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Racing to the Bottom and Racing to the Top: The Crucial Role of Firm Characteristics in Foreign Direct Investment Choices

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The race to the bottom refers to a competitive situation where a company, state, or nation attempts to undercut the competition's prices by sacrificing quality standards or worker safety (often defying regulation), or reducing labor costs. A race to the bottom can also occur among regions

For example, a jurisdiction may relax regulations or cut taxes and compromise the public good in an attempt to attract investment, such as the building of a new factory or corporate office.

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This study builds on the pollution haven and induced innovation arguments as explanations for firm behavior with regard to international environmental management and argues both need to be integrated. This implies that foreign direct investment is capable of facilitating a “race to the bottom” and a “race to the top” simultaneously

Using novel and detailed data, we test whether environmental capabilities and weaknesses and other characteristics affect US firms’ foreign direct investment choices in Chinese provinces with more or less stringent environmental regulation. This enables a more detailed analysis by allowing country regulation to vary spatially and over time. Our study finds that heterogeneity in capabilities and firm size jointly determine foreign direct investment and in doing so shows the simultaneity of a race to the bottom and to the top. Specifically, firms with environmental capabilities invest in more stringently regulated regions and firms with weaknesses are less likely to target such regions. These diverging effects are both moderated by firm size, which further amplifies each of them. Our findings underscore the need to integrate pollution haven and induced innovation arguments in a joint analysis.

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For instance in China, a variety of "Go Global" policies have been proposed to encourage many Chinese firms to acquire strategic resources and gain greater access to foreign markets (e.g

the "Belt and Road Initiative" policy) (Luo and Tung, 2018). A reverse technology spillover effect brought by OFDI can improve the green technology and innovation in domestic parts, and the knowledge-based view can be explained in the process of the knowledge transfer from the oversea subsidiaries to the parent firms in emerging economies (Ferraris, 2017). However, there are still considerable theoretical gaps and methodological limitations which undermine our understanding of the relationship between green innovation and international business especially in the context of emerging economies. For example, what mechanisms and processes of emerging economies' firms used for acquiring, transmitting and utilizing the environmental knowledge to promote green innovation? What mechanisms and processes are employed by the FDI from developed countries to influence the green innovation of firms in emerging economies? What and how domestic and foreign formal (e.g. government green subsidy or intervention) and informal (e.g. social media or religion) institutions enhance or constrain green innovation?

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Given these points, in fiscally weak cities, foreign investment is associated with decreased disclosure, suggesting they aim to promote local development by becoming pollution havens

Similarly, high levels of pollution induce fiscally strong cities to increase pollution disclosures while the opposite holds in fiscally weak cities. These findings imply that mismatched decentralization policies can undermine other important governance reforms, even ones that might be expected to be complementary to decentralizing initiatives.

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Hao, Y., Guo, Y., Guo, Y., Wu, H., & Ren, S. (2020). Does outward foreign direct investment (OFDI) affect the home country's environmental quality? The case of China. Structural Change and Economic Dynamics, 52, 109-119.

Ferraris, A., Santoro, G., & Dezi, L. (2017). How MNC's subsidiaries may improve their innovative performance? The role of external sources and knowledge management capabilities. Journal of Knowledge Management, 21(3), 540-552.

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