Literature on FDI and trade has mainly concentrated on export-substituting or
export-complementary nature of foreign direct investment (FDI). However, the
relationship between FDI and trade has become far more complex in the current WTO
regime wherein several developing countries have initiated import liberalisation and
entered into trading arrangements. These have drastically reduced trading costs and
encouraged trade. With the growing volumes of trade, the focus of policy makers in
the developing countries has now shifted from whether FDI causes trade to whether
trade can boost FDI inflows and in particular, what kinds of trade can boost FDI
inflows?
There are reasons to expect that different kinds of trade would influence FDI
flows differently. While trade associated with cross-border vertical integration may
boost FDI by providing incentives of cost reduction, intra-industry trade may
discourage FDI that seeks economies of scale. Within intra-industry trade (IIT) the
impact may differ with respect to vertical and horizontal intra-industry trade. Vertical
ITT may encourage FDI as it assures ownership advantages and a market; while
horizontal IIT may discourage FDI as it may be more beneficial to trade rather than
invest if the product is not produced locally. Net effect on FDI of such trade may be
an important empirical question.