Effect of Foreign Direct Investment on Bilateral Trade: Experience From Asian Emerging Economies

Abstract

This study examines the effects of foreign direct investment (FDI) on bilateral trade between East and South Asian emerging economies, including their related trading partners. We cover the bilateral data on trade and FDI from June 2001 to June 2019. We estimate an augmented gravity model of trade to examine the study sample. This study is the first to use the Mundlak approaches an alternative for the fixed effect model to empirically estimate the relationship between FDI and trade among the countries in the region. Results show that free trade agreements (FTAs) and the corruption perception index (CPI) significantly and positively affect bilateral trade. However, the distance variable has become insignificant after introducing the FTA variable to the model. This finding indicates that FTAs marginalize the effect of distance on bilateral trade between the member countries. Thus, policymakers in developing countries should encourage and liberalize FDI from developing countries to enhance the bilateral trade volume.