Revisiting economic distance and its role in foreign subsidiary survival

In this study, we argue the coexistence of arbitrage and costs associated with economic distance engender a non-linear relationship between foreign subsidiary survival and economic distance. Specifically, we suggest that low to medium economically distant countries offer scope of economic arbitrage, whereas the cost of operating in medium to high economically distant countries is substantially high. Thus, subsidiary survival is high in low to medium economically distant countries and low in medium to high ones. We construct an index of economic distance using arguments from the eclectic paradigm of international production and organisational learning theory, and base our measurement on the Mahalanobis method of distance calculation. Empirical analysis is conducted by applying the Cox’s proportional hazard model to a sample of 1771 Finnish foreign direct investments. Our study contributes to the eclectic paradigm of international production by showing that economic distance is a key locational advantage with attached costs and benefits. The key determinant of subsidiary survival in economically distant countries is the net arbitrage over cost disadvantage.