The Role of Geography in Financial and Economic Integration: A Comparative Analysis of Foreign Direct Investment,Trade and Portfolio Investment Flows

The objective of this paper is to examine the role of geography in explaining the patterns of financial and economic integration among both developed and developing countries. Using a gravity model, we compare North‐North, North‐South and South‐North FDI, trade and portfolio investment flows to examine how geographical factors influence these bilateral flows. The results indicate that the impact of geography variables on FDI and portfolio are similar to their effect on trade. Geography variables have a statistically significant effect both on FDI and portfolio investment, but FDI is more sensitive to distance. We interpret the negative effect of distance as the existence of information costs in financial flows. Also bilateral FDI, trade and portfolio investment flows react to macroeconomic fundamentals in the same way, however, with different degrees of sensitivity. There are significant differences between North‐North and North‐South flows. Our results find support for the argument that most FDI among industrial countries are horizontal, whereas most FDI investment in developing countries is vertical. The fact that the significance of geographical variables on financial flows still remained even after controlling for the macroeconomic fundamentals, is in contrast with the standard capital market model. The results can, however, be reconciled if geographical factors can proxy for information costs, which may in turn explain why country portfolios are still home‐biased. The significant effect of distance on financial flows may also explain how idiosyn cratic shocks are spread (i.e. contagion) to other countries in the same region. Ultimately, the geographical location of a country may determine its economic and financial integration into the world economy.     

Political regime and FDI from advanced to emerging countries

We investigate the effect of the political regime on bilateral FDI flows from advanced to emerging countries in the period 1992–2004. We control for country size, per capita income and privatization proceeds in the host country, and use a random-effect Tobit model to exploit information from zero entries. Our results suggest that democracy does have a positive effect on the amount and probability of FDI flows from developed to emerging countries. Moreover, we find that the effect of democracy on FDI also works through the total factor productivity channel, not only the political risk one as suggested in the literature.

Firm-level effects of offshoring of materials and services on relative labor demand

Based on firm-level data over the period 1997–2002 for the Swedish manufacturing sector the objective of this paper is to analyze relative labor demand effects due to offshoring, separating between materials and services offshoring and also geographical location of trade partner. Overall, our results give no support to the fears that offshoring of materials or services lead to out-location of high-skilled activity in Swedish firms. Rather, this paper finds evidence that the aggregate effects from offshoring lead to increasing relative demand of high-skilled labor, mainly due to services offshoring to middle income countries.