The Trade Balance Effects
of U.S. Foreign Direct Investment in Mexico
PETER WILAMOSKI AND SARAH TINKLER*
This paper examines the effect of U.S. foreign direct investment (FDI) in Mexico on U.S.
exports to and imports from Mexico. The rise of intrafirm exports and imports following U.S.
FDI in Mexico suggests that FDI affects trade flows. Empirical estimation proceeds with tests
for stationarity and cointegration. The finding of cointegration among the variables leads to
estimation of the hypothesized relationships with a vector error-correction model. Impulse
response functions and variance decomposition reveal that FDI leads to increased exports and
imports during the time period considered. (JEL F21)
Introduction
The 1993 ratification of the North American Free Trade Agreement (NAFTA) is the
most visible symbol of the deepening relationship between the U.S. and Mexico.
However, earlier bilateral agreements and Mexico's joining the General Agreement on
Tariffs and Trade had already moved the two economies inexorably closer.
This relationship poses unique challenges to the U.S. and Mexico. The principle
popular concern expressed in the U.S. about NAFTA is that it will export jobs to Mexico,
a concern immortalized in Ross Perot's statement that NAFTA would create a "giant
sucking sound" as U.S. firms migrate across the border, taking U.S. jobs with them.
Indeed, NAFTA does contain provisions to encourage U.S. investment in Mexico,
including the establishment of the North American DevelopmentBank to finance MexicoU.S. projects.
The second major criticism of NAFTA is related to the first. Critics contend that
NAFTA will worsen the U.S. trade balance because additional investment in Mexico,
coupled with the elimination of tariffs, will increase U.S. imports from Mexican affiliates
of U.S. firms. Also, a greater Mexican industrial base might reduce the demand for U.S.made goods in Mexico. On the other hand, those supporting NAFTA suggest that the
removal of barriers to investment will allow U.S. firms to establish a presence in the
Mexican market. This would increase their sales and require the Mexican subsidiary to
import inputs from the U.S. parent firm and capital goods from unaffiliated U.S. firms.
This paper examines the effect of U.S. FDI in Mexico on U.S. trade. The second
section explains how FDI may affect trade flows. The third section reports the growth of
aggregate and sector-level U.S.-Mexico trade and FDI. The fourth section presents
estimates of the effects of U.S. FDI in Mexico on both aggregate U.S. exports and
*WeberStateUniversity--U.S.A.
24
WILAMOSKI AND TINKLER: FOREIGN DIRECT INVESTMENT
25
imports and intrafirm trade using classical regression techniques. Empirical estimation
proceeds with tests for stationarity and cointegration. Impulse response functions and
variance decomposition are utilized to reveal the dynamic effect of FDI on exports and
imports. The fifth section concludes this paper.
FDI and Trade Flows
Theoretically, FDI and exports can be substitutes [Mundel, 1957] or complements
[Markusen, 1983; Helpman, 1984] and the effect on imports cannot be predicted apriori.
Table 1 summarizes several ways FDI can affect exports and imports. If FDI substitutes
Mexican for U.S.-manufactured goods for sale in the Mexican market, then U.S. exports
will fall. However, exports will rise if Mexican production requires inputs from the U.S.
parent or unaffiliated firms. U.S. exports of inputs will rise if lower Mexican production
costs raise Mexico's demand for the multinational corporation's (MNC) product
[Blomstrom et al., 1988]. Also, if the MNC's Mexican market grows due to falling
production costs, then a market for the MNC's higher-end, home-produced goods may
arise. Imports may rise or be unaffected by U.S. FDI in Mexico.
TABLE 1
Possible Relationships Between FDI and Trade
FDI Activity
Host nation production requires home nation capital goods.
Host nation affiliate production requires inputs from parent firm.
Host nation is a low-cost source of production for sale in host
nation (substituting for home production).
Host nation is a low-cost source of production for sale in home
nation (substituting for home production).
Parent has unexportable firm-specific advantages (FDI raises
demand for parent firm's product).
Host nation affiliate production raises demand for higher-end
products from home nation.
As host nation supplier network grows, inputs from parent firm
decrease.
Transfers of technology and management skills increase
competitiveness of host nation f'Lrms.
FDI raises host nation growth rate.
Effect on Home Nation
Exports
Imports
positive
positive
negative
positive
positive
positive
negative
negative
positive
positive
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AEJ: MARCH 1999, VOL. 27, NO. 1
The effect of FDI on exports has been examined by Orr [1991], Blomstrom et al.
[1988], Pfaffermayr [1994], and Lin [1995]. Only Orr examined the trade balance effects
of inward FDI to the U.S. For the U.S., he suggests that FDI improves the
competitiveness of U.S. firms in both U.S. and international markets. He finds an
elasticity of U.S. aggregate exports to FDI of .21 which suggests that FDI in the U.S.
during the late 1980s raised U.S. exports by roughly 20 billion dollars over the long
term.
Orr hypothesized that inward FDI should lead to lower U.S. imports, but, empirically,
an increase in FDI appears to raise aggregate imports even after several years. However,
this finding does not hold up at the industry level. For example, Orr finds that FDI in the
U.S. auto industry initially raised the trade deficit as imports of capital goods and parts
offset the reduction in imports of finished automobiles. However, after four years, FDI
led to a trade surplus in automobiles as imports of capital goods and parts fell and
domestic content rose.
Orr's findings suggest that U.S. FDI in Mexico may initially raise U.S. exports and
improve the U.S. trade balance. However, Mexico's imports of U.S. goods may
eventually fall and U.S. imports from Mexico may eventually rise. Total U.S. exports
could rise if the U.S. parent would ship inputs to Mexico for final assembly before
shipment back to the U.S. and if lower production costs in Mexico create a larger U.S.
market for the good than would otherwise exist.
The Growth of U.S.-Mexico FDI, Exports, and Imports
Table 2 shows the growth of aggregate U.S. merchandise exports to and imports from
Mexico as well as aggregate U.S. FDI. Growth in trade and investment has been steady
since the late 1980s when Mexico joined the General Agreement on Tariffs and Trade and
began unilaterally dismantling its external barriers. U.S. merchandise exports increased
dramatically to about 50 billion dollars by 1994. From 1988 to 1994, growth of U.S.
merchandise exports and imports averaged about 25 percent and 17 percent a year,
respectively. The U.S. ran trade deficits with Mexico from 1982 to 1990 but began a
series of trade surpluses in 1991.
TABLE 2
U.S. Merchandise Exports and Imports and FDI in Mexico (in Billion Dollars)
Year
Exports
Imports
Total FDI*
Total U.S. FDI**
U.S. Share***
1980
1981
1982
15.146
17.789
11.817
12.835
14.013
15.770
8.46
10.16
10.78
5.99
6.96
5.54
.690
.680
.680
27
WILAMOSKI AND TINKLER: FOREIGN DIRECT INVESTMENT
T A B L E 2 (CONT.)
Year
Exports
Imports
Total FDI*
Total U.S. FDI**
U.S. Share***
1983
9.082
17.019
11.47
4.99
.663
1984
11.992
18.267
12.90
4.59
.660
1985
13.365
19.392
14.62
5.07
.673
1986
12.392
17.558
17.10
4.82
.648
1987
14.582
20.502
20.90
4.93
.655
1988
20.473
23.534
24.10
5.69
.621
1989
24.969
27.590
26.60
7.34
.631
1990
28.375
30.797
30.30
9.36
.629
1991
33.276
31.866
33.90
11.57
.634
1992
40.598
35.886
37.0t
13.33
.617
1993
41.635
40.745
40.5t
14.14
--
1994
50.840
50.356
43.8t
16.37
--
Notes: *denotes MexicanFDI figures from the General Directorate of Foreign Investment [ SeCoFI, 1994]and
adapted from NAFTA andForeign Investments in Mexico [Ortiz, 1994]. **denotes data for U.S. FDI in Mexico
from the Survey of Current Business [U.S. Departmentof Commerce, various issues]. ***denotes U.S. share
of FDI in Mexico from the General Directorate of Foreign Investment [SeCoFI, 1994]. The figures are not
consistentwith the Survey of Current Business figuresas SeCoFI reports muchhigher U.S. FDI in Mexico. For
1991, SeCoFI reports cumulativeU.S. FDI as 21 billion dollars and the Survey of Current Business reports
cumulativeU.S. FDI as 11.57 billion dollars, t denotesthe estimateis based on U.S. FDI in Mexicoand U.S.
share of FDI in Mexico.
In 1989, regulations concerning FDI were significantly liberalized to allow up to 100
percent foreign ownership if certain criteria are met [Lustig, 1992].1 NAFTA extends the
areas of permissible FDI and protects foreign investors with a dispute settlement
mechanism. Mexican (Banco de Mexico and SeCoFI) and U.S. (Bureau of Economic
Analysis) statistics for U.S. FDI in Mexico differ but, by any measure, FDI soared in the
early 1990s.
To what extent has FDI driven trade? Table 3 shows total U.S. FDI exports and
imports as well as FDI exports and imports for U.S. multinationals and their Mexican
affiliates in specific sectors. Trade between U.S. parents and their Mexican affiliates grew
more rapidly than arms-length trade, suggesting that part of the rise in U.S.-Mexico trade
is the result of earlier FDI by U.S. f'Lrms in Mexico. U.S. MNC's intrafirm trade
accounted for 28 percent of U.S. exports to Mexico and 24 percent of U.S. imports from
Mexico in 1 9 9 2 - - u p from 23 percent and 20 percent, respectively, in 1983.
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AEJ: MARCH 1999, VOL. 27, NO. 1
TABLE 3
FDI by Manufacturing Sector and Intrafirm Exports and Imports
(in Billion Dollars)
FDI
1992
Sector
1983
Total
All Manufacturing
Food
Chemicals
Metals
Machinery
Electronics
Transportation
4.990 13.330
3.680 9.281
.298 1.340
.763 1.949
.503
.350
.281
.435
.349
.610
.490 2.533
%A
Exports
1983 1 9 9 2 %A
Imports
1983 1 9 9 2 %A
167.0
152.0
349.0
251.0
-30.4
54.8
74.7
421.0
2.187
2.067
.008
.090
.025
.073
.978
.519
1.893 10.817 462
1.853 8.396 353
.006 .077 1,183
.014 .065 364
.006 .037 502
.031 .307 912
.954 2.552 167
.442 4.539 927
11.867 442
8.916 331
.114 1,325
.234 160
.021 -16
.332 354
2.534 163
4.700 805
On average, 68 percent of the output of U.S.-owned Mexican subsidiaries is sold
locally with considerable variation at the industry level. In the case of food and like
products, 99 percent of output is sold locally while in electronic equipment nearly 100
percent of output is exported to the U.S. Eventually, U.S. exports of finished goods
might fall as industries other than food and like products make inroads in the Mexican
market.
Estimating the Trade Balance Effects of FDI
How does U.S. FDI in Mexico affect trade? Aggregate trade and trade between U.S.
MNCs and their Mexican affiliates are both examined using annual data and classical
regression analysis. 2 To test for properties of stationarity, estimates of the effect of FDI
on aggregate trade flows are made using quarterly data. 3 The following model is
estimated with all variables expressed as logarithms and in real terms:
S t = X 1 + x 2 Y t , raex+ x 3 R t + x 4 F D I t + x s ~ C F D l t _ I +
M t = m 1 + m 2 Y t , us + m 3 R t + m 4 ~ C F D I t _ I + u t
ut
,
,
(1)
(2)
where: X t is U.S.-manufactured exports to Mexico; M t is U.S.-manufactured imports
from Mexico; Yt, i is gross domestic product (i is country) with expected sign of
x 2, m 2 > 0 ; R t is real exchange rate with expected sign of x 3 > 0 and m 3 < 0; F D 1 t is
WILAMOSKI AND TINKLER: FOREIGN DIRECT INVESTMENT
29
U.S. FDI in Mexico in year t with expected sign of X4 .9, and C F D I t is cumulative U.S.
FDI in Mexico to year t with expected sign of x s , m4 .9. Current FDI captures U.S.
exports of capital to Mexico and the inclusion of past values of cumulative FDI (CFDI)
allows for lag effects between FDI and subsidiary production.
Table 4 presents ordinary least squares (OLS) estimates of (1) and (2) using annual data
from 1977 to 1994, correcting for serial correlation. Mexican and U.S. sources give
different figures for U.S. FDI. Both measures were initially used to estimate the
equations, but the results were qualitatively similar, so only the results based on U.S.
measures of FDI are reported.
TABLE 4
Trade Balance Effects of FDI on Aggregate and Intrafirm Trade: 1977-94
Aggregate
Exports
Explanatory Variable
Intercept
Mexican GDP
(1)
Intrafirm
Imports
Exports
-.615
(-.450)
-.470
(-.110)
.889
(.670)
Imports
(2)
16.280 21.350
(1.720) (2.380)
4.070 3.970
(1.430) (1.250)
U.S. GDP
1.480
(4.130)
.077
(.490)
3.460
(3.470)
-.290
(-3.260)
Real Exchange Rate
1.430 1.290
(2.980) (2.630)
FDI Flow
.116
.091
(1.880) (1.590)
CFDI (-1)
.662 2.340
(1.760) (3.500)
-1.670
(-2.690)
.353
(3.410)
-.420
(-.850)
1.520
(3.150)
.467
(1.990)
.996
2.090
.992
2.120
.984
1.940
.991
2.060
CFDI (-2)
R2
DW
.956
1.690
.445
(1.667)
-6.170
(-1.050)
.085
(1.620)
Notes: All variables are entered in logarithmic form, therefore, the coefficients are elasticities. The t-statistics
are reported in parentheses. All equations are corrected for serial correlation. DW denotes the Durbin-Watson
test. GDP denotes gross domestic product.
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AEJ: MARCH 1999, VOL. 27, NO. 1
Coefficients display the expected signs and are inline with prior estimates. Both the real
value of the peso and Mexican GDP raise U.S. exports. At the aggregate and intrafirm
level, there is a small positive relationship between current FDI and U.S. exports. This
is consistent withthe hypothesis that investment in Mexico requires U.S. capital goods.
CFDI raises aggregate U.S. exports after one year but lowers them after two years. No
effect of FDI on exports is found after two years. The net effect on exports is positive
though small. These findings suggest that FDI will eventually lower U.S. exports as
Mexican content rises. The exchange rate appears less important for intrafirm exports
than for aggregate exports, and the positive effect of CFDI on exports to subsidiaries
comes after two years.
The sum of the coefficients on CFDI for total U.S. exports to Mexico (.67) indicates
that FDI has a small positive effect on total U.S. exports to Mexico. The 7 billion dollars
increase in U.S. FDI from 1990 to 1994, along with the elasticity of exports to FDI of
.67, suggests that exports to Mexico were about 4.5 billion dollars higher because of the
increased FDI. Total exports were more than 50 billion dollars, so FDI raised exports by
about 8 percent and can explain about 25 percent of the 22 billion dollars increase in
exports during that time.
The results for imports indicate that U.S. FDI to Mexico will raise U.S. imports from
Mexico after one year. The coefficients are not statistically different for aggregate imports
and intrafirm imports. The FDI coefficient of.35 suggests that, as a result of the 7 billion
dollars increase in FDI from 1990 to 1994, U.S. imports were about 2.5 billion dollars
higher than they would otherwise be. Also, increased FDI can explain about 8 percent of
the 20 billion dollars increase in imports over that period. The results for aggregate
exports and imports indicate that the net trade balance effect of FDI between the U.S. and
Mexico is slightly positive.
These estimates, as well as those of Orr [1991], Blomstrom et al. [1988], and Lin
[1995], were obtained by estimating conventional trade models without considering the
stationarity properties of the relevant time series. If the variables are not stationary, this
method will generate spurious results, that is, test statistics that are biased toward finding
significant relationships that do not exist. To overcome this problem, Pfaffermayr [1994]
examines FDI and Austrian exports using vector autoregression (VAR) analysis.
To test for stationarity and the order of integration of the relevant time series,
augmented Dickey-Fuller tests (ADF) are applied. If a group of variables is integrated of
order one, that is, they are stationary only in first differences, then it is necessary to test
whether the group is cointegrated before estimating a VAR in first differences. A model
estimated in first differences removes common influences but also information about longrun relationships among the variables. A group of nonstationary variables will be
cointegrated if some linear combination of them is stationary.
The long-run cointegration relationships can be estimated and used as cross-equation
restraints in VAR models, making them vector error-correction (VEC) models. To test
for cointegration, the ADF and DW tests are applied to the residual series obtained from
estimating the long-run relationship in levels.
W I L A M O S K I AND T I N K L E R : F O R E I G N D I R E C T I N V E S T M E N T
31
Because exports may cause FDI, as well as FDI causing exports, VAR analysis is
useful since it treats all variables symmetrically. To determine if feedback effects exist,
the dynamics of the adjustment process must be identified by estimating a VAR model
and using the innovation accounting techniques of VAR analysis to measure the speed and
strength with which one variable responds to shocks arising with another. Innovation
accounting is undertaken using impulse response functions and variance decompositions. 4
ADF unit root tests of the stationarity of the time series in levels and differences on
quarterly data from 1977 to 1994 for aggregate U.S.-Mexico exports and imports reveal
that all the series are nonstationary in levels but are stationary in first differences.
Estimation continues with the two-step methodology developed by Engle and Granger
[1985]. In step one, the hypothesized relationship (the cointegrating regression) is
estimated in levels using OLS without any dynamic components, providing estimates of
the long-run effect on trade of the explanatory variables. The residuals from this
regression are tested for stationarity using the ADF and DW tests. Both equations were
tested for cointegration and these results are reported in Table 5. The ADF test statistics
exceed the critical value, rejecting the hypothesis of no cointegration for both exports and
imports with respect to FDI.
TABLE 5
Cointegration Test
Explanatory Variable
Mexican GDP
U.S. GDP
FDI
Real Exchange Rate
Constant
Exports
.845
1.79
1.21
-14.81
Imports
(4.32)
(18.70)
(9.34)
(-6.31)
1.41
2.12
-.42
-8.53
ADF t-statistic
-2.68
-2.72
MacKinnon Critical Value*
DW t-statistic**
-2.58
1.46
1.22
(2.27)
(7.42)
(-2.52)
(-5.69)
Notes: * and **denote null of no cointegration is rejected at 10 and 5 percent levels, respectively.
The analysis proceeds with a two-equation VEC model for exports and CFDI and for
imports and CFDI. A VEC model is, in essence, a VAR model that incorporates an errorcorrection term which, here, is the residual series from the cointegrating equation, lagged
one period. The inclusion of an error-correction term in a VAR model allows the
32
AEJ: MARCH 1999, VOL. 27, NO. 1
estimated model to reflect long-run equilibrium constraints while, at the same time,
permitting flexibility in the short-run dynamics captured by the VAR.
The real exchange rate and GDP are taken as exogenous. The Akaike information
criterion is used to identify the proper number of lags. Granger causality tests are
conducted using the lag specification determined in the VEC analysis to determine the
nature of the relationship between FDI and exports and FDI and imports. The null
hypotheses (that exports are not Granger-caused by FDI and that imports are not Grangercaused by FDI) are both rejected at the 5 percent level. The test results also indicate a
bidirectional relationship, that is, exports and imports both help explain FDI.
To assess the effect of FDI on exports and imports, the analysis proceeds by examining
the impulse response functions and variance decompositions of the system. The results
of the impulse response functions are traced out in Figures 1 and 2. The impulse response
function for the effect of a one-unit innovation to FDI on exports indicates a small
positive effect that continues for two years before tailing off. The effect of FDI on
exports, again, turns slightly positive after 13 quarters. The dynamics revealed by the
impulse response function suggest that the effect of new FDI on U.S. exports of capital
goods and production inputs to U.S.-owned manufacturing subsidiaries is complete within
two years.
FIGURE 1
Response of U.S. Exports to a One-Standard Deviation Innovation in FDI
0.07
0.06
0.05
0,04
0.03
0.02
0.01
Y
0.00
The small positive effect witnessed after three years suggests that, over time, U.S. FDI
raises Mexican income and supports the growth of new Mexican firms needing U.S.
inputs. 5 The cumulative response after eight quarters to an innovation in FDI is about a
WILAMOSKI AND TINKLER: FOREIGN DIRECT INVESTMENT
33
.345 standard deviation change in U.S. exports to Mexico and, after 16 quarters, is about
.475. Over the sample period, the standard deviation for CFDI was about 4 billion
dollars. For exports, it was about 15 billion dollars. Back-of-the-envelope calculations
suggest that the 7 billion dollars increase in FDI to Mexico from 1990 to 1994 accounts
for about 11 billion dollars of extra U.S. exports, explaining about 50 percent of the 22
billion dollars in increased exports over that time. These estimates are higher than those
found using the long-run elasticities from Table 4.
FIGURE 2
Response of U.S. Imports to a One-Standard Deviation Innovation in FDI
0.06
0.04.
/
0.02.
0.00
-0.02
2.
.
.4.
.
.6 .
. 8.
.
10
1 2-
'
14
'
'
16
The variance decompositions are reported in Tables 6 and 7. SE represents the forecast
error of exports and imports at points in the future. The percentage of the variance due
to innovations in. trade and FDI is also given. For exports, FDI explains a rising portion
of the forecast error, reaching 28 percent after one year and 32 percent after two years. 6
The impulse response function for U.S. imports indicates that, following an innovation
in FDI, initially, there is almost no effect on imports. However, after two years, there
is a steady, positive effect that reaches a cumulative value of about .45 after four years.
The variance decompositions for imports reveal that almost none of the forecast error can
be explained by FDI after eight quarters, but, by the 16th quarter, more than 40 percent
of the variation in the forecast error is caused by innovations in FDI. Again, back-of-theenvelope calculations indicate that the rise in FDI from 1990 to 1994 of 7 billion dollars
suggests an increase in imports of more than 10 billion dollars out of the total increase
in imports of 20 billion dollars over that period. When the results for imports are viewed
along with the impulse response function for exports, they suggest that the effect on the
34
AEJ: MARCH 1999, VOL. 27, NO. 1
U.S. trade balance with Mexico is positive for the first two years. However, gradually
rising imports reduce the positive effect of exports, leaving net exports unchanged. This
result is different from that found using the elasticities reported in Table 4 which
concluded that FDI would improve the U.S. trade position with Mexico.
The Granger-causality results and the impulse response functions reveal that both
exports and imports positively affect FDI. This result is not surprising given that 60
percent of new FDI into Mexico is in retailing and wholesale distribution. Rising export
sales provide an incentive for U.S. firms to invest in better distribution networks for their
products.
TABLE 6
Variance Decompositions: Exports
Variance Decomposition of Exports
Variance Decomposition of FDI
Period
SE
Exports
FDI
SE
Exports
1
.082380
98.06023
1.93977
.013721
0.00000
100.00000
2
.130504
85.41642
14.58358
.020971
2.43643
97.56357
3
.163323
77.26559
22.73441
.027903
13.53984
86.46016
4
.188303
72.13344
27.86656
.036742
21.84510
78.15490
5
.207405
71.00482
28.99518
.044043
25.73601
74.26399
6
.222006
68.87857
31.12143
.050145
29.06322
70.93678
7
.233623
68.97745
31.02255
.055030
31.51119
68.48881
8
.237072
68.69030
31.30970
.059328
34.86454
65.13546
9
.239309
69.02928
30.97072
.063634
38.33583
61.66417
10
.240899
69.22632
30.77368
.067580
41.19720
58.80280
11
.242071
69.39342
30.60658
.071458
43.77337
56.22663
12
.242914
69.25094
30.74906
.075597
46.17462
53.82538
13
.244128
69.27351
30.72649
.079719
47.83714
52.16286
14
.245474
68.88067
31.11933
.083876
49.10171
50.89829
15
. 2 4 7 8 3 1 68.45000
31.55000
.087791
49.91830
50.08170
16
.250190
32.32217
.091363
50.46065
49.53935
67.67783
FDI
Notes: Orderingis log of cumulativeforeigndirect investment(LCFDI)and log of U.S. exportsto Mexico
(LUSX).
35
WILAMOSKI AND TINKLER: FOREIGN DIRECT INVESTMENT
TABLE 7
Variance Decompositions: Imports
Variance Decomposition of Imports
Variance Decomposition of FDI
Period
SE
Imports
FDI
SE
Imports
FDI
1
.09
98.04
1.96
.01
0.00
100.00
2
.11
98.60
1.40
.02
2.15
97.85
3
.12
98.04
1.96
.03
14.07
85.93
4
.12
98.08
1.92
.04
20.50
79.50
5
.13
98.16
1.84
.05
23.28
76.72
6
.14
96.63
3.37
.06
26.57
73.43
7
.14
96.43
3.57
.06
28.00
72.00
8
.15
93.08
6.92
.07
29.31
70.69
9
.16
87.87
12.13
.08
30.31
69.69
10
.16
83.64
16.36
.08
30.25
69.75
11
.17
78.71
21.29
.09
29.73
70.27
12
.18
73.53
26.47
.10
28.99
71.01
13
.19
69.11
30.89
.11
27.91
72.09
14
.20
64.29
35.71
.11
26.77
73.23
15
.20
60.13
39.87
.12
25.63
74.37
16
.21
56.30
43.70
.13
24.46
75.54
Notes: Orderingis log of cumulativeforeigndirect investment(LCFDI)and log of U.S. importsfrom Mexico
(LUSM).
Summary
Opponents of NAFTA were concerned that trade and investment liberalization between
the U.S. and Mexico would cause U.S. jobs to migrate to Mexico. This paper has
indirectly examined that question by addressing the effects of U.S. FDI in Mexico on
trade flows. The empirical results presented here suggest that U.S. FDI in Mexico raises
total U.S. exports to and imports from Mexico. Results from traditional OLS estimates
indicate a small positive effect on the U.S. trade balance with Mexico from increased
FDI, but the contribution to exports and imports is relatively small compared to other
determinants of trade.
36
AEJ: MARCH 1999, VOL. 27, NO. 1
To ensure that the empirical results generated by classical regression procedures are
not spurious, stationarity tests and V A R analysis are conducted to examine the
relationships among the variables. The results of Granger-causality, impulse response
analysis, and variance decompositions reveal information about the relationship between
trade and FDI not found in the OLS analysis. Impulse response functions, which allow
the dynamic nature of the relationship between FDI and trade to be observed, show that
the positive effect on exports is complete within a couple of years, while the effect on
imports does not begin for a couple of years. Given similarities in the size and growth of
exports and imports over the sample period, the impulse response function results
suggest, first, that FDI explains a substantial portion of the rapid increase in trade
between the two nations and, second, that the initial, small positive effect on the U.S.
trade balance with Mexico resulting from new FDI will diminish over time.
Footnotes
1.
2.
3.
4.
Prior to 1989, FDI in Mexico was regulated by the 1973 Law to Promote Mexican Investment
and Regulate Foreign Investment which created four categories of activity:
1) activities reserved exclusively to the Mexican state (for example, petroleum);
2) activities reserved exclusively to Mexicans (television, transportation, and forestry);
3) activities in which foreign investment was subject to percentage limitations ranging from 0
percent to 49 percent foreign ownership (for example, automobile components); and
4) activities where foreign ownership could not exceed 49 percent.
In 1984, the Guidelines for Foreign Investment and Objectives for Its Promotion [United
Nations, 1992, p. 14] was issued to encourage foreign investment in activities that were
oriented toward exports or that required high investment requirements per person-hour.
Data on aggregate U.S. exports to and imports from Mexico are from the Direction o f Trade
Statistics [International Monetary Fund, various issues]. Data for trade between U.S.
multinationals and their affiliates are from the Survey o f Current Business [U.S. Department
of Commerce, various issues].
On a quarterly basis, U.S.-Mexico trade statistics are created from data on aggregate exports
and imports for Mexico, adjusted for the share of U.S.-Mexico trade over the period 1977:11994:3 (fromInternational Financial Statistics [International Monetary Fund, various issues)]
An impulse response function will separate the determinants of a change in exports or imports
into innovations that can be identified with FDI. It traces the effect on current and future values
of exports or imports of a one-standard deviation change in the innovation. In this case, it is
the change in FDI. Forecast error variance decompositions reveal the proportion of movement
in a variable due to its previous values and the proportion that can be attributed to some other
variable. Developing an impulse response function requires the imposition of an identification
restriction through a Cholesky decomposition which constrains the system so that, in a twoequation system ofx and y for a particular ordering, a one-unit innovation to x t will affect x
and y, but a one-unit shock to Yt will only affect y. A different ordering will change the effect
of a one-unit innovation to x t and Yt on x and y and will result in a different impulse response
function. Theory could be used to determine the ordering, but the ordering does not matter if
the correlation coefficient between the error terms in each equation is low (less than .2). If the
correlation coefficient is large, however, the impulse response function from each potential
ordering should be obtained and the results compared. In this case, the ordering of the
WILAMOSKI AND TINKLER: FOREIGN DIRECT INVESTMENT
.
6.
37
variables does not appear to matter. The reported results use an ordering of FDI and then
exports or imports in calculating the impulse response function.
Estimates using FDI flows rather than CFDI resulted in the effect of FDI on exports falling to
zero after 10 periods (results available from the authors).
A long-run model treating GDP and the exchange rate as endogenous variables was also found
to be cointegrated and a VEC model estimated. The impulse response function between exports
and FDI was strikingly similar to that reported in Figure 1. However, the variance
decomposition, including the new endogenous variables, showed that FDI explained a much
smaller portion of the forecast error in exports (7 percent) with GDP and the exchange rate
explaining the difference (results available from the authors).
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