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This is to certify that the

thesis entitled

FOREIGN DIRECT INVESTMENT IN THE U.S. SERVICE SECTOR,
1977-1988

presented by

King Chiu Chan

has been accepted towards fulfillment

of the requirements for
Geography and

MA degree in Urban Studies Programs

 

 

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FOREIGN DIRECT INVESTNHENT IN THE U.S. SERVICE SECTOR,
1977-1988

By

King Chiu Chan

A THESIS
Submitted to
Michigan State University
in partial fulfillment of the requirement
for the degree of

MASTER OF ARTS

Department of Geography and Urban Affairs Programs

1993

ABSTRACT

FOREIGN DIRECT INVESTMENT IN THE U.S. SERVICE SECTOR, 1977-1988.
By

King Chiu Chan

Much of the expansion in foreign direct investment (FDI) in the United States
during the 19805 is a direct result of the growth of FDI in services. As a result,
employment in the U.S. afﬁliates of foreign service ﬁrms increased 1.2 million during
the period 1977-1988. This paper studies the location patterns of FDI in wholesale
and retail trade and ﬁnance, insurance and real estate (FIRE) - the two major service
sectors receiving FDI. The location analysis of FDI in wholesale and retail trade is
conducted at the state level for the period 1977-1982 and 1983-1988. A regression
model is developed to examine the locational association of FDI in wholesale and
retail sector with the domestic wholesale and retail sector, the domestic manufacturing
and the foreign—owned manufacturing sectors. The location analysis of FDI in FIRE
is conducted at the metropolitan level for the period 1981-1983 and 1985-1988. The
association between the location of FDI in FIRE and domestic FIRE employment is

examined using a regression model.

TABLE OF CONTENTS

LIST OF FIGURES ....................................... iii
LIST OF TABLE ........................................ iv
CHAPTERS
I. INTRODUCTION ...................................... 1
1.1. Trends of FDI in Services ........................... 1
1.2. Determinants of FDI in Services ........................ 6
1.3. Study Objectives ................................. 17
1.4. Research Outline ................................. 19
II. DETERMINANTS AND LOCATION OF SERVICE INDUSTRIES
IN THE UNITED STATES ............................. 20
2.1. Determinants of the Growth in the Service Sector ............. 20
2.2. Theoretical Explanations of the Location of Service Industries ..... 25
2.3. The Location of Service Industries in the United States .......... 31
2.4. FDI in the Service Sector in the United States ............... 37
111. LOCATION ANALYSES OF FDI IN SERVICES ................. 48
3.1. Location Model of FDI in Wholesale and Retail Trade Sector ...... 48
3.2. Location Model of FDI in Finance, Insurance and Real Estate ..... 58
IV. CONCLUSIONS ...................................... 67
LIST OF REFERENCES ................................. 70

iii

LIST OF FIGURES

Figure

1. U.S. Direct Investment Abroad and Foreign Direct Investment

in the United States, 1980-1990 ........................... 38
2. FDIUS in Manufacturing and Services ......................... 41
3. Percentage Growth Rate of Wholesale and Retail Employment

in the U.S. Afﬁliates of Foreign Firms, 1977-1982 ............... 45
4. Percentage Growth Rate of Wholesale and Retail Employment

in the U.S. Afﬁliates of Foreign Firms, 1983-1988 ............... 46
5. U.S. Census Regions .................................... 55

iv

LIST OF TABLES

Table

1. Sectoral Distribution of FDI Outﬂow for Five Major Home
Countries, 1981-1984 and 1985-1989 ........................ 4

2. Inward FDI in Services, Selected Host Countries,
by Descending Order of Share in Services ..................... 5

3. Factors Affecting the Location of Service
Transnational Corporations .............................. 13

4. Ownership, Location, and Intemalization
Advantages for Service FDI ............................. 16

5. Foreign Direct Investment in the United States,
1981-1990 ........................................ 40

6. Foreign Investment Transaction in Services,
1981—1983 and 1985-1988 ............................... 42

7. Employment in the U.S. Afﬁliates of Foreign Firms
by Regions, 1977—1982 and 1983-1988 ....................... 44

8. Pearson Correlation Matrix: Wholesale and Retail
Trade Sector, 1977—1982 ............................... 50

9. Pearson Correlation Matrix: Wholesale and Retail
Trade Sector, 1983-1988 ............................... 52

10. Regression Results: Location Model of
Wholesale and Retail Trade Sectors ......................... 57

11. Sixty-three Selected Metropolitan Areas,
Corresponding States and Census Regions ..................... 61

12. Regression Results: Location Model of
Finance, Insurance and Real Estate Sectors .................... 65
V

CHAPTER 1

INTRODUCTION

Foreign direct investment (FDI) in services in the United States has attracted
considerable attention following its rapid growth in the 19805. The literature on FDI
in the U.S. service sector has concentrated mostly on its determinants (Baer, 1990;
De Witt, 1987; Dunning and Norman, 1987; Exstein, 1991; Helsey and Levi, 1989;
Hultman and McGee, 1989) and little attention has been paid to the spatial and
temporal patterns of service FDI in the United States. The purpose of this study is to
examine the spatial and temporal patterns of FDI in wholesale and retail trade, and
ﬁnance, insurance and real estate sectors - the two major recipients of FDI in the

United States.

1.1. Trends of FDI in Services

Services embrace a diverse set of activities with a wide range of suppliers and
consumers. Several deﬁnitions of services exist. However, there is little controversy
that service activities include wholesale and retail trade, transportation,
communications, banking, ﬁnance, insurance, data services, professional services,
community services (including education and health services) and personal services
(such as repair or laundry). Service activities have certain characteristics in common,
that is, most services are intangible and non—storable in nature and are produced and

consumed at the same place (Gray, 1987; Grubal, 1985; Hill, 1977; Nusbaumer,

2
1987; Sampson and Shape, 1985; Shelp, 1981). Although the quality and variety of

services vary more than that of goods, the demand for services at a given level of
income is likely to be less heterogenous. This characteristic helps to explain the
current trend toward the globalization of some services such as wholesale and retail

trade, investment banking, insurance, hotels, advertising, and transportation.

Service activities may be delivered to foreign markets through a variety of
modes. Services such as accounting, advertising, investment banking and brokerage,
engineering, insurance, wholesale and retail trade are sold abroad through foreign
afﬁliates rather than through exports. Exports of services prevail in travel, education,
and legal services. Both exports and FDI appear to be important in transportation,
communications, construction, health, information, consulting and software. The
intangible and non-storable nature of services suggest that FDI would be the
predominant mode for delivering services to customers abroad. Sectorally, "...in
most home and host countries..., the dominant positions are occupied by FDI in
ﬁnance—related services (banking, insurance, and other ﬁnancial services) and in

trade-related services (wholesale and retail trade and marketing)" (UNCTC, 1989a,

p.20).

During the 19805, FDI in services has become the most dynamic part of FDI
growth in general. FDI in services constitutes approximately 50 to 60 percent of the

current worldwide ﬂows of FDI. This share represents a signiﬁcant increase from the

3

19705, when approximately a quarter of the world’s total FDI flows was in services.
During the ﬁrst half of the 19805, more than half of total investment ﬂows of about
$50 billion annually were in the services sector, of which no less than two third were
in ﬁnance- and trade-related activities. The rapid increase of FDI in services is part
and parcel of the general process of the internationalization of business activities.
The international transactions of industrial activities through trade and FDI required
and increasingly relied on supporting services such as wholesale and retail trade,
ﬁnance, accounting, advertising etc. As producers globalized, their service suppliers
have followed. In addition, service transnational corporations (TNCs) have followed
industrial TNCs abroad and gained their experience of operating in international
markets. As a consequence, service FDI has been expanding more rapidly than FDI

in other sectors throughout the last decade.

Trends in the inward flow of FDI show that the ﬁve major investing countries
- France, Germany, Japan, the United Kingdom, and the United States - are also the
largest recipients of FDI inﬂow (UNCTC, 1989b). The share of total inward FDI
flow into these ﬁve countries increased from 53 percent in 1981-1983 to 57 percent in
1984-1988. Inward FDI in services have grown considerably in more developed
countries mirroring the growth of the outward ﬂow of FDI (Table 1 and Table 2).
By the mid-19805, services accounted for about half of the inward flow of FDI in the

United States and Germany.

Table 1: Sectoral distribution of FDI outﬂow for ﬁve major home countries,
1981-1984 and 1985-1989
(millions of national currency and percentage)

 

Country 1981-1984 1985-1989 1981-1984 1985-1989
Average annual ﬂows Percentage share

United States1

Services 5981 10289 52 57

Non-services 5435 7804 48 43

Total 11416 18093 100 100
France

Services 8031 29213 41 49

Non-services 11468 30790 59 51

Total 19498 60004 100 100
Japan2

Services 5280 26723 61 73

Non-services 3448 9770 39 27

Total 8727 36493 100 100
United Kingdom3

Services 1396 56994 35 38

Non-services 2650 9360 65 62

Total 4046 15059 100 100
Germany5

Services 8415 61604 55 64

Non-services 6865 3455 45 36

Total 15280 9615 100 100

 

Source: United Nations Center for Transnational Corporations, 1991, pp.16.

1. Excluding outﬂows to the ﬁnance (except banking), insurance and real estate sectors of the Netherlands
Antilles. Data for 1985-1989 exclude currency translation adjustments. Other industries have been broken into
services and non-services. The petroleum industry, a portion of which includes services (for instance. trading
activities) is included in the non-services category.

2. In U.S. dollars.

3. Data prior to 1984 exclude investments by oil companies.

4. Covers 1985-1988.

5. Calculated from changes in outward stocks between consecutive years.

5

Table 2: Inward FDI in services, selected host countries.
(value and percentage)

 

Country and currency Year Total FDI FDI in services Share of services
in total FDI
France 1980 89.7 33.1 37
(Billions of Francs) 1985 129.0 81.7 63
Germany 1974 78.9 26.3 33
(Billions of Deutche Marks) 1980 93.9 36.4 39
1985 112.8 50.1 44
1986 119.1 54.9 46
Japan 1975 1.5 0.3 18
(Billions of Dollars) 1980 2.9 0.7 22
1983 4.9 1.2 25
1986 7.0 2.0 29
United Kingdom 1971 5.6 0.6 11
(Billions of Pounds) 1981 30.0 6.0 20
1984 38.5 13.3 35
United States 1974 26.5 11.5 43
(Billions of Dollars) 1980 83.0 37.7 45
1985 182.9 92.2 50
1986 209.3 111.2 53

 

Source: United Nations Center for Transnational Corporations, 1989a, Table 1.4, pp.14.

6

The United States is now the most dominant destination for FDI, receiving
approximately 40 percent of the ﬂow generated outside its boundaries. The major
providers of investment flow to the United States during the 19805 were Canada,
Japan and Germany. In 1990, FDI in United States reached $403.7 million, in which
the largest investing sector was services ($185.6 million). The predominance of FDI
in the U.S. service sector has contributed to a rapid growth in direct investment in the
United States. The role of direct investment is considered to be important in the
economic restructuring process in the United States (Connaughton and Madsen, 1990;
Goe, 1991; Noyelle, 1983). Furthermore, the potential role of FDI in services could
affect technology transfer (embodied in plant and equipment or ’hard technology’ and
in the form of knowledge and skills or ’soft technology’), level of employment, trade
patterns, and linkages with other economic sectors within the United States (UNCTC,
1989). The following section discusses why ﬁrms invest directly rather than export

services to the United States.

1.2. Determinants of FDI in Services
The pioneer work in understanding foreign direct investment (FDI) is Stephen
Hymer’s analysis of the growing impact of U.S. direct investment in Canada and
Western Europe (Hymer, 1976). In order to analyze the impact of FDI, it was
necessary to understand how it was possible for U.S. ﬁrms to compete successfully
abroad with the indigenous ﬁrms. According to Hymer, two conditions have to be

fulﬁlled for the existence of FDI: (1) foreign ﬁrms must possess a countervailing

7

advantage over the local ﬁrms, and (2) the market for the sale of this advantage must

be imperfect.

Hymer (1976) suggested that FDI could occur if the investing ﬁrm possessed a
particular advantage over indigenous ﬁrms. In his view, indigenous ﬁrms have a
better understanding of the local business environment, the nature of local markets,
business customs and legislation. In contrast, foreign ﬁrms lack such knowledge, at
least initially. Therefore, transnational corporation (TNC) must possess some
compensating advantages in order to compete in the overseas market. Such
advantages are considered to be technology or knowledge (intangible asset), the ability
of ﬁrms to differentiate their products by quality or variety, and to create a distinctive

brand image or trade mark (Caves, 1974; Johnson, 1970; Magee, 1977).

Another question considered by Hymer was why U.S. managers did not
transfer technology by licensing to indigenous ﬁrms. Hymer’s answer was that the
market for knowledge was not perfectly competitive. However, Hymer did not
clearly distinguish between various types of market imperfections. Kindleberger
(1969) later suggested the following classification of market imperfections:
imperfections in goods markets, imperfections in factor markets, scale economies, and
government-imposed disruption. The Hymer-Kindleberger school of thought found its
roots in the traditional theory of the market; it dealt with market imperfections in a

partial equilibrium setting and emphasized the monopolistic nature of TNCs.

8
Johnson (1970) attempted to go beyond the Hymer-Kindleberger framework by

investigating the welfare implications of the international transfer of knowledge.
Johnson placed the FDI issue "...in a broader and more fundamental perspective by
relating it to the welfare economics of technological and managerial knowledge as a
factor of production" (Johnson, 1970, p.36). Although the cost of producing
knowledge is very high, the cost in transferring the knowledge is relatively lower.
Therefore, it is proﬁtable for a ﬁrm to set up a subsidiary abroad by transferring

knowledge from the headquarters.

Hymer and Rowthom (1970), Knickerbocker (1973) and Vernon (1974) argued
that the extent of FDI depended on the form of oligopolistic interdependence among
existing ﬁrms. In a oligopolistic competition, ﬁrms recognize their interdependence
with their rivals but lack sufﬁcient mutual understanding to co-ordinate their
activities. They are, therefore, likely to adopt simple patterns of imitative behaviors;
that is, to follow the leader. For example, the price leader raises the price, and
others follow; another may expand capacity, and the rivals imitate. Knickerbocker
(1973) suggested that this "follow the leader" behavior could occur in FDI. For
instance, rival A establishes a subsidiary in the United States. If the FDI of the ﬁrst-
mover proves successful, rivals B and C are likely to undertake FDI in the United

States.

9
Others including Brown (1976), Buckley and Casson (1976), Hennart (1982),

McManus (1972), and Swedenborg (1979), used the internalization approach in
explaining FDI. These writers believe that the transaction cost incurred in
intermediate product markets could be reduced by internalizing these markets within
the ﬁrm. Since the intermediate product markets, including marketing, research and
development (R & D), and training of labor are difﬁcult to organize due to their
imperfections, a ﬁrm may prefer to bring these activities under common ownership
and control through FDI (Buckley and Casson, 1976). An example is the
internalization of knowledge. Many ﬁrms, especially in high-technology industries,
spend a signiﬁcant portion of investment on research and development. To ensure a
satisfactory return on such investment, ﬁrms have a strong incentive to retain the
technology within their own production facilities rather than sell or lease it to other
ﬁrms overseas (Magee, 1976). Thus, there is a reason for believing that
internalization of the knowledge market will generate a high degree of multinationality
among ﬁrms. Because knowledge is a public good which is easily transmitted across
national boundaries, its exploitation is logically an international operation. Therefore,
"...unless comparative advantage or other factors restrict production to a single
country, internalization of knowledge will require each ﬁrm to operate a network of
plants on a world-wide basis" (Buckley and Casson, 1976, p.45). Firms must not
only possess superior resources as in Hymer’s argument, they should also have the

desire and ability to internalize the advantages which trigger off their FDI.

 

10

Dunning proposed the eclectic paradigm to explain the role of TNCs and the
growth of FDI (Dunning, 1979, 1988, 1989). The paradigm incorporates:

" . . .the traditional theory of factor endowments which explains how

country speciﬁc endowments might create the origin of some

competitive advantages and where these advantages are exploited,

and the theory of economic organization which explains how such

advantages become the privileged property of ﬁrms" (Dunning,

1988, p.57).
The greater the competitive advantages of ﬁrms over the others, the more they are
willing to combine these advantages with foreign endowments. Moreover, the greater

the transaction costs in intermediate product markets, the greater the incentive for

ﬁrms to bypass them by internalizing the activities under common ownership.

According to the eclectic paradigm, the conﬁguration of value-adding activities
undertaken by TNCs outside their national boundaries are governed by three variables
— ownership—speciﬁc advantages of TNCs, location-speciﬁc advantages of countries,
and market internalization advantages. The conﬁguration of these three advantages
and the response to them by ﬁrms varies according to industry, country and region,
and ﬁrm-speciﬁc characteristics. The conﬁguration also varies over time. Change in
technology and the entrepreneurial and economic development may affect the

competitive position of corporations and the location of their value-adding activities.

Ownership-speciﬁc advantages of TNCs refer to the extent and nature of the
technological, managerial and marketing advantages of TNCs vis-a-vis indigenous

ﬁrms in the country in which they are producing. The principal competitive

11

advantages possessed by TNCs are the ability to create and sustain a successful brand
name, the capability of TNCs to monitor quality, economies of scope, economies of
scale and specialization, availability of technology and information, and accessibility

to inputs and markets.

Market internalization advantages are the advantages of controlling and co—
ordinating cross-border production within a TNC hierarchy, rather than selling the
right to use those advantages to indigenous ﬁrms in the country of production. The
way in which a TNC internalize its competitive advantages may vary be affected by
the nature of the production activity, the organization structure of the ﬁrm, and the

market conditions speciﬁc to the countries engaged in transactions.

Location-speciﬁc advantages of countries apply to the beneﬁts of combining
ownership-speciﬁc advantages with immobile factor endowments in a foreign country
to undertake value-adding activities. A variety of factors may inﬂuence the location
choice of a service TNC. Generally, the size and character of markets, the
availability of human and natural resources as well as real wage rates, agglomerative
and linkage-related economies of being close to competitors, suppliers and customers,
the role of government, and infrastructure provisions exert locational pull toward

TNCs.

12

Dunning’s eclectic paradigm has been mostly used to understand the growth of
FDI in the service sector. The eclectic paradigm has been adopted in explaining the
location of international tourism activities, hotel and restaurants, international
banking, and the location of international ofﬁce activities (Dunning and McQueen,
1982, 1971; Dunning and Norman, 1979; Yannopolous, 1983). The eclectic
paradigm emphasizes not only the initiative of foreign ﬁrms to engage in international
transactions of services, but also the importance of location factors within host
countries. Location factors refer to "...those which are available, on the same terms,
to all ﬁrms whatever their size and nationality, but which are speciﬁc in origin to
particular locations and have to be used in those locations" (Dunning, 1980, p.9).
Service ﬁrms possessing ownership-speciﬁc advantages usually have a choice of
where they engage in value—adding activities. Since most competitive advantages are
mobile across national boundaries, the question is where they can be most proﬁtably

combined with country-speciﬁc endowments.

Some of the location-speciﬁc variables which inﬂuence FDI in services are
listed in Table 3. To what extent are these location variables signiﬁcant in the United
States? While cross-border transport cost is not as important a factor in services as in
other production sectors to determine the location choice in the United States,
nearness to customers and adapting a service to customer needs become more
important. The size and character of U.S. domestic markets, as well as real wages,

are also signiﬁcant in inﬂuencing the location of FDI in service industries, especially

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14

intermediate services and tourist—related activities. The availability of human and
national resources in the United States is crucial in business and professional services,
restaurants, and medical and educational services. There are also agglomeration and
linkage—related economies of being close to competitors, suppliers, and customers.
Security and ﬁnancial companies, foreign exchange, and commodity markets are
highly concentrated in major U.S. metropolitan areas, such as Los Angeles, Chicago,
and New York. In addition, the role of the Federal Government in inﬂuencing the
location of service activities is signiﬁcant. There has been deregulation of FDI in
telecommunications, ﬁnance, insurance, and real estate which stimulated FDI in these
activities. Very often, regulations require a local presence if service activities such as
banking, security, insurance, wholesale and retail trade are to be sold in the United

States.

Dunning (1989) identiﬁed six types of services in which FDI is the
predominant delivery mode to foreign markets. These are as follows: (1) those
services for which the sales of which are dependent upon the presence of people,
goods, or other services in the destination country. These include hotel and most
local tourist facilities, restaurants, car rental, construction development, motion
picture, real estate, and news agencies; (2) transport facilities; (3) telecommunications
and public utility services; (4) warehousing, wholesale and retail services, including
repair and maintenance services; (5) most forms of public administration and social

and related community services (e. g. libraries); (6) services which require a face-to—

15

face contact between buyer and seller, such as ﬁnance, banking, insurance, and real
estate (Dunning, 1989, p.18). Among these services, wholesale and retail trade and
ﬁnance, insurance and real estate have received nearly two third of FDI in services in
the United States during the 19805. With reference to the eclectic theory, the location
pattern of FDI in wholesale and retail trade may vary from that in ﬁnance, insurance
and real estate since these two types of services are inﬂuenced by different
conﬁguration of factors (see Table 4). The location choice of FDI in consumption
services, especially retailing and trade-related activities is affected by factors such as
close contact with suppliers and customers, the need for local sales ofﬁce and
supporting transportation facilities, and adaption to local customer needs. The
proximity to customers, suppliers, and competitors are, therefore, important
determinants in the location of FDI in trade-related activities. On the other hand,
location advantages such as the need for person-to-person contact, government
regulations prohibiting direct imports, lower costs of foreign operations, oligopolistic
strategies among large ﬁrms, and economies of concentration explain FDI in ﬁnance,

insurance and real estate.

Studies in FDI in the United States mostly addressed the question of why
foreign ﬁrms are investing in the United States (Coughlin, Terza and Arromdee,
1990; Glickman and Woodward, 1989; Kahley, 1987; O’hUallachain and Reid, 1992;
Warf, 1988). Although the eclectic paradigm does not go into detail in explaining the

location pattern of service FDI within the host country, the spatial distribution of FDI

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17

in services is expected to be affected by the location-speciﬁc variables discussed in
Table 4. It is expected that the location pattern of FDI in services will resemble the

spatial distribution of domestic services.

1.3. Study Objectives

The purpose of this study is to analyze the location pattern of FDI in two
major service categories - wholesale and retail trade and ﬁnance, insurance and real
estate - between 1977 and 1988. First, this study will examine the location pattern of
FDI in wholesale and retail trade in association with domestic wholesale and retail
sector, and foreign-owned and domestic manufacturing sector in the United States.
Then, the analysis will focus on the association between the location pattern of FDI in
FIRE and the domestic FIRE sector in the United States. Spatial and temporal
variations in these associations will also be estimated. It is expected that these
associations will vary from region to region and over time given the temporal

variation in the regional economic structure within the United States.

The location analysis of FDI in the wholesale and retail sector is conducted at
the state level. The percentage growth rate of employment is used to illustrate the
growth of FDI in wholesale and retail sector. The location pattern of domestic
wholesale and retail sector, foreign-owned and domestic manufacturing sector are
surrogates of supply and demand side factors affecting service location. Foreign

wholesale and retail companies tend to follow their domestic competitors for exploring

 

18

agglomeration economies. It is expected that the location of FDI in wholesale and
retail trade will follow the spatial distribution of domestic wholesale and retail ﬁrms.
Since the wholesale and retail sector is dominated by retailing - a market oriented
industry, proximity to customers and providing service to the local market is
considered to be important. Spatial variation in the above association will be
examined across the four U.S. Census regions (Northeast, North Central, South, and
West) between the period 1977—1982 and 1983-1988. Temporal variation in the above
association will be analyzed for the period 1977-1988 to determine whether or not the

association between service FDI and its determinants is temporally stable.

The location analysis of FDI in FIRE is conducted at the metropolitan level.
Foreign direct investment transaction is used to measure the level of FDI in FIRE.
Sixty—three metropolitan areas with a population size over one million as of October
1986 are selected for the study. Metropolitan areas with well-developed localization
economies (agglomeration economies, high local income, proximity to clients) act as
centers of business innovation and employment growth. It is expected that FDI in
FIRE will locate near their domestic counterparts in order to access localization
economies. Spatial variation in the location of FDI in FIRE will be examined across
four U.S. Census regions for the period 1981-1983 and 1985-1988. Temporal
variation in the association will be analyzed to determine whether or not the locational
association between FDI in FIRE and domestic FIRE is temporally stable between the

two period, 1981-1983 and 1985-1988.

19
1.4. Research Outline

The next three chapters are organized as follows. The second chapter
discusses the determinants and location of service industries in the United States. The
topics included in this chapter are: (l) determinants of services growth; (2) the
location of services in the United States; and (3) FDI in services in the United States.
Chapter three describes the research methodology used in this study. The results of
regression models are presented and discussed in this chapter. Finally, chapter four

provides the conclusion of this study.

CHAPTER II

DETERMINANTS AND LOCATION OF SERVICE INDUSTRIES
IN THE UNITED STATES

Over the past two decades, the service sector has recorded an above average
annual growth rate and became the largest sector in the United States (Carey and
Franklin, 1991). While the real GNP in the United States increased at an average
annual rate of 2.8 percent between 1975 and 1990, the service component increased at
a rate of 3.1 percent. During the same period, the share of services in the GNP
increased from 51.6 percent in 1975 to 54.0 percent in 1990. A growing literature
has focused on the importance of services in U.S. economic restructuring (Beyers,
Alvine and Johnson, 1985a, 1985b; Gillis, 1987; Groshen, 1987; Hansen, 1990;
Illeris, 1989; Kim, 1987; Kutscher, 1987; Noyelle and Stanback, 1984;
O’hUallachain, 1989; O’hUallachain and Reid, 1991; Ott, 1987; Quinn, 1988;
Stabler, Jack and Howe, 1988). Studies on services sector in the United States
indicate that the growth in the share of services in GNP has resulted from a
combination of both changes in the pattern of demand for services and changes in the

supply of factors of services production.

2.1. Determinants of the Growth in the Service Sector
The growth in the demand for a speciﬁc service is a function of the growth in

consumer income, the growth in intermediate services, changes in business practice,

20

21
and innovation in services provision. First, the demand for services has grown
because of the growth in demand for consumer services resulting from a rise in real
income per capita in the United States. Tschetter (1987) suggested that in the United
States "...over the 1972-1985 period, the composition of ﬁnal demand changed
modestly" (T schetter, 1987, p.33). While the U.S. economy grew 2.6 percent per
year during 1972-1985, the expenditures allocated for services expanded rapidly. In
1972, expenditures for durable goods accounted for approximately 8 percent of total
GNP, compared with 10 percent in 1985. Expenditures for services accounted for 29
percent of GNP in 1972, and increased to 32 percent in 1985. While the share of
consumer spending allocated to goods has declined, the share allocated to services has
increased in the 19803. As income increased, the demand for recreational and
cultural services (including motion picture, radio and television broadcasting,
entertainment and recreational services), and personal and household services
(including laundry and cleaning, social escort services and shopping services) have
grown correspondingly. In part, this shift of ﬁnal demand toward services as a

response to higher income reﬂects a shift in emphasis from quantity to quality of life

(Kim, 1987).

The growth of service consumption, especially the consumption of producer
services, is also stimulated by the increasing extemalization of service activities from
corporate enterprises to independent service ﬁrms. Extemalization refers to "...a

reduction or elimination of the internal provision of indirect production activities by

 

22

businesses coupled with the transfer of provision to independent ﬁrms who specialize
in those activities" (Goe, 1990, p.330). The extemalization of service activities is
motivated by the desire to reduce costs and the overhead costs for specialized
knowledge regarding particular service activities. The specialized knowledge
provided by producer service industries is often needed to help business ﬁrms
adapting more easily to changing economic conditions. Kim ( 1987) and
O’hUallachain and Reid (1991) suggested that the increased consumption of services
by the producers is partly due to ﬁrms externalizing service functions that previously
had been performed internally. In fact, the extemalization of service provides greater
ﬂexibility for ﬁrms contracting out for service activities. Specialized service ﬁrms
therefore "... play a buffering role in the economy by facilitating adaptation to the

changing conditions and complexities of the global economy" (Goe, 1991, p.330).

Changes in business practice is another reason for the growth of services
(Tschetter 1987). Companies are concerned with the inputs that are required to
assemble and deliver their products. For example, companies require material inputs
such as plastics, steel, glass and packaging materials. They also need service inputs
such as transportation, ﬁnancial, communications, maintenance, and repair. In order
to compete in an increasingly complex business environment, ﬁrms have expanded
their efforts to marketing, distribution and after-sale maintenance. Consequently,
these subdivisions create further expansion of the demand for services, especially

trade-related and ﬁnancial services.

 

 

23

Innovation in service provision has been identiﬁed as a basis for the expansion
of services. Telecommunications, previously based on simple electro-mechanical
technology, have become a sophisticated set of activities, and are closely linked to
computers, micro—electronics, ﬁbre optics and satellite. Telecommunications are now
more widely in demand. Increasing demand for information processing and
telecommunications have expanded service employment in operating
telecommunication networks (Beyers, 1989; Hepworth 1990; Howells and Green,

1988; Ochel and Wegner, 1988).

On the supply side, the expansion of services could occur through import
substitution process, with local supply replacing prior imports (Beyers, 1989).
Although most services are inherently non-storable, some services can be imported to
U.S. local markets through trade. Importing services prevail in travel, education,
legal services, engineering, marketing, and investment consultancy. The competitive
advantages of foreign TNCs seeking to establish a local presence in these services are
not as great as those of domestic companies. In addition, government regulations
exert controls over the extent and form of FDI in strategically sensitive industries
such as transportation, telecommunications, and community services. Once the
markets of these service industries expand, there is room for foreign competitors to
join the market. As a consequence, increasing number of foreign investors in

telecommunications brings in more service outputs.

 

24

Furthermore, the growing importance of service outputs is based on the
observation of a differential rate of labor productivity growth in the services and other
production sectors (Fuchs, 1968; Gershuny and Miles, 1983; Kutscher, 1988). Labor
productivity growth has grown more slowly in the services sector in comparison to
the manufacturing and primary sectors. This difference is a result of difﬁculties in
standardizing the production of many service outputs without signiﬁcant loss in
product quality, and the perceived lower rate of technological advancement in the
services sector. With lower than average productivity growth in the services sector,
average service production costs and output prices will be higher than those in other
production sectors. Given the observation that "...services have an income elasticity
of demand greater than unity" (O’hUallachain and Reid, 1991, p.256), as the U.S.
economy grows, the share of total expenditures on services will expand. The larger
share of services expenditures implies that the proﬁt margin of existing service ﬁrms
has also been increased. More service companies, therefore, will compete for the

surplus proﬁt margins.

The growth in the share of services in the GNP of the United States during the
last two decades reﬂects the effect of both demand and supply-led forces. The growth
of services is mainly driven by the size and growth of the U.S. economy. Under-
standing the location of demand should lead to an explanation of the location of
services. The location theories of services and the location factors that characterize

the spatial distribution of individual service activity are discussed in next section.

 

25

2.2. Theoretical Explanations of the Location of
Service Industries

Dunning’s electic paradigm provides a theoretical explanation for
understanding the growth of FDI in services. The paradigm, however, does not
account for the location pattern of service FDI within a host country. Therefore, it is
necessary to understand location theories which are used to explain the location and
spatial distribution of services. The central place theory has provided a theoretical
basis for understanding the location and frequency of services, especially consumer
services. One of the limitations is that the central place theory does not make any
reference to producer services. Other location theories, such as bid-rent theory,
equilibrium models of ofﬁce locations, have been used to understand the location

pattern of producer services.

The central place theorv: Christaller (1933) developed the central place theory
to account for regularities in the size and spacing of settlements in southern Germany.
He found that these regularities were explicit among those settlements which provided
goods and services for their own residents as well as for those in the surrounding
areas. Such settlements were deﬁned as central places and Christaller identiﬁed their
relationship by reference to the tertiary services, especially retailing. It is assumed
that the suppliers of goods and services make their location decisions on an isotropic
plain over which a rural population with equal levels of purchasing power is
uniformly distributed. In order to ﬂourish, each ﬁrm must establish a market, and

the size of the this market will be determined by several factors. First, there must be

 

26

a minimum number of potential consumers whom will obtain a service at sufﬁciently
frequent intervals to make a ﬁrm viable. Second, each ﬁrm must take advantage of
economics of scale in the production process. large service ﬁrms, such as
department stores and supermarkets, command more extensive markets in order to
have sufﬁcient potential customers. Third, market areas will be determined by
transportation costs, which comprise delivery cost for the seller and travel costs to the
place of consumption of a service for the consumer. For any particular service, there
will be a maximum distance which an individual will travel to obtain it. The location
of services is, therefore, the result of a minimum size of market or threshold for each

ﬁrm with the size of the market determined by the above factors.

Services with low market thresholds, such as grocery stores, bars, post ofﬁces,
and laundries, will occur frequently and tend to be associated with the smallest
(lowest-order) settlements. Those with much larger market thresholds, such as hotels,
department stores, or jeweller stores will occur less frequently and will be located in
fewer settlements. Some of the lower-order settlements will also act as locations for
higher-order services, thus creating a hierarchy of settlements in which there is a
limited number of centers with full range of retail and consumer services, and a large
number of centers with limited number of services. Complex and specialized services
are more likely to be found in the largest central places where the service ﬁrm can

gain access to a market of sufﬁcient size. All these larger central places will

incorporate all of the services found in the lower-order central places.

27

Central place theory is relevant to an interpretation of the location and spatial
distribution of consumer services, especially retailing (Berry, 1967; Everson and
Fitzgerald, 1969; Johnson, 1964; King, 1962; Marshall, 1969). The theory,
however, does not make any references to producer services. In common with
consumer services, some producer services are subject to the same hierarchical
inﬂuences on location frequency. The notions of threshold, market range, and
centrality will be relevant in explaining the spatial distribution of producer services.
Computer consultants, share brokers, and investment analysts all require extensive
market areas to provide their services; therefore, there are relatively few of them.
While low-order producer services such as local banking, insurance, and real estate
require smaller markets; they are distributed in a greater number of locations. There
are, however, other variables such as localization and urbanization economies which

affect the location of producer services.

Agglomeration confers economies resulting from locational association between
a service ﬁrm and a number of similar or totally different production units. The
clustering of ﬁrms at one location assumes that they will all beneﬁt in a similar way
from that agglomeration. By choosing locations near to competitors or to external
services, new producers minimize the risk involved in starting up a business. Such
risks will be greatest for small ﬁrms and will be higher as the distance from their
market increases. Large ﬁrms will require to be in locations offering a large enough

market, so that the combined effect is the promotion of agglomeration in urban

28

centers. The economics accruing to individual service activities will increase as the

size of an agglomeration increases.

Linkages are the key element of service ﬁrms to agglomerate. A producer
service ﬁrm, such as advertising agency, will have a number of different linkages. It
will have links with the suppliers of the services that it needs to assemble its own
services, such as printers, market researchers, and ﬁnancial services. Secondly, it
will have links with the purchasers of its advertising copy and advice. Thirdly, the
advertising agency will have links with other agencies either as a subcontractor or
through cooperation. Fourthly, it will have links with the media which carry
advertising. Finally, the agency may have links with government which regulate the
quality, timing, and content of advertising. The potential to use these linkages is
greatest when service ﬁrms are located close to their clients, competitors, and
suppliers. Agglomerations also create demand for labor (both skilled and non-
skilled), public and private transport facilities, and other infra-structures such as

telecommunication networks, postal services, electricity and gas supplies.

Eguilibrium models of ofﬁce location: The location of producer services and

corporate headquarters in large metropolitan areas is a response to agglomeration
economies. Studies have been made to devise intra-urban models of ofﬁce location in
which spatial distribution and agglomeration economies are determined simultaneously

(Clapp, 1980, 1983; O’Hara, 1977; Tauchen and Witte, 1983, 1984;). It is assumed

 

29

that the location is determined by ﬁrms making proﬁt-maximizing decisions which in
turn will have an impact on land values. In addition, all ﬁrms are located within a
central business district (CBD) and only have contacts with other CBD ﬁrms. The
cost of providing ofﬁce space is assumed to be increasing over time. Each ﬁrm has
zero economic proﬁt and the ofﬁce rent at each location is the marginal cost of
providing the ﬂoorspace. Tauchen and Witte (1983) addressed the importance of
agglomeration by adopting linear curves for the functions describing contact beneﬁt
and facility cost. Since ﬁrmsare assumed to have contacts throughout the CBD, the
contact-expense curve rise as a ﬁrm moves further from the center, partly because of
the higher cost of contact and because of the more limited contact opportunities
among ﬁrms. The steady increase in cost disadvantage with distance from the center

of the CBD means that ﬁrms will lower rents as distance increase.

Bid-rent theory: Alonso (1960) also adopted the land rent concept in explaining
the location of individual service activities within urban areas. He proposed a model
for the location of activities in which they can offset declining revenue and higher
operating costs (including transportation costs) by lower site rent at locations
increasingly distant from some central point. The bid rent refers to the amount of
rent each service ﬁrm is willing to pay for competing a production site. The
equilibrium location for an activity occurs where the bid rent matches the rent

determined by the market at a site.

3O

Alonso hypothesized a perfect market in which all potential users are fully
informed about all the available sites. In this hypothetical city, accessibility declines
uniformly in all directions, and the utility of ﬁrms depends upon accessibility. Bid-
rent functions are different for each type of service activity. Some services will
obtain more central locations than others because their steeper bid-rent curves will be
associated with a willingness to pay more for a central site than services with ﬂatter
bid-rent curves. The rent which each service activity is prepared to pay reﬂects the
utility it will receive from occupying the site; the higher the utility, the higher the

rent it will be prepared to pay.

 

The bid-rent theory has an application to the location of producer services.
Most producer services are willing to pay high rent for locating their businesses
within the CBD of metropolitan areas. Since information and knowledge are the
essential elements for the operation of many producer services, their locations can be
interpreted within the context of the demand for information, the way it circulates and
exchanges. The diffusion of the information available to decision-makers is spatially
biased. The majority of corporate decision-makers are likely to seek information
from existing contacts near to them. This reinforces the prospects for the growth of
producer services at large metropolitan areas because it minimizes the need to identify
alternative suppliers. As many corporate headquarters have been clustered around the
CBD of large metropolitan areas, the agglomeration creates local markets for

producer services such as management consultancy, advertising, insurance, ﬁnancial

 

31

management agencies. As a consequence, many producer service ﬁrms offer high

land rent for central locations.

2.3. The Location of Service Industries in the United States

Location analyses of services in the United States suggest that services are
becoming an important part of the basic sector of metropolitan areas. Service
industries are concentrated in large U.S. metropolitan areas (Beyers, Alvine and
Johnson, 1985; Clark, 1985; Kim, 1987). Many fast-growing service industries have
been "disproportionately located in the new service-based metropolitan areas in the
U.S. Sunbelt, and have been increasingly Sunbelt-oriented during the 1980s"
(Wheeler, 1990, p.433). O’hUallachain (1989) suggested that the spatial
concentration of many service industries stems from a combination of forces. These
forces "include (a) a market penetration effect causing large cities to experience the
largest absolute job growth, (b) rapid technological change in products and processes
leading to a reassertion of the product life cycle emphasis on agglomeration due to
demand for skilled labor, (c) a business climate of government deregulation that has
created market uncertainty and increased reliance on external economies of scale, (d)
institutional and infrastructure constraints that favor established industry locations, (e)
increasing efﬁciency in communication systems allowing markets to be served at
increasing distance, and (t) the emergence of many specialized small service
enterprises that rely on external economies generated in large urban areas"

(O’hUallachain, 1989, p.34). The process of service agglomeration arises from

 

32

localization effects. For many service industries, centralization is a response to rapid
technical changes and aimed at reducing the cost of searching for personnel, services,
suppliers, and distributors. Finding market niches and new opportunities may also
lead to agglomeration of growing services. The delivery cost of inputs to
agglomerated producers of services may be lowered if suppliers can more easily
identify rapid changing needs, ﬁnd larger markets for increasingly specialized outputs,

and sell new products that require face-to-face contact between buyer and seller.

 

The treatment of service industries as a homogeneous sector with identical
locational pattern is erroneous since the combination of location determinants of each
service industry is different. Service industries include a broad range of activities.
From the viewpoint of consumption, services might be sold to ﬁnal consumers
(consumer services), or they might be sold to other ﬁrms for further value-adding

activities (intermediate services).

For consumer services, proximity to customers remains important since the
service production normally requires the service producer and service user to be
present at the same time and place. Consumer services, especially retail services,
tend to follow the distribution of population. The concepts of threshold and range of
services from the central place theory are useful in explaining the spatial distribution
of retail services. Threshold is the minimum amount of demand needed to ensure the

offering of a service. A service in a rural area may serve just the threshold

33

population, while the same service in a densely populated region may serve many
times the threshold population. The range of a service measures the farthest distance
which the dispersed population is willing to travel in order to obtain a service. The
more expansive the service (e. g. insurance, advertising, engineering consultancy), the
greater the willingness of customers to travel longer distance. For more frequently
consumed services (e. g. laundry and cleaning, haircut, repair services), the range
would be smaller. The location of retail services can be explained by the distribution
of households, weighted by purchasing powers. The absence of high-priced service
activities in rural regions and corresponding over-concentration in large cities may be
explained by reference to central place theory. The sparsely distributed rural
population must travel to the closest central place in order to avail itself to these

services (Coffey and McRae, 1989; Illeris, 1989).

Studies show that another major category of services - producer services - is
mainly a metropolitan phenomenon (Beyers, 1989; Hansen, 1990; Howland, 1991;
Kim, 1987; Noyelle, 1983; O’hUallachain, 1989; O’hUallachain and Reid, 1991;
Wheeler, 1988; Warf, 1988). Producer services are deﬁned as those activities which
produce intermediate and intangible outputs that are used as inputs by other businesses
or by government (Harrington and Lombard, 1989). Examples of producer services
include activities, such as ﬁnance, insurance and real estate; legal services;
transportation and communications; accounting; advertising and marketing; research

and development; data processing; and management training (Hansen 1990). Noyelle

34

(1983) suggested that U.S. cities with strong producer services, especially ﬁnance,
insurance and real estate, enjoyed favorable growth prospects because future job
growth would be concentrated in producer services and because advanced service

centers held increasingly greater control over the diffusion of innovation and the ﬂows

of investment.

The location of corporate headquarters imposes economies of centralization
inﬂuence upon the location of producer services (Coffey and Polese, 1987; Marshall,
et.al., 1987; Noyelle and Stanback, et.al., 1981; Van Dinteren, 1987; Wheeler,
1988). Headquarters and regional ofﬁces of large corporations have a high propensity
to purchase producer services. As corporate head- quarters tend to be highly
concentrated in a small number of U.S. large metropolitan areas, the demand for

these intermediate services will be similarly concentrated.

Coffey and Polese (1987) proposed a location model which posited that "...a
producer service ﬁrm will seek to minimize a production cost function involving three
factor inputs: complementary intermediate demand services, human resources, and the
cost of delivering its output" (Coffey and Polese, 1987 , p.72). Each producer service
establishment is subjected to three locational pulls: toward urban centers characterized
by the availability of diversiﬁed complementary producer services; toward centers
with specialized pools of skilled labor; and toward the market for its output. Certain

locations, such as New York, Chicago, and Los Angeles may combine two or more

35

of these attributes and thus will enjoy a major advantage in attracting and retaining

producer service ﬁrms.

Other factors varying from place to place may affect the location of producer
services. Infrastructure such as transportation and communications networks; regional
and local economic policies; input costs such as wages; the availability of skilled
labor are not distributed equally across space. In addition, independent enterprises
and local governments form distinctive markets for producer services (O’hUallachain
and Reid 1991). Goe (1991) demonstrated that the agglomeration of producer service
ﬁrms within metropolitan areas depended upon local market linkages between
producer service ﬁrms and corporate ofﬁces which required close physical proximity.
The ﬁndings from Goe’s survey suggested that:

"...the primary role of producer service industries in each

metropolitan area is to provide their products of labor to other

industries... Additionally, producer services industries in each

metropolitan area are characterized by a dual structure: (1) a larger

tier of establishment that is primarily dependent upon local markets

and linked into local corporate complex agglomerations; and (2) a

smaller tier of establishment that is primarily dependent upon

export markets and linked into the broader spatial division of

labor" (Goe, 1991, p.328).

Moreover, the high wage paid to workers in govemment-relafed services has an
income effect that induces additional growth of services. Specialized services, such as

political analysts, legal services and consultancy, and welfare services tend to be

agglomerated near government ofﬁces.

36

Wheeler (1988) argued that dramatic growth of services occurred in large
metropolitan areas such as New York, Chicago, and Los Angeles. The concentration
of intermediate services in a few large cities enables the transaction costs associated
with the production and delivery of such services to be minimized. In particular, it is
the cost of maintaining face—to-face contact between the producers and the consumers
of these services that is the most expensive element of producer services, and the
expanse can be mostly reduced in spatial agglomerations (O’hUallachain, 1989).
Large urban centers such as New York therefore continue to reap the rewards of

comparative advantage for services location (Warf, 1988).

New information and communications technologies have contributed to the
growing centralization of ofﬁce-based activities in a small number of metropolitan
areas, while at the same time permitting the decentralization of back ofﬁce activities
into areas characterized by lower factor costs (Hepworth, 1987; Langdale, 1989;
Wheeler and Mitchelson, 1989;). Howlands (1991) described a clear pattern of
service decentralization to the suburban counties of metropolitan areas and the
medium-size cities. Although producer services are decentralizing, they are not
following manufacturing jobs to rural communities. Beyers ( 1991) argued that there
was no strong evidence of downﬁltering in the distribution of producer service
employment. Although producer services became a more important component of the
medium size cities and large suburban communities, the share of the total producer

service employment found in non—metropolitan areas remained constant.

37

In summary, the growth of services in the United States is mainly driven by
the size and the growth of the U.S. economy. The location of consumer services,
especially retail services are mainly inﬂuenced by the proximity to local markets,
competitors, and suppliers. Localization becomes the dominant factor that determines
the spatial concentration of producer services, speciﬁcally ﬁnance, insurance and real
estate industries among U.S. metropolitan areas. Given the fact that the location
choices of FDI in services require the adaption to local customer needs and the
demand for services is less heterogeneous within a local economy, the foreign service
ﬁrms are expected to follow the location pattern of domestic service ﬁrms within the
United States. The following section describes the location of FDI in services in the
United States. Service employment in U.S. afﬁliates of foreign ﬁrms is used as an

indicator of the level of FDI in services.

2.4. FDI in the Service Sector in the United States

The United States has become the leading recipient of FDI during the 1980s,
receiving of nearly 60 percent of all FDI ﬂows from other countries (UNCTC,
1989a). By far the largest host country for service FDI is also the United States, with
over $185 million of inward stock in services in 1990. Inward ﬂows of FDI to the
United States (FDIUS) increased three times from $83 million in 1980 to $403 million
in 1990 (USDOC, 1992). The rapid increase of FDIUS had brought down the net
balance between FDIUS and the outward ﬂows of FDI from the United States

(USDIA) from $132 million in 1980 to $17.8 million in 1990 (Figure 1). Statistics

 

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39

on the composition of FDIUS show that inward FDI in services remains the dominant
component of FDIUS (Table 5). The percentage share of service FDI in the United
States increased gradually from 40.7 percent in 1981 to 46.0 percent in 1990,
compared to the second largest sector — manufacturing, having 37.3 percent in 1980
and 39.6 percent in 1990. The difference between FDI in services and in
manufacturing was widened during 1984 to 1988 when FDIUS experienced rapid

growth (Figure 2).

Statistics on the composition of FDI in services in the United States illustrate
that the dominant positions are occupied by FDI in ﬁnance-related services (ﬁnance,
insurance and real estate) and trade-related services (wholesale and retail trade).

More than 60 percent of the transactions during 1981-1983 and over 50 percent
between 1985 and 1988 are in ﬁnance, insurance and real estate (FIRE) and wholesale
and retail trade (see Table 6). Within the wholesale and retail trade category, most of
the transactions are in retail trade. The FDI transactions in FIRE and wholesale and
retail trade vary across regions during 1981 to 1988. Northeast region favors FDI in
both FIRE and wholesale and retail trade. Most FDI in FIRE have the tendency to
gravitate toward the large metropolitan areas such as New York for agglomeration

economies.

40

Table 5: Foreign direct investment in the United States, 1981-1990.
(Historical costs)

 

Year FDI in servicesl % FDI in Manufacturing2 % Total FDI
1981 44249 40.7 40533 37.3 108714
1982 53057 42.6 44065 35.3 124677
1983 60780 44.3 47665 34.8 137061
1984 73861 44.9 51802 31.5 164583
1985 82704 44.8 59584 32.5 184615
1986 100410 45.6 71963 32.6 220414
1987 120393 45.7 93865 35.6 263394
1988 142515 45.3 122582 38.9 314754
1989 166121 44.4 151820 40.6 373763
1990 185595 46.0 159998 39.6 403735

 

Source: Calculated from the Bureau of Economic Analysis, Survey of Current Business, 1981-1990.

1. Services include production activities from SIC 40 to 89.
2. Manufacturing activities include SIC 20—39.

41

 

 

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The rapid increase in FDIUS in services during the 19805 has boosted the
growth of service employment in the U.S. afﬁliates of foreign ﬁrms (Table 7). Total
employment in the U.S. afﬁliates of foreign ﬁrms doubled its size from 1.2 million in
1977 to 2.4 million in 1982, and increased another 1.3 million between 1983 and
1988. The percentage share of service employment in U.S. afﬁliates increased 15
percent to 43.2 percent in 1988. During 1977 to 1982, service employment in U.S.
afﬁliates had increased rapidly in North Central and South region. At the same time,
many manufacturing jobs in foreign ﬁrms were lost in South and West region.
Between 1983 and 1988, service employment in U.S. afﬁliates increased
dramatically in Northeast and West region. Both regions experienced over 12 percent

increment in the percentage share of employment in U.S. afﬁliates.

Figure 3 and 4 show the percentage growth rate of wholesale and retail
employment in the U.S. afﬁliates of foreign ﬁrms during 1977-1982 and 1983-
1988, respectively. Between 1977 and 1982, Arizona, Louisiana, Rhode Island, West
Virginia, Wisconsin, and Wyoming experience above average growth rate (greater
than plus two standard deviations). Only South Dakota had above average growth
rate (smaller than plus two, but greater than plus one standard deviation). While most
of the states having average growth rate (within plus and minus one standard
deviation) were in South region, many states in North Central and Northeast region
had below average growth rate (smaller than minus one but greater than minus two

standard deviations). Kentucky and Nebraska were states having much below average

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45

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ai

Percentage growth rate of wholesale and ret

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Figure 4

46

- Above average

 

 

E Below average

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47

growth rate (smaller than minus two standard deviations). During the period 1983-
1988, the spatial distribution of foreign wholesale and retail employment growth
showed that wholesale and retail industries were distributed in relation to population
more evenly between regions. Only Maine had above average growth greater than
plus two standard deviation. Idaho and Nebraska had above average growth rate
greater than plus one standard deviation. States with average growth rate were
concentrated in Northeast, South, and West region. Illinois, Minnesota, Mississippi,
North Dakota, Oklahoma, Pennsylvania, South Dakota, Texas, West Virginia,

Wisconsin, and Wyoming had below average growth rate.

Clearly the location of FDI in services in the United States displays similar
pattern of spatial distribution of U.S. services sector. Both FDI in FIRE and
domestic FIRE favor the location of large metropolitan areas. In addition, FDI in
wholesale and retail trade and domestic wholesale and retail ﬁrms are inﬂuenced by
the proximity to suppliers, competitors, and customers. The locational variation of
FDI in wholesale and retail trade and in FIRE is further analyzed in the next chapter

using regression models.

 

CHAPTER III

LOCATION ANALYSES OF FDI IN SERVICES

This chapter presents the location analyses of FDI in wholesale and retail trade
and FIRE in the United States, respectively. Wholesale and retail sector and FIRE
are examined separately since the location pattern of FDI in wholesale and retail
sector may vary from that in FIRE. The growth rate of wholesale and retail trade
employment is a surrogate representing the growth of FDI in wholesale and retail
sector. It is expected that foreign-owned wholesale and retail sector will locate near
their domestic counterparts, and near the manufacturing sector, both foreign and
domestic ﬁrms within the United States. Foreign direct investment transactions in
FIRE is used to measure the level of FDI in FIRE. The location of foreign direct
investment transactions in FIRE is also expected to locate near their domestic

counterparts. Spatial and temporal changes in these associations are also estimated.

3.1. Location Model of FDI in Wholesale and Retail Sector
The location of foreign—owned wholesale and retail industries is analyzed at the
state-level. The model is speciﬁed as follows:
FW=a+bTW+cFM+dDM+e (l)
where the dependent variable FW is the percentage growth rate of wholesale and
retail trade employment in the U.S. afﬁliates of foreign ﬁrms between 1977-1982 and

1983-1988. TW is the growth rate of total domestic wholesale and retail trade

48

 

 

49
employment between 1977-1982 and 1983-1988; and FM and DM are the growth

rates of manufacturing employment in the U.S. afﬁliates of foreign ﬁrms and the
domestic sector between 1977-1982 and 1983-1988, respectively. Coefﬁcient "a" is
the intercept; "b","c", and "d" are the regression coefﬁcients and "e" is the error
term. Equation (1) is estimated using ordinary least squares (OLS) multiple

regression for the two time periods 1977-1982 and 1983-1988, respectively.

Data on manufacturing and wholesale and retail trade employment in the U.S.
afﬁliates of foreign ﬁrms are obtained from Foreign Direct Investment in the United
States, Operations of U. S. Aﬂiliates of Foreign Companies (U .S. Department of
Commerce, 1985a, 1985b, 1986, 1991). Data are collected for the year 1977, 1982,
1983, and 1988 for computing the percentage growth for the two time periods 1977-
1982 and 1983-1988. The total domestic employment data in manufacturing and
wholesale and retail trade are obtained from Employment and Earnings for the same

years (U.S. Department of Labor, 1979, 1984, 1984, 1990).

Pearson correlation coefﬁcients between variables in Equation (1) for the
period 1977-1982 are listed in Table 8. There is a high correlation between the
independent variable TW and DM (0.79838). Such high correlation creates the
problem of multicollinearity between explanatory variables and results in biased
estimates. Therefore, the model for the ﬁrst time period for the wholesale and retail

sector is not presented here. Pearson correlation coefﬁcients of the variables in

 

 

 

50

 

Table 8: Pearson Correlation Coefﬁcients: Wholesale and Retail Trade
Sector, 1977-1982.

 

 

FW TW FM DM
FW 1.000 0.299 0.299 0.370
TW 1.000 0.259 0.798
PM 1.000 0.036
DM 1.000

 

 

51

Equation (1) for the second time period (1983—1988) showed that the multicollinearity
problem did not exist for the second time period (see Table 9). The highest
correlation coefﬁcient between independent variables FM and DM was 0.34167. The
level is acceptable for estimating the parameters of Equation (1) using OLS multiple
regression. An examination of the correlation coeﬁcients for the time period 1977—
1988 showed the existence of multicollinearity. Therefore, temporal changes in the

association indicated in Equation ( 1) is not estimated.

The OLS estimates of the parameters in Equation (1) in the second time period
are presented below with t—values indicated in parentheses:
1983-1988
FW = 111.219 + 8.651TW - 3.524FM - 0.787DM
(0.924) (2.188) (-2.263) (-O. 153) (2)

R2 = 0.1829 F = 3.507

The results show that the two signiﬁcant predictors are TW and FM. The
effect of domestic manufacturing (DM) is negative but not statistically signiﬁcant.
High levels of employment growth in wholesale and retail sector in the U.S. afﬁliates
of foreign ﬁrms is associated with high levels of employment growth in the domestic
wholesale and retail sector. However, high levels of employment growth in the
foreign-owned wholesale and retail sector is associated with lower levels of

employment growth in the U.S. manufacturing afﬁliates of foreign ﬁrms. The results

52

Table 9: Pearson Correlation Matrix: Wholesale and Retail Trade Sector,

 

 

 

1983-1988.
FW TW FM DM
FW 1.000 0.278 -0.312 -0.060
TW 1.000 0.046 0.238
PM 1.000 0.342
DM 1.000

 

 

53

illustrate that there is a tendency for foreign investors in wholesale and retail sector to
locate close to their domestic counterparts. The economies of agglomeration
signiﬁcantly attract foreign investment in the wholesale and retail sector. In
addition, the agglomeration effect generates lower costs between suppliers and
customers, access to market and skilled and unskilled labor. The size of the domestic
sector also suggests the presence of localization economies. Therefore, for new
investors, these locations/existing spaces are attractive as potential niches in the U.S.
market. On the other hand, the association between foreign-owned manufacturing
sector and FDI in wholesale and retail trade indicates that a growth of employment in
foreign-owned manufacturing sector is not necessarily stimulating the growth of FDI
in the wholesale and retail sector. The foreign-owned wholesale and retail sector is
dominated by retailing - a market oriented industrial sector. However, manufacturing
investment by foreign ﬁrms has been dispersing away from major population centers,
for examples Chicago, Detroit, and Pittsburgh. The initial association indicates that
FDI in retailing and wholesaling is following the market and not the distribution of

the manufacturing sector.

Spatial variation: The above analysis demonstrated the locational association
of the foreign-owned wholesale and retail sector vis-a-vis domestic wholesale and
retail sector, domestic manufacturing sector, and the foreign-owned manufacturing
sector. Similarities and differences in this association in the U.S. regions are

examined in this section. The regional variation in the association shown in Equation

 

54

(l) is examined using regional dummy variables (D1, D2, and D3) representing four
U.S. Census regions (Figure 5). These dummy variables have a value of either 0 or

1 depending on the regional afﬁliation of a state. The dummy variables are speciﬁed

 

as follows:
Region D1 D2 D3
Northeast 0 O 0
North Central 1 0 0
South 0 1 0
West 0 O l

 

The parameters of Equation (1) are redeﬁned as linear functions of dummy

variables, D1, D2, D3:

a = a0 + alDl + a2D2 + a3D3 (3)
b = b0 + lel + b2D2 + b3D3 (4)
c = c0 + chl + czD2 + c3D3 (5)
d = (10 + dlDl + d2D2 + d3D3 (6)

Substituting Equation (3) through (6) in Equation ( 1), the spatial model is obtained as
follows:

FW = a0 + alDl + a2D2 + a3D3 + boTW + b1D1.TW +
b2D2.TW + b3D3.TW + + d3D3.DM + e (7)

Equation (7) is estimated using stepwise regression procedure which selects signiﬁcant

explanatory variables that best predict the variation in the dependent variable.

 

56

The results from the stepwise regression are as follows (F-values are shown
in parentheses):
1983-1988

FW = 97.481 + 29.029TW - 21.899FM - 32.321D1.TW
(1.72) (74.78) (78.39) (13.47)

- 29.053D2.TW - 28.832D3.TW + 22.483D1.FM
(49.54) (32.87) (46.75)

+ 21.405D2.FM + 21.528D3.FM
(57.11) (60.38) (8)

R2 = 0.7268 F = 13.97

Regional variations are noted in the association between the foreign—owned
wholesale and retail sector and the domestic wholesale and retail sector (TW) and
foreign-owned manufacturing sector (FM) (see Table 10). The results indicate that
high levels of employment growth in the foreign-owned wholesale and retail sector is
associated with high levels of employment growth in the domestic wholesale and retail
sector in the Northeast and West regions, and is associated with low levels of
employment growth in the domestic wholesale and retail sector in North Central and
South regions. Foreign investors tend to concentrate near their competitors in sharing
the large domestic market, especially large metropolitan areas such as New York, and
Los Angeles. In addition, international seaports such as Boston and New York in
Northeast region; Los Angeles, San Francisco, and Seattle in West region are
gateways for foreign wholesale and retail ﬁrms in distributing their products to the

U.S. market.

57

Table 10: Regression Results: Location Model of Wholesale and Retail
Trade Sectors.

 

Coefﬁcient
Intercept
TW

FM

Northeast

97.481

29.029

21.899

North Central

97.481

-3.292

0.584

South

97.481

-0.024

-0.494

West

97.481

0.197

-0.316

 

 

 

58

The results also indicate that in the Northeast and North Central region, high
levels of employment growth in the foreign-owned wholesale and retail sector is
associated with high levels of employment growth in the foreign-owned manufacturing
sector. However, in the South and West regions, high levels of employment growth
in the foreign wholesale and retail sector is associated with low levels of employment
growth in the foreign-owned manufacturing sector. The foreign—owned manufacturing
sector in fact represents partly the foreign investment in the United States. The
locational association of foreign wholesale and retail ﬁrms with foreign manufacturing
ﬁrms indicates the client following strategy of foreign direct investors. The growth of
Japanese investment in auto industries in the North Central region during the mid-

1980s may have stimulated the growth of Japanese FDI in other industrial sectors.

3.2. Location Model of FDI in Finance, Insurance and Real Estate
The location of foreign direct investment transactions in FIRE is analyzed at
the metropolitan level. The model is speciﬁed as follows:
FF=p+qDF+e (9)
where FF indicates the total number of foreign investment transactions in FIRE in
1981-1983 and 1985-1988. DF is the mid-year employment level of domestic FIRE,
1982 for the ﬁrst time period and 1986 for the second time period. Coefﬁcient "p" is

the intercept, "q" is the regression coefﬁcient, and "e" is the error term. Equation

(9) is estimated using OLS regression method.

59

Data on FDI transactions are collected from Foreign Direct Investment in the
United States, Completed Transactions, 1974-1983 (U .S. Department of Commerce,
1985b) and Foreign Direct Investment in the United States, 1985, 1986, 1987, and
1988 (U.S. Department of Commerce, 1986, 1987, 1988, 1989). In 1984, FDI
transactions were not reported for metropolitan areas, therefore, the ﬁrst time period
does not include 1984 data. Mid-year employment data of domestic FIRE are

obtained from the Bureau of Labor Statistics publication - Employment and Earnings

(U.S. Department of Labor, 1984, 1988).

The results of the OLS estimation of Equation (9) for the period 1981-1983

and 1985-1988 are presented below (t-values are indicated in parentheses):

1981-1983

FF = -2.612 + 0.260DF
(-0.933) (8.593) (10)

R2 = 0.8329 F = 299.011

1985-1988

FF = -3.817 + 0.136DF
(4722) (17.292) (11)

R2 = 0.5476 F = 73.846

60
The Rz-value decreases from .8329 during 1981-1983 to .5476 during 1985-

1988. This result suggests that the association between the foreign-owned FIRE
sector (FF) and the domestic FIRE sector (DF) is less strong in the second time
period. The results show that DF is statistically signiﬁcant for the two periods. High
levels of foreign investment transactions in FIRE is associated with high levels of
domestic FIRE employment in sixty-three U.S. metropolitan areas. The strong
association of FF with DF suggests that not only domestic FIRE ﬁrms, but also
foreign-owned FIRE companies are favoring large metropolitan areas for investment.
As Coffey and Polese (1989, p.60) noted, "...each producer service establishment is
subjected to three locational pulls: toward urban centers characterized by the
availability of diversiﬁed complementary producer services; toward centers with
specialized pools of skilled labor; and toward the market for its output". Large
metropolitan areas such as Chicago, Los Angeles, and New York combine these
attributes and therefore, enjoy a major advantage in attracting FIRE ﬁrms. In
addition, the agglomeration of foreign-owned FIRE ﬁrms toward domestic
competitors not only saves foreign investors’ time and efforts in searching local

markets, but also offers instant supply of skilled labors.

Spatial variation: In this section, the regional variation in the association
shown in Equation (9) is examined using regional dummy variables (D1, D2, and
D3). The sixty-three metropolitan areas with their corresponding states and afﬁliates

regions are listed in Table 11. The assignment of the three dummy variables (D1,

61

Table 11: Sixty-three selected metropolitan areas, corresponding
state and Census regions.

 

Metropolitan areas State Census region
Akron OH NC
Albany NY NE
Allentown PA NE
Anaheim CA W
Atlanta GA S
Baltimore MD . S
Birminghan AL 8
Boston MA NE
Charlotte NC S
Chicago IL NC
Cincinatti OH NC
Cleveland OH NC
Columbus OH NC
Dallas TX 8
Dayton OH NC
Denver CO W
Detroit MI NC
Fort Lauderdale FL S
Greenboro NC S
Houston TX 8
Indianapolis IN NC
Jacksonville FL 8
Jersey City NJ NE
Kansas City MO NC
Los Angeles CA W
Louisville KY 8
Memphis TN S
Miami FL 8
Milwaukee WI NC
Nashville TN 8
New Brunswick NJ NE
New Orleans LA ‘ S
New York NY NE
Newark NJ NE
Norfolk VA 8
Oklahoma City OK 8
Omaha NB NC
Orlando FL 8
Philadelphia PA NE
Phoenix AZ W
Pittsburgh PA NE
Protland "OR : W
Providence RI NE
Richmond VA S
Riverside CA W
Rochester NY NE

62

Table 11: Continued.

 

Metropolitan areas State Census region
Sacramento CA W
Salt Lake City UT W
San Antonio TX S
San Diego CA W
San Francisco CA W
San Jose CA W
Seattle WA W
Springﬁeld MA NE
St. Louis _ MO NC
Syracuse \NY NE
Tampa FL S
Toledo OH NC
Tulsa OK 3
Washington DC S
Wilmington DE S
Worcester MA NE
Youngstown OH NC

 

1. Four census regions are North Central (NC), Northeast (NE), South (S), and West (W).

63

D2, and D3) is based on the spatial variation model of the wholesale and retail sector.

The parameters of Equation (9) are redeﬁned as linear functions of dummy variables,

D1, D2, and D3:
q = q0 + qlDl + q2D2 + q3D3 (13)

Substituting Equation (12) and (13) in Equation (9), the spatial model is expressed as

follows:

FF = pO + plDl + p2D2 + p3D3 + qODF + q1D1.DF +
q2D2.DF + q3D3.DF + e (14)

Equation (14) is estimated using stepwise regression procedure for
the two time periods in order to select signiﬁcant variables that best explain variations

in the dependent variable.

The results from the stepwise regression are presented below (F-values are

indicated in parentheses):

1981-1983

FF = -5.163 + 0.273DF - 0.129D1.DF + O.227D2.DF
(3.38) (90.04) (4.11) (7.95) (15)

R2 = 0.8613 F = 120.08

 

 

64
1985-1988

FF = -3.350 + 0.146DF - 0.055D1.DF — 0.028D3.DF
(19.35) (336.35) (10.45) (3.40) (16)

R2 = 0.6393 F = 34.86

The results indicate that the models vary spatially, as in each time period, two
spatial variables (D1.DF, D2.DF, and Dl.DF and D3.DF) are statistically signiﬁcant
in the stepwise regression Regional variations are noted in the association of foreign
direct investment transactions in FIRE with domestic FIRE employment during 1981-
1983 and 1985—1988 (Table 12). The results for the ﬁrst time period show that high
levels of foreign direct investment transactions of FIRE is associated with high levels
of domestic FIRE employment in Northeast, North Central, and South region.
Boston, New York, and Philadelphia in Northeast region; and Chicago, Cleveland,

Detroit in North-Central region are major metropolitan areas where headquarters and
and regional ofﬁces of business enterprises are located. The proximity to

clients and nearness to their domestic competitors bring foreign-owned FIRE ﬁrms to
Northeast and North Central region. Metropolitan areas in South region, such as
Houston, Kansas City, and Miami, received foreign direct investment transactions in
FIRE in the form of real estate during 1981-1983. For the second time period, the
stepwise regression results illustrate that high levels of foreign direct investment
transactions in FIRE is associated with high levels of domestic FIRE employment in

the Northeast, North Central, and West regions. Northeast and North Central regions

65

Table 12: Regression Results: Location Models of Finance, Insurance,
and Real Estate Sectors.

 

 

1981-1983

Coefﬁcient Northeast North central South West
Intercept -5.163 —5. 163 —5. 163 -5. 163
FF 0.273 0.144 0.500 --
w

Coefﬁcient Northeast North central South West
Intercept -3.350 -3.350 -3.350 -3.350

FF 0.146 0.091 -- 0.118

 

 

66

continue to attract and retain FDI in FIRE because of the inertia effect. Since most
of the headquarters and regional ofﬁces of business enterprises are location bound to
major metropolitan areas, foreign investors in FIRE tend to locate their businesses

close to their clients and local markets (Goe, 1991). Los Angeles, Seattle, Portland,

San Francisco, and San Diego in West region received most of the foreign investment

 

transactions in FIRE during 1985-1988 (USDOC, 1986-1989). While U.S.
manufacturing ﬁrms have been relocating their production sites toward Sun-belt areas,

many producer service ﬁrms have followed their clients in these regions. Moreover,

 

population growth in Seattle, Los Angeles, and San Francisco has stimulated the
demand for housing. As a consequence, the booming real estate market has attracted

domestic and foreign-owned real estate ﬁrms to the West.

Tempgral variation: In this section, the temporal variation in the association
shown on Equation (9) is examined. The parameters of Equation (9) are redeﬁned as
functions of a temporal dummy as follows:

P = P0 + Pit (17)

q = 90 + cm (18)

The dummy variable "t" is equal to zero for the ﬁrst period (1981-1983), and is equal
to one for the second period (1985-1988). Substituting Equation (17) and (18) in
Equation (9), the temporal model is denoted as follows:

FF = p0 + plt + qot + qlt.DF + e (19)

Equation (19) is estimated using stepwise regression.

67
The results show that the coefﬁcient associated with the term "t.DF" is
statistically signiﬁcant. Therefore, the effect of BF on FF has changed signiﬁcantly
between the ﬁrst and the second time periods. The results from the stepwise
regression are as follows (F-values are indicated in parentheses):
FF = -3.l98 + 0.264DF - 0.132t.DF
(4.71) (169.62) (29.62) (20)

R2 = 0.6076 F = 94.47

The temporal change in the effect of DF on FF indicates that the association
between the location of foreign direct investment transactions in FIRE with the
location of domestic FIRE employment has weakened between 1981-83 and 1985-88.
Foreign-owned producer service ﬁrms continue to locate in the major metropolitan
areas whereas their domestic counterparts have demonstrated some decentralization
toward medium sized and small metropolitan areas -hence, the relatively weaker
association between the foreign and the domestic FIRE sectors over time. New
information techniques and communication networks have permitted the
decentralization of back ofﬁce activities to medium-sized metropolitan areas, while at
the same time retaining strong connections with their headquarters in the major
metropolitan areas. It is expected that familiarity with the total U.S. market will

eventually allow foreign producer service ﬁrms to decentralize.

 

CHAPTER IV

CONCLUSIONS

FDI in the U.S. service sector has come to the forefront of FDI analysis in
recent years. Although the service sector received the largest share of total FDI ﬂows
into the United States throughout the 19803, little attention has been focused on the
location pattern of FDI in U.S. service industries. This study examined the changing
pattern of FDI in wholesale and retail trade and FIRE sectors - the two major
recipients of FDI in the U.S. service sector. Spatial and temporal variations of the

location patterns were also investigated.

The location analysis of FDI in wholesale and retail trade indicates that there
is a strong association of the location pattern between foreign-owned and domestic
wholesale and retail sectors. The results are expected since agglomeration with
domestic counterparts enables foreign-owned wholesale and retail ﬁrms to explore
localization economies (O’hUallachain, 1989). The presence of domestic wholesale
and retail ﬁrms suggests the existence of local markets. Therefore, foreign investors
tend to locate near their domestic counterparts for competing potential niches in the
U.S. market. On the other hand, the results show that high level of employment
growth in the foreign-owned wholesale and retail sector is associated with lower
levels of employment growth in the foreign-owned manufacturing sector. Foreign

investors in wholesale and retail sector, especially retailing, prefer large metropolitan

68

69

areas for their businesses since these metropolitan areas with large population size
provide potential markets for a wide range of consumer goods and services. Foreign
manufacturing investment, however, has been dispersing away from metropolitan
areas. The results indicate that the location pattern of foreign-owned manufacturing
industries has been changing in an opposite direction from that of foreign-owned
wholesale and retail sector. The results of the spatial model show that the association
varied across U.S. region in 1983-1988. High levels of employment growth in the
foreign-owned wholesale and retail sector associated with high levels of employment
growth in the domestic wholesale and retail sector in the Northeast and West regions;
and associated with lower levels of employment growth in the North Central and
South regions. Foreign investors tend to locate near their competitors in sharing
large domestic market, especially serving large metropolitan areas such as New York

and Los Angeles.

The location analysis of FDI in FIRE indicates that foreign-owned FIRE ﬁrms
follow the spatial distribution of domestic FIRE companies and cluster around major
U.S. metropolitan areas. The association between the location pattern of FDI in
FIRE and domestic FIRE employment suggests that both foreign-owned and domestic
FIRE ﬁrms favor large metropolitan areas for investment. The location pattern of
FDI in FIRE around metropolitan areas displays a strong tier of establishments that is
primarily dependent upon local markets and linked into local corporate

agglomerations. The results of the spatial model for the period 1981-1983 indicate

70

that high levels of foreign direct investment transactions in FIRE associated with high
levels of domestic FIRE employment in the Northeast, North Central, and South
regions. For the second period 1985-1988, high levels of foreign investment
transactions in FIRE associated with high levels of domestic FIRE employment in the
Northeast, North Central, and West regions. The temporal analysis results illustrate
that the association between the location of foreign investment transactions in FIRE
and domestic FIRE employment is temporally unstable as the association weakened
between 1981-1983 and 1985—1988. The above results suggest that location
determinants which affect the spatial distribution of domestic service industries may

also affect the location pattern of FDI in these service industries.

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