An economic theory of FDI: A behavioral economics and historical approach☆
Abstract This is an attempt to argue that explaining the foreign investment decision (FDI) need not lie outside the realm of economics, for it can be explained using the attributes of behavioral economics. Behavioral economics, which tries to improve the assumptive realism of economic theory, and objects to the neoclassical acceptance of the simplistic economic model of rational agents exhibiting optimizing behavior, is certainly capable of explaining the decision of multinational enterprises making investment decisions when they face the complex and uncertain international environment. It is in this spirit that I have tried to model the FDI decision using the attributes of behavioral economics. However, before presenting this behavioral economics model of FDI decisions, I discuss the problems that neoclassical economics faced in explaining the new reality of FDI/international production after World War II, when neoclassical economists utilized the unrelated arbitrage theory of portfolio flows to explain it. I do also Stephen Hymer's critique of that attempt, and his attempt to explain FDI decision, which helped it move outside of the realm of economics. I do also review and discuss the various FDI theories that emerged, after the 1960 dissertation of Hymer, in the works of Dunning, Buckley, Casson, Markusen, and others presented as transaction cost, internalization, and the eclectic theories of foreign direct investment. While praising the contributions of these theories, I argue that they are inferior to the behavioral economics based model I develop in this model.