Regional Integration and the Location of FDI

Regional Integration and the Location of FDI

Eduardo Levy Yeyati

Ernesto Stein

Christian Daude

Motivation

• Spectacular increase in FDI around the world in recent years

• Similar trend in Latin America, starting in 1993

FDI Inflows 1980-1999

1000000

0

100000

200000

300000

400000

500000

600000

700000

800000

900000

198

0

198

1

198

2

198

3

198

4

198

5

198

6

198

7

198

8

198

9

199

0

199

1

199

2

199

3

199

4

199

5

199

6

199

7

199

8

199

9

TotalFlows

Note: Millions of Dollars, 1996 constant prices

Total Flows

0

10000

20000

30000

40000

50000

60000

70000

80000

90000

100000

Flows towards

LAC

Flows towards LAC

Motivation



• FDI: major source of private capital inflows to Latin America

Net Private Capital Flows towards Latin America

Net private Capital Inflows Portfolio FDI Loans

-1

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

4

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Source: Balance of Payments, IMF

As

% o

f G

DP

Motivation




• At the same time, increase in number and depth of regional integration agreements around the world.

Motivation





• Latin America is no exception: NAFTA, Mercosur, Andean Community, G-3, etc.

Motivation





• Latin America is no exception: NAFTA, Mercosur, Andean Community, G-3, etc.

• What should we expect in terms of FDI to the region in light of a future FTAA?

Policy questions

• What effects should FTAA have on FDI from the US and Canada to Latin American countries?

• How will FTAA affect FDI from the rest of the world?

• What should the effect be on Mexico, whose preferential access to US and Canada is diluted?

• Should effects on the rest of the countries be similar, or should we expect winners and losers?

How should RIA affect FDI?

• Sparse literature. No systematic empirical evaluation of large set of countries

• Answer is not obvious. Depends on a number of dimensions– Drivers of FDI

– Insiders vs. outsiders of an RIA

– Host and source country characteristics

Drivers of FDI: Standard models

• Vertical (Helpman, 1984; Helpman and Krugman, 1985): Single-product firm with two separable production stages with different skilled-labor intensity; no trade costs Trade-complementary, vertical FDI between “dissimilar” countries (with different factor endowments)

• Horizontal (Markusen, 1984): Single-product firm with (plant- and firm-level) scale economies; trade costs Trade-substitutive, horizontal FDI between similar countries if trade costs are large (tariff-jumping, distance, etc.)

North - North and North - South FDI What should we expect?

• Factor proportions Horizontal North-North FDI and vertical North-South FDI

• Trade barriers Vertical North-North FDI (location) and horizontal North-South FDI (tariffs, as, e.g., the auto industry during ISI)

• Evidence: FDI-trade complementarity in developed economies Horizontal model + country-specific preferences (large cars in the U.S., small cars in Europe) Trade-complementarity, horizontal FDI between similar countries if trade costs are large

Effects on FDI

• Vertical integration: Lower tariffs lower transaction costs for firms to integrate vertically within the RIA FDI creation

• Tariff-Jumping: Lower tariffs lower costs of serving markets through trade FDI destruction

• FDI diversion/dilution: Non-members (or old members) become relatively less attractive.

• Extended market effect: Fosters tariff jumping in activities with economies of scale higher FDI from outsiders.

• Redistributive effects: The regional effect is not evenly distributed: New and existing FDI may be relocated to more attractive countries winners and losers.

Data and empirical strategy

• Dependent variable: bilateral outward FDI stocks from 1982 through 1998 from OECD International Direct Investment Statistics database

• 20 source countries and 60 host countries: 1200 country pairs, 20400 observations

• Same FTA dummy based on Frankel et al, 1997

• Caution: Very few North-South FTA pairs (developing countries do not report their outward FDI)

Basic specification

– where FDIijt is the stock of FDI of source country i in host country j at time t, as reported by the source country.

– Dij is a vector of country pair dummies

– Yt is a vector of year dummies

Log (1+FDIijt) = + 1 lGDP hostijt + lGDP sourceijt + sameftaijt +

+ EM hostijt + EM sourceijt + Dij + Yt + ijt

FDI diversion and extended market variables

• Diversion / dilution effects:– source extended market: log of the joint GDP of all FTA partners

of the source country, including source country itself

• Extended market effect:– host extended market: log of the joint GDP of all FTA partners of

the host country, including host country itself

Baseline results

GDP Host

GDP Source

Extended Market Host

Extended Market Source

Same FTA

Privatization

Inflation

Constant

ObservationsNumber of pairR2 Withintest F Pair Effectstest F Time Effects

(1)

0.862(14.676)**

-0.136(1.314)

0.060(2.668)**

-0.268(11.756)**

0.770(9.507)**

-9.218(2.900)**

183081140

0.265818.89**41.32**

(2)

0.879(14.917)**

-0.134(1.297)

0.050(2.213)*

-0.270(11.860)**

0.818(9.945)**

0.020(3.324)**

-9.448(2.973)**

1830811400.2662

18.91**36.45**

(3)

0.895(12.931)**

-0.203(1.848)

0.045(1.900)

-0.264(10.879)**

0.769(9.278)**

0.025(1.546)

-8.007(2.312)*

167391100

0.265217.95**36.52**

(4)

0.896(12.948)**

-0.203(1.844)

0.042(1.774)

-0.265(10.906)**

0.783(9.305)**

0.006(0.977)

0.024(1.460)

-7.976(2.303)*

167391100

0.265317.92**33.94**

Vertical vs. Horizontal

GDP Host

GDP Source



Same FTA

Same FTA * Openness host

Trade

Same FTA * Trade

Same FTA * Distance

Same FTA * Av Diff in capital / worker

Constant

Effect of Same FTA (MIN)Effect of Same FTA (MEAN)Effect of Same FTA (MAX)ObservationsNumber of pairR2 Withintest F Pair Effectstest F Time Effects

(1)0.862

(14.676)**-0.136(1.314)0.060

(2.668)**

-0.268(11.756)**

0.770(9.507)**

-9.21(2.900)**

183081140

0.265818.89**41.32**

1.447

(2)0.854

(14.540)**-0.137(1.331)0.065

(2.913)**-0.269

(11.817)**0.123

(0.563)0.009

(3.161)**

-9.097(2.863)**

0.3190.795

183081140

0.266218.84**18.04**

(3)0.866

(12.409)**-0.168-1.53

0.044-1.783

-0.296(12.426)**-2.044(7.150)**

0.119(3.639)**0.425

(10.535)**

-7.877(2.265)*-1.5451.0043.072

163411105

0.278016.23**35.34**

(14.159)**

(11.519)**

(4)0.847

-0.179(1.707)0.064

(2.832)**-0.266

3.168(3.017)**

-0.347(2.285)*

-7.876(2.441)*1.4600.8700.442

179571104

0.266418.72**40.97**

(5)0.766

(8.744)**-0.363(2.727)**-0.020(0.681)

-0.273(9.211)**1.152(9.021)**

-0.780(4.186)**

1.828(0.428)1.1520.829

-0.325

12343740

0.279118.04**41.33**

FDI as a beauty contest: Attractiveness

Independent Variables

GDP Host

GDP Source



Same FTA

Coefficient

0.849

-0.095

0.080

-0.233

0.319

t statistic

(11.51**)

(-0.74)

(8.34)**

(2.86)**

(4.88)**

Distance

Border Colonial Links

Common Language

-0.747

0.06020.1460.619

(23.78)**

(0.6)

(0.9)(8.49)**

Host Effects

Source Country Effects

Year Effects

43.12**

195.75**

108.94**

Dependent variable : Stock of FDI

ObservationsAdjusted R2

18013 0. 7145

Attractiveness

GDP Host

GDP Source



Same FTA

Same FTA * Attract

Extended Market Host * Attract

Extended Market Host * Most Attractive

Extended Market Host * Biggest

Constant

Effect of Same FTA (MIN)Effect of Same FTA (MEAN)Effect of Same FTA (MAX)

ObservationsNumber of pairR2 Withintest F Pair Effectstest F Time Effects

(1)

0.862(14.676)**

-0.136(1.314)

0.060(2.668)**

-0.268(11.756)**

0.7702(9.507)**

-9.218(2.900)**

183081140

0.265818.89**41.32**

(2)

0.855(14.543)**

-0.1314(1.268)

0.062(2.784)**

-0.269(11.814)**

2.060(4.090)**

0.341(2.595)**

-9.201(2.896)**

0.4460.7911.407

183081140

0.266018.73**41.37**

(3)

0.864(14.536)**

-0.131(1.265)

0.006(0.104)

-0.268(11.779)**

2.135(4.197)**

0.364(2.736)**

-0.016(1.068)

-9.498(2.978)**

0.4080.7771.436

183081140

0.266116.58**41.43**

(4)

0.8421(14.316)**

-0.1335(1.289)

0.0266(1.125)

-0.2714(11.909)**

1.9369(3.842)**

0.2954(2.243)*

0.1749(5.023)**

-8.6671(2.728)**

0.5380.8371.370

1830811400.2671

18.51**41.29**

(5)

0.8022(13.648)**

-0.1328(1.286)

0.0208(0.883)

-0.2747(12.089)**

2.0558(4.089)**

0.3125(2.380)*

0.2037(5.848)**

0.618(10.160)**-10.1947(3.215)**

0.5760.8921.457

183081140

0.271518.62**38.8**

Winners and Losers - FTAA

HostCountry

Argentina

Brasil

Canada

Chile

Colombia

Costa Rica

Mexico

Panama

USA

Venezuela

Rest of the countries

14.25%

14.25%

0.79%

33.63%

16.46%

43.92%

0.67%

50.42%

0.79%

ALCAcountries

137.51%

137.51%

-2.82%

177.82%

142.13%

199.21%

-2.93%

212.73%

-2.79%

142.09% 16.43%

All countries

105.34%

94.02%

-2.55%

141.52%

59.78%

134.04%

-2.58%

183.92%

-0.75%

92.26%

Baseline Regression

39.97%

37.79%

-2.49%

125.98%

37.74%

160.31%

-2.48%

216.82%

-0.52%

70.06%

With Openness

All countries

48.52% 15.74%

49.81% 15.74%

-2.77% 0.86%

155.76% 37.48%

74.89% 18.21%

240.66% 49.15%

-2.89% 0.73%

251.39% 56.56%

-2.74% 0.86%

104.19% 18.18%

ALCAcountries

Rest of the countries

Conclusions

• Common membership in a FTA with source country increases bilateral FDI (trade complementarity) from within the region and the rest of the world

• Effects are highly significant and large

• However, regional integration agreements will likely to produce winners and losers, as FDI to countries with deficient investment environment is likely to decline

Regional Integration and the Location of FDI

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