Private and Public Information for Foreign Investment Decisions

Using a specially-designed survey of Japanese firms planning investments in Asia, this paper highlights the importance of privately-held information in making foreign investment decisions. Information from direct experience on operating conditions in a country is likely to be the most credible, but for investors entering a new country information signalled by others investing in that country proves of great value, leading possibly to cascading investments in countries. Publicly available information is also important, and largely complementary to private information. Perceptions of FDI policy are also complementary to private information, but policy is of little value to those who already invest in or perceive rivals to be active in a country. "...either he should discover the truth about them for himself or learn it from some one else; or if this is impossible, he should take the best and most irrefragable of human theories and make it the raft on which he sails through life." Plato. Introduction What information sources do investors use to make their decisions? Does privately-held information play an important role in the decision-making? If so, is the private information acquired through direct experience? Or is it based upon observations of actions undertaken by others? These questions are especially relevant for foreign investment decisions where public, or commonly-held, perceptions are characterized by considerable uncertainty and, in particular, may be quite misleading for an investor's specific requirements. In this paper, we demonstrate the empirical importance of private information, with others' actions being a specially important guide when "new" countries are opening up. Significant discontinuties in investment flows are observed at such times. China has attracted a rush of investment not only from overseas Chinese but also from U.S., Japanese, and European investors, starting quite abruptly in the late 1980s and growing explosively into the mid-1990s. China receives about $40 billion a year of foreign investment despite cumbersome procedures and uncertainty on property rights and contract enforceability; in contrast, India after rolling back restrictions and a longer tradition of a market economy chalks up less than $2 billion a year. A similar discontinuity is now being observed for Vietnam, where competing investors are staking out their positions. Investors do use publicly available information on market size, stocks of infrastructure, costs of doing business (including labor costs), foreign investment policies, and other country characteristics to make new investment decisions. However, such information is rarely a sufficient 2 guide to investment decisions. Moreover, public information,by definition, available to all potential investors,cannot lead to cascades unless new developments occur, as when a major policy initiative is announced. Policy initiatives do matter,however, as we show, their consequences depend upon private information. In contrast, privately-held information,or more accurately, private beliefs,can have a significant impact on investment flows even when no fundamental change has occurred but when a perception of change leads to actions by a critical mass of investors, which then has a snowballing effect. In practice, public and private information complement each other. They also interact: certain publicly announced, though minor, events can reinforce latent private beliefs, which may then become the primary drivers of foreign investment. What is the content of private information? Investors seek information on a variety of operational conditions which are not publicly available, including the functioning of labor markets, industrial literacy of the workforce (as distinct from educational attainments), the practical implementation of foreign investment polices, and the timely availability of inputs. Such information may be acquired in two ways: through direct experience via past investments in a country and through inferenences from the behavior of other investors. Where a firm's past investment is the influence on future investment, we refer to that as a "learning" effect: presence in an earlier period generates valuable information on market and cost conditions which forms the basis for making new investments. Such information, this paper shows, is considered very valuable by investors; but, by definition, it is not available to new investors in a country. Where the behavior of other investors spurs investment, we infer the influence of reputation and of strategic rivalry. A rivals' decision conveys the information that the rival considers investment in a particular country to be a profitable venture, thus increasing the incentive to invest 3 in that country to benefit from the same opportunities. The importance of such intrinsically valuable information on operating conditions in a country is notably illustrated by General Motors' decision to locate its Asian hub in Thailand: "...the fact that 11 car manufacturers already operate in Thailand was a sign that the country's infamous physical infrastructure and labor bottlenecks could be overcome" (Bardacke 1996). However, this example also highlights that, in addition, private beliefs may reflect strategic considerations, which may also lead to a self-reinforcing cycle of investment (Kuran 1995). Anecdotal evidence suggests that the strategic element of such investment decisions is important. While the learning effect creates persistence through inducing continued investments by existing foreign investors, inferences based on reputation of others and on strategic rivalry considerations leads more directly to "herd" behavior. This paper draws upon two streams of literature: the economics of private information flows and beliefs and the determinants of foreign investment. Herd behavior parallels and reflects "cascades" of information flows (Scharfstein and Stein 1990, Bikhchandani, Hirshleifer, and Welch 1992, and Lee 1993). The so-called "herd" behavior,actions based on others' actions,can be quite rational in as much as it economizes on the gathering of scarce information. Arthur (1995) discusses several examples from economics and finance where private beliefs play an important role. Kuran (1995) explains the persistence of several social institutions as well as their abrupt breakdown on the basis of privately-held but publicly concealed preferences. 1/ The rush of Japanese motorcycle investors to Vietnam has followed from a perceived "first mover" advantage. Referring to the general interest in Vietnam, a German investor recently summarized well the phenomenon: "We simply cannot sit back and let the Japanese take over another market unchallenged" (Financial Times, March 28, 1995). 4 The influence of rivalry in driving foreign investment was examined in a pioneering study by Knickerbocker (1973). He showed that the more oligopolistic an industry, the greater was the likelihood that foreign investments would be concentrated into a short period of time, and hence display spikes or discontinuities in foreign investment flows. Knickerbocker did not, however, study the influence of past presence. Recently, Head, Ries, and Swenson (1995) have shown that Japanese investors in the United States tend to "follow-the-leader," affirming the signalling value of others' behavior. Kogut and Chang (1996) have used firm-level data for Japanese multinationals investing in the United States and they find past presence to be an important predictor of new investments,however, they do not explore the influence of rivalry. The findings of this paper are also consistent with aggregate evidence of persistence in foreign investment. Wheeler and Mody (1992) found that U.S. investments into a country were strongly conditioned by existing stocks of foreign investment in that country (after controlling for a variety of factors, including market size) and speculated that agglomeration economies may be important especially where investors were likely to be engaged in the purchase of intermediate inputs from other investors. But even where agglomeration economies are unimportant, past presence can provide, or the presence of others can signal, information on business operating conditions which are critical to smooth functioning but which cannot be easily inferred from generally reported statistical indicators or from stated policy towards foreign investors. Also, subsequent analysis shows that Japanese investors are equally influenced by the stock of past investment (Mody and Srinivasan 1996). This study reinforces earlier micro and aggregate evidence on the value of private information but additionally distinguishes between the different sources of private information and demonstrates their complementarity with public information. 5 The setting for the empirical examination is investment by Japanese manufacturing firms in a number of key Asian countries in the early 1990s and the data is from a specially designed survey of Japanese investors. The next section describes the questions asked in the survey, the data thus generated, and the analysis methodology. We then present the simplest model that reveals the role of private information in determining a firm's likelihood of investing in a country and distinguishes between the influence of learning and rivalry among the sampled firms. We examine the robustness of the finding by introducing several firm characteristics in the estimated equation to determine if the "private information" merely reflects firm attributes. The role of public information on investment decisions is dealt with by introducing country dummies, which are assumed to embody information available to all; also, since public information is assumed accessible to all, regressions for individual countries help further highlight the role of private information. Successive models add other host country features that influence the behavior of foreign investors; interaction of learning and rivalry with these factors provides additional perspectives on foreign investment flows. Data and methodology The survey questionnaire was mailed by the Japanese Ministry of Trade and Industry (MITI) to several hundred Japanese firms of which 173 returned usable responses in March 1993. The sample thus obtained cannot be treated as representative of all Japanese firms,we do not know the characteristics of firms who did not respond. There is, however, sufficient heterogeneity amongst the respondents to permit a statistical analysis of their foreign investment behavior. The firms in our sample are relatively large. The average annual sales are 330 billion yen (over $3 billion), the 6 largest firm in the sample has sales of $70 billion and the smallest has sales of $2 million. This is also a set of firms that is prone to making significant foreign investments,in the three years prior to the survey, over a fifth of their investment was undertaken outside Japan. Our dependent variable is based on the following question regarding the firm's expectation that it will invest in specific Asian countries: "In each of the following countries, how likely are you to invest in the next three years?" Respondents were asked to check a space on a 1-7 scale provided, ranging from "very unlikely" to "very likely". VERY VERY UNLIKELY LIKELY :___:___:___:___:___:___:___: The question was answered for the following seven countries: China, Thailand, Malaysia, Indonesia, Vietnam, Philippines, and India. These countries constitute the principal developing country recepients of foreign investment in Asia. Their level of economic development is substantially lower than in the so-called Asian Tigers,South Korea, Taiwan, Hong Kong, and Singapore,with Malaysia being the closest to the Tigers by most development measures. For each of the seven countries, we have 173 responses, potentially creating 1211 (173x7) observations (however, since all respondents did not answer all questions, for certain estimations fewer usable observations are available and where appropriate we have tested for selection bias). Our two key independent variables are PAST and RIVAL. The questionnaire asked whether the firm already had a presence in each of the seven countries being studied. For each firm and each country, the PAST variable was coded 1 if the firm was present in the country and 0 if it 7 was not. Recall that we infer a learning effect if past presence leads to a high likelihood of future investment. The other key variable allowed inference on the information obtained from competitors and the extent of strategic rivalry. The question asked was: "Are your competitors making investments in the following Asian countries?" Once again, the response allowed ranged on scale of 1 (very little) to 7 (very substantial). The average value of the responses for the seven countries (and the standard deviations) are reported in table 1. Respondents to our survey are most likely, by far, to invest in China, the average measure on the 1-7 scale for China being 4.08. Only 20 percent of the firms have existing investments in China; however, the perceived level of rivals' interests in China is high, second to Thailand. Four countries have similar likelihoods of investment: Thailand, Malaysia, Indonesia, and Vietnam. Of these, Malaysia and Thailand have traditionally attracted substantial Japanese interest, with 25 and 30 percent of firms respectively reporting existing presence in those countries; and rivals are also strongly interested. In contrast, Vietnam has low existing Japanese presence and also a relatively low interest from rivals. The least attractive sites are the Philippines and India, with low expected investment, low initial presence, and low rivals' activity. Thus, a simple comparison across countries indicates a correlation between expected investment by the firm and its perception of the strength of rivals' interest in the country. Since past presence is indicated only in 15 percent of the possibilities, information provided by behavior of rivals is likely to be valuable where the firm is entering new countries. An ordered logit model was used to investigate these relationships more precisely. The model is an extension of the binomial logit model: instead of two choices, we here have three ordered choices (see Greene 1993). For the purpose of the regression, the likelihood of investment 8 (LFDI) variable was rescaled. As illustrated, the original data is on a scale of 1 through seven. This was reconstructed to create three categories: 2 (highly likely to invest where the response was 6 or 7), 1 (moderately likely, where the response was 3,4, or 5), and 0 (unlikely to invest, where the response was 1 or 2). As in the binomial logit model, we assume a latent regression model of the following form: The latent variable y is not observed, but the response indicating the likelihood of investment is observed. The observed responses are related to the latent variable in the following manner: Then, for the logistic cumulative distribution function, the model predicts the following probabilities for each of the responses: The joint probability or the likelihood function is: * y = x + β ε