The FDI location decision: Distance and the effects of spatial dependence Fre ´de ´ ric Blanc-Brude a,b , Graham Cookson f , Jenifer Piesse c,d , Roger Strange e, * a EDHEC, Singapore b King’s College London, UK c Bournemouth University, UK d University of Stellenbosch, South Africa e University of Sussex, UK f University of Surrey 1. Introduction Tobler’s (1970: 7) first law of geography states that ‘‘everything is related to everything else, but near things are more related than distant things’’. But how should near and distant be conceptualized? In geography, distance is most often equated to physical distance, contiguity, or travel time. In international business (IB), alternative conceptions of distance (for example, cultural, psychic, institu- tional) are often more pertinent, and have been put forward as explanations for various aspects (e.g. international market selec- tion, choice of entry mode) of multinational enterprise (MNE) behavior. The concept of distance is particularly important in understanding the spatial dimensions of international business activity. Various studies have demonstrated that the distance between countries is a major determinant of bilateral international trade (e.g. Frankel & Rose, 2002) and international investment flows (e.g. Baltagi, Song, & Koh, 2003; Blonigen, Davies, Waddell, & Naughton, 2007; Hall & Petroulas, 2008) but there has been little work (see Coughlin & Segev, 2000; Ledyaeva, 2009) on how the distance between locations at the sub-national level impacts upon MNEs’ decision-making. In this paper, we draw upon economic geography and institutional theory to investigate how different conceptions of distance impact upon one of the fundamental decisions made by foreign investors, namely the choice of foreign direct investment (FDI) location within the selected host country. There is a large literature on FDI location but, with a couple of exceptions (e.g. Coughlin & Segev, 2000; Ledyaeva, 2009), all the empirical studies treat alternative locations as distinct places, and implicitly assume that the distances between these have no impact upon the likelihood of FDI location. Yet the boundaries between the alternative locations are often quite arbitrary and defined by administrative fiat rather than political-economic reality, and proximate locations may well impact significantly upon the attractiveness to foreign investors. This results in a situation of spatial dependence which, if ignored, can give rise to various estimation and inference problems. The theoretical contribution of this paper is to explain why the attractiveness of host country International Business Review xxx (2014) xxx–xxx A R T I C L E I N F O Article history: Received 16 September 2012 Received in revised form 16 December 2013 Accepted 19 December 2013 Keywords: China Distance FDI Location Proximity Spatial dependence Spillovers A B S T R A C T We investigate how different conceptions of distance impact upon one of the fundamental decisions made by foreign investors, the choice of foreign direct investment (FDI) location within the selected host country. We argue that the attractiveness of host country locations to foreign investors depends not only upon location-specific attributes such as labor costs, but also upon the location’s proximity to alternative locations. We provide theoretical rationales for how and why alternative concepts of distance might impact upon firms’ FDI location decisions, and explicitly model different measures of geographic, economic and administrative distance. Empirically we illustrate the use of a number of spatial regression models with a new dataset on FDI in Chinese prefecture-cities, and have shown, in this context, that geographic distance is not the ‘best’ measure of distance to use. We find clear evidence of spatial dependence between the cities based upon economic distance, with weaker evidence related to administrative distance. The distinctive contribution of this paper is to emphasize that city-level policy to attract FDI is more likely to succeed if the prefecture-city is economically (and administratively) close to alternative city locations, while any policy expenditure may fail to attract FDI inflows if the prefecture- city is distant from other city locations. ß 2014 Elsevier Ltd. All rights reserved. * Corresponding author. Tel.: +44 1273 873531. E-mail address: R.N.Strange@sussex.ac.uk (R. Strange). G Model IBR-1063; No. of Pages 14 Please cite this article in press as: Blanc-Brude, F., et al. The FDI location decision: Distance and the effects of spatial dependence. International Business Review (2014), http://dx.doi.org/10.1016/j.ibusrev.2013.12.002 Contents lists available at ScienceDirect International Business Review jo u rn al h om epag e: ww w.els evier.c o m/lo cat e/ibu s rev 0969-5931/$ – see front matter ß 2014 Elsevier Ltd. All rights reserved. http://dx.doi.org/10.1016/j.ibusrev.2013.12.002