Transcript Ch. 1: Determinants of Exports

Determinants of Exports and
Foreign Direct Investment in
a Small Open Economy
PhD defense June 16th 2004
Helga Kristjánsdóttir
Background
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Following World War II, the production
capacity of industrialized countries increased
substantially
In 1960s large Japanese car manufacturers
had to choose between exporting and
investing in United States
Multinational entity (MNE), or a multinational,
is a firm with multinational activities
Background
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In 1980s, general-equilibrium and partialequilibrium trade theories were combined in
New Trade Theory
Vertical FDI – Production located to gain
access to abundant factors (Helpman, 1984)
Horizontal FDI – Production located to
overcome trade costs and gain market access
(Markusen, 1984)
Background
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Most FDI among developed countries, i.e.,
East and West, rather than North and South
Small open economies particularly dependent
on exports and FDI
Export ratio of Iceland is comparatively small,
or 34% in 1999
• Scandinavian countries’ export ratios ranged
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from 37-44%
Japan and US had export ratios below 12%
Trade in
1940s and
1950s
Trade in
1960s and
1970s
Iceland
joined EFTA
in 1970
Trade in
1980s and
1990s
Research Objective
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Extend existing knowledge in the field
Emphasize criteria used for selecting certain
theories for application to Icelandic data
• Gravity, as in physics, and knowledge
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Interpret implications of empirical results for
Iceland in an international perspective
Overview
The dissertation chapters are:
1. A Gravity Model for Exports From Iceland
2. Determinants of Foreign Direct Investment in
Iceland
3. The Knowledge-Capital Model and Small
Countries
4. What Drives Sector Allocation of Foreign
Direct Investment in Iceland?
Data Used in this Research
The data used in the research is unique:
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Data on Exports From Iceland
• Statistics Iceland
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Panel data: 17 countries, 4 sectors,11 years,
Trade blocs EFTA, EU, NAFTA and NON-bloc
Data on Foreign Direct Investment in Iceland
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Central Bank of Iceland
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Panel data, with the data dimension being: 17
countries, 4 sectors and 11 years
Ch. 1: Determinants of Exports
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Krugman (1991) observes Iceland’s export
ratio to be smaller than expected
Gylfason (1999) finds it to be only 2/3 of its
expected value
Gravity model
• Trade-theoretic intuition:
• Export volume explained by market size and
geographical location
Ch. 1: Determinants of Exports
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PX ij = b 0 (Yi ) b 1 (Y j ) b 2 ( Dij ) b 3 ( Aij ) b 4  ij
Bergstrand 1985 specification:
• Yi is GDP of exporting country
• Yj is GDP of recipient country
• Dij is distance between economic centers of
source and host countries
• Aij reflects factors that aid or restrict trade
between country i and j
•  log-normally distributed error term,E(lnij) = 0
Ch. 1: Determinants of Exports
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The specifications applied here include
Sector and trade bloc fixed effects, both
individually and simultaneously
• Fishing, Manufacturing, Power, Other
• EFTA, EU, NAFTA, NON-bloc
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Correcting for small size of Iceland
Also test some marine product subsamples
Ch. 1: Determinants of Exports
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Distance is found to be a barrier to exports
• As in Krugman (1991)
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Unlike Krugman
• Market size and wealth of recipient country
more important than size and wealth of
exporting country, Iceland
• Even when corrected for small size
Ch. 2: Determinants of FDI
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Trade literature: Foreign direct investment
(FDI) viewed as form of trade
• Trade in financial capital
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FDI: Foreign ownership of controlling stock in
a particular firm (generally 10% or more)
Inward FDI sectors in Iceland
• Power, Com & Fin, Tel & Trans, Other
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Study if FDI in Iceland can be explained by
location, market size, and several other factors
Ch. 2.: Determinants of FDI
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Trade literature: Gravity models increasingly
popular for estimating FDI
• Brainard (1997); Mody, Razin and Sadka
(2003)
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Fixed country and sector effects
• Jeon and Stone (1999) and di Mauro (2000)
used countries and sectors
• Here also trade bloc effects
Ch. 2.: Determinants of FDI
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Gravity model useful in predicting FDI levels
• Consistent with previous literature
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Unlike earlier findings, wealth more important
than market size
Effects of market size variables (GDP, POP)
often close to being equal and opposite in sign
Distance negatively affects FDI, and FDI
appears to be driven more by wealth effects
than by market size effects
Ch. 3.: Knowledge-Capital Model
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Trade and investment relations of Iceland
viewed in global perspective, incorporating
factor endowments
Knowledge-Capital (KK) model by Carr,
Markusen and Maskus (CMM 2001) applied to
small country case, using Icelandic data
KK model incorporates both horizontal and
vertical incentives for FDI
Edgeworth Box
Origin for
Host Country = Oh
Unskilled host
country
skill(i)-skill(j)>0
Small host
country
Y(i)-Y(j)>0
Ydiff=0
Location
of Iceland
Sdiff=0
Skilled
Labor
RELATIVE
SIZE
RELATIVE
ENDOWMENTS
Skilled host
country
skill(i)-skill(j)<0
Large host
country
Y(i)-Y(j)<0
Os = Origin for
Source Country
Unskilled Labor
Ch. 3.: Knowledge-Capital Model
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Blonigen, Davies, and Head (2003)
• Horizontal model cannot be rejected in
favor of the KK model
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Davies (2003)
• Finds support for KK model
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Braconier, Norbäck, and Urban (2003)
• Find support for CMM specification
Ch. 3.: Knowledge-Capital Model
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Basic KK specification and modification
Thoroughly analyze knowledge effects
• Specification restrictions, enlarged sample,
outlier omission
• Blonigen, Davies, and Head (2003)
• Davies (2003)
• Also proxy by education and per capita wealth
• Squared and cubed skill level and subsamples
Ch. 3.: Knowledge-Capital Model
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Driving forces for FDI in Iceland appear to be
different from those in large countries
Potential data difficulties when there are large
differences in GDPs or population
Alternatively, omission of important factor
endowments such as energy or fish stock
Ch. 4.: Sector Allocation of FDI
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Skilled and unskilled labor may not be right
endowment approach for Iceland
Inward FDI
• Sector decomposition, resource endowments
• Power, Com & Fin., Tel & Transport, Other
• Waldkirch (2003)
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Also natural resources, infrastructure, pollution
quotas and government stability
Ch. 4.: Sector Allocation of FDI
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FDI sector shares and levels
• FDI shares reflect relative size of each sector
within a particular year of investment
Brainard (1997)
• Inward and outward FDI share proxies
separately as share of affiliate sales in total exp
Slaughter (2000)
• FDI proxied by investment share (measured as
majority-owned affiliates) in overall MNE
investment
Threshold Cost and FDI
FDI
Market Size
Ch. 4.: Sector Allocation of FDI
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FDI theories assume certain threshold costs
• Generally not dealt with in FDI empirical models
• Markusen (2002): fixed cost that MNEs need to
consider when undertaking FDI
• Heckman's (1979) two-step model to control for
whether sample selection is driving results
KK model seems to explain fixed costs but not
the level of investment (marginal change)
However, gravity model provides information on
both
Levels FDI Heckman GM, 1st step
Levels FDI Heckman GM, 2nd step
Ch. 4.: Sector Allocation of FDI
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Results different from what was anticipated
since KK model still does not perform very
well for Iceland
Heckman procedure application to gravity
rather than KK model, since this gives better
indication of how host-country characteristics
affect FDI
However, endowment inclusion in gravity
model can be credited to KK literature
Conclusions I
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Geographic approach to trade theory applied
to small open economies like Iceland
• With incorporation of gravity models
Gravity forces appear to describe Iceland's
exports
• Distance hampers trade whereas size of trade
partners encourages trade
Distance effect apparent not only for export
• Also important for FDI in Iceland
Conclusions II
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Reasons to prefer gravity model for FDI
Also find support for the intuition behind KK
model, i.e., that endowments matter
Use more endowment proxies than merely the
knowledge-endowment proxies
Employ proxies for endowments that are
crucial to Icelandic economy
• Useful both for explaining levels of investment
and fixed costs typical of FDI models