Do overseas investments create or replace trade? New insights from a macro-sectoral study on Japan

Abstract

This paper investigates the relationship between outward foreign direct investment (FDI) and exports and imports from Japan, employing an augmented standard gravity model. Several econometric techniques, including the Gamma Pseudo Maximum Likelihood estimator, are used to rectify possible problems of heteroskedasticity and zero trade flows inherent in the estimation of gravity models of trade. The major finding is that outward FDI is trade enhancing for the Japanese manufacturing industry. However, we find that whether outward FDI creates or replaces trade depends on the industry under scrutiny. Our results indicate that the complementary relationship between FDI and trade is dominant in Japanese manufacturing, especially in the food and beverages, electric machinery, primary metals, and precision machinery sectors. We find also that Japanese overseas investments substitute for imports of chemical products, and for both exports and imports of general machinery.

Keywords:

• gravity model
• outward foreign direct investment (FDI)
• heteroskedasticity
• Gamma Pseudo Maximum Likelihood

JEL Classifications:

• C23
• F14
• F21

Acknowledgements

The author is indebted to two anonymous reviewers for very valuable and helpful comments.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. See Figure A1 in Appendix.

2. See Table A1 in Appendix.

3. See Table A2 in Appendix.

4. The complete list is contained in Table A3 in Appendix.

5. Pfaffermayr 1994; Fontagné and Pajot 1999; Alguacil and Orts 2002; Chiappini 2011.

6. We use the stata commands ppml and glm.

7. See Table A3 in Appendix.

8. Food and beverages, Textiles and apparel, Chemicals, Glass and ceramics, Primary metals, General machinery, Electric machinery, Transportation equipment, and Precision machinery.

9. Around 45 % in nominal terms according to IMF statistics