Bilateral foreign direct investments: differential effects of tariffs in source and destination countries

We study the asymmetric effects of bilateral tariffs in FDI-receiving (destination) and FDI-sending (source) countries on bilateral FDI using Gravity analysis, with bilateral FDI and average tariff data for 47 countries during the period 2001-2012. Theory suggests that while the former would encourage tariff-jumping inward FDI, the latter would discourage offshoring and export-oriented outward FDI. Our empirical study uses two alternative methodologies to estimate a Gravity model, viz., PPML estimation method which uses pairwise, destination-time and origin-time fixed effects, and GMM with time fixed effects, which can deal with possible two-way causality. After correcting for possible two-way causality, our study confirms the theoretical expectations. We also find that the 2008 Financial Crisis has had a significant impact on the magnitude of the effects of bilateral tariffs. We find that one percentage-point increase in tariffs in the destination country increases inward FDI stock to GDP ratio in that country by 0.06% in the non-crisis years and by 0.01% in the crisis years. Similarly, one percentage-point increase in tariffs in the origin country decreases outward FDI stock to GDP ratio from that country by 0.06% in the non-crisis years and by 0.02% in the crisis years.