No. 337 - Foreign direct investment and trade: complements or substitutes?

This paper examines the relationship between international production and exports for a number of countries. In the theoretical literature the relationship between direct investment and trade is not certain apriori: some works emphasize their complementarity, others their reciprocal substitutability, depending on the aim of the investment (e.g. to serve the local market, to transfer production phases to low-wage countries, to circumvent trade barriers, to acquire natural or technological resources). The empirical investigation performed finds that the hypothesis of complementarity is more robust than that of substitutability, albeit with pronounced differences between areas. A panel econometric analysis of an “enlarged” gravitational model, performed on the markets of five industrial countries for the period 1985-94, shows that the imports of market i from country j are positively correlated with the sales of the foreign affiliates of country j that are present in market i, after controlling for the effect of the ordinary variables of scale, economic similarity and relative distance. However, an alternative analysis, using appropriate “indices of relative geographical orientation” constructed for the exports and direct investment flows of the leading investor countries towards the main areas of the world in 1982-94, shows that the complementarity hypothesis is not confirmed in equal measure for all the flows examined. In particular, complementarity is greater for flows between the United States and the European Union than for those between European countries and those between North America and Japan, where a possible substitution of direct investment for exports is found.