Regional Integration and the Location of FDI
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Regional Integration and the Location of FDI
Eduardo Levy Yeyati
Ernesto Stein
Christian Daude
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Motivation
• Spectacular increase in FDI around the world in recent years
• Similar trend in Latin America, starting in 1993
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FDI Inflows 1980-1999
1000000
0
100000
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TotalFlows
Note: Millions of Dollars, 1996 constant prices
Total Flows
0
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Flows towards
LAC
Flows towards LAC
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Motivation
• Spectacular increase in FDI around the world in recent years
• Similar trend in Latin America, starting in 1993
• FDI: major source of private capital inflows to Latin America
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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
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Motivation
• Spectacular increase in FDI around the world in recent years
• Similar trend in Latin America, starting in 1993
• FDI: major source of private capital inflows to Latin America
• At the same time, increase in number and depth of regional integration agreements around the world.
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Motivation
• Spectacular increase in FDI around the world in recent years
• Similar trend in Latin America, starting in 1993
• FDI: major source of private capital inflows to Latin America
• At the same time, increase in number and depth of regional integration agreements around the world.
• Latin America is no exception: NAFTA, Mercosur, Andean Community, G-3, etc.
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Motivation
• Spectacular increase in FDI around the world in recent years
• Similar trend in Latin America, starting in 1993
• FDI: major source of private capital inflows to Latin America
• At the same time, increase in number and depth of regional integration agreements around the world.
• 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?
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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?
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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
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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.)
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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
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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.
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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)
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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
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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
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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**
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Vertical vs. Horizontal
GDP Host
GDP Source
Extended Market Host
Extended Market 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**
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FDI as a beauty contest: Attractiveness
Independent Variables
GDP Host
GDP Source
Extended Market Host
Extended Market 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
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Attractiveness
GDP Host
GDP Source
Extended Market Host
Extended Market 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**
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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
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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