Hajderllari, Luljeta

Karantininis, Kostas

Lawson, Lartey Godwin

English

Research Papers in Economics

 
 
 
 
 
 
Gravity model of outward FDI and trade in Agri-food in Denmark 
 
 
 
Luljeta Hajderllari* 
Kostas Karantininis** 
Lartey Lawson* 
 
*University of Copenhagen 
**University of Copenhagen & Swedish University of Agricultural Sciences 
 
 
The Names of the Authors Appear in Alphabetical Order – No Senior Authorship 
Assigned 
 
 
 
 
 
 
 
 
Paper prepared for presentation at the EAAE 2011 Congress 
Change and Uncertainty 
Challenges for Agriculture, 
Food and Natural Resources 
 
August 30 to September 2, 2011 
ETH Zurich, Zurich, Switzerland 
 
 
 
 
 
Copyright 2011 by L. Hjderllari, K. Karantininis.L. Lawson. All rights reserved.  
Readers may make verbatim copies of this document for non-commercial purposes by 
any means, provided that this copyright notice appears on all such copies. 
 
 Gravity model of outward FDI and trade in Agri-food in Denmark 
 
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Gravity model of outward FDI and trade in Agri-food in Denmark 
 
Introduction  
  Foreign direct investment (FDI) stock is one of the components that may contribute to the 
globalization process given that it is growing more rapidly than international trade. Stocks of FDI, 
aided by the removal of many national barriers to capital movements and measures to enhance 
integration within regional markets have expanded rapidly in recent years.  
  There are different views regarding the effect that foreign investment can have in the local 
economy. Alguacil and Orts (2003) stress that, theoretically either relationship (positive or 
negative) may exist between inwards FDI and imports. One view holds that FDI can have negative 
effects on receiving countries as a result of the local companies being pushed out of the market by 
big companies from outward FDI countries. Thus for a receiving country, a negative relation 
between FDI and trade will mean that its exports and imports reduce and increase respectively to 
diminishes the benefits of FDI. This leads economists to once considered FDI as a substitute for 
trade. Intuitively, when the main aim of outward FDI is to lower transaction cost or other trade 
barriers by induced investment for producing goods that are already exported from the host, then 
inflow FDI and imports in the home countries are expected to be substitutes. 
  Another view holds that the relationship between FDI and trade is complementary. FDI can be 
an important source of needed capital, knowledge and technology for the poorer countries’. A 
positive relation between FDI and trade may raise the opportunities of increasing the production of 
goods that otherwise need to be imported hence the increase in domestic manufacturing output 
reinforcing increased productivity (Alguacil and Orts, 2003). Furthermore as suggested by 
Rodriguez and Pallas (2008), trade and particularly imports, if linked to FDI, help economic growth 
through importing of ideas, intermediate goods and investments. Thus suggesting that increase 
productivity is the main focus for increase FDI and subsequently the complementary relationship 
between imports and FDI. 
  Pick and Warth (2005) suggested that cross border capital flows allows a company to acquire 
control of a subsidiary in another country. This seems to support the claim by Dries and Swinnen 
(2006) that most transition countries closer to the EU, received a large inflow of FDI in recent 
years. Thus, FDI avoids trade barriers and transportation cost allowing firm and farmers to increase 
their efficiency and their income by investing in foreign subsidiaries within distance and conducting 
transactions within the firm or farm rather than between them. Building factories in short distance 
foreign countries is one way of avoiding tariff barriers.  
  Generally the relationships between FDI and trade are aggregated to reflect investment and 
subsequent production and the trading activities that are expected to take place in an inflow country. 
However, FDI can be a useful measure of agri-food globalization i.e. by focusing on the food 
industry FDI.  
  Within the food industry, Gopinath et al. (1999) confirmed a small substitution effect between 
U.S FDI and the exports of the food processing goods of ten high-income countries. Onnen (1997) 
also for the U S found that FDI and food exports are complements indicating that foreign direct 
investment increases trade. 
  Overend et al. (1997), find both substitution and complementarity effect  and categorize the 
development of relationship between trade and FDI as being exports alone in the first stage, 
complementary exports and FDI in the second stage, and a final stage of substitution at higher 
levels of FDI. The data used is firm level data from 1978 to 1983, 
  Malanoski et al.1997 find that exports may serve as a precursor to FDI, but they find no 
strong support for either a complement or substitute relationship between FDI and exports. They Gravity model of outward FDI and trade in Agri-food in Denmark 
 
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conclude that the trade- FDI relationship differs depending on the level of economic development in 
the host country. 
  The Danish FDI outflow started to grow in the late 1980s. The FDI outward from Denmark is 
lower compared to other countries of comparable size, both on an aggregate level and in relation to 
gross domestic product (GDP) (OECD, 1995).For this reason it is interesting to use Denmark as a 
case study and also because there is a decrease occurring in the FDI flows even though the size of 
inflow and outflow flows in any given year is continuing to be larger than the year before 
(Danmarks Nationalbank, 2004). Denmark seems to experience an outward capital flow that is 
larger than the inflow. 
  This paper investigates the factors that affect the expansion of the Danish Food-FDI outward 
127 countries. 
 
Methodology and data  
Specified regression model 
  To investigate the relationships between Danish Food-industry FDI outward and trade, the 
gravity model using the translog functional form was specified and tested against a Cobb-Douglas 
functional form. The model accounted for receiving country accountability, political stability, 
production intensity and the population. The trade variables are represented by the exports and 
imports from Denmark to the 127 Food-FDI receiving countries as well as the exports of the 127 
receiving countries to the world. The gravity variables are the physical distance and the common 
border /language between Denmark and the Food-FDI receiving countries.  
i ki ji jk ji j i x x x y ε β β β + + + = ∑∑ ∑ ln ln ½ ln ln 0  
Where y is the Food-FDI outward, i = 1 to 127 countries, xj  the 8 explanatory variables in question,  
and xji xki are the product terms and εi is error term expected to be N(0,1). 
The explanatory variables are presented in text box below.  Gravity model of outward FDI and trade in Agri-food in Denmark 
 
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Text box. List of the x explanatory variables and symbols used for the model parameter 
estimates  
e - is the food exports of home country (i) to host country (j)  
i - food imports of home country (i) from host country ( j)  
km - is the physical distance between home country (i) and host country (j).The expected sign of b 
is positive 
g - is the ratio of GDP per capital of the host country (j)/GDP per capital of home country (i). The 
sign of coefficients in GDP per capital are indeterminate. 
a - is accountability, the first variable as a representative of the institutional distance of the host 
country (j) 
p - is the political stability second variable representative of the institutional distance of the host 
country (j). The expected sign of the coefficient in P is positive since many of the governance 
indicators are measured in a positive sense, meaning larger values indicate greater quality 
eu - is dummy variable for common border and common language. There is no an excepted sign for 
the coefficient of this variable  
w - is the food export of host country j to the world 
c - is the population of the host country   
Note: home country represents Denmark and host country represents the rest of the world 
 
Data  
  The data set comprises data on FDI of food industry and trade in 127 different countries over 
the same period 2004-2008. The sources include Statistics Denmark, World Trade Organization and 
International Monetary Fund. From Statistics Denmark it was possible to extract exports and 
imports for the food industry of the home country to the world. The trade data for import and export 
of food industry of the host countries to the world are extracted by World Trade Organization. 
 
  The GDP, GDP per Capita and Population was extracted by International Monetary Fund for 
all the countries. Current GDP is used as a deflator of other variables such as food FDI, food 
exports, and food imports whilst GDP per Capita and Population are used to represent the size of 
economy. 
All the variables except the physical distance, institutional distance and the variable for the common 
border used are in logarithms. There are 127 countries and 5 years considered in our sample.  
The endogenous variable in our model is the food-foreign direct investment outward and the 
exogenous variables are aggregated food imports of the host country to the world, aggregated food 
exports of the host countries to the world, voice and accountability, political stability, physical 
distance and (EU) the variable for common border. 
 
Results 
 Gravity model of outward FDI and trade in Agri-food in Denmark 
 
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A translog functional model was tested against Cob Douglas one. The test suggests that the simpler 
Cobb-Douglas functional model is well suitable for describing the relationships between Food-FDI 
and the trade variables in question. Table 2 shows the parameter estimates for the Cobb-Douglas 
functional model. 
 
Table 2: Estimated parameters for the Cobb-Douglas functional form model 
  Cobb Douglas 
Variable Parameter  estimate  Standard 
error 
 
Intercept -1.21
NS 1.24   
e 0.82
* 0.33   
i -0.23
 NS 0.17   
a 0.29
 NS 0.73   
p 2.42
** 0.75   
g 0.83
 NS 0.55   
w 0.59
* 0.24   
c 1.36
** 0.41   
km 0.00015
 NS 0.00016   
eu 1.78
 NS 1.74   
R-squared 0.55 
NS indicates no significance, * indicates significance at 95% level, ** at 99% level 
 
  The parameter estimates for the imports of the home country to the host (i), the accountability 
variable (a), the gdp per capita (g), the physical distance (km) and  the variable of the common 
border (eu) are not significantly different from zero (p>0.05) and hence do not affect outward food-
FDI. However, parameters estimates for  exports of the home country to the host country (e), 
political stability (p), food export of host country to the world (w) and population size (c) are 
significant (p<0.05). These parameters all have a significantly positive effect on outward Food-FDI. 
Looking at the magnitudes of the parameter estimates, these indicate that political stability has the 
largest influence on fdi outward, while common border has the second most influence, exports of 
home country to host country third and food export of host country to the world has the smallest 
parameter estimate.  
  The parameter estimate for exports suggests that a unit increase in exports of the home 
countries to host countries increases outward of Danish food FDI by 0.82 units. 
 
Discussion and conclusion  
 
  What is the reason for FDI from Denmark towards the rest of the world? If relationship 
between food FDI outflow from the home country and imports of food products to the host country 
is positive, so that FDI outflows and imports are substitute, the objective of FDI may be resource 
seeking. In contrary, a positive relationship between FDI outflow and exports indicate that FDI 
enhance exports and the objective is market seeking (Nagubadi and Zhang, 2008). If Danish exports 
a lot of goods to another country that means that in this country is already created a demand for the 
Danish goods. Therefore in order to support their goods they have to invest money. On the other 
side when the other countries export to Denmark their own goods, there is no initiative from the 
Danish side to invest to these countries.  
  Our results show the more the host countries export to the world the more Danish food 
companies invest to these countries. It is possible that Danish agri-food uses these countries as a Gravity model of outward FDI and trade in Agri-food in Denmark 
 
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hub to export further to third countries. Also the institutions are very important in Danish Agrifood 
firm’s decision to invest abroad. The more stable from political point of view is a country the more 
attracted this country became for the Danish food companies to invest. Danish agri-food firms also 
prefer to invest in large countries where local demand is high. 
 
References 
Alguacil, M. T. and Orts, V. (2003). Inward foreign direct investment and imports in Spain. 
International Economic Journal 17(3):19-38. 
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København: Finansiel Statistik, Oktober, Danmarks Nationalbank. 
Dries, L., Reardon, T., and Swinnen, J. F. M. (2004). The rapid rise of supermarkets in Central and 
Eastern Europe: Implications for the agrifood sector and rural development. Development 
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The economics of foreign direct investment and trade with an application to the US food processing industry.

The rapid rise of supermarkets in Central and Eastern Europe: Implications for the agrifood sector and rural development. Development Policy Review

Gravity model of outward FDI and trade in Agri-food in Denmark

Gravity model of outward FDI and trade in Agri-food in Denmark

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