyer of foreign FSA is key to establishing a theory for
integrated theory adds home advantage and institutional Chinese ODI.
support to OLI. It also reverses the role of “O”, generalizes the D. Generalized Location Advantage
“L”, and strategizes the “I”. The solution to the Chinese ODI
puzzle lies in the reversal of fortune of China and the reversal Rugman and Verbeke have thoroughly reviewed location,
of roles of Chinese MNEs. Below is a brief explanation of each strategic and MNEs in international business [16]. For Chinese
component of the new framework. ODI, given the cultural emphasis on personal connections and
trust, confidence gained through a vibrant local Chinese
A. Reversal of Fortune: Home Advantages community is definitely a factor when choosing a location.
After decades of rapid economic growth and trade surplus, Similarly, Chinese executives, compared to their Western
in part due to voluminous inbound FDI, China has experienced counterparts, may feel more at ease with developing or socialist
a reversal of fortune. The Chinese economy has been countries because the social/economic/political distances
transformed from a less develop one with a severe foreign between China and these countries are shorter. Thus location
exchange shortage to the fastest growing in the world. It boasts for Chinese ODI should includeboth physical and non-physical
to be the second largest economy worldwide and possesses the distance in addition to the four traditional advantages listed in
highest foreign exchange reserves. the Introduction. We shall this expanded view of location
“Generalized Location Advantage”.
Such a profound transformation, never seen in economic
history, should serve as a backdrop of a theory for Chinese ODI. E. Strategic Internalization
While China is still a developing country and its MNEs may Pioneered by Buckley and Casson [17], internalization
not have transferrable FSA, they do have home country based on transaction cost considerationis a basic construct of
advantages at the macro level that the OLI paradigm did not OLI and plays an important role in international business [18].
cover. But one of its restrictions is that it only considers transaction
The two most striking advantages are the abundant foreign costs [19]. We argue that when choosing an entry mode, the
exchange reserves and the huge domestic market with potential strategic benefits should be taken into consideration besides
for further growth. The deep financial capability of the state cost efficiency. For example, cross-border M&A has been a
enables Chinese MNEs to go on a shopping spree globally at a main form of Chinese ODI. One of the reasons is that M&A is
lower cost of capital to buy FSA from foreign firms to more time-effective than green field investment. This is
compensate for their competitive weaknesses. The deep particularly true when competing for scarce strategic resources
domestic market not only provides customers for their products globally [20]. Thus transaction costs alone do not fully explain
and natural resources but also lowers their market risk. Thus the choice of entry mode. We shall call this broadened entry
the advantages of the Chinese MNEs are not firm-specific but mode selection “Strategic Internalization”, which encompasses
rather country-specific: lower capital cost and lower market strategic benefits and transaction cost considerations.
risk. III. CONCLUSION
B. Institutional Support Based on the above discussion, we may start to delineate a
The Chinese institutional environment has had a profound Chinese ODI theoretical framework. “The Reversal of Fortune”
influence on its ODI. This is indeed a “Chinese characteristic” theory is rooted in the Chinese home country advantages, the
that distinguishes Chinese ODI from the rest of the world. To deep pocket and the deep market. The pursuit of ODI activities
begin with, the waves of FDI pouring into China during the is strongly supported by a spectrum of pro-ODI policies since
past three decades were one of the results of the states “Reform the 2001 strategic shift to “Going Global”. Equipped with the
and Opening Up” strategies since 1978. Then the surge of above, Chinese MNEs are able to acquire competitive
Chinese ODI after entering into the 21st century was the direct advantages that they did not own. When choosing a location, a
outcome of the game-changing “Go Global” policy announced non-physical social/economic/political distance is also
in 2001. To support “Go Global”, not only did the state identify considered in addition to physical distance and traditional
strategic ODI goals, such as natural resources, technology, and location advantages. When they choose ODI as an entry mode,
managerial capabilities, there was a spectrum of pro-ODI benefits they intend to internalize include strategic benefit as
policies to support ODI, including financing, foreign exchange, well as transaction cost efficiency. Figure. 2 contrasts OLI and
and risk management. Given the top-down political system and the integrated Chinese ODI framework. Further research needs
the SOE dominated MNE sector, the whole package of support,

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