Testing for the Bidirectional Relationship Between FDI in Services and Trade in Services: Evidence from Emerging Economies

Published date01 August 2023
AuthorP. Jithin,M. Suresh Babu
Date01 August 2023
Subject MatterArticles
Testing for the Bidirectional
Relationship Between
FDI in Services and
Trade in Services:
Evidence from
Emerging Economies
P. Jithin1 and M. Suresh Babu2
We examine the two-way links between foreign direct investments (FDI) in services
and trade in services for 26 emerging economies from 2003 to 2015 using sectoral
and sectoral disaggregated FDI data. Within a multivariate framework, we use panel
unit root tests, recently developed heterogeneous panel cointegration and panel
vector error correction model (VECM). Our results confirmed the cointegrating
relationship between trade in services, FDI in services, financial services FDI and
nonfinancial services FDI. We find the existence of long-run unidirectional causality
from trade in services to FDI in services. However, the disaggregated analysis shows
a bidirectional link between nonfinancial services FDI and trade in services in the
short run. Still, there is no causality between financial services FDI and trade in
services both in the short run and long run. The result also shows the evidence of
unidirectional causality running from trade in services to nonfinancial services FDI
in the long run. It implies that sectoral decomposition matters in the FDI–trade
nexus in emerging economies.
JEL Codes: G20, F14, G20, F23
Emerging markets, foreign direct investment, services, panel vector error
correction model
1 Department of Economics, Christ University, Bangalore, Karnataka, India.
Department of Humanities and Social Sciences, Indian Institute of Technology Madras, Chennai, Tamil
Nadu, India.
Corresponding author:
P. Jithin, Department of Economics, Christ University, Bangalore, Karnataka 560029, India.
E-mail: jithinpchand21@gmail.com
Foreign Trade Review
58(3) 412–427, 2023
© 2022 Indian Institute of
Foreign Trade
Article reuse guidelines:
DOI: 10.1177/00157325221095650
Jithin and Babu 413
According to UN World Investment Report (UNCTAD, 2015), worldwide ows
of foreign direct investment (FDI) have grown at unprecedented rates, to reach a
total outow of US$1.7 trillion in 2015 compared to the US$159 billion in 1991.
This spurt in recent years can be attributed to the expansion of FDI in service
industries. For example, FDI in services accounted for a quarter of worldwide FDI
stock in 1970; by 1990, the percentage of services FDI had risen to 50%, and by
2005, the share of services FDI in global stock had risen to two-thirds (UNCTAD,
2015). The multinational company’s share in the world trade increases steadily
over a period. These changes in the world led to changes in the overall trade
pattern and performance of many countries, including emerging economies.
The last two decades witnessed the emergence of the services sector as the most
prominent sector in the global economy with more than 60% of total output and a
larger employment generating sector (Hoekman & Mattoo, 2008). In addition to
the employment and output generation, it also attracts a generous portion of total
FDI (UNCTAD, 2009). Along with these, the tremendous increase of trade in
services leads to an increase in productivity and large-scale production, leading to
economic growth in both developed and emerging economies. This trend is more
or less visible in world trade statistics; the ratio of services trade in goods trade
was around 20% in 1980, which was increased to 27% in 2010 (WDI, 2011). This
phenomenon is directly visible in emerging economies regarding improvements
in service-led growth in the last three decades. FDI plays a vital role in trade in
services across emerging economies and among developed economies.
The Industry Commission (Hardin & Holmes, 1997) argues that there is a high
chance of complementarity between FDI and services trade, mainly because of the
characteristics of the services sector. In trade literature, the contribution of FDI
flows for trade in emerging economies has emerged as a subject undergoing intense
study. Higher FDI inflows may influence the export pattern and export performance
of the emerging economies, depending on the country-specific factors. Given these
facts, we can observe both direct and indirect effects of FDI on exports. Zhang and
Song (2001) argued that multinational firms could be considered a primary source
to increase exports in the short run, especially if the domestic firms are lagging the
multinational firms in terms of technologies and skilled labour. In terms of updated
technology, international safety criteria and international social and distribution
norms, the presence of multinational corporations has spilled over to local firms.
The indirect benefits of FDI on exports or trade include the enhancement of domestic
businesses’ competitiveness, which leads to a rise in indigenous firms’ exports. The
export of domestic firms will also increase via vertical linkages of FDI. In the case
of domestic firms, FDI is considered the main source for the upgradation of
technology, quality of production and improved exports (Din, 1994). Because of the
perishability, inseparability, intangibility, heterogeneity and commercial presence
of the service sector, there has been no consensus on the relationship between FDI
in services and commerce. When services are obtained from an international
corporation rather than a domestic company, domestic customers perceive a higher
level of risk. In the case of the service sector, commercial presence characteristics
play a key role in the FDI–trade nexus.

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