1. Regional Integration and the Location of FDI
Eduardo Levy Yeyati
Ernesto Stein
Christian Daude

2. Motivation
Spectacular increase in FDI around the world in recent years
Similar trend in Latin America, starting in 1993

3. FDI Inflows
10000
20000
30000
40000
50000
60000
70000
80000
90000
100000
Flows
towards
LAC
Flows towards LAC
100000
200000
300000
400000
500000
600000
700000
800000
900000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
Total
Flows
Note: Millions of Dollars, 1996 constant prices
Total Flows

4. Motivation
Spectacular increase in FDI around the world in recent years
Similar trend in Latin America, starting in 1993
FDI: major source of private capital inflows to Latin America

5. Net Private Capital Flows towards Latin America-1
-0.5
0.5 1
1.5 2
2.5 3
3.5 4
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
Source: Balance of Payments, IMF
As % of GDP
Net private Capital Inflows
Portfolio
FDI
Loans

6. Motivation
Spectacular increase in FDI around the world in recent years
Similar trend in Latin America, starting in 1993
FDI: major source of private capital inflows to Latin America
At the same time, increase in number and depth of regional integration agreements around the world.

7. Motivation
Spectacular increase in FDI around the world in recent years
Similar trend in Latin America, starting in 1993
FDI: major source of private capital inflows to Latin America
At the same time, increase in number and depth of regional integration agreements around the world.
Latin America is no exception: NAFTA, Mercosur, Andean Community, G-3, etc.

8. Motivation
Spectacular increase in FDI around the world in recent years
Similar trend in Latin America, starting in 1993
FDI: major source of private capital inflows to Latin America
At the same time, increase in number and depth of regional integration agreements around the world.
Latin America is no exception: NAFTA, Mercosur, Andean Community, G-3, etc.
What should we expect in terms of FDI to the region in light of a future FTAA?

9. Policy questions
What effects should FTAA have on FDI from the US and Canada to Latin American countries?
How will FTAA affect FDI from the rest of the world?
What should the effect be on Mexico, whose preferential access to US and Canada is diluted?
Should effects on the rest of the countries be similar, or should we expect winners and losers?

10. How should RIA affect FDI?
Sparse literature. No systematic empirical evaluation of large set of countries
Answer is not obvious. Depends on a number of dimensions
Drivers of FDI
Insiders vs. outsiders of an RIA
Host and source country characteristics

11. Drivers of FDI: Standard models
Vertical (Helpman, 1984; Helpman and Krugman, 1985): Single-product firm with two separable production stages with different skilled-labor intensity; no trade costs  Trade-complementary, vertical FDI between “dissimilar” countries (with different factor endowments)
Horizontal (Markusen, 1984): Single-product firm with (plant- and firm-level) scale economies; trade costs  Trade-substitutive, horizontal FDI between similar countries if trade costs are large (tariff-jumping, distance, etc.)

12. North - North and North - South FDI What should we expect?
Factor proportions  Horizontal North-North FDI and vertical North-South FDI
Trade barriers  Vertical North-North FDI (location) and horizontal North-South FDI (tariffs, as, e.g., the auto industry during ISI)
Evidence: FDI-trade complementarity in developed economies  Horizontal model + country-specific preferences (large cars in the U.S., small cars in Europe)  Trade-complementarity, horizontal FDI between similar countries if trade costs are large

13. Effects on FDI
Vertical integration: Lower tariffs  lower transaction costs for firms to integrate vertically within the RIA  FDI creation
Tariff-Jumping: Lower tariffs  lower costs of serving markets through trade  FDI destruction
FDI diversion/dilution: Non-members (or old members) become relatively less attractive.
Extended market effect: Fosters tariff jumping in activities with economies of scale  higher FDI from outsiders.
Redistributive effects: The regional effect is not evenly distributed: New and existing FDI may be relocated to more attractive countries  winners and losers.

14. Data and empirical strategy
Dependent variable: bilateral outward FDI stocks from 1982 through 1998 from OECD International Direct Investment Statistics database
20 source countries and 60 host countries: 1200 country pairs, observations
Same FTA dummy based on Frankel et al, 1997
Caution: Very few North-South FTA pairs (developing countries do not report their outward FDI)

15. Basic specification
where FDIijt is the stock of FDI of source country i in host country j at time t, as reported by the source country.
Dij is a vector of country pair dummies
Yt is a vector of year dummies
Log (1+FDIijt) = a + b1 lGDP hostijt + b2 lGDP sourceijt + g sameftaijt +
+ d1 EM hostijt + d2 EM sourceijt + fDij + jYt + eijt

16. FDI diversion and extended market variables
Diversion / dilution effects:
source extended market: log of the joint GDP of all FTA partners of the source country, including source country itself
Extended market effect:
host extended market: log of the joint GDP of all FTA partners of the host country, including host country itself

17. Baseline results (1) 0.862 (14.676)** -0.136 (1.314) 0.060 (2.668)**
-0.268
(11.756)**
0.770
(9.507)**
-9.218
(2.900)**
18308
1140
0.2658
18.89**
41.32**
(2)
0.879
(14.917)**
-0.134
(1.297)
0.050
(2.213)*
-0.270
(11.860)**
0.818
(9.945)**
0.020
(3.324)**
-9.448
(2.973)**
18308
1140
0.2662
18.91**
36.45**
(3)
0.895
(12.931)**
-0.203
(1.848)
0.045
(1.900)
-0.264
(10.879)**
0.769
(9.278)**
0.025
(1.546)
-8.007
(2.312)*
16739
1100
0.2652
17.95**
36.52**
(4)
0.896
(12.948)**
-0.203
(1.844)
0.042
(1.774)
-0.265
(10.906)**
0.783
(9.305)**
0.006
(0.977)
0.024
(1.460)
-7.976
(2.303)*
16739
1100
0.2653
17.92**
33.94**
GDP Host
GDP Source
Extended Market Host
Extended Market Source
Same FTA
Privatization
Inflation
Constant
Observations
Number of pair
R2 Within
test F Pair Effects
test F Time Effects

18. Vertical vs. Horizontal
(1)
0.862
(14.676)**
-0.136
(1.314)
0.060
(2.668)**
-0.268
(11.756)**
0.770
(9.507)**
-9.21
(2.900)**
18308
1140
0.2658
18.89**
41.32**
1.447
(2)
0.854
(14.540)**
-0.137
(1.331)
0.065
(2.913)**
-0.269
(11.817)**
0.123
(0.563)
0.009
(3.161)**
-9.097
(2.863)**
0.319
0.795
18308
1140
0.2662
18.84**
18.04**
(3)
0.866
(12.409)**
-0.168
-1.53
0.044
-1.783
-0.296
(12.426)**
-2.044
(7.150)**
0.119
(3.639)**
0.425
(10.535)**
-7.877
(2.265)*
-1.545
1.004
3.072
16341
1105
0.2780
16.23**
35.34**
(14.159)**
(11.519)**
(4)
0.847
-0.179
(1.707)
0.064
(2.832)**
-0.266
3.168
(3.017)**
-0.347
(2.285)*
-7.876
(2.441)*
1.460
0.870
0.442
17957
1104
0.2664
18.72**
40.97**
(5)
0.766
(8.744)**
-0.363
(2.727)**
-0.020
(0.681)
-0.273
(9.211)**
1.152
(9.021)**
-0.780
(4.186)**
1.828
(0.428)
0.829
-0.325
12343
740
0.2791
18.04**
41.33**
GDP Host
GDP Source
Extended Market Host
Extended Market Source
Same FTA
Same FTA * Openness host
Trade
Same FTA * Trade
Same FTA * Distance
Same FTA * Av Diff in capital / worker
Constant
Effect of Same FTA (MIN)
Effect of Same FTA (MEAN)
Effect of Same FTA (MAX)
Observations
Number of pair
R2 Within
test F Pair Effects
test F Time Effects

19. FDI as a beauty contest: Attractiveness
Independent Variables
GDP Host
GDP Source
Extended Market Host
Extended Market Source
Same FTA
Coefficient
0.849
-0.095
0.080
-0.233
0.319
t statistic
(11.51**)
(-0.74)
(8.34)**
(2.86)**
(4.88)**
Distance
Border
Colonial Links
Common Language
-0.747
0.0602
0.146
0.619
(23.78)**
(0.6)
(0.9)
(8.49)**
Host Effects
Source Country Effects
Year Effects
43.12**
195.75**
108.94**
Dependent variable : Stock of FDI
Observations
Adjusted R2
18013

20. Attractiveness (1) 0.862 (14.676)** -0.136 (1.314) 0.060 (2.668)**
-0.268
(11.756)**
0.7702
(9.507)**
-9.218
(2.900)**
18308
1140
0.2658
18.89**
41.32**
(2)
0.855
(14.543)**
(1.268)
0.062
(2.784)**
-0.269
(11.814)**
2.060
(4.090)**
0.341
(2.595)**
-9.201
(2.896)**
0.446
0.791
1.407
18308
1140
0.2660
18.73**
41.37**
(3)
0.864
(14.536)**
-0.131
(1.265)
0.006
(0.104)
-0.268
(11.779)**
2.135
(4.197)**
0.364
(2.736)**
-0.016
(1.068)
-9.498
(2.978)**
0.408
0.777
1.436
18308
1140
0.2661
16.58**
41.43**
(4)
0.8421
(14.316)**
(1.289)
0.0266
(1.125)
(11.909)**
1.9369
(3.842)**
0.2954
(2.243)*
0.1749
(5.023)**
(2.728)**
0.538
0.837
1.370
18308
1140
0.2671
18.51**
41.29**
(5)
0.8022
(13.648)**
(1.286)
0.0208
(0.883)
(12.089)**
2.0558
(4.089)**
0.3125
(2.380)*
0.2037
(5.848)**
0.618
(10.160)**
(3.215)**
0.576
0.892
1.457
18308
1140
0.2715
18.62**
38.8**
GDP Host
GDP Source
Extended Market Host
Extended Market Source
Same FTA
Same FTA * Attract
Extended Market Host * Attract
Extended Market Host * Most Attractive
Extended Market Host * Biggest
Constant
Effect of Same FTA (MIN)
Effect of Same FTA (MEAN)
Effect of Same FTA (MAX)
Observations
Number of pair
R2 Within
test F Pair Effects
test F Time Effects

21. Winners and Losers - FTAA
All
countries
105.34%
94.02%
-2.55%
141.52%
59.78%
134.04%
-2.58%
183.92%
-0.75%
92.26%
Baseline Regression
39.97%
37.79%
-2.49%
125.98%
37.74%
160.31%
-2.48%
216.82%
-0.52%
70.06%
With Openness
All
countries
Host
Country
Argentina
Brasil
Canada
Chile
Colombia
Costa Rica
Mexico
Panama
USA
Venezuela
Rest of the
countries
14.25%
0.79%
33.63%
16.46%
43.92%
0.67%
50.42%
ALCA
137.51%
-2.82%
177.82%
142.13%
199.21%
-2.93%
212.73%
-2.79%
142.09%
16.43%
48.52%
15.74%
49.81%
-2.77%
0.86%
155.76%
37.48%
74.89%
18.21%
240.66%
49.15%
-2.89%
0.73%
251.39%
56.56%
-2.74%
104.19%
18.18%
ALCA
countries
Rest of the

22. Conclusions
Common membership in a FTA with source country increases bilateral FDI (trade complementarity) from within the region and the rest of the world
Effects are highly significant and large
However, regional integration agreements will likely to produce winners and losers, as FDI to countries with deficient investment environment is likely to decline