1. Þjóðarspegillinn 2006 Sjöunda ráðstefna um rannsóknir í félagsvísindum
Fixed Costs, Foreign Direct Investment, and Gravity with Zeros (Fastur kostnaður, bein erlend fjárfesting og þyngdaraflslíkan með núllgildum) Helga Kristjánsdóttir, 27. okt. 2006
Þjóðarspegillinn 2006
Sjöunda ráðstefna um rannsóknir í félagsvísindum
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum

2. Background
In 1980s, general-equilibrium and partial-equilibrium 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)
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum

3. Background
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 (goods and services) of Iceland is comparatively small, or 35% of GDP in 2003
Scandinavian countries’ export ratios ranged from 37-44%
Japan and US had export ratios below 12%
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum

4. Research Objective Extend existing knowledge in the field
Emphasize criteria used for selecting certain theories and procedures for application to Icelandic data
Gravity, as in physics, and knowledge
Heckman 2 step, 2 steps of investment
Interpret implications of empirical results for Iceland in an international perspective
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum

5. Earlier Research
Trade literature: Gravity models increasingly popular for estimating FDI
Brainard (1997)
Mody, Razin and Sadka (2003)
Fixed country and sector effects
Jeon and Stone (1999) and di Mauro (2000) used countries and sectors
Razin, Rubinstein, and Sadka (2004)
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum

6. Fixed cost and FDI FDI Market Size
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum

7. Data used in this research
The data used in the research is unique:
Data on Foreign Direct Investment in Iceland on the 24 countries having OECD membership throughout the period estimated
FDI: Foreign ownership of controlling stock in a particular firm (generally 10% or more)
24 OECD countries, 4 sectors,
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum

8. Data used in this research
Turning to the data, our goals are twofold. First, we desire to test the above theoretical predictions, in particular what factors determine whether any FDI takes place at all (i.e. whether profits from FDI exceed those of exporting). Second, we wish to see to what extent estimates from a typical FDI regression may be affected by ignoring the two-stage decision process of whether to undertake FDI (the selection stage) and then, conditional on this, how much FDI to do (the treatment stage). Thus, we will compare the results from a Heckman (1979) two-stage estimation process with those from simple OLS.
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum

9. Unskilled host country skill(i)-skill(j)>0
Os = Origin for
Source Country
Unskilled Labor
Origin for
Host Country = Oh
Unskilled host country
skill(i)-skill(j)>0
Skilled host
country
skill(i)-skill(j)<0
Small host country
Y(i)-Y(j)>0
Location
of Iceland
RELATIVE
ENDOWMENTS
SIZE
Sdiff=0
Large host country
Y(i)-Y(j)<0
Ydiff=0
Skilled Labor
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum
Os = Origin for
Source Country
Unskilled Labor
Origin for
Host Country = Oh
Unskilled host country
skill(i)-skill(j)>0
Skilled host
country
skill(i)-skill(j)<0
Small host country
Y(i)-Y(j)>0
Location
of Iceland
RELATIVE
ENDOWMENTS
SIZE
Sdiff=0
Large host country
Y(i)-Y(j)<0
Ydiff=0
Skilled Labor
Os = Origin for
Source Country
Unskilled Labor
Origin for
Host Country = Oh
Unskilled host country
skill(i)-skill(j)>0
Skilled host
country
skill(i)-skill(j)<0
Small host country
Y(i)-Y(j)>0
Location
of Iceland
RELATIVE
ENDOWMENTS
SIZE
Sdiff=0
Large host country
Y(i)-Y(j)<0
Ydiff=0
Skilled Labor
Os = Origin for
Source Country
Unskilled Labor
Origin for
Host Country = Oh
Unskilled host country
skill(i)-skill(j)>0
Skilled host
country
skill(i)-skill(j)<0
Small host country
Y(i)-Y(j)>0
Location
of Iceland
RELATIVE
ENDOWMENTS
SIZE
Sdiff=0
Large host country
Y(i)-Y(j)<0
Ydiff=0
Skilled Labor
Os = Origin for
Source Country
Unskilled Labor
Origin for
Host Country = Oh
Unskilled host country
skill(i)-skill(j)>0
Skilled host
country
skill(i)-skill(j)<0
Small host country
Y(i)-Y(j)>0
Location
of Iceland
RELATIVE
ENDOWMENTS
SIZE
Sdiff=0
Large host country
Y(i)-Y(j)<0
Ydiff=0
Skilled Labor
Os = Origin for
Source Country
Unskilled Labor
Origin for
Host Country = Oh
Unskilled host country
skill(i)-skill(j)>0
Skilled host
country
skill(i)-skill(j)<0
Small host country
Y(i)-Y(j)>0
Location
of Iceland
RELATIVE
ENDOWMENTS
SIZE
Sdiff=0
Large host country
Y(i)-Y(j)<0
Ydiff=0
Skilled Labor
Os = Origin for
Source Country
Unskilled Labor
Origin for
Host Country = Oh
Unskilled host country
skill(i)-skill(j)>0
Skilled host
country
skill(i)-skill(j)<0
Small host country
Y(i)-Y(j)>0
Location
of Iceland
RELATIVE
ENDOWMENTS
SIZE
Sdiff=0
Large host country
Y(i)-Y(j)<0
Ydiff=0
Skilled Labor
Os = Origin for
Source Country
Unskilled Labor
Origin for
Host Country = Oh
Unskilled host country
skill(i)-skill(j)>0
Skilled host
country
skill(i)-skill(j)<0
Small host country
Y(i)-Y(j)>0
Location
of Iceland
RELATIVE
ENDOWMENTS
SIZE
Sdiff=0
Large host country
Y(i)-Y(j)<0
Ydiff=0
Skilled Labor

10. Model Setup Bergstrand (1985), basic specification of Gravity Model
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
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum

11. Model Setup
Combination of Gravity Model and Knowledge-Captial (KK) Model
Knowledge-Capital model by Carr, Markusen and Maskus (CMM, 2001)
Endowment inclusion in gravity model obtained from the KK literature
Generally the KK model with incorporation of endowments – skilled / unskilled labor
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum

12. Model Setup
Typical KK model with skilled and unskilled labor may not be the right endowment approach for Iceland
Additions here include important factors of endowments - hydro energy supply, oil prices
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum

13. Model Setup
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
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum

14. Table 1: FDI Flows into Iceland
OLS
Heckman 1st step
Heckman 2nd step
GDPj,t
2.410*** (3.54)
(-0.81)
2.457* (1.74)
GDPcapj,t
(-0.80)
16.365*** (3.85)
(-0.92)
Skillj,t
(-0.88)
2.396* (1.95)
(-0.87)
Opennessj,t
(-0.54)
-9.226*** (-3.32)
(0.62)
Distancej
-9.302** (-2.05)
-8.775*** (-3.52)
(0.36)
Hydroj,t
-3.920*** (-3.72)
-3.774* (-1.83)
Oilt
(-0.68)
(-0.28)
CO2j,t+1
(0.36)
3.470*** (2.79)
(-0.54)
Hydroj,t-1
(1.03)
Oilt-1
(0.96)
Constant
(0.34)
*** (-3.98)
(0.84)
Observations 28
263
Adjusted R2
0.5127
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum

15. Table 2: FDI Stock into Iceland
OLS
Heckman 1st step
Heckman 2nd step
GDPj,t
2.462*** (12.15)
(-0.81)
2.360*** (3.60)
GDPcapj,t
-4.788** (-2.47)
16.365*** (3.85)
(0.54)
Skillj,t
-1.750*** (-2.62)
2.396* (1.95)
.352 (0.12)
Opennessj,t
5.068*** (4.11)
-9.226*** (-3.32)
(-0.22)
Distancej
-1.917* (-1.87)
-8.775*** (-3.52)
(-0.89)
Hydroj,t
-1.342*** (-4.69)
(-1.29)
Oilt
(-1.00)
(-0.33)
CO2j,t+1
.358 (0.68)
3.470*** (2.79)
(0.59)
Hydroj,t-1
.094 (1.03)
Oilt-1
.999
(0.96)
Constant
(1.12)
*** (-3.98)
(-0.67)
Observations 44
263
Adjusted R2
0.8969
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum

16. Table 3: The Effect of Other FDI on FDI Flows
Other FDI Dummy
1st step
Other FDI Dummy 2nd step
Other FDI
2nd step
GDPj,t
(-0.49)
2.509** (2.30)
(-0.87)
2.369*** (3.88)
GDPcapj,t
16.547*** (4.05)
(-1.03)
15.041*** (3.26)
(-0.85)
Skillj,t
2.441*** (2.12)
(-1.03)
2.249* (1.77)
(-1.07)
Opennessj,t
-9.082*** (-3.39)
(0.62)
-9.090*** (-3.20)
(0.25)
Distancej
-8.963*** (-3.62)
(0.24)
-8.438*** (-3.31)
(-0.32)
Hydroj,t
-3.810** (-2.40)
-3.875*** (-4.31)
Oilt
(-0.30)
(-0.70)
CO2j,t+1
3.611*** (2.84)
(-0.50)
3.765*** (2.80)
(-0.21)
Hydroj,t-1
.080 (0.85)
.066 (0.65)
Oilt-1
.854 (0.80)
(1.02)
Other FDI Dummyj,t-1
(-0.74)
Other FDIj,t
.072 (0.75)
Constant
*** (-4.13)
(0.92)
*** (-3.52)
(0.67)
Observations
263
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum

17. Table 4: The Effect of Other FDI on FDI Stock
Other FDI Dummy 1st step
Other FDI Dummy 2nd step
Other FDI
1st step
2nd step
GDPj,t
(-0.49)
2.322*** (3.47)
(-0.87)
2.447*** (3.10)
GDPcapj,t
16.547*** (4.05)
(0.60)
15.041*** (3.26)
(0.49)
Skillj,t
2.441*** (2.12)
.593 (0.19)
2.249* (1.77)
.518 (0.14)
Opennessj,t
-9.082*** (-3.39)
(-0.25)
-9.090*** (-3.20)
(-0.24)
Distancej
-8.963*** (-3.62)
(-0.95)
-8.438*** (-3.31)
(-0.76)
Hydroj,t
(-1.26)
(-1.09)
Oilt
(-0.39)
(-0.32)
CO2j,t+1
3.611*** (2.84)
(0.60)
3.765*** (2.80)
(0.51)
Hydroj,t-1
.080 (0.85)
.066 (0.65)
Oilt-1
.854 (0.80)
(1.02)
Other FDI Dummyj,t-1
(-0.74)
Other FDIj,t
.072 (0.75)
Constant
*** (-4.13)
(-0.72)
*** (-3.52)
(-0.59)
Observations
263
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum

18. Conclusions High skilled, small economy,mainly greenfield FDI
ind GM and KK model combination useful for explaining fixed FDI costs
OLS versus Heckman 2 step estimates indicate the importance of fixed costs
Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum

19. Þjóðarspegillinn 2006: Sjöunda ráðstefna um rannsóknir í félagsvísindum