A global analysis of factors impacting the intensive and extensive margins of bilateral foreign direct investment

• Date: 01 September 2019
• DOI: http://doi.org/10.1111/twec.12827
• Author: Anh T. N. Nguyen
• Published date: 01 September 2019

World Econ. 2019;42:2649–2667. wileyonlinelibrary.com/journal/twec

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2649

© 2019 John Wiley & Sons Ltd

Received: 8 March 2018

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Revised: 14 December 2018

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Accepted: 16 May 2019

DOI: 10.1111/twec.12827

ORIGINAL ARTICLE

A global analysis of factors impacting the intensive

and extensive margins of bilateral foreign direct

investment

Anh T. N.Nguyen

Department of Economics,University of Otago, Dunedin, New Zealand

KEYWORDS

extensive margin, foreign direct investment, gravity model, intensive margin

1

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INTRODUCTION

Recent theoretical models for foreign direct investment (FDI) rely on partial or general equilibrium

(Anderson, Larch, & Yotov, 2017; Bergstrand & Egger, 2007; Markusen, 2002). Those models are

mainly constructed for a world with two countries and derive the determinants of bilateral FDI by find-

ing the analytical or numerical solutions for the equilibrium. Many empirical papers apply these models

to analyse drivers of FDI, considering both home and host countries' characteristics. However, the ma-

jority of these studies, such as Davies (2008) and Araujo, Lastauskas, and Papageorgiou (2017), focus

onlyon FDI from developed countries (DCs); FDI between less‐developed countries (LDCs) has been

neglected. In their extensive survey of FDI studies, Paul and Singh (2017) also show that there is still

a need for a global study with an extensive sample to compare the results between different groups of

countries. Furthermore, most of the previous studies ignore the fact that zero FDI is far more prevalent

than positive FDI. Figure 1 indicates that 60–70% of country pairs do not invest in one another over the

whole period, 2001–12. Simply pooling data of both zero and positive values into a one‐stage regression

such as OLS, tobit or Poisson pseudo‐maximum likelihood (PPML) may lead to inappropriate results.

Recent theories of FDI, as proposed by Razin and Sadka (2007) and Anderson et al. (2017), also sepa-

rate determinants of zero and positive FDI which corresponds to the extensive and intensive margins of

FDI, respectively. The extensive margin of FDI refers to the decision of whether or not to invest, while

the intensive margin is concerned with the amount of FDI invested once the decision to invest is made.

This is the first study to apply the formal structural gravity model of FDI developed by Anderson

et al. (2017) to find the determinants of both FDI margins, especially the role of technology capital.

Using the biggest and most up‐to‐date data set of 110 countries over nine years, 2004–12, this is also

the first study to examine the results for country groups by development extensively at a global level.

There are only a very small number of empirical studies analysing the determinants of both FDI

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NGUYEN

margins, but they do not consider FDI between developing countries and do not apply panel methods.

I find that source country technology capital has a significant and positive impact on both FDI mar-

gins and this result is consistent across different country groups. Bilateral investment treaties play a

significant role only in determining the probability of investment. In addition, many variables, usually

regarded as determinants of FDI, such as source country GDP, common currency, common religion

and trade agreements, are not statistically significant in the case of FDI from LDCs.

The remainder of the paper proceeds as follows. The next section presents a literature survey of

determinants of both margins of FDI. Section 3 describes the theoretical framework and hypotheses,

while Section 4 discusses the multilateral resistance terms in empirical studies in international trade.

Data and hypotheses are given in Section 5, followed by the methodology in Section 6. Section 7

presents the regression results. Section 8 concludes and suggests extensions and improvements for

future studies. Also, details of data collection and data quality, and some additional regression results

are reported in an Appendix S1.

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LITERATURE REVIEW

Although the general literature on determinants of FDI at the aggregate or bilateral levels is vast, there

are only a handful of empirical studies analysing the drivers of both intensive and extensive margins

of FDI. Razin and Sadka (2007) pioneer the development of FDI models explaining zero and positive

FDI separately and then empirically test their theoretical models using OECD data. Besides typical

gravity variables, the authors find that the intensive and extensive margins of FDI are not affected

identically by the same factors such as corporate tax rates and set‐up costs. Davies and Kristjánsdóttir

(2010) investigate the impact of natural resources on FDI inflows to Iceland over the period 1989–

2001. Their empirical results show that distance and trade openness play a more important role in the

probability of investment than the investment amount. Cavallari and d'Addona (2013) examine FDI

between 24 OECD countries from 1985 to 2007 and find a negative influence of output volatility on

the extensive margin. Garrett (2016) employs data from 101 countries between 1995 and 2002 and

finds the significant role of productivity thresholds in FDI decisions. Meanwhile, Araujo et al. (2017)

focus on market entry costs as the key factor between the two margins and investigate outward FDI

data from OECD countries to the rest of the world. Eicher, Helfman, and Lenkoski (2012) use a panel

FIGURE 1 Distribution of country pairs based on direction of FDI stocks.

Data source: UNCTAD, 110 countries

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2001 2002 2003 2004 2005 2006200720082009201020112012

No FDI FDI in one direction only FDI in both direction