The research on the linkages between trade and investment has attracted strong attention. The main question in the debate is whether FDI is a substitute for trade, or whether FDI is complementary to trade. It has often been stated that FDI affects the recipient country and home country in terms of exports, imports, employment, and balance of payments. Moreover, some FDI are aimed at tariff jumping, whereby foreign investors invest in a host country to avoid certain import or export restrictions.

The negative effects of FDI on trade originated from the theory of Mundel, who argued that the free movement of capital (and labour) was a substitute to free trade. In other words, the complete free movement of factors of production produce the same results as the completely free movement of goods and services. This would implicate that FDI substitutes trade, and therefore has a negative effect on the trade account. If FDI, on the other hand, is complementary to trade, the positive effects arising from FDI may be greater than the potential drawbacks. Positive effects will then depend on the amount of imports, and possible exports deriving from FDI. How far MNCs actually contribute to the host country’s trade balance depends on a number of factors. One factor is whether the foreign affiliate’s role is to serve the host market itself, or using the host country as an export platform. Foreign affiliates set up to serve the local market, by definition, will not be large exporters. Thus, the net effect of the trade balance will be influenced by the extent to which the export-producing activities depend on imported components.

This section reviews some of the publications on the effects of FDI and trade and their relation to international trade integration and export competitiveness. 

The World Investment Report 2002: TNCs and Export Competitiveness, Division on Investment, Technology, and Enterprise Development, 2002

Part II, entitled TNCs and Export Competitiveness, explores the changing nature of export competitiveness and the role that TNCs can play in enhancing it in different countries and activities. Part III provides an analysis of policies to attract, upgrade, and benefit from export-oriented FDI deals with various policies developing countries may use to attract export-oriented FDI.

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The FDI-Trade Relationship: Are Developing Countries Different? Bedassa Tadesse and Michael Ryan, version prepared for the Northeast Universities Development Consortium Conference at Williams College, Williamstown, 2002

This paper empirically examines the extent to which the FDI–trade relationship is affected by host-country heterogeneities associated with the development and market servicing roles of Japanese FDI host countries. Using the counts and values of Japanese aggregate FDI and trade flows into more than 100 geographically and developmentally diverse countries, it is shown that Japanese FDI in the 1990s was generally trade creating. However, the extent to which FDI complemented trade varied by geographic, developmental, and market servicing status of the host countries. Moreover, according to the study, higher factor costs and exchange rate volatility lowered the occurrence and value of Japanese FDI. Japanese FDI during the reference period was mostly tariff jumping.

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FDI and Trade: Exemplification of Poland and other Post-communist States, K. Zukrowska, M. Gracik, A. Pochylczuk, D. Sobczak, J. Zombirt, Ezoneplus Working Paper No. 7A, August 2002

This study examines the mutual relations between FDI and foreign trade in transition economies. The authors focus on institutional arrangements for liberalization of FDI and trade, the impact on foreign trade, and the main investors. The study also emphasises the important role of FDI in changes of ownership, productivity, functioning of the economy, quality of production, exports innovativeness, competitiveness, and exports. According to the authors, the structure of trade changed in most ECE economies because of FDI. There was a shift from labour intensive towards capital-intensive production. Enterprises with a FDI component were more actively involved in foreign trade than those without such component, moving from imports to exports. Most of the trade is conducted by SMEs.

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Openness and Growth: Re-Examining Foreign Direct Investment, Trade and Output Linkages in Latin America, A. Cuadros, V. Orts and M.T. Alguacil, Centre for Research in Economic Development and International Trade, University of Nottingham, March 2001.

This paper analyses the relationship between openness and economic growth in developing countries. It employs an econometric model to test the existence and nature of the causal relationship between output level, inward FDI and trade in Argentina, Brazil, and Mexico from the middle seventies to 1997. Its principal aim is to analyse the extent and sources of international linkages between openness and economic performance in these developing countries. Although the paper did not find evidence about the export-led growth hypothesis, the results suggest a significant impact of FDI on economic growth and trade in the analysed countries.

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The Relationship between Foreign Direct Investment and Trade Flows in a Transition Economy: the Case of Ukraine, Nadiya Mankovska, National University of Kyiv-Mohyla Academy, 2000/2001.

This paper examines the relationship between FDI flows into Ukraine, and imports and exports to and from the country. The paper shows that FDI from the European Union (EU) into primary industries is mostly export-oriented and thus complements trade, whereas that into secondary, manufacturing industries tends to substitute for trade. The paper argues that primary-industry FDI from the EU is motivated by Ukraine’s comparatively abundant and cheap natural resources, whereas secondary-industry FDI is motivated on the cost side by Ukraine’s low wage labour and on the revenue side by its large and relatively untapped domestic market. Secondary-industry FDI thus has the potential for import-substitution, although tests of this hypothesis at aggregate levels were inconclusive. FDI from countries of the former Council for Mutual Economic Assistance (CMEA), on the other hand, complements trade in secondary products. The paper argues that FDI from the CMEA is motivated by the potential for economies of scale, including those that might arise from resuming production links obtained during the Soviet times. This inference is supported by evidence of relationships between FDI from the CMEA and intra-industry trade between the CMEA and Ukraine.

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International Trade and Factor Mobility: An Empirical Investigation, Linda S. Goldberg

This paper investigates whether FDI serves as a complement to trade or a substitute for trade based on the effects identified by the Rybczynski theorem. This theorem assumes that an increase in a factor of production used intensively in one sector, affects production both in that sector and in other sectors. With the use of detailed data on bilateral capital and trade flows between the United States and individual Latin American countries, the linkages between FDI into particular sectors of Latin American economies and the net exports of those and other manufacturing sectors were examined. It was found that FDI from the United States could lead to significant, and varied, shifts in the composition of activity in many Latin American countries and across many manufacturing industries.

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Modelling Links between Canadian Trade and Foreign Direct Investment, Walid Hejazi and A. Edward Safarian, University of Toronto, No.02, April 1999

This research paper used bilateral trade and FDI data between Canada and 35 other developed and developing countries over the period 1970-96, and based its findings on a gravity model framework. The outcome of the research is that trade and FDI are complementary, instead of substituting. The analysis was extended to the industry level (SIC-C 1980) using bilateral FDI data. This enabled the authors to show that links between trade and FDI vary substantially across industries.

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Trade Effects of FDI in Mercosur; A Disaggregated Analysis, M. Castilho, S. Zignago

The authors examined the relationship between FDI, trade, and regional integration in Mercosur. They use different econometric models on trade and FDI flows between two Mercosur members – Argentina and Brazil – and their partners during the nineties. The authors find that the investment flows into the Mercosur countries has generated strong flows of imports without generating exports. At the same time, they find that the strategies of foreign investors depend on the country where the firm is located. Investors in Brazil paid special attention to the regional market, whereas investors in Argentina did not.

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Trade and foreign direct investment, WTO Report, October 1996.

The second part of this report focuses on the inter-linkages between FDI and trade. According to the authors, the available evidence suggests that FDI and host country exports are complementary and that there is a weaker, but still positive relationship between FDI and host country imports. Moreover the authors find similar conclusions for the relationship between FDI and home country trade, although for FDI and host country exports the complementary forces are stronger (than between FDI and home country exports). These conclusions are mainly drawn from analyses based on developed country data.

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