Trade and investment patternsLecture for the course STV4284B

Carl Henrik KnutsenDepartment of Political Science, UiO

8/4-2008

Important questions

• Which firms import and export, and why?• Which firms invest, and why?• What characterizes FDI flows and stocks?• What are the factors influencing allocation of

FDI?• How does trade relate to FDI?

Actors

• Firms invest• However, we are often interested in aggregate

patterns at the national level, even if individual investment decisions are taken by firms (and even individuals within the firm).– Structural factors, political economic systems– Generalization

The profit-maximizing firm in neo-classical economics

• Invest or not?– Invest if: p*f(x) – w*x – c > δ – A wide interpretation of c: plant investment, administrative costs,

corruption, reputation effects etc..• Uncertainty and risk-averse firms• Are investors rational? Other important factors more or less

compatible with rational choice theory: – knowledge and learning; bounded rationality – external effects on other activities– market power (mergers and acquisitions)– maximizing profits or size?

• Parsimony: Benefits and drawbacks.

Empirical studies

• Aggregate vs firm level data• Firm level data are only available for a certain

number of countries, and this limits the number of studies

• Secrecy• Short time series• Comparability across nations; data at the

national level• Definitions and comparability. OECD.

Norwegian FDI

• Data from the Statistics Norway (SSB)• Data on investment projects• 1998-2005• Based on survey• Reporting, bias and lack of data• Availability and secrecy

Project on Norwegian FDI

• Hveem et al (2008a and 2008b) are first outputs from this projects.

• Aggregate studies on FDI-patterns. Descriptions and causal analysis.

• Forthcoming: State-owned enterprises and FDI• Need for nuance: Sector studies and firm

studies. Studies on particular host countries?• A very good opportunity for writing MA-thesis!

”The Latecomer Investor”

• Large-scale outward FDI from Norway is a relatively novel phenomenon, with some exceptions (e.g. shipping)

• Historically, Norway has been a net importer of FDI• But this has changed! In 2005: Outward = 2x Inward FDI

– Economic growth and growth of firms (large firms are much more likely to engage in FDI)

– Capital accumulation– Business culture changes, even in state-owned enterprises?

• According to UNCTAD statistics, Norwegian outward FDI-stock in 1980 was only 0,4% of that in 2006, and in 1990 it was 9,0% of that in 2006.

Some numbers• Total outward FDI stock:

– 1998: 238 864 million NOK– 2005: 665 349 million NOK– Annual growth rate of 15,8% from 1998 to 2005. The growth rate from 1980

to 1998 was 25,1%, starting from a very low level!– The growth rate in global FDI-stocks over the period from 1998 to 2005 was

10,9%. The growth rate from 1980 to 1998 was 11,6%.• Norwegian outward FDI as a share of global FDI went up from 0,09% in

1980 to 1,04% in 2005. The Norwegian population accounts for about 0,08% of the world’s population.

• Total outward FDI stock in oil and gas production:– 1998: 87 408 million NOK– 2005: 216 755 million NOK– Annual growth rate of 13,9%

Norwegian FDI from 1980-2006

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 270

20000

40000

60000

80000

100000

120000

140000

Series1

Geographical dispersion Norwegian FDI1969 1979 1989 1996 1999 2002 2005

Western Europe

73,3 67,2 68,3 65,5 72,4 61,9 51,3

Eastern Europe/ former Soviet Union

0 0 0 6,7 1,8 3,2 7,4

Middle East/North Africa

n.a. n.a. n.a n.a. 0.6 0,6 2,2

Africa South of the Sahara

n.a. n.a. n.a. n.a 2,9 2,9 3,6

North America

16,7 15.5 19,6 14,4 15,3 16,9 19,9

Central and South America

n.a. n.a n.a. n.a. 3,2 3,7 3,2

Asian and Oceania

} 6,7 } 10,3 } 9,5 } 10,6

2,5

0,3

4,8

3,0

8,2

1,9Caribia n.a. n.a. n.a. n.a. 1,0 3,1 2,4

Some claims from the paper• Norwegian FDI has had a dramatic increase in later years, outgrowing even the

global trend• Norwegian FDI has been and still is very concentrated geographically, but the trend

is deconcentration, as Norwegian investors have increasingly turned to for example Africa and Asia

• The largest ”receivers” of FDI in 2005: Sweden, USA, Belgium, Canada, Netherlands, Singapore, Denmark, Great Britain, Germany, Angola, Azerbaijan

• Norwegian oil and gas investments are a substantial part of the story, but not the whole story. Other sectors: Telecom, aluminium, mechanical industries, shipping

• Norwegian FDI has grown because of 1) New investments in existing projects, 2a) Mergers and acquistions, 2b) Greenfield investments

• In addition to FDI, Norway’s state owned petroleum/pension fund is a very large global investor in stocks and bonds.

• Not in paper: State owned companies are important: 30,3% of 2005 FDI, when applying a 50% ownership criterion.

”Blue-eyed investors”

• Underlying premise: A very wide range of host-country characteristics can affect the allocation of Norwegian FDI.

• Economic, geographic, political and social factors.• Earlier studies have tended to focus on economic

factors• No existing coherent model is able to capture these

diverse factors A need for theoretical eclecticism and an explorative strategy, empirically.

Some methodology

• A regression-based framework, but applied on a panel data set OLS does not suffice

• Pooled Cross Section Time Series analysis: OLS with panel corrected standard errors. Takes into account heterogenous standard errors across panels, autocorrelation and contemporaneous correlation

• Time series from 1998-2005. Country-years are units.• Data from several sources: SSB, WDI, FHI, WGI, ILO, CEPII….• Regression equation:

Y = α + β1Xi1 + β2Xi2 + …. + βnXin + εi

• Interpretation of coefficients (Controlled for all other factors!)

Methodological pitfalls• Data: Measurement errors from survey. Lacking data classified as 0

underreporting– Systematic biases if FDI in some particular countries are systematically

underreported (tax-havens?)• Transit countries and final investment location: Belgium and

Singapore!!• Bi-directional causality: Only affects some variables in this study• Omitted variable bias• Controlling away indirect effects• Multi-colinearity and uncertainty• All these points imply that the results from the article have to be

interpreted with care. Nevertheless, these are the best estimates we can get!

The main empirical results• These factors seem to significantly increase Norwegian FDI:

– Large market– Small geographical distance– EU-membership– Being Nordic– High tertiary school enrollment rate– Low capital density– Energy-resources– Low corruption– Stricter labour standards

• These factors show diverging results or are insignificant in most analyses:– Wages– Democracy– Rule of law– Trade-taxes– Bilateral investment treaties– Tax-haven status– Primary school enrollment rate

Economic factors

• The ”gravity model” in studies of trade. Works quite well here as well.– The role of a big market and well developed factor markets– Distance and FDI. Vertical vs horizontal FDI and theoretical

predictions• Factors of production– Type of education and sectors– The role of wages– Investment and two theoretical predictions (Solow vs

Krugman)

Economic policy and trade

• Bilateral investment treaties and tax-havens: Why such weak results?

• Trade taxes and alternative explanations of the negative relationship with FDI

• EU/Nordic• Trade and FDI: The issue of causal direction

and interpretation of regression results

Political structures

• High correlation between political structures. Institutional structures that tend to og togetherMulti-colinearity and the difficulty of determining relative effects.

• But: Political structures clearly matter!– Rational investors and cost of doing business– Rational investors and uncertainty– Business leaders and norms– Reputation effects

Specifications

• The choice of functional form: Logarithmic transformations and interpretation of coefficients

• Alternative operationalization and robustness of results

• The largest problem however is choosing the most suitable model-specification

• Remember that we are only dealing with model-contingent estimates: The most important thing is not the numbers, but ”sign” of coefficients and statistical significance.

How to read a regression table

Variables Model X

Constant 1257963

5,82*

GDP, 2000 $ 4,41E-06

13,53*

Weighted distance -72,78349

-5,97*

GDP per capita, 2000 $ -49,398

-1,40

R-squared 0,5123

Countries 175

Observations 1020

Interpretation and nuance

• Estimates are estimates• We are dealing with aggregate data: way of

generalizing, does not strictly say anything about factors moving decisions in concrete, singular instances

• Nuancing the aggregate data: Sectors and diversity!

Bernard et al. (2007)

• Firms and trade in the US.• What are the characteristics of trading firms, and

how do they perform?• Data from 1993-2000: Notice the short time

interval when interpreting trends• Trends versus levels, shares versus growth• Links customs data with data on firms• Paper is mostly descriptive, and does not conduct

any rigorous analysis. Correlation and causation.

Main findings• Importing and exporting are correlated activities (omitted variables? Size?)• Trade is very concentrated: Top 1% trading firms account for 81% of trade, and concentration

increases over time.• Only a small number of firms engage in trade, but the number is growing (entry and exit

mechanisms)• But these firms are in general big!• Greates share of trading firms are ”wholesale and retail trade” firms, but the largest volume of

trade takes place in the goods sector• Most of the trade is with other OECD countries, and the average number of trading partners is

low (approx 3), but growing.• Trading firms have better performances (employment growth and exit). Causal interpretation:

Learning and spill-overs as well as profits from trade AND/OR self-selection into trade by most successful firms: Trade as symptom (Dani Rodrik)

• ”Most Globally Engaged Firms” are firms that both import and export with related parties. These account for 80% of US exports and imports and are more likely to trade with less developed countries

• Intra-firm trade is on the rise in MGEs, and in general, these firms also have higher growth rates in exports and imports than other firms.

Hummels et al. (2001)

• Point of departure: Production processes increasingly involve sequential, vertical trading along the value chain. Import of inputs - production - export of good (alternatively used as new input in receiving country)

• (International) Vertical specialization: Use of imported goods that are used in producing goods that are later exported

• More formally:– Good is produced in two or more stages– Two or more countries provide value added to good– At least one country must use imported inputs and export some of

the production

Data and main findings

• Uses input-output tables from OECD database for 10 OECD countries, plus separate data from Ireland, Korea, Taiwan and Mexico (These countries account for more than 60% of world exports).

• Vertical Specialization as share of trade for these countries: From 0,165 in 1970 to 0,21 in 1990. A 30% growth.

• Vertical Specialization accounts for 30% of the growth in total exports over the period.

Other findings

• Heterogeneity: Small countries have a higher share of VS/export, and the US in particular has a low share.

• VS/export has grown in most countries, but some countries experienced a slow-down in the 1980’s. VS was particularly important in increasing export growth rates in Mexico and Taiwan.

• The VS share has mainly grown because there has been an increasing VS share within sectors, and not because countries have changed their sectoral composition

Causes

• Countries are able to reap benefits from Ricardian ”comparative advantages” not only in trading ”home-grown” final goods, but also by trading inputs: gains from trade.

• Why has this become increasingly possible?– Technological change– Transport costs– Lowering of tariffs– The transnational corporation and intra-firm trade

(organizational change)

Feenstra• Increase in trade, and economic integration (mainly focusing on the US).• ”The skeptic”: Pre WWI trade levels were high!

– Feenstra: Sectoral composition has changed as GDP has increased. Less trade in services than in goods: Merchandise trade/production is much higher today (1998)

• Economic integration goes together with disintegration of production process (”outsourcing”). Relate to Hummels et al and vertical specialization

• US trade in goods and long-run developments: From agriculture and raw materials to manufactured consumer goods and particularly capital goods

• Capital goods, but also manufacturing are increasingly done abroad, but often by affiliates belonging to US TNCs or by firms engaged in different types of long-run contractual relations (licensing etc.)

• ”Low skill” production undertaken abroad, and ”high skill” production at home (a simplified model). Advertising, marketing and product development remains in the US. The logic of comparative advantage

The political debate and the academic debate

• The political debate, especially in the US, has focused on the negative effects of globalization and outsourcing on real wage decline or at least stagnation for low-skilled workers and uneployment

• Economists, with a basis in empirical studies, have argued that technological change, which has reduced demand for low-skilled workers, is largely to blame for declining real wages (US) and high unemployment (Europe)

• Feenstra argues that one cannot separate easily between effects from technological change and the effects from trade, and that these economists have based their studies on trade in final goods. According to Feenstra, the picture changes if we take into account vertical specialization and trade in inputs.

• In addition, increased mobility of capital has increased the relative bargaining power of capital owners over laborers. Often, the threat to move the factory is enough to reduce wages, and we do not need to see outsourcing for the threat of outsourcing to have an effect on wages.

• Feenstra’s point is well taken, but in my view, the public debate has one-sidedly focused on economic integration as a cause for these economic ills, and has not taken into account the role of technological change. Both factors have probably been at work.

Policy-remedies

• Trade policy: From altering and using the ”escape clauses” in WTO to outright unilateral protectionism: Efficiency issues!

• Subsidize the losers, but let the economy restructure: Norman and Dixit’s subsidies and taxes

• Rodrik and the need for a strong welfare state in a globalized economy

• Labour-market policies: Retrain and reeducate the unempolyed industrial workers

• Technological development and new sectors: Find your new comparative advantage!

• Provide a well-functioning and broad educational system.