Article

Bilateral FDI Flows: Threshold Barriers and Productivity Shocks

CESifo Economic Studies (Impact Factor: 0.62). 10/2005; 54(3). DOI: 10.1093/cesifo/ifn025
Source: RePEc

ABSTRACT

A positive productivity shock in the host country tends typically to increase the volume of the desired FDI flows to the host country, through the standard marginal profitability effect. But, at the same time, such a shock may lower the likelihood of making any new FDI flows by the source country, through a total profitability effect, derived from the a general-equilibrium increase in domestic input prices. This is the gist of the theory that we develop in the paper. For a sample of 62 OECD and Non-OECD countries over the period 1987-2000, we provide supporting evidence for the existence of such conflicting effects of productivity change on bilateral FDI flows. We also uncover sizeable threshold barriers in our data set and link the analysis to the Lucas Paradox.

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    • "Given the importance of FDI, its determinants have been extensively described in the literature. Researchers have focused on several factors as determinants of FDI inflow-outflow, including bilateral distance [23] [22] [5], trade costs in the host and home countries, gross domestic product (GDP), GDP growth rate [35], market size of the host country relative to other countries [11] [2] [7] [10], productivity [28], differences in factor endowments, exchange rate volatility [12], financial system development, economic policy activity [17], financial risk [28], host and source corporate tax rates [27], the existence of regional trade agreements [3], country-pair specific impacts, such as language [25], border and colonial history, legal protection, and the quality of institutions [6]. Empirical works employ several regressors to identify FDI determinants. "

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    • "We expect a positive relationship between FDI and Inf ra jt : Increases in the infrastructure endowment lower production costs and lead ceteris paribus to a higher profitability of the investment; (j) finally, the per capita GDP of the origin countries of FDI, lnGDP cap it [+], is used as an indicator of the capital abundance of the country (see e.g., Egger and Pfaffermayer, 2004). Under standard assumptions FDI outflows should be higher the higher the capital abundance of a country (see e.g., Razin et al., 2008). Thus we expect a positively signed coefficient. "
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    • "They argued that factors disrupting the flow of information between specific markets reduce a firm's awareness of business opportunities in other markets, as well as raising the risk that the firm may either be mistaken about the opportunity, or unable to effectively capitalize on it. Since that time, psychic or cultural distance has played a consistent role as a predictor variable for bilateral FDI flows (Habib & Zurawicki, 2002; Razin et al., 2005), the source of inward FDI (Grosse & Goldberg, 1991; Grosse & Trevino, 1996), the destination of outward FDI (Davidson, 1983), and the order of market entries for FDI (Benito & Gripsrud, 1992; Erramilli, 1991). Unfortunately, as highlighted earlier, five of these seven studies used Hofstede as their sole indicator of distance, and only a slim majority (4 of 7) of these studies found a statistically (negative) relationship. "
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