The foreign direct investment - export relationship : a US-Mexico analysis using the Gravity model
Jones, Thomas Allen
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Hypothesis: Foreign direct investment can have an ambiguous effect on trade flows. Industry, country of origin, and country of destination matter in determining the effects of foreign direct investment on export flows. As a result, the real effects from NAFTA can be obscured if these factors are not taken into account. The North American Free Trade Agreement (NAFTA) is expected to alter trade flows between the United States and Mexico and therefore it provides the perfect opportunity to study the effects of foreign direct investment (FDI) on export flows. There were several special events and issues that occurred during the period leading up to and during implementation of NAFTA. These events and issues have been accounted for in the empirical model. The gravity model, first prescribed by Jan Tinbergen, which uses national income as a central variable, is then an excellent candidate model to analyze export flows. The inclusion of exchange rates helps to account for the shocks from the Mexican currency crisis and currency devaluation. Foreign direct investment is included as one possible alternative method of capital transfer between countries. There are several factors which influence the sign of foreign direct investment in the empirical model. Some stylized facts explaining certain countries' or industries' predispositions are developed in the theoretical model to explain the FDI - exports relationship. Several "predispositions" are supported by the empirical results. For capital-intensive firms which invest in capital-intensive industries abroad, there is a predisposition for exports to increase in this industry. The same holds for labor-intensive firms that invest in industries with labor-intensive goods. The empirical results are in favor of the theoretical model in 25 of the 28 single-industry models. For three of the single-industry models, where Mexico, a labor-abundant country, is exporting and investing in a capital-intensive good, this theoretical relationship breaks down.