The economic impact of trade openness on foreign direct investment into emerging market countries.

Abstract

This paper addresses a central research question that will enable us to understand the economic impact trade openness has on FDI. Does a government’s effort to liberalise trade, lead to an increase of FDI into the host country? Using a comprehensive sample of emerging market countries over the period 1990 to 2010, together with panel data techniques, the paper disaggregates total FDI inflows to empirically investigate, at a sectoral level of the economy, the effect trade openness has on primary, secondary and tertiary FDI inflows. The main findings are that liberalising trade openness in the emerging market countries leads to an increase in total FDI inflows, and in the secondary sector-wise FDI inflows. A 10% increase in the trade openness of an EMC member (i.e. lower trade barriers), resulted in an 8.43% increase in the total sector FDI, and a 4.01% increase in the secondary sector FDI, ceteris paribus. Trade liberalisation is therefore an important motive for FDI in the manufacturing sector of EMCs. This follows the efficiency seeking (vertical FDI) theories the export-orientated market seeking (horizontal FDI) theories. This liberalisation effort has the opposite effect in the Asia Pacific Trade Agreement region, where increased openness results in a strong decrease in the manufacturing sector FDI inflows. This suggests tariff jumping motives for FDI into this region.