Foreign Direct Investment by Large Swedish Firms - the Role of Economic Integration and Exchange Rates

Abstract: Two important features of the global economy in the last few decades have been the increasing degree of regional economic integration and the increasing volatility of real exchange rates. Due to the EU membership and the single European currency, issues related to regional economic integration and exchange rate changes hold prominence on the business and political agenda in Sweden. This dissertation examines how changes in international conditions for trade and investment, induced by economic integration and exchange rates, influence the FDI decisions of Swedish firms. The study examines which firms are particularly sensitive to changes in these factors in their FDI decisions, and the strategic nature of these FDI projects. The empirical data was derived from structural interviews with the decision-makers behind 36 FDI projects (mergers & acquisitions) undertaken by the 18 largest manufacturing firms in Sweden in 1995. The empirical results show that the policy content of the EU influenced a number of FDI decisions, particularly FDIs undertaken by firms with small plant-level scale economies in production. The results indicate that firms with small plant-scale economies - as opposed to firms with large plant-scale economies - are particularly inclined to undertake intra-regional FDIs in response to economic integration since they experience less transactional benefits from intra- regional trade liberalisation by increasing exports from established production units. The policy content of economic integration in the EU and its market- enlargement and growth-enhancing effects were particularly pronounced in FDIs designed to increase the degree of process specialisation and to reorganise the production structure in Europe, respectively. The results show that actual or anticipated exchange rate changes influenced a considerable number of FDIs. The most profound influences were associated with exchange rate variability - in the host or home country - rather than to exchange rate misalignments. The influence of exchange rates was particularly pronounced in FDIs undertaken by firms with few opportunities to pass through exchange rate changes to customers and by firms with small plant-level scale economies in production. The results show that exchange rate stability in the host country was a particularly important determinant in FDIs designed to broaden the product line. It was also shown that changes in the labour costs, induced by exchange rate changes, were an important determinant in low cost labour- seeking FDIs designed to enter a new national market. Finally, the results show that process-specialisation FDIs were undertaken in foreign locations partly because of anticipation of an unfavourable Swedish Krona.