A Formal Modeling of the Imbalance Theory to Explain Two Directions of Foreign Direct Investment
Foreign direct investment (FDI) has two directions - downward and upward. Traditional FDI theories explain downward FDI, but not upward FDI. This paper introduces a new model, the imbalance theory, which explains both downward and upward FDI. The new theory deals with the balance of both ownership advantages and disadvantages, while the traditional theories mainly focus on ownership advantages in the decision of FDI. For a formal modeling of the imbalance theory, this paper explains the relationship between the optimal input and optimal output. The imbalance theory then explains and predicts FDI when there is a difference between a firm’s expected level of optimal output for the best factor-proportion and its actual level of output.