Working Paper: NBER ID: w10145
Authors: Assaf Razin; Yona Rubinstein; Efraim Sadka
Abstract: The paper provides a reconciliation of Lucas' paradox, based on fixed setup costs of new investments. With such costs, it does not pay a firm to make a small' investment, even though such an investment is called for by marginal productivity conditions. Using a sample of 45 developed and developing countries we estimate jointly the participation equation (the decision whether to invest at all) and the FDI flow equation (the decision how much to invest). We find that countries which are more likely to serve as source for FDI exports than their characteristics project export lower flow of FDI than is predicted by their characteristics. This negative correlation suggests that the source countries with relatively low setup costs are also those with high marginal productivity of capital.
Keywords: Foreign Direct Investment; Lucas Paradox; Setup Costs
JEL Codes: F1; F3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| lower setup costs (D29) | higher marginal productivity of capital (D24) |
| lower setup costs (D29) | higher FDI flows (F21) |
| fixed setup costs (D24) | decision to invest (G11) |
| GDP per capita differences (F62) | decision to invest (G11) |
| GDP per capita differences (F62) | size of FDI flows (F21) |
| unobserved factors (C29) | likelihood of investment (G11) |
| unobserved factors (C29) | size of FDI flows (F21) |