The Influence Of Trade Integration To Foreign Direct Investment

Since the late 1990s, the international trade theory and the financial development theory are increasing integrated, the research for both of them have become an important direction of the current international trade academic. As Classic Heckschel-Olin-Mundell model argues that, the integration of trade and capital flows can be substituted in a way. That is mean the integration of trade can quickly reduce the motivation of the capital flowing to the capital-scare countries. But the model didn’t consider the existent of the financial frictions, also the financial friction is varies in the world, it will affect the allocation of the capital and labor. This paper demonstrates due to different financial friction, the trade integration and capital movement have a certain degree of complementarity in finance underdeveloped countries. For financial underdeveloped countries, trade integration will promote these countries to attract foreign direct investment inflows rather than reducing the motivation.First, from the theory research, based the classic model of two countries-two department-two products, with the Cobb-Douglas production function, we introduce the loan capital to our model. The loan capital borrowing from financial structure, will be restricted to financial market efficiency (from the perspective of financial friction). This paper divide the financial friction into two types, one is integrity financial frictions, one is structured financial friction. And according to the size of structured financial friction, we distinguish the two department, one is constrained sector, the other is unconstrained sector. From this, we can examine the role of financial friction in the allocation of capital and labor. At the same time, considering the scale of sector and technical differences, this paper made an assumption:only the capitalist in constrained sector know how to produce the good of this department, that means the capitalist in constrained can invest his capital to the two sector, but the rent capitalist in unconstrained sector can only invest his capital to this department. First, we consider the closed economy equilibrium, the integrity financial frictions will reduce the social capital endowment, but will not distort the allocation of capital and labor, influence the rental rate and wage. While the structured financial friction will guide the capital to unstrained sector, make the capital of constrained sector be relatively scare, the rental rate drops, the relative price of unstrained department decreased at the same time. When the economy opening to the outside world, small southern countries with larger financial friction can only passive to accept the relative price of the world, and the relative price will be larger than the one in closed equilibrium. This will result the small south countries export unconstrained sector and import the constrained sector. From this, we allow the capital flowing across counties, the paper distinguish two situation, facing less trade barriers or larger barriers, to identify the relation between trade integration and capital flow. We found that when the unconstrained sector facing larger trade friction, the capitalist can’t obtain capital income through trade, also the rental rate of southern lower than the one of northern, so the capital will flow from the southern to northern. But when the small south country facing small trade friction, the trade will increase the rental rate of northern, this will attract foreign direct investment. And there is a threshold of trade barrier, if the trade barrier is higher than the threshold, capital flows to northern, while lower than the threshold, the capital will flows to southern countries. Empirical research, through the construction of the regression model of foreign direct investment, exports and financial friction. We do the analysis from the data of 174 countries through year 1995 to 2014. In this paper, we examine the relation of trade integrity and capital flow in the countries with larger friction. So we divide the world into two categories according to the average of financial frictions. As for the methods, we used the dynamic panel system GMM and differential GMM. The results show that trade integration doesn’t like the classic Herschel-Olin-Mundell will substitute the capital flow, but will promote the capital flow. The deeper of the trade integrity the more of the foreign direct investment. The more of the financial friction the less of the foreign direct investment. But the financial friction will affect the capital allocation, through the trade integrity increase the motivation of capital flow from northern to southern.From two aspect of theory hypothesis and empirical research, we can come to a conclusion that the financial friction also has its good aspect, will increase the foreign direct investment through trade integrity.