THE KNOWLEDGE‐CAPITAL MODEL OF FDI: A TIME VARYING COEFFICIENTS APPROACH
| Author | Petr Mariel,Carlos Rodríguez,Susan Orbe |
| Published date | 01 May 2009 |
| Date | 01 May 2009 |
| DOI | http://doi.org/10.1111/j.1467-9485.2009.00480.x |
THE KNOWLEDGE-CAPITAL MODEL OF
FDI: A TIME VARYING COEFFICIENTS
APPROACH
Petr Mariel
n
, Susan Orbe
n
and Carlos Rodrı´guez
n
Abstract
The present article reexamines some of the issues regarding the Knowledge-Capital
Model that encompasses both horizontal and vertical Foreign Direct Investment.
The empirical support for this model is however mixed. This article proposes a new
way of estimating coefficients by allowing them to vary over time. The estimation
results obtained using data from 30 OECD countries for the period from 1982 to
2003 confirm that these coefficients cannot be considered as constant over time and
that the vertical component of the Knowledge-Capital Model is relevant.
I Intro ductio n
It is well known that the activity of multinational enterprises (MNEs), measured
in terms of world foreign direct investment (FDI) flows, has grown in recent
decades at a rate that has outpaced growth in trade and income. This trend has
led to an interest in empirically investigating the fundamental factors behind the
determinants and location of FDI. Most of the research done has been based
largely on the ‘eclectic paradigm’ and on partial equilibrium analyses. However,
a more recent line of the literature has begun to incorporate MNEs into a
general equilibrium framework providing a solid base for empirical work in the
shape of a well-founded theory. One basic question still in dispute in the realm of
this newer theoretical setting is the extent to which FDI flows are horizontal or
vertical and how they change over time. To quote Navaretti and Venables (2004,
p. 144): ‘. . . even though the empirical evidence indicates that vertical FDI does
not account for a significant amount of (world) FDI, it still suggests that it plays
a role and, most likely, an increasing one’.
Previous empirical studies that estimate constant time coefficients for the
variables designed to capture horizontal FDI (HFDI) and vertical FDI (VFDI)
in fact reveal the prevalence of HFDI factors behind FDI cross-country
distribution. Helpman (1984) proposes a model of multinational activity that
leads to a pattern of vertical integration of production across countries and
VFDI in which headquarters activity is more capital- and skilled labor-intensive
n
Universidad del Paı
´s Vasco
Scottish Journal of Political Economy, Vol. 56, No. 2, May 2009
r2009 The Authors
Journal compilation r2009 Scottish Economic Society. Published by Blackwell Publishing Ltd,
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196
than production at plants. So, in order to take advantage of factor cost
differences, firms will locate headquarters in the skilled labor-abundant country
and plants in the unskilled-labor one. Therefore, although the vertical model can
explain FDI flows between roughly developed and developing countries, in fact
a large amount of FDI is a two-way flow between advanced countries with
similar factor endowments. Markusen (1984) and Markusen and Venables
(2000) develop the horizontal model where MNEs are multi-plant firms with one
integrated plant (headquarters and production plant) at home and production
plant replicas in foreign countries servicing each market with production from
within its borders. As the model assumes that headquarters and production
activities use factors in the same proportion, the model predicts that HFDI will
be prevalent between countries with similar endowments and large, similarly
sized markets and when there are significant barriers to trade. Nevertheless, both
types of investment can be observed in the actual behavior of an MNE.
Based on this reasoning Markusen et al. (1996) and Markusen (1997, 2002)
provide a closer approximation to the reality of MNEs adopting both strategies
by integrating the vertical and horizontal models into a unified general
equilibrium framework called the knowledge-capital (KC) model. The KC
model is a two-country (parent and host), two-factor (skilled and unskilled
labor) and two-sector model in which various combinations of vertical and
horizontal multinationals and domestic firms can emerge endogenously. It is
assumed that headquarters services, producing intangible assets, are skill-
intensive activities and that plant-level fixed costs are a combination of skilled
and unskilled labor, whereas final production requires unskilled labor only.
With this setup FDI between countries is now a function of all the following
variables considered in the vertical and horizontal model together: differences
between countries in relative factor endowments, differences in the size of parent
and host countries, trade costs and investment barriers. In equilibrium, as
expected by the horizontal model, HFDI between countries will dominate when
trade costs are moderate or high and countries are similar in size and relative
factor endowments. VFDI will prevail when trade costs are moderate or low
and/or countries differ significantly in relative endowments, particularly if the
skilled-labor abundant country (the parent country) is small. Finally, there will
be no FDI if trade costs are low and countries are similar in relative endowments
and size or when trade costs are moderate and countries are very different in
size. But due to the complexity of the model, the simulations used to solve the
equilibrium also disclose some interesting interactions between variables that
make their relationships with FDI non-linear and the empirical specification
challenging (Markusen, 2002).
Previous empirical studies on FDI use different databases, usually spanning
several years, in order to estimate time-constant coefficients of the above stated
variables. However, changes in these variables over time are expected to reflect
qualitative changes in FDI, converting for example most VFDI to HFDI
between two converging economies. A time varying-coefficient approach arises
naturally here. Allowing the parameters of the model to vary over time makes it
possible to note any changes in the nature of FDI in a given sample.
THE KNOWLEDGE-CAPITAL MODEL OF FDI 197
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