Effects of cultural institutes on bilateral trade and FDI flows: Cultural diplomacy or economic altruism?

• Date: 01 September 2020
• Author: Firat Demir,Hyeonjin Im
• Published date: 01 September 2020
• DOI: http://doi.org/10.1111/twec.12906

World Econ. 2020;43:2463–2489. wileyonlinelibrary.com/journal/twec

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2463

© 2019 John Wiley & Sons Ltd

Received: 17 December 2018

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Revised: 5 September 2019

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Accepted: 12 November 2019

DOI: 10.1111/twec.12906

ORIGINAL ARTICLE

Effects of cultural institutes on bilateral trade

and FDI flows: Cultural diplomacy or economic

altruism?

FiratDemir1

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HyeonjinIm2

1Department of Economics, University of Oklahoma, Norman, OK, USA

2Department of Economics, University of Missouri, Columbia, MO, USA

KEYWORDS

bilateral FDI, bilateral Trade, country heterogeneity, cultural institutes

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INTRODUCTION

Do cultural affinity and language familiarity affect bilateral economic exchanges? This question has

been at the heart of a large and growing number of papers with a mostly affirmative answer. The ex-

isting evidence suggests that common language, religion, cultural affinity and other aspects of cultural

and historical connections are significant drivers of bilateral trade and investment flows. In this paper,

we contribute to this debate by exploring the heterogeneous effects of cultural and language institutes

on bilateral trade in goods and services and FDI flows.

Cultural and language differences are known to be major drivers of economic decision-making and

preferences at least since the time of John Stuart Mill(2004), who argued that such differences can be

even more important than the pursuit of self-interest. Since then, a large and growing literature has

established that language or cultural heterogeneity creates non-tariff entry barriers and is important

determinants of economic exchanges between countries. Common language and language proficiency,

for example, are found to be robust and significant determinants of bilateral trade and FDI flows

(Anderson & Wincoop, 2004; Bergstrand & Egger, 2007; Egger & Lassmann, 2012, 2015; Gokmen,

2017; Guiso, Sapienza, & Zingales, 2006, 2009; Ku & Zussman, 2010; Melitz, 2008; Melitz & Toubal,

2014).1

Cultural similarity (or distance) is also shown to be a significant driver of bilateral economic ex-

changes. Guiso et al. (2006, 2009) argue that cultural biases, conditioned by traits such as religion,

history of conflicts, and genetic and somatic differences, have a significantly negative effect on bilat-

eral trade, portfolio investment and FDI flows. Likewise, Boisso and Ferrantino (1997), Disdier and

1 Using meta-analysis on 81 articles, Egger and Lassmann (2012) show that the effect of common language on trade is

positive and significant, increasing trade on average by 44%. Ku and Zussman (2010) also show that the level of English

proficiency, measured by TOEFL scores, has a positive effect on trade, suggesting that language acquisition can help negate

historically determined fixed language barriers to trade.

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DEMIR anD IM

Mayer (2007) and Gokmen (2017) confirm that cultural familiarity has a significantly positive effect

on bilateral trade flows. Culture also affects the type and structure of domestic institutions (Hofstede,

2001). Particularly, institutional differences in legal codes, transparency, financial system, corruption,

law and order, etc. are shown to be significant drivers of trade and investment flows. Such differences

create non-tariff entry barriers, increase the cost of doing business and hurt exporter entr y, growth and

survival as well as trade volumes (Anderson & Marcouiller, 2002; Araujo, Mion, & Ornelas, 2016;

Belloc, 2006; Fernandes, Freund, & Pierola, 2016; Konya, 2006; Levchenko, 2007; Papaioannou,

2009).

In short, increasing language and cultural recognition and affinity between countries can help de-

velop bilateral economic exchanges by lowering entry barriers and transaction costs through providing

know-how and country-specific information.2 Recognising such benefits, many countries have estab-

lished cultural and language centres as well as foreign language radio and TV broadcasts across a wide

range of countries. Furthermore, cultural institutes offer various scholarships, allowing students and

academics to visit those home countries. British Council (2015), for example, reports that its work helps

improve the economic prosperity of the UK through establishing international connections, building

trust and cultural understanding, and increasing trade and investment flows.3 Cultural institutes can also

serve political purposes as they promote the social, cultural and political values and priorities of home

country governments.4 Overall, therefore, language and cultural institutes are expected to play a major

role in lowering non-tariff entry barriers and help build bridges between home and host countries, al-

lowing increased trade, investment and social, political and educational exchanges.

Seeing them as strategic instruments for economic penetration into new markets and for soft power

through cultural and political influence, home country governments subsidise these cultural institutes

and support their operations.5 British Council of the UK, for example, was operational with 193 of-

fices in 118 countries in 2015. Likewise, Germany's Goethe Institut, Japan's Foundation, France's

Institut Francais, Spain's Instituto Cervantes and Portugal's Instituto Camoes are other similar centres

that are established across a wide range of countries. While up until recently most such institutes were

from developed countries, developing countries have also started following suit, including the

Confucius Institute of China and the Yunus Emre Institute of Turkey. Particularly, reflecting its grow-

ing global power, China has become a major exporter of cultural institutes around the world through

its Confucius Institute, which reached a record number of 453 in 118 countries in 2015.6 Reflecting

Chinese government's strategic goals to expand its soft power, the majority of these institutes are

opened in developed countries with the US coming first with 99 and the UK coming second with 27

institutes. We observe similar soft power and economic expansion objectives for Turkey, whose Yunus

Emre Institute is mostly opened in former Ottoman territories of Balkan states with Bosnia and

Herzegovina and Kosovo coming as the top two destinations with three institutes in each.

2 Ginsburgh et al. (2017) find that trade linkages increase the demand for foreign language acquisition.

3 British Council (2015) reports that people who attended British Council's cultural and language activities trust the UK on

average 24 percentage points more than other countries.

4 The British Council, for example, states that it aims at promoting equality and human rights while fighting against

discrimination (British Council, 2015).

5 The annual report of British Council (2015) indicated that they helped establish networks with emerging markets and

facilitated the export of 1.3billion pounds worth direct higher education exports and indirect contribution to higher education

of 5.5billion pounds in 2015.

6 The Confucius Institute Headquarters is also referred to as Hanban, named after the parent organization headquartered in

Beijing.