Download Exports and Investment

Driving Forces of Exports and
Investment in Iceland
Dr. Helga Kristjánsdóttir
Ministry for Foreign Affairs and the Trade
Council of Iceland
September 3rd 2004
Overview
1.
2.
3.
Overview of data sources on-line
Overview of statistics for Iceland together
with economic history and future prospects
Specific discussion about forces driving
exports going out of Iceland, and investment
made in Iceland
Data Sources On-line:
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Icetrade.is
Vur.is
Invest.is
Chamber.is
Iceland.org/icex.is
Hagstofa.is/fjr.is
Worldbank.org/data
Imf.org
Statistics - History - Prospects
•
The Icelandic economy experienced growth
rates above the industrialized countries'
average during the years 1996-2001. This led
to a period of overheating that peaked in the
year 2000 when the current account deficit
exceeded 10% of GDP. These imbalances
have now been corrected with only a relatively
mild recession and in 2002. GDP growth is
now expected to be above 3 ½ % in 2004.
Statistics - History - Prospects
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The economy is entering a period of strong
growth led by investment in hydro-power
facilities and energy-intensive industries.
The greatest challenge will be to avoid
overheating and an unsustainable
appreciation of the Icelandic krona during the
period of investment-led growth that is
expected to last until the end of this decade.
Statistics - History - Prospects
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While risks of overheating should not be
underestimated, the economy is in many
respects better equipped than in recent years
to take on the challenges associated with
these investment projects.
Investments will contribute to increased export
revenues and further diversify the economy.
Statistics - History - Prospects
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Monetary Policy
Assuming an unchanged monetary stance
inflation is now forecast below the target for
the whole of this year, but will reach the target
in early 2005.
The most likely outlook is still that interest
rates will remain unchanged for the time
being, then rise as the peak of aluminiumrelated investments approaches.
Statistics - History - Prospects
% of GDP
97
98
99
00
Exports
37.2
36.0
35.0
35.2
Net FDI
equity
0.7
0.8
-0.5
-3.0
-3.8
Net portfolio -2.5
investment
equity
01
02
03
04
05
06
07
08
41.0 39.8
34.8
33.3
32.6
32.5
33.4
35.4
-2.6
-1.4
-1.0
-0.1
1.1
3.9
4.6
3.7
0.3
-8.1
-0.2
-2.9
-2.5
-1.1
-1.1
-0.9
-0.7
-0.7
Third session Kyoto, 1-10 December 1997
KYOTO PROTOCOL TO THE UNITED NATIONS FRAMEWORK CONVENTION ON
CLIMATE CHANGE
Quantified emission limitation or reduction commitment (percentage of base year or
period)
Australia 108
EC 92
Japan 94
Poland* 94
Switzerland 92
Austria 92
Finland 92
Latvia* 92
Portugal 92
UK 92
Belgium 92
France 92
Liechtenstein 92
Romania* 92
USA 93
Bulgaria* 92
Germany 92
Lithuania* 92
Russian Fed* 100
Canada 94
Greece 92
Luxembourg 92
Slovakia* 92
Croatia* 95
Hungary* 94
Monaco 92
Slovenia* 92
Czech Rep* 92
Iceland 110
Netherlands 92
Spain 92
Denmark 92
Ireland 92
New Zealand 100
Sweden 92
Estonia* 92
Italy 92
Norway 101
Ukraine* 100
* Countries that are undergoing the process of transition to a market economy.
Exports and Investment
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Following World War II, the production
capacity of industrialized countries increased
substantially
In 1960s large Japanese car manufacturers
had to choose between exporting and
investing in United States
Background
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Multinational entity (MNE), or a multinational,
is a firm with multinational activities
Vertical FDI – Production located to gain
access to abundant factors (Helpman, 1984)
Horizontal FDI – Production located to
overcome trade costs and gain market access
(Markusen, 1984)
Background
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Most FDI among developed countries, i.e.,
East and West, rather than North and South
Small open economies particularly dependent
on exports and FDI
Export ratio of Iceland is comparatively small,
or 34% of GDP in 1999
• Scandinavian countries’ export ratios ranged
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from 37-44%
Japan and US had export ratios below 12%
Trade in
1940s and
1950s
Trade in
1960s and
1970s
Iceland
joined EFTA
in 1970
Trade in
1980s and
1990s
Overview
Discussion overview:
1. A Gravity Model for Exports From Iceland
2. Determinants of Foreign Direct Investment in
Iceland
3. The Knowledge-Capital Model and Small
Countries
4. What Drives Sector Allocation of Foreign
Direct Investment in Iceland?
Ch. 1: Determinants of Exports
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Export volume explained by market size and
geographical location
Krugman (1991) observes Iceland’s export
ratio to be smaller than expected
Gylfason (1999) finds it to be only 2/3 of its
expected value
Ch. 1: Determinants of Exports
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In my research I have tested for the following:
Sector and trade bloc fixed effects, both
individually and simultaneously
• Fishing, Manufacturing, Power, Other
• EFTA, EU, NAFTA, NON-bloc
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Correcting for small size of Iceland
Also test some marine product subsamples
Ch. 1: Determinants of Exports
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Distance is found to be a barrier to exports
• As in Krugman (1991)
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Unlike Krugman
• Market size and wealth of recipient country
more important than size and wealth of
exporting country, Iceland
• Even when corrected for small size
Ch. 2: Determinants of FDI
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Trade literature: Foreign direct investment
(FDI) viewed as form of trade
• Trade in financial capital
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FDI: Foreign ownership of controlling stock in
a particular firm (generally 10% or more)
Inward FDI sectors in Iceland
• Power, Com & Fin, Tel & Trans, Other
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Study if FDI in Iceland can be explained by
location, market size, and several other factors
Ch. 2.: Determinants of FDI
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Trade literature: Gravity models increasingly
popular for estimating FDI
• Brainard (1997); Mody, Razin and Sadka
(2003)
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Fixed country and sector effects
• Jeon and Stone (1999) and di Mauro (2000)
used countries and sectors
• Here also trade bloc effects
Ch. 2.: Determinants of FDI
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Gravity model useful in predicting FDI levels
• Consistent with previous literature
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Unlike earlier findings, wealth more important
than market size
Effects of market size variables (GDP, POP)
often close to being equal and opposite in sign
Distance negatively affects FDI, and FDI
appears to be driven more by wealth effects
than by market size effects
Ch. 3.: Knowledge-Capital Model
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Trade and investment relations of Iceland
viewed in global perspective, incorporating
factor endowments
Knowledge-Capital (KK) model by Carr,
Markusen and Maskus (CMM 2001) applied to
small country case, using Icelandic data
KK model incorporates both horizontal and
vertical incentives for FDI
Edgeworth Box
Origin for
Host Country = Oh
Unskilled host
country
skill(i)-skill(j)>0
Small host
country
Y(i)-Y(j)>0
Ydiff=0
Location
of Iceland
Sdiff=0
Skilled
Labor
RELATIVE
SIZE
RELATIVE
ENDOWMENTS
Skilled host
country
skill(i)-skill(j)<0
Large host
country
Y(i)-Y(j)<0
Os = Origin for
Source Country
Unskilled Labor
Ch. 3.: Knowledge-Capital Model
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Basic KK specification and modification
Thoroughly analyze knowledge effects
• Specification restrictions, enlarged sample,
outlier omission, (occupation)
• Blonigen, Davies, and Head (2003)
• Davies (2003)
• Also proxy by education and per capita wealth
• Squared and cubed skill level and subsamples
Ch. 3.: Knowledge-Capital Model
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Driving forces for FDI in Iceland appear to be
different from those in large countries
Potential data difficulties when there are large
differences in GDPs or population
Alternatively, omission of important factor
endowments such as energy or fish stock
Ch. 4.: Sector Allocation of FDI
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Skilled and unskilled labor may not be right
endowment approach for Iceland
Inward FDI
• Sector decomposition, resource endowments
• Power, Com & Fin., Tel & Transport, Other
• Waldkirch (2003)
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Also natural resources, infrastructure, pollution
quotas and government stability
Ch. 4.: Sector Allocation of FDI
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FDI sector shares and levels
• FDI shares reflect relative size of each sector
within a particular year of investment
Brainard (1997)
• Inward and outward FDI share proxies
separately as share of affiliate sales in total exp
Slaughter (2000)
• FDI proxied by investment share (measured as
majority-owned affiliates) in overall MNE
investment
Threshold Cost and FDI
FDI
Market Size
Ch. 4.: Sector Allocation of FDI
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FDI theories assume certain threshold costs
• Generally not dealt with in FDI empirical models
• Markusen (2002): fixed cost that MNEs need to
consider when undertaking FDI
• Heckman's (1979) two-step model to control for
whether sample selection is driving results
KK model seems to explain fixed costs but not
the level of investment (marginal change)
However, gravity model provides information on
both
Ch. 4.: Sector Allocation of FDI
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Results different from what was anticipated
since KK model still does not perform very
well for Iceland
Heckman procedure application to gravity
rather than KK model, since this gives better
indication of how host-country characteristics
affect FDI
However, endowment inclusion in gravity
model can be credited to KK literature
Conclusions I
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Geographic approach to trade theory applied
to small open economies like Iceland
• With incorporation of gravity models
Gravity forces appear to describe Iceland's
exports
• Distance hampers trade whereas size of trade
partners encourages trade
Distance effect apparent not only for export
• Also important for FDI in Iceland
Conclusions II
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Reasons to prefer gravity model for FDI
Also find support for the intuition behind KK
model, i.e., that endowments matter
Use more endowment proxies than merely the
knowledge-endowment proxies
Employ proxies for endowments that are
crucial to Icelandic economy
• Useful both for explaining levels of investment
and fixed costs typical of FDI models