The Impact of Economic Integration on FDI and Exports: A Gravity Approach. CEPS Working Document No. 156, November 2000

This paper uses the gravity-model approach to deal with two issues related to economic integration. The first concern is to analyse the impact on FDI stocks of specific variables denoting the will to integrate, and their relative impact on exports. Variables considered include tariffs, non-tariff barriers and exchange rate variability. The results show that the widespread opinion – and theoretical claim – of ‘tariff-jumping’ FDI is not supported by the evidence. Moreover, non-tariff barriers have a negative impact on FDI, revealing the greater role of sunk costs for foreign investors as opposed to exporters. In contrast to the impact on exports, exchange rate variability does not have a negative impact on FDI, since it can partially be overcome by directly investing in the host country. The second concern deals with the debate on the complementarity vs. substitutability relationship between exports and FDI. At the aggregate level, the results show that a complementary relationship holds.