Foreign Direct Investment (FDI) and the Liberalization of Trade in Services: An Evaluation of the Euro-Mediterranean Partnership (EMP)Influence

FEM34-19 | June 2012

Title

« Foreign Direct Investment (FDI) and the Liberalization of Trade in Services: An Evaluation of the Euro-Mediterranean Partnership (EMP)Influence »

By

Joan Costa Font & Mireia Borrell Porta, The London School of Economics and Political Science, United Kingdom

Contributeurs

Lior Herman & Alfred Tovias, Hebrew University, Israel

Note :

This document has been produced with the financial assistance of the European Union within the context of the FEMISE program. The contents of this document are the sole responsibility of the authors and can under no circumstances be regarded as reflecting the position of the European Union.

Summary :

Foreign direct investment is argued to result from the liberalisation of trade, and we are set to examine whether this is especially the case of trade in services.  Mediterranean Non Member Countries (MNMCs) offer a paramount case study to explore this hypothesis given its diversity and the fact that all have received equivalent institutional dimension in the context of the Euro Mediterranean Partnership (EMP). There is a growing literature emphasising the role of FDI in economic growth and many authors point at FDI as a key factor that could improve the poor results of the Euro-Mediterranean Association Agreements (EMAAs). At the same time, the literature also highlights the important contribution of services in economic growth. Existing research has already pointed out that the lack of trade in services liberalisation in the EMAAs has been a root cause in the EMAAs’ failure to facilitate trade (World Bank 2003; Muller-Jentsch 2005; Tovias, Kalaycioglu et al. 2007; Hoekman and Özden 2010; Galal and Hoekman, 1997; Sadeh 2004; European Commission 2005, Lahouel 2001).This project evaluates the effect that liberalization of trade in services by Mediterranean Non Member Countries (MNMCs) plays in boosting (or not) FDI levels. Drawing from identifying stylised patterns and economic evidence from gravity modelling, we have attempted to empirically test the existence of an association between liberalization of trade in services and the development of FDI, therefore placing liberalization of trade in services at the top of the Euro-Mediterranean agenda in order to foster FDI, enhance world transactions and ultimately boost economic growth. The main reason for this is that the Mediterranean partner country becomes a place where it is easier and more attractive to do business. Given significant barriers to trade in services prevailing in the MNMCs (e.g., exchange rates, duties etc.), as well as the relative low levels of FDI relative to other European regions, this analysis and its results are of utmost importance for the future of the EMP. Given that building a counterfactual is a complex duty, we compare patterns of MNMCs with that of Central and Eastern European Countries. The relevance of such a comparison lies in that similarly as in the case of MNMCs; the Europe Agreements signed in the 1990s included a degree of liberalization of trade in services in the form of adoption of rules of establishment of foreign firms.The main results are the following: trade in services has been proved to impact positively and significantly on FDI in the CEECs and MNMCs. This has been corroborated by robustness checks which tested the methodology used, the treatment of the dependent variable, as well as come potentially sources of endogeneity. At the same time, in the report has confirmed the importance of standard gravity model specification such as GDP and distance, in explaining FDI.Finally, data limitations have prevented us to be more concise about the average impact of trade in services in FDI, and it has only allowed us to conclude for the few MNMCs (aside from most CEECs) that had available data on trade in services, which are Egypt, Morocco and Israel. Moreover, we have not been able to discern the impact of different types of trade in services on FDI, since disaggregated trade in services data is not available neither. More work on database and methodology needs to be done in order to have reliable data and quantify in a more accurate way the relevance of trade in services and FDI.Relevant policy implications have been drawn from the above-mentioned conclusions, concerning the effectiveness of existing EU policies towards the MNMCs, which suggest the role that a free trade area can exert in fostering the development of foreign direct investment to the region.