The pattern of EU FDI in the manufacturing industry: What role do third country effects and trade policies play?

The aim of this paper is to assess the impact of “third country effects” and trade policies on the outward stocks of FDI of the EU. We estimate a model based on the knowledge-capital theory of the multinational enterprise over the period 1995–2008 by using a sample of five EU countries and 24 partner countries. Explanatory variables include an index of applied bilateral tariffs, a dummy to capture the presence of bilateral investment treaties (BITs) and a variable to take into account the impact of the participation of host countries to free trade agreements (FTA) with other than EU countries. The paper checks the third country effects by testing whether there is spatial lag dependence in bilateral FDI. The results show that trade costs play a key role in explaining the pattern of FDI in the manufacturing sector as a whole and in four out of six disaggregated industries. The impact of tariffs varies across industries, suggesting the predominance of horizontal FDI in some industries, and the existence of export-platform FDI in others. BITs and the participation of the host country in other FTAs positively affect the outward stock of EU FDI, while we find no empirical evidence to support the hypothesis of spatial lag dependence in bilateral FDI.