The gravity equation is a common and often used empirical technique to analyse bilat-eral trade. The relationship between the theoretical background of multinational firms and findings from the empirical research with the gravity equation, however, had not been proven to be strong. This results from the fact that gravity equations which try to explain foreign affiliate sales are ad hoc and therefore the coefficients estimated by them are hard to interpret.
That is why Kleinert and Toubal (2010), from now on re-ferred to as K&T, further elaborate the theoretical origin of the structural gravity equa-tion by Redding and Venables (2003) which they use to analyse exports and FDI. In their paper they focus on three different theoretical models. Two models on horizontal FDI by Brainard (1997) and by Helpman et al. (2004) and one on vertical FDI by Ve-nables (1999). After the theoretical part they try to apply the gravity equations they derived on a dataset on affiliate sales to analyse if these equations hold true in the empirical analysis.
In our paper we will focus on the theoretical origins of the two models on horizontal FDI, since these are the models who hold in the empirical test. Our focus lies on the derivation of these models. We show the differences among the models themselves, as well as the similarities and differences between the original models and the revised models by K&T.
We will further show how these models lead to the gravity equations by analysing its connections with the structural gravity equation by Redding and Vena-bles (2003) in greater detail.
Summing up, the paper of K&T is very rich in information but rather short considering the scope. This is why they abbreviate some of the theoretical underpinnings behind the models. With our paper we want to give some further insides concerning the hori-zontal FDI models to ensure a better understanding of the paper by K&T and the intu-itions behind their elaborations.
Table of Contents
1. Introduction
2. Theory of Horizontal FDI
2.1 Theory of symmetric firms and intermediate inputs
2.2 Theory of heterogeneous firms and fixed costs increasing with distance
3. Gravity equation
3.1 From aggregate affiliate sales to the gravity equation
3.2 The gravity equation and its application for the empirical analysis
4. Conclusion
5. Critical reception
Research Objectives and Themes
This paper examines the theoretical foundations of horizontal foreign direct investment (FDI) models used in the study "Gravity for FDI" by Kleinert and Toubal (2010). The primary objective is to clarify the derivation of these models—specifically those rooted in the work of Brainard (1997) and Helpman et al. (2004)—and to explain how these theoretical frameworks lead to structural gravity equations that account for the impact of distance and intermediate inputs on affiliate sales.
- The proximity-concentration trade-off in FDI decisions.
- Comparison of symmetric versus heterogeneous firm models.
- Role of intermediate inputs in creating distance-dependent costs for multinational firms.
- Derivation and log-linearization of gravity equations for empirical testing.
- Critical analysis of the theoretical gaps and assumptions in the literature.
Auszug aus dem Buch
1. Introduction
The gravity equation is a common and often used empirical technique to analyse bilateral trade. The relationship between the theoretical background of multinational firms and findings from the empirical research with the gravity equation, however, had not been proven to be strong. This results from the fact that gravity equations which try to explain foreign affiliate sales are ad hoc and therefore the coefficients estimated by them are hard to interpret. That is why Kleinert and Toubal (2010), from now on referred to as K&T, further elaborate the theoretical origin of the structural gravity equation by Redding and Venables (2003) which they use to analyse exports and FDI. In their paper they focus on three different theoretical models. Two models on horizontal FDI by Brainard (1997) and by Helpman et al. (2004) and one on vertical FDI by Venables (1999). After the theoretical part they try to apply the gravity equations they derived on a dataset on affiliate sales to analyse if these equations hold true in the empirical analysis.
In our paper we will focus on the theoretical origins of the two models on horizontal FDI, since these are the models who hold in the empirical test. Our focus lies on the derivation of these models. We show the differences among the models themselves, as well as the similarities and differences between the original models and the revised models by K&T. We will further show how these models lead to the gravity equations by analysing its connections with the structural gravity equation by Redding and Venables (2003) in greater detail.
Summing up, the paper of K&T is very rich in information but rather short considering the scope. This is why they abbreviate some of the theoretical underpinnings behind the models. With our paper we want to give some further insides concerning the horizontal FDI models to ensure a better understanding of the paper by K&T and the intuitions behind their elaborations.
Chapter Summary
1. Introduction: Outlines the research problem regarding the link between gravity equations and theoretical models of multinational firms, establishing the focus on horizontal FDI models.
2. Theory of Horizontal FDI: Explains the theoretical framework of firms, contrasting Brainard's symmetric approach with Helpman's heterogeneous firm model, and introduces the impact of intermediate inputs.
3. Gravity equation: Details the derivation of gravity equations from the theoretical models and discusses their application in empirical analyses of affiliate sales.
4. Conclusion: Synthesizes the main findings, emphasizing that intermediate goods and distance-dependent fixed costs are crucial for a robust gravity model.
5. Critical reception: Offers a reflective critique of the brevity and assumptions made in the original Kleinert and Toubal study.
Keywords
Foreign Direct Investment, FDI, Gravity Equation, Multinational Firms, Horizontal FDI, Proximity-Concentration Trade-off, Symmetric Firms, Heterogeneous Firms, Affiliate Sales, International Economics, Redding and Venables, Brainard, Helpman, Trade Barriers, Intermediate Inputs.
Frequently Asked Questions
What is the primary focus of this research paper?
This paper aims to provide a deeper understanding of the theoretical derivations of horizontal FDI models presented by Kleinert and Toubal (2010), specifically focusing on how they bridge the gap between theoretical economic models and empirical gravity equations.
Which theoretical models are central to this work?
The paper focuses on two main horizontal FDI models: the model of symmetric firms by Brainard (1997) and the model of heterogeneous firms by Helpman et al. (2004).
What is the central research question?
The research seeks to clarify how theoretical foundations regarding firm behavior and trade costs can be effectively translated into structural gravity equations for FDI and why these horizontal models receive more empirical support than vertical models.
Which scientific methodology is employed?
The paper utilizes a literature-based theoretical analysis, examining the mathematical derivations and assumptions of established economic models and comparing them to the structural gravity approach by Redding and Venables (2003).
What does the main part of the paper cover?
The main part covers the specific mechanics of symmetric and heterogeneous firm models, the role of intermediate goods in creating distance-dependent costs, and the derivation process for the gravity equations used in empirical estimations.
Which keywords characterize this work?
Key terms include Foreign Direct Investment (FDI), Gravity Equation, Proximity-Concentration Trade-off, Firm Heterogeneity, and Intermediate Inputs.
Why do the authors argue that distance affects affiliate sales in these models?
Unlike earlier models where affiliate production was distance-independent, the authors explain that by introducing intermediate goods that must be imported from the home country, distance-related transport costs are incurred, thereby influencing affiliate profitability.
How does firm heterogeneity influence the FDI decision according to the paper?
In the heterogeneous model, firms possess varying productivity levels; high-productivity firms are more likely to engage in FDI, while lower-productivity firms opt for exporting or domestic production, as they can better absorb the fixed costs associated with setting up foreign subsidiaries.
- Quote paper
- Tobias Maurer (Author), Roman Hartinger (Author), 2015, The Theory of Horizontal FDI and the Gravity Equation, Munich, GRIN Verlag, https://www.grin.com/document/309714
