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Effect of Fdi on Bilateral Trade

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Submitted By majumdarnirlep
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Effect of FDI on Bilateral Trade
Abstract
Contemporary literature refers to trade and Foreign Direct Investment (FDI) as alternative strategies. The debate is mainly between two notions: (1) that FDI displaces trade, and (2) that FDI and trade complement each other. Literature on FDI talks about the effect of foreign investments on trade. Lipsey (2002) mentions that outward FDI may decrease or increase (or have no effect on) exports of home country. These effects depend largely on the competitiveness of the host country and the motives behind investment by the home country in the host country. This paper is aimed at studying the effect of FDI on bilateral trade as well as effect at the aggregate level especially in the developed-developing nation paradigm.
Introduction
Literature suggests that there are a number of motives on which FDI takes place across nations. Most of the firms in the developed countries will go for foreign investment once they fulfill their domestic market and they in order to grow will go to foreign market. In this case the main motive of a firm is to tap new markets. This entry of one firm in to a foreign market will create a bandwagon effect thorough which their competitors will also enter that market. Again, when the competition sets in the foreign market, companies will be forced to take cost reduction measures to achieve higher profits will look for other destinations which have lower cost of production and thus the motive will become efficiency seeking and the cycle continues (Sethi et al, 2003). FDI is the measure of foreign ownership of productive assets. FDI can be through investments, participation in management, JVs, M&A, transfer of technology/ knowhow/ skills, creating a subsidiary or a new firm. Studies have shown that FDI involves change in share of production of domestic firms and foreign firms; this is to say that FDI...

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