《《Foreign_Direct_Investment》.pdf

The Predictive Capacity of the Gravity Model of Trade on Foreign Direct Investment Nationalekonomiska Institutionen Shen Gao Uppsala Universitet Handledare: Christian Nilsson HT-2008 2009-01-06 Index 1 Introduction……………………………………………………………………………3 2 Theoretical background ……………………………………………………………5 2.1 Reasoning behind FDI………………………………………………………5 2.2 The Gravity Model ………………………………………………………….8 3 Empirical approach………………………………………………………………10 4 Basic Model Specifications…………………………………………………………...12 4.1 The OLS model………………………………………………………12 4.2 OLS estimations……….……………………………………………………14 5 The Fixed-effect Model……………………………………………………………….19 5.1 Fixed-effect model specification……..……………………………………..19 5.2 Fixed-effect estimations……….……………………………………………21 6 Conclusions……………………………………………………………………………25 Appendices………………………………………………………………………………27 1 Introduction The link between foreign direct investments (FDI) and trade is firmly established in economic literature. Casson (1990) has for example suggested that FDI is a “logical intersection” of the theory of international capital markets, the theory of the firm and trade theory. Singh Jun (1995) and Tanaka (2006) mention that firms might conduct FDI for the specific purpose of “tariff hopping” and avoiding trade costs, suggesting that trade issues have significant sway when firms make investment decisions. Yet despite the vast amount of literature on this subject, very few have tried to look at FDI through the lens of trade theory, choosing rather to approach the subject on either a macroeconomic- level or on firm-level. The purpose and scope of this paper is not to extend and bu