Agglomeration and Location Decision of Foreign Direct Investment (FDI) in Indonesia

Abstract

Foreign direct investment (FDI) may precipitate remarkable economic growth, even in developing countries. FDI can provide financial resources, transfer technology, improve organizational and managerial practices and skills, and afford access to international markets. This paper aims to measure the relative importance of the different types of agglomeration for location decision of FDI in the manufacturing sector in Indonesia. These data are analyzed with a multinomial logit model where the dependent variable is the choice of location. It examines the determinant factors of new (greenfield) foreign direct investment in the manufacturing sector in Java Island, Indonesia. This study used unpublished micro-level data of principle licenses from the Indonesia Investment Coordinating Board (IICB), which examine 23 counties of Java Island that received manufacturing FDI in the last five years. The finding is agglomeration economies in production (both foreign-owned and domestic firms) show a significant and positive but small impact. Other variables, including facilities, and labor market conditions-anomalously in that a higher minimum wage-matter as much or more than an agglomeration of production. Because the agglomeration effect is small, it means that agglomeration economies are not the determining factor in attracting FDI. The new foreign investors not only seek counties in which foreign or domestic plants have already located but also consider other things such as the density of roads and the availability of labor.