DP5318 FDI, Allocation of Talents and Differences in Regulation

Author(s): Giovanni Pica, José Vicente Rodríguez Mora
Publication Date: October 2005
Keyword(s): heterogeneous agents, multinational firms, policy harmonization
JEL(s): E61, F23, F41
Programme Areas: International Macroeconomics, Public Economics, International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5318

This paper presents evidence on the effect of countries proximity in regulation on bilateral FDI flows. By exploiting the OECD International Direct Investment Statistics and data on nationwide regulation levels, we find a significant negative effect of the absolute value of the difference between countries indexes of regulation on the associated bilateral flows of FDIs, controlling for each country regulation level. Motivated by this evidence, we build a model where agents are heterogeneous and differ in their abilities to be entrepreneurs or workers. Entrepreneurs may engage in FDIs, which entails incurring additional fixed costs, one of which is the cost of learning the foreign regulation. In this framework, more similar regulations foster FDI, raise wages, output and productivity. The increase in productivity is the consequence of very efficient foreign entrepreneurs driving out of the market inefficient local firms, improving the allocation of talent in the economy as a whole.