Vertical Foreign Direct Investment Research Articles

Political oil import diversification by financial and commercial traders

International politics affects the oil trade. But do financial and commercial traders who participate in spot oil trading also respond to changes in international politics? We construct a firm-level dataset for all U.S. oil-importing companies over 1986–2008 to examine how these firms respond to increases in “political distance” between the U.S. and her trading partners, measured by divergence in their UN General Assembly voting patterns. Consistent with previous macro evidence, we first show that individual firms diversify their oil imports politically, even after controlling for unobserved firm heterogeneity. However, the political pattern of oil imports is not entirely driven by the concerns of hold-up risks, which exist when oil transactions via term contracts are associated with backward vertical FDI that is subject to expropriation. In particular, our results indicate that even financial and commercial traders significantly reduce their oil imports from U.S. political enemies. Interestingly, while these traders diversify their oil imports politically immediately after changes in international politics, other oil companies reduce their oil imports with a significant time lag. Our findings suggest that in designing regulations to avoid harmful repercussions on commodity and financial assets, policymakers need to understand the nature of political risk.

Foreign direct investment, trade integration and the home bias: evidence from the European Union

This paper combines two fields in the economic literature by examining empirically the pattern of foreign direct investment (FDI) flows within the European Union (EU) and the relevance of trade integration as an influence upon investment flows over the period 1995–2009. We capture trade integration primarily by means of the home bias, rather than by using other indicators such as tariffs and non-tariff barriers. In turn, the home bias is computed for the countries in our sample by a standard gravity model. Our results find a positive and robust correlation between trade integration and FDI activity for the countries in our sample. For the particular case of the EU, it is not possible to strictly discriminate between horizontal or vertical FDI. FDI flows seem to be more consistent with a knowledge-capital hybrid model, where considerations about the market size of the partners and their relative endowment of skilled labour are relevant.

The Influence of Firm Global Supply Chains and Foreign Currency Undervaluations on US Trade Disputes

AbstractWe apply insights from “new, new” trade theory to explain a puzzling decline in US firm antidumping (AD) filings in an era of persistent foreign currency undervaluations and increasing import competition. Firms exhibit heterogeneity both within and across industries regarding foreign direct investment (FDI). We propose that firms making vertical or resource-seeking investments abroad will be less likely to file AD petitions, and firms are likely to undertake vertical FDI in the context of currency undervaluation. Hence, we argue, the increasing vertical FDI of US firms makes trade disputes far less likely. We use firm-level data to examine the universe of US manufacturing firms and find that AD filers generally conduct no intrafirm trade with filed-against countries. We also find that persistent currency undervaluation is associated over time with increased vertical FDI and intrafirm trade by US multinational corporations (MNCs) in the undervaluing country. Among larger US MNCs, the likelihood of an AD filing is negatively associated with increases in intrafirm trade. In the context of currency undervaluation, we confirm the existing finding that undervaluation is associated with more AD filings. We also find, however, that high levels of intrafirm imports from countries with undervalued currencies significantly decrease the likelihood of AD filings. Our study highlights the centrality of firm heterogeneity in international trade and investment in understanding political mobilization over international economic policy.

The Effect of Macroeconomic Instability on FDI Flows: A Gravity Estimation of the Impact of Regional Integration in the Case of Euro-Mediterranean Agreements

In order to diversify their risks, firms facing increased demand uncertainty in their domestic market may choose to increase their investment abroad by transferring production to the more stable host economies. Using a gravity model, we test the assumption that foreign direct investment is reactive to macroeconomic instability in both source and host countries in a sample of European and MENA countries for 1985-2009. Using a gravity model form model, we show that the incidence of FDI between two countries increases with source GDP instability and with host GDP stability. We also find that although this reactivity is not conditioned by trade and investment agreements, it must be qualified with respect to the type of FDI, with North-South vertical investment being significantly affected by source country uncertainty. For the same level of cost differential, the incidence of vertical FDI thus tends to be higher when uncertainty is high than when uncertainty is low.

Knowledge Spillovers, Absorptive Capacity and Growth: An Industry-Level Analysis for OECD Countries

Given the decline in growth momentum in the manufacturing sector in many OECD countries, the role of knowledge-based capital has emerged as a key driver for sustained growth. While empirical studies on estimating knowledge spillovers have usually been undertaken at the country level, the spillover effects can be more definitive only if the analysis is conducted at the industry-level. The effectiveness of international spillovers is conditional on recipient country’s absorptive capacity and this is an important component of the spillover mechanism that has not attracted significant attention so far. This paper therefore assesses the effect of spillovers in driving per capita output growth taking into account the role of absorptive capacity. Our main findings are first, the confirmation of the robust positive relationship between human capital and output growth for 14 OECD countries at industry level. Second, the gains from international spillover are conditional to the level of human capital and the degree of protection of intellectual property rights. Third, countries that improve absorptive capacity can potentially increase gains from spillovers via either trade or FDI (including vertical FDI). Finally, significant heterogeneity is found between high and low-tech industries. The former group is more effective in absorbing spillovers while the latter has failed to reach the critical level of technological advancement in order to absorb foreign and domestic knowledge.

Logistic infrastructure and the international location of fragmented production

Casual evidence suggests that multinational companies increasingly look for places with adequate transport and logistic infrastructure to locate affiliates that participate in cross-border production sharing. Yet, there are no systematic empirical analyses examining how logistic infrastructure interacts with the location decisions made by multinationals. Most studies on the determinants of FDI address the issue of transportation-logistics by examining the impact of distance on the relevant outcome, but distance does not capture by itself the quality of the logistic systems in place. We overcome this shortcoming in the literature by embedding indicators of infrastructure into an empirical framework that examines whether countries with adequate logistic systems attract more vertical FDI and particularly in industries that are more dependent on logistic services. We find that logistic infrastructure positively impacts vertical FDI in addition to the impact typically found on distance. A change from the first quartile to the third quartile of the distribution of logistic infrastructure is associated with an average increase in the number of vertically-integrated subsidiaries equivalent to 29%.

Trade liberalization in Asia and FDI strategies in heterogeneous firms: evidence from Japanese firm-level data

This article clarifies the reasons for the recent rapid growth of foreign direct investment (FDI) in developing countries, particularly Asian countries. For this purpose, we theoretically and empirically examine the mechanics of both horizontal FDI and vertical FDI (VFDI) to shed light on the role of trade costs. Our empirical analysis using a logit or multinomial logit model of Japanese firms’ FDI choices reveals that the tariff reduction in Asian countries has lowered the productivity cutoff for VFDI. This result indicates that since developing countries, particularly Asian countries, have experienced a relatively rapid decrease in tariff rates, the increase in VFDI through tariff reduction led to the recent surge of FDI in developing countries.

The spatial econometrics of FDI and third country effects

Different fundamental methodological spatial econometric issues are discussed not yet addressed by the existent empirical literature on FDI and third country effects that explains why it has failed to find results consistent with formal theory. This is demonstrated by taking the baseline spatial econometric model developed by Blonigen et al. (Eur Econ Rev 51:1303–1325, 2007) as point of departure and using US data on outbound FDI into 20 European countries observed over the 1999–2008 period. By refining the spatial econometric approach, we find significant empirical evidence in favor of competition among European countries in attracting US companies, and results that are consistent with export-platform and pure vertical FDI motives.

Location choice in low-income countries: Evidence from Japanese investments in East Asia

Unlike most existing studies, this paper examines the location choices of multinational enterprises (MNEs) in low-income countries. Specifically, we investigate the location choices of Japanese MNEs among East Asian developing countries by estimating a four-stage nested logit model and a mixed logit model at the province level. Our findings are as follows. First, Japanese MNEs consider Cambodia, Laos, Myanmar, and Vietnam to be host countries different from China and the forerunners of ASEAN. In other words, for Japanese investors, ASEAN forerunners are countries replaceable by China. Second, the mechanics of vertical FDI are more likely to appear in FDIs in low-income countries. For example, rather than the market size of the host country, tariff rates on products from investing countries are more crucial location elements.

Foreign Direct Investment and the Survival of Domestic Private Firms in Viet Nam

Foreign direct investment (FDI) may benefit local firms in the host country through various kinds of spillovers, but it may also raise competition and result in the crowding out of domestic firms. Using detailed firm-level data for the period 2001–2008, this paper examines the aggregate effect of FDI on the survival of domestic private firms in Viet Nam. We estimate the impact of both horizontal and vertical FDI and explore how the presence of state-owned enterprises (SOEs) influences the exit hazard for private firms. The results suggest that horizontal and upstream FDI raise the exit hazard significantly, while downstream FDI may reduce the hazard. The presence of SOEs has a direct negative effect on the survival odds of local private firms in the same industry, but there is also an indirect impact on the exit hazard from FDI. Local firms are more vulnerable to foreign entry in sectors with high SOE shares. Looking at the net effects of FDI during the period 2001–2008, we find that results vary between sectors and over time but that the overall impact has been surprising small. The paper also discusses policy conclusions and implications for empirical analyses of spillovers from FDI.

Intra-regional FDI and Economic Integration in South Asia

This article examines trends and patterns of intra-regional foreign direct investment (FDI) in South Asia, with a focus on the potential for integrating production processes among countries in the region through further trade and investment policy reforms. The empirical evidence pieced together from scattered sources suggests that horizontal (market seeking) FDI has continued to dominate South Asian intra-regional FDI, with a significant shift in recent years in favour of services sector activities. Vertical (efficiency seeking) FDI in the region has remained confined to a few product lines, predominately garments, and also a few industries in which the availability of specific natural resources plays an important role in the site selection decisions of firms. In other industries, including electronics and electrical goods in which global production sharing is heavily concentrated, there is no evidence of notable cross-border operations by regional firms.

Testing for FDI Externalities in Thailand: A Firm Level Analysis of Horizontal and Vertical Spillovers

Many empirical researches have been dedicated to study the impacts of MNCs on host nations’ growth and trades; however, the consensus among them is still a far reaching destination. Among all aspects of the impact of MNCs, the externalities toward the local firms have lately gained the most attention. By using Thailand’s firm level database combined with an I/O table at the most disaggregate level, this paper is designed to empirically investigate the externalities from the presence of foreign-controlled plants toward the performances of local plants, who reside in identical industries (Horizontal FDI spillovers) / in the related industries (Vertical FDI spillovers). In the study at the overall manufacturing sector, we find that the participation of foreign plants in supplying industries significantly increases the productivity of local plants. In capital and labor intensive industries, we find that there is a strong evidence of positive externalities from the foreign plants’ participation in the downstream industries. Interestingly, the performances of local plants in natural based industries are not significantly influenced by the presences of foreign plants either in the same or related industries.

The (Im)possibility of Distinguishing Horizontal and Vertical Motivations for FDI

AbstractSkill differences between parent and host countries are considered a key variable for distinguishing horizontal and vertical motivations within aggregate foreign direct investment (FDI). This paper tests the robustness of the skill difference term in the knowledge‐capital model for FDI in a sample of Organisation for Economic Co‐operation and Development (OECD) countries. The evidence in this paper indicates that skill differences per se do not properly explain FDI: the skill level of the host country is also important. This paper argues that both horizontal and vertical FDI may increase in the skill level of the host. It follows that the distinction between vertical and horizontal motivations for FDI with respect to skills is less straightforward than generally assumed in the literature.

FDI Location and the Relevance of Spatial Linkages: Evidence from Provincial and Industry FDI in China

AbstractIn this study both aggregate and industry‐level foreign direct investment (FDI) data are employed to investigate the spatial dependence of FDI hosts. The analysis contributes to the existing literature by focusing on the heterogeneous spatial correlation of FDI in different industries. Using more comprehensive FDI data across multiple industries and multiple provinces in China from 1999 to 2007, the results show a significant spatial correlation among provinces. Aggregate FDI tends to be regional trade platform oriented indicating neighboring provinces become competitors for FDI. In contrast, results based on industry‐level provincial FDI show stronger support for vertical or complex vertical FDI.

Tariffs and EU countries foreign direct investment: Evidence from a dynamic panel model

According to the models of the multinational enterprise tariffs play a fundamental role in determining the pattern of foreign direct investment (FDI). The aim of this paper is to assess the impact of tariffs on the outward stocks of FDI of the European Union (EU). We estimate a model based on the knowledge–capital theory of the multinational enterprise over the period 1995–2008 by using a sample of five EU countries and 24 partner countries. We consider, first, manufacturing sector as a whole and, then, six manufacturing industries defined at the two-digit level of the Nomenclature statistique des activités économiques dans la Communauté européenne (NACE) classification. Explanatory variables include an index of applied bilateral tariffs and a dummy to capture the presence of bilateral investment treaties (BITs). A dynamic panel model is estimated through the generalized method of moments estimator, taking also into account the endogeneity of regressors. The results show that the pattern of EU outward FDI is a mix of vertical and horizontal FDI. BITs in force have a significant and positive impact on the outward FDI. The impact of tariffs varies across industries and countries, suggesting the predominance of horizontal FDI in some industries, and the existence of vertical FDI in others.

The Quest for Non-Resource-Based FDI: Do Taxes Matter?

Using manufacturing and services firm-level data for 30 sub-Saharan African (SSA) countries, this paper shows that taxation is not a significant driver for the location of foreign firms in SSA, while other investment climate factors, such as infrastructure, human capital, and insitutions, are. By analyzing disaggregate FDI data, the paper establishes that, while there is considerable contrast in behavior between vertical FDI (foreign firms producing for export) and horizontal FDI (foreign firms producing for local markets), taxation is not a key determinant for either type of FDI. Horizontal FDI is attracted to areas with higher trade regulations, highlighting interest in protected markets. Furthermore, horizontal FDI is affected more by financing and human capital constraints, and less by infrastructure and institutional constraints, than is vertical FDI.

The Quest for Non-Resource-Based FDI: Do Taxes Matter?

Using manufacturing and services firm-level data for 30 sub-Saharan African (SSA) countries, this paper shows that taxation is not a significant driver for the location of foreign firms in SSA, while other investment climate factors, such as infrastructure, human capital, and insitutions, are. By analyzing disaggregate FDI data, the paper establishes that, while there is considerable contrast in behavior between vertical FDI (foreign firms producing for export) and horizontal FDI (foreign firms producing for local markets), taxation is not a key determinant for either type of FDI. Horizontal FDI is attracted to areas with higher trade regulations, highlighting interest in protected markets. Furthermore, horizontal FDI is affected more by financing and human capital constraints, and less by infrastructure and institutional constraints, than is vertical FDI.

The Influences of Foreign Direct Investments, Intrafirm Trading, and Currency Undervaluation on U.S. Firm Trade Disputes

We apply insights from “new, new” trade theory to explain a puzzling decline in U.S. firm antidumping (AD) filings in an era of persistent foreign currency undervaluations and increasing import competition. Firms exhibit heterogeneity both within and across industries regarding foreign direct investment. We propose that firms making vertical, or resource-seeking, investments abroad will be less likely to file AD petitions, and firms are likely to undertake vertical FDI in the context of currency undervaluation. Hence, we argue, the increasing vertical FDI of U.S. firms makes trade disputes far less likely. We use firm level data to examine the universe of U.S. manufacturing firms and find that AD filers generally conduct no intrafirm trade with filed-against countries. We also find that persistent currency undervaluation is associated over time with increased vertical FDI and intrafirm trade by U.S. MNCs in the undervaluing country. Among larger U.S. MNCs, the likelihood of an AD filing is negatively associated with increases in intrafirm trade. In the context of currency undervaluation, we confirm the existing finding that undervaluation is associated with more AD filings. We also find, however, that high levels of intrafirm imports from countries with undervalued currencies significantly decrease the likelihood of AD filings. Our study highlights the centrality of firm heterogeneity in international trade and investment in understanding political mobilization over international economic policy.

FDI, Trade Integration and the Border Effect: Evidence from the European Union

This paper intends to combine two fields in the economic literature by examining empirically the FDI pattern –horizontal versus vertical– within the European Union and the relevance of trade integration as a potential determinant of investment flows over the period 1995-2009. We capture trade integration by estimating the magnitude and evolution of the home bias or border effect rather than by using other indicators such as the openness rate or the existence of tariffs and non-tariff barriers. We find that, for the particular case of the EU, it is not possible to strictly discriminate between horizontal or vertical FDI. The market-seeking strategy appears to be more important than factor-proportion related motivations; however, the robust relationship of complementarity between trade integration and FDI provides at least one argument in support of vertical FDI and suggests that the vertical model cannot be dismissed entirely.

The Impact of Free Trade Agreements on Foreign Direct Investment: The Case of Korea

This paper aims to empirically identify the effects of FTAs on outward and inward FDIs in Korea. Considering the income differences between Korea and its FTA partners, we hypothesize that FTAs have a positive effect on outward FDI to developing countries and inward FDI from developed countries. An underlying source of the hypothesis is the Knowledge-Capital model, addressing the positive (negative) relationship between trade costs and horizontal (vertical) FDI. We test for the hypothesis using data on Korea’s FTAs and FDI over the period 2000-2010. We find that our empirical results support the hypothesis, and additionally, FTAs in general encourage FDI by creating an FDI-friendly environment.