Determinants of foreign direct investment of OECD countries 1991–2001

Abstract

It is the objective of this paper to identify the determinants that led to the increase in worldwide foreign direct investment during the 1990s. The paper also addresses the question of whether these factors influenced exports differently. Therefore, using data from 22 countries reporting to the OECD, gravity models for bilateral FDI stocks/flows and exports are estimated, first in a cross-section setting for 1999 and then as a panel data set for the period 1991–2001. In order to control for EU-specific effects, a distinction is made between intra-EU25 observations and observations outside the EU25 area. Regressions are repeated with exports as a dependent variable in order to elaborate how far determinants of trade flows are identical or how far they differ. In the panel context, the results show that a change in total market size is an important aspect that leads both FDI and exports in the same direction. Only exports are significantly influenced by relative market size. Stock market booms boost FDI but not exports. Political indicators and exchange rate changes suggest that exports are demand-driven while FDI is supply-driven. Overall, FDI and exports tended to flow relatively less abundantly to distant countries than to nearby countries over the period under consideration. This supports the idea of a complementary relationship between investment and trade. However, this trend is reversed for exports within the EU25 area.

Keywords:

• foreign direct investment and international trade
• multinational firms
• models with panel data

JEL Codes :

• F21
• F23
• F14
• C23

Acknowledgements

This article is based on the first author's PhD thesis at the University of Giessen (Gast 2007). Financial support for the project by the German national science foundation, Deutsche Forschungsgemeinschaft (DFG), is gratefully acknowledged. Thanks are due to two anonymous referees of this journal for very helpful comments on an earlier draft.

Notes

The share of the population in agriculture is unlikely to be an ideal indicator of unskilled labour. It would have been preferable to use data from the International Labour Organization (ILO) for skilled labour, as Carr et al. (2001) do. However, ILO data exhibit breaks in series within the period 1991–2001.

Statistical tests with data from the sources indicated in Table 2 showed that these variables were not highly correlated with FREE – in contrast to many other political indicators.

Changes in relative country size are significant when the two subsets are merged; however, as they seem to be very different from each other, it might not be appropriate to do so.

However, if standard errors need not account for possible autocorrelation, the coefficient of TREATIESj becomes significantly positive. This result is not reported in Table 4. Bilateral investment treaties that CEEC countries established prior to their EU accession might have raised EU-FDI into the new member states.

However, as with relative market size, the distance terms are highly significant and negative when the two data subsets are merged. This finding supports the observation that FDI activity flourished between (future) EU countries and only stresses the need to differentiate between the EU25-area and other investment.