Trabajos investigativos acerca de la marca Arequipa:

The development of theoretical thought on MNE activities occurred in three distinct stages. The initial efforts were based on Heckscher-Ohlin type of trade models, under the assumption of constant returns, which promoted the view of a polarised production space (Iversen, 1935). Accordingly, the models predicted a landscape where MNEs’ HQ activities would exclusively locate in capital-abundant countries with their subsidiaries populating capital-scarce countries instead. A typical conclusion coming out of these early analytical efforts is that there is no incentive for FDI to occur between countries that exhibit equivalent levels of economic development. Yet, that view contrasted strongly with real world observations: the bulk of FDI activity occurred primarily between developed countries, especially among those with very similar levels of economic development (UNCTAD, 2007).

In the second stage, a more sophisticated range of models emerged to include increasing returns to scale and imperfect competition as standard technical tools of analysis. The new trade theory therefore allowed for a more detailed distinction of multinational

100 _{For a state of the art summary of existing knowledge on FDI the interested reader may refer to Dunning}

activity. Following the pioneering work of Helpman (1984) and Helpman and Krugman (1985) the concept of vertical FDI was mainstreamed into the literature. Their starting point is based on a simple observation which states that the different stages of production vary in terms of requirements of different production factors. Therefore, MNEs could geographically fragment their production by shifting some, alternatively all, of their operations to a location featuring lower factor costs whereas the output could be then re- exported or sold to either home or third country destinations. Nevertheless, the authors noted that vertical FDI would be a viable option only in presence of real differences in factor endowments (factor prices) across countries. Moreover, an important assumption of the model would require the trade and transportation costs to be non-prohibitive. Thus, the predictions from the theory appeared to be of relevance especially to regional integration agreements between unequal partners, i.e. North-South agreements.

In contrast to vertical investments, the concept of horizontal FDI suggests that MNEs aim to replicate, as opposed to dis-integrate, their operations in the host country. In other words, foreign investors driven by horizontal investment motives are concerned with the production of the same products in several different markets, thereby foregoing the option of exporting as an alternative method of supplying the markets. The concept has been also formalised in a more sophisticated manner based on basic NEG frameworks.101 _{In a}

nutshell, the trade offs between the transportation costs on the one side and benefits pertaining to economies of scale on the other apply to MNEs activities as well, thus giving rise to horizontal FDI. In particular, the theory states that we are likely to observe horizontal FDI where home markets are large with similarly large trade costs [for a seminal contribution, see Brainard (1993)].

In the final stage, Markusen et al. (1996) and Markusen (1997) combined the two frameworks into a unifying theoretical model, the so called “Knowledge Capital” model. It considers, in addition to horizontal and vertical FDI, exporters from the home country

which gives rise to a number of outcomes that depend, in the first instance, on the relative country characteristics. From the model, it follows that vertical FDI will prevail if the differences in terms of countries’ factor endowments and prices are large enough. On the contrary, horizontal FDI type is likely to dominate the production landscape if comparatively large countries are located far away from home markets and trade costs are not insignificant (the so called ‘tariff jumping motive’). As it can be anticipated, the model predicts that between both extremes, the firms’ landscape remains mixed. Summarising, whereas vertical FDI is conducted between countries that substantially differ in factor endowments (prices), horizontal FDI is associated with cross border investments involving countries that are comparable in size and development levels.102

Although the theories allow for a clear delineation of the general concepts there is nevertheless rather little scope for clear-cut prediction as to which type of FDI will prevail in the market. To be able to do so, and purely from the empirical point of view, one would require detailed data on firm-level inputs and outputs, production and sales structures, etc. This type of empirical inquiry is far beyond the scope of this paper. Instead, given the information at hand we only aim at deriving an approximation of motives for MNEs to invest in the CEEC.

As the most detailed unit of analysis available to us is at the sectoral level, we already note that the idiosyncratic nature of services and manufacturing allows for some preliminary discussion as to which type of investors is likely to be observed in each of the sectors. Thereby, services sector FDI is expected to be on average market-seeking given the need for local adaptation and its generally non-tradable nature [Fillipaios, (2006); Riedl (2010)]. By contrast, FDI in manufacturing is thought to be more sensitive to difference in factor costs as manufactures generally tend to face stronger international price competition. Thus, in addition to market-seeking motives manufacturing sector FDI

102 _{For our subsequent analysis we alternate between different terminologies so that investments that are}

vertical in nature are associated with resource (or efficiency) -seeking investors while FDI driven by horizontal motives can be thought of as market-seeking instead. See also Dunning and Lundan (2008) for a detailed discussion of main types of foreign investors.

may be to the same extent efficiency-seeking. Further support to these hypotheses may be provided by considering the geographical context in which FDI is taking place. As a point in case, services sector FDI might indeed be market-seeking as markets for services have been either non-existent or largely underdeveloped in the pre-transition period.103

Therefore, economic transition is expected to have fuelled the demand for services in the region via different routes, such as domestic consumers but also other foreign investors. As regards manufacturing sector, the bulk of FDI inflows to the countries have been associated with investors from developed countries and in particular EU (Barry, 2002). Thus, taking into consideration initially large factor price differences between the regions the distinction between FDI types becomes slightly less ambiguous. Indeed, there is ample empirical evidence of the region hosting primarily vertically integrated MNEs.104

Clearly, investment decisions do not rely on spot markets for inputs only. Instead, there is a plethora of other production related costs that best describe the complex relationship between various location factors. While existing theoretical models are good in conceptualising the broader outcomes of interactions between FDI and aggregate location factors, their treatment of principal investment or business environment is usually confined to a single parameter ‘trade costs’.105 _{Neoclassical investment theory formally}

refers to this type of costs as adjustment or instalment costs borne by the investor, while new institutional economics (NIE) literature describes the existence of broader

transaction costs characterising a particular location or activity. Sticking to the latter, the concept of transaction costs implies that economic agents incur expenditures each time they undertake business transactions, such as the cost of obtaining information or writing and enforcing contracts [Williamson (1989); Williamson (1998); Antras and Helpman

103 _{Nevertheless, services sector FDI may be also efficiency-seeking depending on the particular nature of}

their activity. The outsourcing of services has been well documented in the case of CEEC as well (Stare and Rubalcaba, 2009). However, given that our inquiry is rather at the broader sectoral level we assume that, on average, services sector FDI is market-seeking.

104 _{See, among others, Bevan et al. (2001); also Lankes and Venables (1996).}

105 _{Thereby, the chosen values for the parameter are often arbitrary in nature, yet they prove to significantly}

(2004)]. Proponents of the approach stipulate that, for instance, absence of sufficiently protected property rights, burden of corruption and political hazard, all raise the level of uncertainty in economic interactions. It follows that locations characterised by higher levels of uncertainty are expected to, all else equal, have lower profitability which in turn makes them less likely to host any significant agglomerations within their respective borders. Thus, the idea of transaction costs can be used to rank the localities according to their respective levels of uncertainty. Accordingly, institutions and institutional quality in particular are the prime determinant of size and distribution of transaction costs [North (1990); also Murrell (2003)]. However, the role of institutions goes beyond pure efforts to reducing transaction costs. Thereby, institutions can also directly affect transformation or production costs in a locality and therefore may qualify as a location factor. North (1990) highlights that institutions are a technological feature of the production process in most industries, since regulative institutions are entrusted, among others, with the task of resolving the issues of variability in the quantity and quality of input factors. Institutions therefore also entail micro-economic implications for the economy given that they affect resource allocation at the firm level.106 _{As a result, the demand for them is expected to be}

industry or sector specific [for a similar argument see also Levchenko (2004)]. We therefore conclude that institutional factors are critical in determining comparative advantage of locations hosting them as they are unevenly distributed across space with the tendency to expose a significant variation in perceived quality.107

This statement particularly applies to transition economies where the cost of establishing FDI has been described as generally high (Meyer, 2001).108 _{At the same time, however,}

FDI inflows to the region have been strong throughout the past two decades.

106 _{For further theoretical insights see, among others, Henisz (2000); Henisz and Williamson (1999); Lucas}

(1990); Vinod (2003).

107 _{For a further reference see Dunning (1998) who incorporates institutions, as an L-bound factor, neatly}

into his eclectic or OLI framework.

108 _{A number of authors hint towards the institutional vacuum, that followed the dismantling of old Soviet-}

style institutional structures, as the main reason for high cost of doing business in those countries (e.g. Murrell, 2003).

Nevertheless, the potential paradox is not necessarily a real one once the progress in regional integration with the EU is taken into consideration. Namely, the CEEC demand for full EU membership resulted in a comprehensive set of reform prescriptions that had to be accepted and enacted by the countries.109 _{In other words, comprehensive}

institutional reforms have been a prerequisite for the EU membership and are therefore assumed to be the centre point of our analysis here. Our main argument runs as follows: while the accession process created an institutional anchor that raised foreign investors’ expectations for more efficient regulative environment in the medium to long term, it was the speed of the institutional convergence, i.e. progress in structural reform, that affected the distribution of FDI in the short run.110 _{It follows that the speed of the reform process}

is crucial determinant of countries’ FDI levels in as far as it entails information on the relative changes in transaction and transformation costs, thus not only approximating the size of entry and adjustment costs but also projecting expectations of future transaction costs. We aim at clarifying this hypothesis in the empirical part of the paper. Next, we survey the relevant empirical literature.