Abstract
We examine the impact of exchange rates on foreign direct investment (FDI) inflows into the United States in the context of a model that allows for the interdependence of FDI over time. Interdependence is modeled as a two-state Markov process where the two states can be interpreted as either a favorable or an unfavorable environment for FDI in an industry. We use unbalanced industry-level panel data from the US wholesale trade sector and our analysis yields two main results. First, we find evidence that FDI is interdependent over time. Second, under a favorable FDI environment, the exchange rate has a positive and significant effect on the average rate of FDI inflows.
Highlights
Foreign direct investment (FDI) flows into the United States (US) have shown substantial fluctuations in the 1980s and 1990s
We first examine the interdependence of foreign direct investment (FDI) over time for the case of static expectations, which means that firms estimate the future exchange rate as the exchange rate of the year previous to the FDI
Common sense tells us that the real exchange rate has an effect on FDI, just as it has an effect on international trade
Summary
Foreign direct investment (FDI) flows into the United States (US) have shown substantial fluctuations in the 1980s and 1990s. In the context of corporate rivalry in FDI, whether a foreign firm finds the investment environment of a US industry favorable or unfavorable may depend on the investment environment in the US and on other factors such as its home investment environment, its interactions with its rivals in markets outside the US, and political actions of governments affecting it but not its rivals. Since these factors include the interactions among foreign firms and governments as well as changing conditions in various markets, they are difficult to measure and subject to a great deal of uncertainty. As in Campa (1993), exchange rate uncertainty may be represented in regressions by the standard deviation of the change in the log of the exchange rate
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