““Foreign Direct Investment (FDI) and Economic Foreign Direct Investment (FDI) and Economic Growth. The Case of Mexico and the United States “Growth. The Case of Mexico and the United States “

Dr. Alejandro Díaz-BautistaDr. Alejandro Díaz-BautistaInvestigador Nacional y Miembro del Investigador Nacional y Miembro del Sistema Nacional de Investigadores, Sistema Nacional de Investigadores, CONACYT, Nivel II.CONACYT, Nivel II.

adiazbau@hotmail.com

http://www.linkedin.com/pub/alejandro-diaz-bautista/6/619/691

Profesor-Investigador de Economía, Departamento de Estudios Económicos, El Colegio de la Frontera Norte.

Preparado para la 1er. Seminario internacional Evaluación del efecto de la Inversión Extranjera Directa (IED) en las economías en desarrollo. El evento se realizara en la Casa COLEF Ciudad de México, con dirección en la Calle Francisco Sosa No. 254, Col. Barrio de Santa Catarina en Coyoacán, México D.F. el 18 de septiembre de 2009 a las 11 a.m.

History of Foreign Direct History of Foreign Direct Investment (FDI)Investment (FDI)

After the Second World War, After the Second World War, global FDI was dominated by global FDI was dominated by the United States. the United States.

The US accounted for around The US accounted for around 75% of new FDI between 1945 75% of new FDI between 1945 and 1960. and 1960.

FDI has grown in importance FDI has grown in importance in the global economy with FDI in the global economy with FDI stocks now constituting 28 stocks now constituting 28 percent of global GDP.percent of global GDP.

FDI Growth over Five Decades

-400

-200

0

200

400

600

800

1000

1200

1400

1600

1800

1960-69 1970-79 1980-89 1990-99 2000-07

Date

Infl

ow

s/O

utf

low

s (b

illi

on

US

D)

FDI Outflow (in Billions USD)

FDI Inflows

Net

*Source: Bureau of Economic Analysis, U.S. International Transactions Accounts Data (2008)

Global FDI flows surpassed Global FDI flows surpassed the peak of 2000 by 2006the peak of 2000 by 2006

($ billion)FDI inflows, global and by group of economies,

1980-2007

FDI in MexicoFDI in Mexico

NAFTA, proximity to the United States, and continued NAFTA, proximity to the United States, and continued political and economic stability make Mexico an attractive political and economic stability make Mexico an attractive location for foreign direct investment (FDI). location for foreign direct investment (FDI).

In recent years, Mexico has passed tax, pension and energy In recent years, Mexico has passed tax, pension and energy reforms. reforms.

Additional reforms to improve competition, education and Additional reforms to improve competition, education and labor conditions within Mexico are needed to increase labor conditions within Mexico are needed to increase competitiveness and encourage more FDI.competitiveness and encourage more FDI.

Overall FDI in Mexico is expected to fall in 2009 as a Overall FDI in Mexico is expected to fall in 2009 as a consequence of the globaleconomic downturn. consequence of the globaleconomic downturn.

FDI in MexicoFDI in Mexico

Mexico received 21 billion US dollars in foreign Mexico received 21 billion US dollars in foreign direct investment (FDI) in 2008, down 16 percent direct investment (FDI) in 2008, down 16 percent from 2007, accordin to the UN report published from 2007, accordin to the UN report published by UNCTAD.by UNCTAD.

In its annual report, the United Nations In its annual report, the United Nations Conference on Trade and Development (UNCTAD) Conference on Trade and Development (UNCTAD) ranked Mexico 18th on its list of 20 major FDI ranked Mexico 18th on its list of 20 major FDI destinations. This was far behind Brazil, Russia, destinations. This was far behind Brazil, Russia, India and China, generally considered to be India and China, generally considered to be Mexico's close competitors for such investment.Mexico's close competitors for such investment.

Mexico is falling down places in the ranking in the Mexico is falling down places in the ranking in the past few years.past few years.

FDI in Latin AmericaFDI in Latin America

FDI inflows to Brazil, Latin America's largest FDI inflows to Brazil, Latin America's largest economy, rose by nearly 29 percent to 45 billion economy, rose by nearly 29 percent to 45 billion US dollars in 2008.US dollars in 2008.

UNCTAD expects FDI to fall by as much as 45 UNCTAD expects FDI to fall by as much as 45 percent in Latin America this year as a result of percent in Latin America this year as a result of the financial crisis. the financial crisis.

This economic crisis has hit private equity firms This economic crisis has hit private equity firms hard and caused big companies to cut their hard and caused big companies to cut their spending.spending.

Mexico is expecting a decrease of around 23 Mexico is expecting a decrease of around 23 percent in FDI inflows in 2009.percent in FDI inflows in 2009.

Economic Integration in North Economic Integration in North AmericaAmerica

The economic relationship between Mexico The economic relationship between Mexico and the U.S. is evident in the evolution of and the U.S. is evident in the evolution of some of their economic indicators since some of their economic indicators since 1993. For example, it is apparent that, 1993. For example, it is apparent that, since 1993, Mexico's GDP shares its trend since 1993, Mexico's GDP shares its trend behavior with the U.S. GDP. behavior with the U.S. GDP.

Nevertheless, during the 1980s and the Nevertheless, during the 1980s and the beginning of the 1990s the synchronization beginning of the 1990s the synchronization of the real sectors of both economies was of the real sectors of both economies was unclear. unclear.

Economic Synchronization Economic Synchronization Between Mexico and the U.S.Between Mexico and the U.S.

Castillo, Fragoso Pastrana and Diaz-Bautista (2004) Castillo, Fragoso Pastrana and Diaz-Bautista (2004) studied the synchronization between the studied the synchronization between the economies of Mexico and the United States with economies of Mexico and the United States with special reference to the manufacturing sector. special reference to the manufacturing sector. The authors examined the dependency between The authors examined the dependency between the assembly plant industry for export in Mexico the assembly plant industry for export in Mexico and the performance of the economy of the and the performance of the economy of the United States. United States.

Herrera (2004) found also synchronization of GDPs Herrera (2004) found also synchronization of GDPs in Mexico and the U.S. became evident with the in Mexico and the U.S. became evident with the implementation of the NAFTA.implementation of the NAFTA.

United States FDI in MexicoUnited States FDI in Mexico

Overall US FDI flows into Mexico for 2008 were $8.9 billion coming Overall US FDI flows into Mexico for 2008 were $8.9 billion coming from U.S. sources. The U.S. currently provides 41% of all FDI in from U.S. sources. The U.S. currently provides 41% of all FDI in Mexico, benefiting more than 21,139 companies. The U.S. Mexico, benefiting more than 21,139 companies. The U.S. provides up to 68% of the total investment in manufacturing and provides up to 68% of the total investment in manufacturing and assembly plants, and 51% of the total investment in the financial assembly plants, and 51% of the total investment in the financial and banking sector. and banking sector.

In 2008, FDI was the third largest provider of foreign currency income In 2008, FDI was the third largest provider of foreign currency income to the Mexican economy, behind petroleum and remittances. to the Mexican economy, behind petroleum and remittances.

In 2008, approximately 40% ($3.5 billion) of U.S. investment in In 2008, approximately 40% ($3.5 billion) of U.S. investment in Mexico was directed to the six Mexican border states. These Mexico was directed to the six Mexican border states. These states, the location of the majority of maquiladora firms, receive states, the location of the majority of maquiladora firms, receive 58% of all U.S. manufacturing investment in Mexico. 58% of all U.S. manufacturing investment in Mexico.

Literature ReviewLiterature Review

Foreign direct investment (Foreign direct investment (FDIFDI) is usually viewed as ) is usually viewed as a channel through which for technologya channel through which for technology

is able to spread from developed countries to is able to spread from developed countries to developing countries. developing countries.

Does foreign direct investment (Does foreign direct investment (FDIFDI) contribute ) contribute to economic growth? to economic growth?

The answer to this is uncertain.The answer to this is uncertain.

Literature ReviewLiterature Review Although the evidence on the relationship between Although the evidence on the relationship between FDIFDI and and

economic growth is ambiguous, several studies argue that economic growth is ambiguous, several studies argue that the host country’s absorptive capacity plays an importantthe host country’s absorptive capacity plays an important

role in explaining role in explaining FDIFDI. . Blomström et al. (1994) state that Blomström et al. (1994) state that FDIFDI is positive and is positive and

significant only for higher income countries and that is has significant only for higher income countries and that is has no impact in lower income countries. no impact in lower income countries.

Borensztein et al. (1998) point out that the contribution of Borensztein et al. (1998) point out that the contribution of FDIFDI to economic growth is enhanced by its interaction with to economic growth is enhanced by its interaction with the level of human capital in the host country.the level of human capital in the host country.

Balasubramanyam et al. (1996) argue that Balasubramanyam et al. (1996) argue that FDIFDI plays plays different role in the growth process due to the differing different role in the growth process due to the differing trade policy regimes. trade policy regimes.

Literature ReviewLiterature Review In the theoretical literature, the role of In the theoretical literature, the role of FDIFDI is that of a is that of a

carrier of foreign technology that can boost economic carrier of foreign technology that can boost economic growth like Findlay (1978) and Romer (1993). growth like Findlay (1978) and Romer (1993).

In the empirical studies on In the empirical studies on FDIFDI, however, the evidence is , however, the evidence is still divided. Aitken and Harrison (1999), for instance, find still divided. Aitken and Harrison (1999), for instance, find that the net effect of that the net effect of FDIFDI on productivity is quite small. on productivity is quite small. Borensztein et al. (1998) and Carkovic and Levine (2005) Borensztein et al. (1998) and Carkovic and Levine (2005) also arrive at similar results by finding also arrive at similar results by finding FDIFDI does not have does not have an unmitigated and positive effect on economic growth. On an unmitigated and positive effect on economic growth. On the other hand, Haddad and Harrsion (1993), Kokko et al. the other hand, Haddad and Harrsion (1993), Kokko et al. (1996), and Alfaro et al. (2004) point out that (1996), and Alfaro et al. (2004) point out that FDIFDI can can increase the rate of growth in the host economy through increase the rate of growth in the host economy through technology transfer.technology transfer.

Literature ReviewLiterature Review Zhang (2001) and Choe (2003) analyses the causality Zhang (2001) and Choe (2003) analyses the causality betweenbetween FDIFDI and and

economic growth. Zhang uses data for 11 economic growth. Zhang uses data for 11 developingdeveloping countries in East countries in East Asia and Latin America. Using co-integration and Granger causality tests, Asia and Latin America. Using co-integration and Granger causality tests, Zhang (2001) finds that in five cases economic growth is enhanced by Zhang (2001) finds that in five cases economic growth is enhanced by FDIFDI but that host country conditions such as trade regime and macroeconomic but that host country conditions such as trade regime and macroeconomic stability are important. stability are important.

Choe (2003) mentions that causality Choe (2003) mentions that causality betweenbetween economic growth and economic growth and FDIFDI runs in either direction but with a tendency towards growth causing runs in either direction but with a tendency towards growth causing FDIFDI; ; there is little evidence that there is little evidence that FDIFDI causes host country growth. Rapid causes host country growth. Rapid economic growth could result in an increase in economic growth could result in an increase in FDIFDI inflows. inflows.

Carkovic and Levine (2002) use a panel dataset covering 72 Carkovic and Levine (2002) use a panel dataset covering 72 developeddeveloped and and developingdeveloping countries in order to analyse the relationship countries in order to analyse the relationship betweenbetween FDIFDI inflows and economic growth. The study performs both a cross- inflows and economic growth. The study performs both a cross-sectional OLS analysis as well as a dynamic panel data analysis. The paper sectional OLS analysis as well as a dynamic panel data analysis. The paper concludes that there is no robust link running from inward concludes that there is no robust link running from inward FDIFDI to host to host country economic growth.country economic growth.

Literature ReviewLiterature Review Most FDI occurs between developed economies, and the country Most FDI occurs between developed economies, and the country

receiving the greatest inflow of FDI is the United States. receiving the greatest inflow of FDI is the United States. Attraye and Hendrick (2006) examined whether such FDI inflows Attraye and Hendrick (2006) examined whether such FDI inflows

have stimulated growth of the U.S. economy. They applied time-have stimulated growth of the U.S. economy. They applied time-series data to a simultaneous-equation model that explicitly series data to a simultaneous-equation model that explicitly captures the bi-directional relationship between FDI and U.S. captures the bi-directional relationship between FDI and U.S. economic growth. FDI is found to have a significant, positive, and economic growth. FDI is found to have a significant, positive, and economically important impact on U.S. growth. The results imply economically important impact on U.S. growth. The results imply that even a technologically advanced country such as the U.S. that even a technologically advanced country such as the U.S. benefits from FDI, the gains from FDI are very substantial in the benefits from FDI, the gains from FDI are very substantial in the long run, and the sustainability of the U.S. current account deficit long run, and the sustainability of the U.S. current account deficit is enhanced by FDI's positive effect on productivity but is enhanced by FDI's positive effect on productivity but undermined by the income inelasticity of FDI. undermined by the income inelasticity of FDI.

The results suggest that U.S. policies should focus on keeping the The results suggest that U.S. policies should focus on keeping the country attractive to foreign direct investors.country attractive to foreign direct investors.

Selected empirical studies on spillovers from FDI on growth

Study Country / Level of analysis

Effects of FDI on growth and productivity

Firm or plant level studies Aitken, Harrison and Lipsey (1996)

Mexico, Venezuela and United States, manufacturing firms wages.

Positive spillovers on wages in United States, but not in Mexico and Venezuela.

Aitken and Harrison (1999)

Venezuela, manufacturing firms

Negative productivity spillovers on domestic firms

Djankov and Hoekman (1999)

Czech Republic, industrial firms, 1992-1996

Negative effect on productivity growth of purely domestic firms

Blomstrom and Sjoholm (1999)

Indonesia, manufacturing firms, 1991

Positive effect on productivity of domestic firms, but only for ‘non-exporters’.

Blomstrom et al. (2000) Uruguay, manufacturing plants, 1988

Positive spillover effects on domestic firms with a small technology gap.

Macro and sectoral studies Caves (1974) Australia, sectoral level,

manufacturing, 1966 Positive correlation FDI presence and productivity in sector

Globerman (1979) Canada, sectoral level, 1972 Positive correlation FDI presence and productivity in sector

Blomstrom (1986) Mexico, sectoral level, 70s Positive correlation FDI presence and productivity in sector, but firms with large technology gaps do not learn.

Pain and Hubert (2000) U K, sectoral level Inter and intra-industry spillovers from FDI on technical progress of domestic firms

Blomstrom et al. (1994) Developing countries, national level

Positive correlation FDI /GDP and per capita GDP growth

Borensztein et al. (1998) 69 countries, national level Weak positive correlation between FDI and per capita GDP growth

Xu (1999) 40 countries, national level Positive technology transfer in developed countries, but not in developing countries and depends on minimum level of human capital

Barrell and Pain (1997) UK and Germany Positive effect of FDI on overall technical progress

Barrell and Te Velde (1999)

Ireland and UK, national level, 1975-1998

Positive effects of FDI

Barrell and Te Velde (2000)

East Germany, national and industrial level, 1991-1998

Positive effects of FDI

Literature ReviewLiterature Review

As a major recipient of As a major recipient of FDIFDI among developing among developing countries (alongside with China, India and Brasil), countries (alongside with China, India and Brasil), MexicoMexico has been the subject of numerous has been the subject of numerous studies that explored both the causes and studies that explored both the causes and implications of implications of FDIFDI flows that have increased in flows that have increased in the wake of economic reforms it implemented the wake of economic reforms it implemented beginning in the mid-1980’s, and more intensely, beginning in the mid-1980’s, and more intensely, after the signing of the NAFTA Agreement.after the signing of the NAFTA Agreement.

Literature ReviewLiterature Review

Numerous studies have explored the implications of foreign investment Numerous studies have explored the implications of foreign investment flows for growth, productivity, income inequality in Mexico.flows for growth, productivity, income inequality in Mexico.

Lopez-Cordova (2002) finds that increased competitionLopez-Cordova (2002) finds that increased competition

and foreign capital penetration had a positive impact on the Mexican and foreign capital penetration had a positive impact on the Mexican productivity at the firmproductivity at the firm

Mollick, Ramos and Silva (2005) find that regional infrastructure (e.g. Mollick, Ramos and Silva (2005) find that regional infrastructure (e.g. the network of paved roads and the number of telephone lines) is the network of paved roads and the number of telephone lines) is important in attracting foreign investments to a region. Chiquiar important in attracting foreign investments to a region. Chiquiar (2004) shows that (2004) shows that FDIFDI flows and international exposure have flows and international exposure have benefited northern states of Mexico to a larger extent than the benefited northern states of Mexico to a larger extent than the central and southern ones and that the impact oncentral and southern ones and that the impact on

wages and returns to schooling is therefore different across the wages and returns to schooling is therefore different across the Mexican states.Mexican states.

Literature ReviewLiterature ReviewWaldkirch (2003) studies the impact of NAFTA formation Waldkirch (2003) studies the impact of NAFTA formation

on the distribution of investment flows into on the distribution of investment flows into MexicoMexico across the origin countries. Using aggregate data across the origin countries. Using aggregate data from 1980 to 1998 for from 1980 to 1998 for FDI FDI flows originating in 9 flows originating in 9 OECD countries, he finds that the case of OECD countries, he finds that the case of MexicoMexico supports the hypothesis that a developing country supports the hypothesis that a developing country benefits from a FTA with a more developed country, benefits from a FTA with a more developed country, since it becomes more attractive for international since it becomes more attractive for international capital. The results show that capital. The results show that FDIFDI flows from Canada flows from Canada and the US have increased more than flows from non-and the US have increased more than flows from non-NAFTA countries and estimates that the NAFTA countries and estimates that the FDIFDI coming coming from the US and Canada would have been 42% lower from the US and Canada would have been 42% lower in the absence of NAFTA.in the absence of NAFTA.

Literature ReviewLiterature Review Cuevas, Messmacher and Werner (2005) use Cross-country Cuevas, Messmacher and Werner (2005) use Cross-country

panel data are used to assess the effect of free-tradepanel data are used to assess the effect of free-trade

agreements on flows of foreign direct investment (FDI). agreements on flows of foreign direct investment (FDI). Free-tradeFree-trade agreements are found to have a significant agreements are found to have a significant positive effect onpositive effect on FDI flows, and free-trade agreements are FDI flows, and free-trade agreements are found to matter morefound to matter more for the smaller members of the for the smaller members of the agreement. For example, the Northagreement. For example, the North American Free-Trade American Free-Trade Agreement’s (NAFTA) effect on FDIAgreement’s (NAFTA) effect on FDI flows into Mexico is flows into Mexico is much larger than its effect on flows intomuch larger than its effect on flows into the United States. the United States. These cross-country results are used to assessThese cross-country results are used to assess NAFTA’s NAFTA’s effect on FDI flows into Mexico. After controllingeffect on FDI flows into Mexico. After controlling for a set of for a set of other factors—such as an increase in worldwideother factors—such as an increase in worldwide FDI flows—FDI flows—the trade agreement is found to generate FDIthe trade agreement is found to generate FDI flows nearly flows nearly 60 percent higher than they would have been without60 percent higher than they would have been without the the agreement.agreement.

Mexico’s FDI in the NAFTA EraMexico’s FDI in the NAFTA Era

Díaz-Bautista (2006) claims that the FDI-induced Díaz-Bautista (2006) claims that the FDI-induced export expansion accounts for more than half of export expansion accounts for more than half of the 3.5 million jobs created in Mexico during the the 3.5 million jobs created in Mexico during the first decade of NAFTA, specially in the Northern first decade of NAFTA, specially in the Northern Border. Border.

FDI may also have contributed to increasing FDI may also have contributed to increasing economic and social disparities and North-South economic and social disparities and North-South polarization in Mexico, like in Dussel (2003) and polarization in Mexico, like in Dussel (2003) and Hanson (2003).Hanson (2003).

FDI and Economic GrowthFDI and Economic Growth Despite the straightforwardness of the argument, empirical Despite the straightforwardness of the argument, empirical

evidence on a positive relationship evidence on a positive relationship betweenbetween FDIFDI inflows and host inflows and host country economic growth has been elusive. When a relationship country economic growth has been elusive. When a relationship betweenbetween FDIFDI and economic growth is established empirically it and economic growth is established empirically it tends to be conditional on host country characteristics such as the tends to be conditional on host country characteristics such as the level of human capital, for example De Mello (1999) and level of human capital, for example De Mello (1999) and Borensztein et al (1998). Borensztein et al (1998).

The difficulty in proving a positive effect from The difficulty in proving a positive effect from FDIFDI on economic on economic growth provides a strong incentive for further empirical studies. growth provides a strong incentive for further empirical studies.

Neoclassical models of economic growth only allow Neoclassical models of economic growth only allow FDIFDI to have a to have a level effect on growth due to diminishing returns to capital. level effect on growth due to diminishing returns to capital. However, the endogenous growth theory and NEG models However, the endogenous growth theory and NEG models provides a framework for studying the link provides a framework for studying the link betweenbetween FDIFDI and and economic growth that makes it possible to take the characteristics economic growth that makes it possible to take the characteristics of of FDIFDI into account and should improve the chances of confirming into account and should improve the chances of confirming the theoretical relationship by empirical evidence.the theoretical relationship by empirical evidence.

FDI and Regional Economic Growth FDI and Regional Economic Growth considering the Distance to the Northern considering the Distance to the Northern

Border of MexicoBorder of Mexico

Diaz-Bautista (2006) reviewed different Diaz-Bautista (2006) reviewed different studies to explain the effects of the NAFTA studies to explain the effects of the NAFTA agreement in regional FDI and regional agreement in regional FDI and regional economic growth. An empirical economic growth. An empirical econometric model was used to analyze econometric model was used to analyze the relation between the FDI and the relation between the FDI and economic growth at the regional level in economic growth at the regional level in Mexico, with an approach of the new Mexico, with an approach of the new economic geography and endogenous economic geography and endogenous economic growth. economic growth.

FDI and Regional Economic FDI and Regional Economic Growth Growth

The impulse caused by the opening of the The impulse caused by the opening of the economy and the signing of NAFTA in 1994 had a economy and the signing of NAFTA in 1994 had a positive effect in the growth of regional northern positive effect in the growth of regional northern border economies of Mexico and FDI in the border economies of Mexico and FDI in the northern border, where the maquiladora sector is northern border, where the maquiladora sector is one of the main motors of economic growth on one of the main motors of economic growth on the Northern Mexican Border. the Northern Mexican Border.

In almost all the regions of the Northern Border, a In almost all the regions of the Northern Border, a process of economic growth is observed, and the process of economic growth is observed, and the impulse due to the commercial opening is impulse due to the commercial opening is apparent. The exporting sector being one of the apparent. The exporting sector being one of the most dynamic sectors of the Mexican economy. most dynamic sectors of the Mexican economy.

FDI and Economic GrowthFDI and Economic Growth By the year 2000, the companies that exported more By the year 2000, the companies that exported more

than 80% of their production, paid 62% higher wages than 80% of their production, paid 62% higher wages than other types of companies. In that same year, the than other types of companies. In that same year, the maquiladora sector had wages 5 times greater than the maquiladora sector had wages 5 times greater than the average national minimum wage. Similarly, Mexico has average national minimum wage. Similarly, Mexico has diversified its export base. diversified its export base.

By the year 2000, companies producing manufactured By the year 2000, companies producing manufactured goods accounted for 87 % of Mexico’s export sales. goods accounted for 87 % of Mexico’s export sales.

In one decade, the liberalization of trade and the In one decade, the liberalization of trade and the macroeconomic policies in Mexico have increased macroeconomic policies in Mexico have increased exports from 41 trillion USD, in 1990, to 166 trillion USD exports from 41 trillion USD, in 1990, to 166 trillion USD in 2000. Similarly, Mexico increased its imports by 310% in 2000. Similarly, Mexico increased its imports by 310% between 1990 and 2000.between 1990 and 2000.

NAFTA increased Trade in North NAFTA increased Trade in North AmericaAmerica

Since 1994, commercial trade between the member Since 1994, commercial trade between the member countries of NAFTA increased at an annual average countries of NAFTA increased at an annual average rate of 11.8%, whereas the worldwide annual rate of 11.8%, whereas the worldwide annual average rate of growth in trade was around 7%. average rate of growth in trade was around 7%. The opportunities of trade for both Mexico and The opportunities of trade for both Mexico and Canada within NAFTA have increased in the last few Canada within NAFTA have increased in the last few years. Mexico became the fourth most important years. Mexico became the fourth most important commercial partner for Canada, whereas the commercial partner for Canada, whereas the bilateral commerce between Mexico and Canada bilateral commerce between Mexico and Canada tripled, reaching 12 trillions USD in 2000. tripled, reaching 12 trillions USD in 2000.

The integration of the intra industry trade is The integration of the intra industry trade is extremely high within NAFTA and shows how the extremely high within NAFTA and shows how the region integrated not only in commercial terms but region integrated not only in commercial terms but also in terms of the region’s productive systems.also in terms of the region’s productive systems.

FDI in the NAFTA RegionFDI in the NAFTA Region The NAFTA region has created new opportunities The NAFTA region has created new opportunities

of investment and trade for the companies of all 3 of investment and trade for the companies of all 3 countries, and 50 % of FDI in NAFTA is between countries, and 50 % of FDI in NAFTA is between trade partners. For Mexico, the United States is trade partners. For Mexico, the United States is the main source of FDI. the main source of FDI.

FDI is of great importance the Northern Border FDI is of great importance the Northern Border Mexican Region, and by the year 2004, FDI in the Mexican Region, and by the year 2004, FDI in the Northern Border States of Mexico represented Northern Border States of Mexico represented 18.7% of total FDI at the national level. The 18.7% of total FDI at the national level. The Northern Border States that are considered in this Northern Border States that are considered in this study are Baja California, Sonora, Chihuahua, study are Baja California, Sonora, Chihuahua, Coahuila, Nuevo Leon and Tamaulipas.Coahuila, Nuevo Leon and Tamaulipas.

States 1996 1997 1998 1999 2000 2001 Acumulado

Baja California 425,404.70 675,360.60 721,929.80 1,114,044.30 942,315.50 690,904.20 4,569,959.10

Coahuila 145,107.20 113,570.10 123,657.10 158,966.70 184,326.10 117,200.30 842,827.50

Chihuahua 534,353.80 508,203.80 590,696.30 579,972.70 909,119.20 630,196.00 3,752,541.80

Nuevo León 331,225.50 2,350,819.50 445,226.50 1,222,275.60 1,861,677.50 1,431,523.70 7,642,748.30

Sonora 107,098.30 159,608.00 164,992.60 186,785.00 384,941.10 155,090.20 1,158,515.20

Tamaulipas 334,327.70 283,720.40 344,089.80 460,190.60 480,730.60 333,562.80 2,236,621.90

Total Northern Border 1,877,517.20 4,091,282.40 2,390,592.10 3,722,234.90 4,763,110.00 3,358,477.20 20,203,213.80

Total FDI in México 7,697,336.30 11,955,554.90 7,853,268.10 12,476,028.00 14,190,104.90 23,168,364.00 77,340,656.20

Percentage of Northern Border w ith respect to the Country 24.40% 34.20% 30.40% 29.80% 33.60% 14.50% 26.10%Baja California as a Percentage of the Northern Border 22.70% 16.50% 30.20% 29.90% 19.80% 20.60% 22.60%

Foreign Direct Investment in the Northern Border of Mexico (thousands of dollars)

Sources: SE y INEGI.

In 2006, approximately 38% ($3.9 billion) of U.S. investment in Mexico was directed to the 6 Mexican border states.

Foreign Direct Investment in MexicoForeign Direct Investment in Mexico

3 billions annual USD 10.731 annual billions USD3 billions annual USD 10.731 annual billions USD Before NAFTA (1993) After NAFTA (2003)Before NAFTA (1993) After NAFTA (2003) FDI Growth of 266% in 10 yearsFDI Growth of 266% in 10 years FIRST FDI RECEPTORS FIRST FDI RECEPTORS DEVELOPING COUNTRIES 2003DEVELOPING COUNTRIES 2003

1ST CHINA 57 BILLION USD1ST CHINA 57 BILLION USD 2ND HONG KONG 14.3 BILLION USD2ND HONG KONG 14.3 BILLION USD 3ER MEXICO 10.731 BILLION USD3ER MEXICO 10.731 BILLION USD

SOURCE :SOURCE :World Economic Situation and Prospects 2004 and Ministry of Economy Mexico. World Economic Situation and Prospects 2004 and Ministry of Economy Mexico.

FDI in Baja CaliforniaFDI in Baja California Baja California has had a foreign direct investment (FDI) Baja California has had a foreign direct investment (FDI)

accumulated from 1999 to 2009 equivalent to 4.6% share accumulated from 1999 to 2009 equivalent to 4.6% share nationally. The accumulated FDI in a decade was 10 thousand nationally. The accumulated FDI in a decade was 10 thousand U.S. $ 428.3 million. U.S. $ 428.3 million.

Within the current situation in the economy of 2009, we note that Within the current situation in the economy of 2009, we note that the path is marked by the globalization of world economy, which the path is marked by the globalization of world economy, which stands out as one of the most salient features in regional stands out as one of the most salient features in regional economies such as Baja California. economies such as Baja California.

Foreign direct investment (FDI) in the Northern Border of Mexico Foreign direct investment (FDI) in the Northern Border of Mexico constitutes 24% of the total received from 1999 to 2009, states constitutes 24% of the total received from 1999 to 2009, states such as Baja California, Coahuila, Chihuahua, Nuevo Leon, Sonora such as Baja California, Coahuila, Chihuahua, Nuevo Leon, Sonora and Tamaulipas. and Tamaulipas.

Economic GrowthEconomic Growth The economics of growth in Mexico has come a The economics of growth in Mexico has come a

long way since it regained center stage for long way since it regained center stage for economists in the last few years. The early focus economists in the last few years. The early focus of economic growth in Mexico was based upon of economic growth in Mexico was based upon theoretical models that generated self-sustaining theoretical models that generated self-sustaining growth, but newer models of economic growth growth, but newer models of economic growth have been applied to Mexico, which have have been applied to Mexico, which have increasingly replaced older models, with an increasingly replaced older models, with an attempt to shed light on the factors affecting attempt to shed light on the factors affecting economic growth in Mexico. On the empirical economic growth in Mexico. On the empirical front, the search for determinants of growth has front, the search for determinants of growth has gone from basic economic growth variables (such gone from basic economic growth variables (such as physical and human capital) to newer as physical and human capital) to newer determinants of economic performance such as determinants of economic performance such as trade and institutions. trade and institutions.

Economic Growth ModelsEconomic Growth Models A Major weakness of the neoclassical growth A Major weakness of the neoclassical growth

model has been detected by economists around model has been detected by economists around the world and has not been overlooked in Mexico. the world and has not been overlooked in Mexico. Long-run growth in that model is exogenous. Long-run growth in that model is exogenous.

Recent empirical studies have found a correlation Recent empirical studies have found a correlation between the rate of growth of FDI and economic between the rate of growth of FDI and economic growth. The direction of causality between the growth. The direction of causality between the rate of growth of investment and the rate of rate of growth of investment and the rate of economic growth has been analyzed by Carrol economic growth has been analyzed by Carrol and Weil (1994), Blomström, Lipsey and Zedjan and Weil (1994), Blomström, Lipsey and Zedjan (1996) and Barro (1997), and found that the (1996) and Barro (1997), and found that the causality was from FDI to economic growth. causality was from FDI to economic growth.

New Growth TheoryNew Growth Theory In the endogenous growth models the increases in In the endogenous growth models the increases in

investment during a period of time, increases the investment during a period of time, increases the rate of economic growth in the long run. In the rate of economic growth in the long run. In the endogenous growth models, FDI can affect growth endogenous growth models, FDI can affect growth endogenously if it generates increasing returns in endogenously if it generates increasing returns in production via externalities and productivity production via externalities and productivity spillovers. Moreover, policy changes might induce spillovers. Moreover, policy changes might induce permanent increases in output growth by providing permanent increases in output growth by providing incentives to host FDI. Specifically, FDI is thought to incentives to host FDI. Specifically, FDI is thought to be an important source of human capital be an important source of human capital accumulation and technological change. accumulation and technological change.

Helpman (1984) and Helpman and Krugman (1985) Helpman (1984) and Helpman and Krugman (1985) are also an important part of the analysis of FDI in are also an important part of the analysis of FDI in the new growth theory. In those models, distance to the new growth theory. In those models, distance to the export market is an important determinant of the export market is an important determinant of economic growth and FDI. economic growth and FDI.

Center Periphery and distanceCenter Periphery and distance Krugman (1997) uses the model developed by Krugman (1997) uses the model developed by

Dixit and Stiglitz (1977) to have a unified spatial Dixit and Stiglitz (1977) to have a unified spatial economic structure which is described by the new economic structure which is described by the new economic geography. economic geography.

Fujita, Krugman and Venables (1999) assume Fujita, Krugman and Venables (1999) assume that factors of production are less mobile that factors of production are less mobile between countries than between different regions between countries than between different regions of the same country,and analyzed the spatial of the same country,and analyzed the spatial order resulting from differing transport costs. order resulting from differing transport costs.

Derivation of the Model with FDI and Derivation of the Model with FDI and

Regional Economic GrowthRegional Economic Growth We assume a regional production function in the following We assume a regional production function in the following

form:Y = F(K, L, F, X) (1) where Y is the product, K is capital, form:Y = F(K, L, F, X) (1) where Y is the product, K is capital, L is human capital, F is FDI and X denotes the vector of L is human capital, F is FDI and X denotes the vector of observable variables that can affect the regional economic observable variables that can affect the regional economic growth and the FDI.growth and the FDI.

A Cobb Douglas function is used to obtain the logarithms in A Cobb Douglas function is used to obtain the logarithms in time that gives us the following expression:time that gives us the following expression:

gy= ζgk+ ψgf+ γgL+ θgx (2) gy= ζgk+ ψgf+ γgL+ θgx (2) The relation shows the empirical relationship between The relation shows the empirical relationship between

regional economic growth (gy) and the presence of FDI (gf), regional economic growth (gy) and the presence of FDI (gf), with other explicative factors (gx). From the conventional with other explicative factors (gx). From the conventional model of growth, the empirical model is developed using model of growth, the empirical model is developed using the economic growth ∆yjt in region j for time t, with the FDI the economic growth ∆yjt in region j for time t, with the FDI represented by F, human capital represented by L, and represented by F, human capital represented by L, and other variables (X) like distance and urban agglomerations. other variables (X) like distance and urban agglomerations.

The empirical model has the following form:The empirical model has the following form: ∆∆Yjt = β0+ β1Ljt+ β2Fjt+ β3Xjt+ ujt (3)Yjt = β0+ β1Ljt+ β2Fjt+ β3Xjt+ ujt (3)

Sources of InformationSources of Information The sources of information for the study are varied. The sources of information for the study are varied. Distance is measured by the number of kilometers on the road from Distance is measured by the number of kilometers on the road from

the capital of a state to the nearest border crossing with the United the capital of a state to the nearest border crossing with the United States. Another distance variable is included and constructed by the States. Another distance variable is included and constructed by the number of kilometers on the road from the capital of a state to Mexico number of kilometers on the road from the capital of a state to Mexico City.City.

The density per kilometer squared in each state of Mexico measures The density per kilometer squared in each state of Mexico measures the level of cluster agglomeration in the economy.the level of cluster agglomeration in the economy.

Another variable is constructed by the number of businesses in the Another variable is constructed by the number of businesses in the commercial, services or manufacturing sector per state. commercial, services or manufacturing sector per state.

The migration variable is measured by the net balance migration per The migration variable is measured by the net balance migration per state in Mexico provided by INEGI. The human capital variable is an state in Mexico provided by INEGI. The human capital variable is an indicator of the educational characteristics of the population in each indicator of the educational characteristics of the population in each state. It includes the percentage of the population 15 years of age or state. It includes the percentage of the population 15 years of age or older that have more than elementary studies in each state of Mexico. older that have more than elementary studies in each state of Mexico.

The regional economic growth is measured by the percentage annual The regional economic growth is measured by the percentage annual increase in income per capita in the period 1994-2000. The initial level increase in income per capita in the period 1994-2000. The initial level of income used in the study is the one provided by INEGI in 1994. of income used in the study is the one provided by INEGI in 1994. Foreign direct investment is constructed from the data provided by the Foreign direct investment is constructed from the data provided by the Ministry of Economy in Mexico from1994 to 2000. The econometric Ministry of Economy in Mexico from1994 to 2000. The econometric technique must take into account the endogeneity argument. technique must take into account the endogeneity argument.

State 1993 1994 1995 1997 1998 1999 2000

Baja California 32,280,985 34,564,015 32,726,727 39,452,448 41,252,702 43,226,867 48,157,432

Coahuila 33,488,722 34,873,364 34,633,813 40,334,408 42,757,805 44,227,705 45,975,854

Chihuahua 45,225,902 47,869,331 44,789,564 52,109,000 56,263,540 60,398,960 66,008,627

Nuevo León 74,070,652 78,141,213 73,103,840 83,572,386 89,573,370 94,372,681 101,688,958

Sonora 30,146,173 32,277,310 31,499,518 34,647,187 36,792,672 38,918,375 40,457,627

Tamaulipas 32,267,729 34,694,384 32,756,334 36,572,894 39,451,068 41,998,268 44,792,600Percentage contribution of the Northern Border in the National Product 21.40% 21.80% 22.00% 22.60% 22.90% 23.30% 21.50%Baja California

as a percentage

contribution of the Product in the Northern

Border 13.00% 13.20% 13.10% 13.80% 13.50% 13.40% 13.90%

Table 4. Gross National Product in Mexico’s Northern Border by State (1993-2000) (thousand pesos with 1993 prices)

Sources: SE y INEGI.

Table 4. FDI and Regional Economic Regression per State of Mexico during the period 1994-2000 Dependent Variable: Growth of regional Income per capita 1994 2000 Method of Estimation: TSLS with instrumental variables Variable Coefficient t-stat. Prob. C 42.993 2.821* 0.010 Distance from the Border -0.0079 2.716* 0.012 Migration 1.9752 3.097* 0.005 R-Squared 0.654 Mean dependent var 25.30 R-Squared Adj. 0.490 S.D. dependent var 9.830 Prob(F-statistic) 0.003 Note: * Statistically Significant.

ConclusionsConclusions The results of the econometric analysis of the regional The results of the econometric analysis of the regional

economic growth with the new economic geography economic growth with the new economic geography perspective shows that the agglomeration variables are non perspective shows that the agglomeration variables are non significant, while the distance from the border is significant, while the distance from the border is statistically significant, which is evidence in favor of the statistically significant, which is evidence in favor of the agglomeration models and the NEG models.agglomeration models and the NEG models.

The distance from the border shows the importance of The distance from the border shows the importance of transport costs and trade to the United States in explaining transport costs and trade to the United States in explaining regional economic growth in Mexico. regional economic growth in Mexico.

The migration variable is also important, showing the The migration variable is also important, showing the importance of migration in determining regional economic importance of migration in determining regional economic growth, due to repulsion and attraction forces that affect growth, due to repulsion and attraction forces that affect regions and agglomerations in Mexico. regions and agglomerations in Mexico.

On the other hand, the human capital variable, which is one On the other hand, the human capital variable, which is one of the most important variables is the endogenous growth of the most important variables is the endogenous growth models is non significant in the regression.models is non significant in the regression.

ConclusionsConclusions In the empirical study, the importance of the distance In the empirical study, the importance of the distance

to the Northern Border of Mexico as a determinant of to the Northern Border of Mexico as a determinant of regional economic growth in Mexico is shown. The regional economic growth in Mexico is shown. The commercial trends in the agglomeration of industry in commercial trends in the agglomeration of industry in the Mexican Northern Border and the transportation the Mexican Northern Border and the transportation technology costs to the border region (which are technology costs to the border region (which are proxied by the distance to the border) are an proxied by the distance to the border) are an important factor driving Mexico first to regional important factor driving Mexico first to regional concentration and then to regional dispersion of concentration and then to regional dispersion of economic activity. The production of manufactures is economic activity. The production of manufactures is subject to increasing returns to scale if the subject to increasing returns to scale if the production activities take place in a single site close production activities take place in a single site close to the border and the selling market.to the border and the selling market.

The recent advances in the field of NEG have The recent advances in the field of NEG have increased our understanding of spreading and increased our understanding of spreading and agglomerating forces in the Mexican economy. agglomerating forces in the Mexican economy.

ConclusionsConclusions

Some other important conclusions Some other important conclusions emerge. Regional integration has emerge. Regional integration has had a positive and significant effect had a positive and significant effect on FDI, which shows a combination of on FDI, which shows a combination of investment creation and diversion.investment creation and diversion.

FDI complements trade in the NAFTA FDI complements trade in the NAFTA region in the first 14 years of the region in the first 14 years of the agreement.agreement.

““Foreign Direct Investment (FDI) and Economic Foreign Direct Investment (FDI) and Economic Growth. The Case of Mexico and the United States “Growth. The Case of Mexico and the United States “

Dr. Alejandro Díaz-BautistaDr. Alejandro Díaz-BautistaInvestigador Nacional y Miembro del Investigador Nacional y Miembro del Sistema Nacional de Investigadores, Sistema Nacional de Investigadores, CONACYT, Nivel II.CONACYT, Nivel II.

adiazbau@hotmail.com

http://www.linkedin.com/pub/alejandro-diaz-bautista/6/619/691

Profesor-Investigador de Economía, Departamento de Estudios Económicos, El Colegio de la Frontera Norte.

Preparado para la 1er. Seminario internacional Evaluación del efecto de la Inversión Extranjera Directa (IED) en las economías en desarrollo. El evento se realizara en la Casa COLEF Ciudad de México, con dirección en la Calle Francisco Sosa No. 254, Col. Barrio de Santa Catarina en Coyoacán, México D.F. el 18 de septiembre de 2009 a las 11 a.m.

References Díaz Bautista, Alejandro (2006), “An economic growth model of institutions,

economic integration and foreign direct investment of Mexico with the United States”, Un modelo de crecimiento económico considerando a las instituciones, integración económica e inversión extranjera directa de México con los Estados Unidos”, Revista Convergencia, Revista de Ciencias Sociales, num. 41, ISSN 1405-1435, Nº. 41, pags. 117-139, mayo – agosto de 2006.

Díaz Bautista, Alejandro (2006), “Foreign Direct Investment and Regional Economic Growth considering the Distance to the Northern Border of Mexico” in Analisis Economico, UAM, Number 46, Vol. XXI, 2006.FDI and Regional Economic Growth.

Díaz Bautista, Alejandro (2005), “Regional Growth and Development, Clusters and FDI in Mexico”, prepared for the conference “ Desarrollo Regional y Competitividad”, organized by the Presidency of Mexico with Centro de Investigación y Docencia Económicas, A.C. (CIDE), September, 2005.

Díaz Bautista, Alejandro (2005), “The Impact of Economies of Agglomeration, Clusters and networking in medium-sized Mexican Telecommunication firms”, Chapter in the Book “Industrial Development and Labor Markets in the United States–Mexico Border”, UCLA Latin American Center Publications (2005), University of California, Los Angeles (UCLA).