The Relationship Between Trade Openness and FDI Literature review

The Relationship Between Trade Openness and FDI - Literature review Example This review of literature is directed at finding the measures leading to increased foreign direct investment (FDI) for a country. Although there is a whole range of factors that cause an increase in the foreign direct investment in a country, yet one of the most significant factors has been found to be the country’s openness towards trade. Openness as a concept, has been defined in a number of ways by the researchers in the past. A comprehensive definition of openness is presented below: (t)he concept of openness, applied to trade policy, could be synonymous with the idea of neutrality. Neutrality means that incentives are neutral between saving a unit of foreign exchange through import substitution and earning a unit of foreign exchange through exports. Clearly, a highly export oriented economy may not be neutral in this sense, particularly if it shifts incentives in favor of export production through instruments such as export subsidies. It is also possible for a regime to b e neutral on average, and yet intervene in specific sectors. A good measure of trade policy would capture differences between neutral, inward oriented, and export-promoting regimes. (Harrison, 1996, p. 20). Trade openness has conventionally been scaled by different researchers in different ways, but in a vast majority of cases, trade openness has been measured by its contribution to the overall gross domestic product (GDP) of a country. Factors that have conventionally been employed for the measurement of trade openness include but are not limited to intensity of import trade, intensity of export trade, intensity of trade, intensity of adjusted trade, and the intensity of real trade (Squalli and Wilson, 2006, p. 22). Three models of adjusted trade intensity have conventionally been tried to measure the trade openness. One of them is adjusted trade intensity in which the outliers having high import for the re-rexport are handled with the modification of denominator. This measure was first proposed by Andersen (1994). The second of them is adjusted trade intensity accompanied with the alternative technique to tackle the outliers as initially proposed by Frankel (2000). The third of them is adjusted trade intensity. This is a modified form of the model originally proposed by Frankel (2000). The modification was suggested by Li et al (2004). The seven measures of openness were also cited by the famous economists Kumar and Kandzija (n.d., p. 13) in their article in which they analyzed the integration and trade theory to evaluate the perspectives of trade in Western Balkans. For the purpose of this research, intensity of trade, the three models of intensity of adjusted trade as discussed before, real trade intensity, real world trade intensity (RWTI) and composite trade intensity (CTI) will be used. They will be evaluated with a view to identifying the one that is the most accurate as a measure of openness. Of all the measures, three of the most commonly employed ar e trade intensity (TI), import trade intensity (M/GDP) and export trade intensity (X/GDP). Trade intensity is obtained by dividing the sum of import (X) and import (M) by the GDP. According to Alcala and Ciccone (2004), the estimate generated by TI upon income is affected by the non-tradable on productivity, and is thus, biased downwards. Thus, in their opinion, it is advisable to divide the nominal trade by the real GDP. The different measures of trade openness lay the basis for a technique to find out the extent to which a country is open to the global trade as well as to the consequential advantages of income growth. For instance, the higher a country’s TI, the increased openness of its economy towards the advantages