Explaining trade and FDI relationships in a gravitational model

Abstract

In recent decades, the world economy has undergone major changes, particularly with regard to trade and foreign direct investment. In view of this evolution, we need to review some basic assumptions of international economics. According to models based on the Heckscher-Ohlin-Samuelson seminal contribution, trade and foreign direct investment are taken as substitutes. Nevertheless this is not consensual. The purpose of this paper is thus to examine the links between trade and foreign direct investment through a gravitational model in the context of the present-day world economy. In the model, the explanatory variables of trade are the physical distances between countries, as proxy to transaction costs, their incomes, dummies for each country and standardized indicators of foreign investment attractiveness. The parameters to be estimated are the distance attrition, the coefficients associated with the foreign investment, and the dummies' coefficients, which can be seen as extra costs or benefits attributable to each country that are not explicit in the physical distance. Taking into account our findings, which favor the argument of substitutability, we draw some conclusions about the relationship between trade and foreign direct investment, with the aim of contributing to the ongoing theoretical debate.