1 Which countries Export FDI, and How Much Assaf Razin, Tel-Aviv University and Cornell UniversityAssaf Razin, Tel-Aviv University and Cornell University Yona Rubinstein, Tel Aviv UniversityYona Rubinstein, Tel Aviv University Efraim Sadka, Tel-Aviv UniversityEfraim Sadka, Tel-Aviv University

2 This paper develops a model with lumpy set up costs of new investments, that govern the flow of Foreign Direct Investment.This paper develops a model with lumpy set up costs of new investments, that govern the flow of Foreign Direct Investment. Each country is a source for FDI flows to several host countries.Each country is a source for FDI flows to several host countries. Each country is a host to capital flows from several source countries.Each country is a host to capital flows from several source countries.

3 How to explain a co-existence of equal marginal productivity of capital (arising from capital mobility), on one hand, and unequal wages across countries (while labor mobility is administratively barred), on the other hand ? Lucas (1990) poses the familiar question: “Why doesn’t capital flow from the rich to the poor countries?”

4 Lucas’ model Before capital moves: After capital moves:

5 The Razin-Rubinstein-Sadka Model-CDF -productivity -production function N continuum of firms

6 THE RRS MODEL: Firm’s market value The

7 First-order conditions Non- Investing firm’s labor The investing firm’s demand for capital and labor capital labor

8 Non-investing firm’s market value: Cut-off splits the continuum to investing and non-investing firms investing and non-investing firms

9 Foreign Direct Investment because because

10 Labor-Market Equilibrium

11 Dividing by N

12 International Effective Wage Differentials

13 Greenfield FDI: establishing new firms through foreign direct investments: Under restricted supply of entrepreneurs, the choice is between establishing the firm In H or in S..

14 Descriptive Statistics Figures 1 and 1(a) describe the distribution of host/source countries by the number of source/host countries. Note: (1)No host countries get FDI flows from ALL source countries. (2)(2)The distribution of source countries by the number of host countries they serve is quite UNIFORM. see Fig 1(a). This suggests that it is expensive to serve many host countries for an individual source country.

15 Fraction of Source countries by number of source countries

16 Fraction of source countries by number of host countries

17 Figures 2-4 demonstrate that the number of source countries that each host country gets FDI from depends ONLY on source country characteristics.

18 Host country GDP by number of source countries

19 Source country GDP by number of source countries

20 Host country education by the number of source countries

21 Source country education by the number of source countries

22 Host country telephone lines by the number of source countries

23 Source country telephone lines by the number of source countries

24 THE ECONOMETRIC APPROACH FDI flows from source i to host j in period t: unobserved time-invariant term and an i.i.d shock term Latent variable, indicating profit

25 The error term in the profit equation: Unobserved set-up costs: time dependent and time dependent and time invariant components time invariant components Latent variable indicating profit Error term

26 For a random sample, the classical assumptions regarding the error term hold: Error term in equation (8) Error term in equation (10) From (9) and (11)

27 According to the model Y is positive, if and only if Z is positive: if and only if Z is positive: unobserved observed

28 Set-up costs and selection bias:

29 Set-up costs and selection bias:

30 Heckman’s Selection Model :Probit analysis Profit - Eq’s residual Vector of Fixed effects

31 Heckman’s Selection Model