CONCLUSION

The purpose o f this chapter was to discuss a number of issues that are relevant to the analysis to be undertaken in subsequent chapters. To begin, we explored potential mechanisms through which foreign direct investment might contribute to economic growth. Although early growth models (such as the Harrod-Domar and neoclassical models) did not make a distinction between foreign and domestic investment, endogenous growth models allow this inadequacy to be corrected. It therefore becomes possible to capture the characteristics of FDI that are thought to stimulate growth in excess of domestic investment (i.e. embedded managerial, technological and organisational knowledge) in a formal model of economic growth. Furthermore, we saw that FDI could be included in endogenous models in a range of formulations leading to different predictions. For example, the inclusion of FDI could be modelled in such a way that it allows countries to close the ‘ideas’ or ‘technology gap’ (implying conditional convergence, in the per capita incomes, of the world’s economies), or it could be modelled to permit increasing returns to scale (potentially resulting in the absence of conditional convergence).

We also discussed the theory behind international trade and investment, with particular reference to the role of the multinational enterprise. Modem theory presents alternative models based on the differing motivations of national and multinational firms. The vertical model, building on the standard model of international trade in differentiated products, posits that multinational firms locate their headquarters in one country and their production facilities in one or more other countries. This is consonant with resource-

seeking and efficiency-seeking motivations for foreign investment. The horizontal model, on the other hand, assumes that the decision to undertake FDI is the outcome of a ‘proximity-concentration trade-off; firms will undertake direct investment when the proximity advantages of local production outweigh the concentration advantages of

exporting from a single domestic facility. This model resonates closely with market- seeking and tariff-jumping motivations for FDI. Empirical studies have found it difficult to discriminate between these alternative theories, although the majority of FDI today is of the horizontal variety, undertaken between developed countries.

We also discussed the relationship between FDI and exports. There are factors that suggest that the two should be substitutes, such as tariff-jumping FDI. However, there are also factors favouring complementarity (such as intra-firm trade). Unfortunately, theory offers no decisive direction as to the true relationship either way and we are left to turn to empirical methods to try to answer the question. As we have seen, the majority of the empirical literature finds in favour of complementarity. However, most of this literature can be criticised for failing to account for the possible spurious correlation between FDI and exports. Graham (1995) attempts to mitigate this problem by adopting a two-stage approach: the first stage involves using the gravity model to run separate regressions for FDI and exports; the second-stage regresses the residuals from the first- stage regression against one another. The intention is to try to remove all factors that might determine both FDI and exports in the first stage, so that any remaining correlation reported in the second stage will be unbiased evidence of either complementarity or substitutability.

The main body of this thesis (i.e. chapters 3, 4 and 5) is dedicated to conducting an empirical analysis building on Graham’s approach. In chapter 3 we will run the first- stage regression for FDI flows, using a panel dataset we have constructed for the period 1992 to 2003. As well as simply obtaining the necessary residuals for the second-stage regression, we will explore the impact of regional integration agreements on FDI flows.

Regionalism has grown enormously in popularity in recent years, not just in terms of the number of agreements, but also in terms of the depth of integration. However, the merits of regionalism versus multilateralism are still the subject of debate. Our discussion of the possible trade and investment effects of RIAs emphasised how difficult it is to predict the impact of such agreements, with much depending on the conditions that are prevailing before the agreement comes into force. Despite this, the increasing adoption of investment provisions (in addition to trade provisions) in integration agreements is likely to stimulate intra-RIA investment. The analysis we conduct in chapter 3 will allow us to form an opinion as to whether integration agreements do, or do not, have a positive effect on FDI flows.

Our first-stage regression analysis for exports is conducted in chapter 4. We utilise the same panel dataset as we used for FDI flows and also employ the same gravity model approach. Once again, in addition to simply capturing the residuals for use in the second- stage analysis, we investigate the impact of regional integration agreements on exports. By also examining the impact of RIAs on exports to-and-from- ‘outsiders’, it is possible to from an idea of the trade creation or trade diversion effects of a RIA. A comparison of the integration effects on FDI and exports is also possible and informative.

The second-stage analysis of residuals on residuals is performed in chapter 5. As discussed, we follow the approach favoured by Graham (1995). However, whereas Graham used data relating to a single year, our panel dataset should afford more accurate and efficient estimation by allowing the temporal variability in exports and FDI to be taken into account (in addition to simply the cross-section variability). It will also permit the relationship between FDI and exports to be analysed over time to assess whether a trend exists. We also build on the work of Graham by disaggregating our dataset into separate subsamples in order to investigate whether the relationship between FDI and exports is dependent on the nature of the two countries involved (i.e. the investor and host countries).

In order to complement our empirical analysis and hopefully add texture to the results, chapter 6 is dedicated to a case study of FDI in Mexico. This provides an apt case study because Mexico is a member of NAFTA (one of the integration agreements we assess empirically in chapters 3 and 4) and also the recipient of large quantities of FDI from the US69. In addition to investigating the impact on inward FDI of its membership of NAFTA, we are able to investigate other determinants of FDI flows (i.e. unit labour costs) and also assess the potential benefit to economic growth of inward FDI.

69 This has two principal benefits in terms of choosing Mexico for a case study assessment: the US collects unparalleled data on the activities of multinationals; given its technological sophistication, FDI from the US should be well-endowed with the ‘additional benefits’ (e.g. management know-how) thought to spill-over to the host economy.