WIIW The Vienna Institute for International Economic Studies - Wiener Institut für Internationale Wirtschaftsvergleiche

Mario Larch

We develop a structural framework that accounts for and decomposes the relationships between trade, growth (physical capital accumulation), and foreign direct investment (FDI). As a byproduct, our theory delivers an intuitive FDI-gravity system that translates into a familiar estimating gravity equation. The FDI-gravity estimates are similar to the corresponding trade indexes, however, we also document some notable differences between them. A counterfactual experiment simulating the effects of trade liberalization between Canada and the European Union demonstrates the effectiveness and the capabilities of our framework.