Liability of Foreignness: Product Distance, Institutional Distance and FDI

Abstract

We empirically analyze the relevance of a country’s export mix in offsetting the liability of foreignness when internationalizing through foreign direct investment. Using a gravity model, we demonstrate that countries with a similar mix of exports will tend to have higher FDI flows between them, even when controlling for per-capita income. We also show that the inclusion of export mix reduces the estimated importance of institutional similarities. Lastly, we discuss which firm-level motivations for internationalization are most consistent with our country level evidence.