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Regional Integration and the Location of FDI Eduardo Levy Yeyati Ernesto Stein Christian Daude.

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Presentation on theme: "Regional Integration and the Location of FDI Eduardo Levy Yeyati Ernesto Stein Christian Daude."— Presentation transcript:

1 Regional Integration and the Location of FDI Eduardo Levy Yeyati Ernesto Stein Christian Daude

2 Motivation Spectacular increase in FDI around the world in recent years Similar trend in Latin America, starting in 1993

3 FDI Inflows 1980-1999 1000000 0 100000 200000 300000 400000 500000 600000 700000 800000 900000 19801981198219831984198519861987198819891990199119921993199419951996199719981999 Total Flows 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

4 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

5 Net Private Capital Flows towards Latin America Net private Capital Inflows Portfolio FDI Loans -0.5 0 0.5 1 1.5 2 2.5 3 3.5 4 1990199119921993199419951996199719981999 Source: Balance of Payments, IMF As % of GDP

6 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.

7 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.

8 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?

9 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?

10 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

11 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.)

12 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

13 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.

14 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)

15 Basic specification –where FDI ijt is the stock of FDI of source country i in host country j at time t, as reported by the source country. –D ij is a vector of country pair dummies –Y t is a vector of year dummies Log (1+FDI ijt ) =  +  1 lGDP host ijt +   lGDP source ijt +  samefta ijt + +   EM host ijt +   EM source ijt +  D ij +  Y t +  ijt

16 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

17 Baseline results GDP Host GDP Source Extended Market Host Extended Market Source Same FTA Privatization Inflation Constant Observations Number of pair R2 Within test F Pair Effects test 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)** 18308 1140 0.2658 18.89** 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)** 18308 1140 0.2662 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)* 16739 1100 0.2652 17.95** 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)* 16739 1100 0.2653 17.92** 33.94**

18 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) Observations Number of pair R2 Within test F Pair Effects test 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)** 18308 1140 0.2658 18.89** 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)** 0.319 0.795 18308 1140 0.2662 18.84** 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)* -1.545 1.004 3.072 16341 1105 0.2780 16.23** 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)* 1.460 0.870 0.442 17957 1104 0.2664 18.72** 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) 1.152 0.829 -0.325 12343 740 0.2791 18.04** 41.33**

19 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 0.0602 0.146 0.619 (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 Observations Adjusted R2 18013 0. 7145

20 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) Observations Number of pair R2 Within test F Pair Effects test 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)** 18308 1140 0.2658 18.89** 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)** 0.446 0.791 1.407 18308 1140 0.2660 18.73** 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)** 0.408 0.777 1.436 18308 1140 0.2661 16.58** 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)** 0.538 0.837 1.370 18308 1140 0.2671 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)** 0.576 0.892 1.457 18308 1140 0.2715 18.62** 38.8**

21 Winners and Losers - FTAA Host Country Argentina Brasil Canada Chile Colombia Costa Rica Mexico Panama USA Venezuela Rest of the countries 14.25% 0.79% 33.63% 16.46% 43.92% 0.67% 50.42% 0.79% ALCA countries 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% ALCA countries Rest of the countries

22 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


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