International Journal of Industrial Organization

19 (2001) 163183
www.elsevier.com / locate / econbase

Trade, foreign direct investment and industry

performance
Catherine Y. Co*
Department of Economics, University of Central Florida, Orlando, FL 32816 -1400, USA
Received 1 September 1997; received in revised form 1 February 1998; accepted 1 July 1999

Abstract
This paper investigates the US margins effect of imports and FDI using a panel of 448
manufacturing industries for 19821990. In the single equation two-way fixed effects
regressions, greenfield FDI has no significant effect on margins; while there is some
indication that non-greenfield FDI affect margins and the effect is found to depend on the
level of industry concentration. When potential endogeneity among variables are taken into
account, both types of FDI are found to increase margins. However, for non-greenfield FDI,
the effect appears with a lag of two periods. For the most part, the results indicate that the
positive effect on margins holds for industries with low levels of concentration. Beyond
some critical level, the competitive effect of FDI predominates. 2001 Elsevier
Science B.V. All rights reserved.
Keywords: Foreign direct investment; Margins; Technology sourcing; Spillovers
JEL classification: F23; F10; L60; C30

1. Introduction
One of the stylized facts that characterize the 1980s is the rapid increase in the
amount of foreign direct investment (FDI) into the US. The share of US affiliates

* Tel.: 11-407-823-3763; fax: 11-407-823-3269.

E-mail address: catherine.co@bus.ucf.edu (C.Y. Co).
0167-7187 / 01 / $ see front matter 2001 Elsevier Science B.V. All rights reserved.
PII: S0167-7187( 99 )00042-9

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C.Y. Co / Int. J. Ind. Organ. 19 (2001) 163 183

of foreign companies in total US manufacturing value added increased from 3.6%

in 1977 to 15.0% in 1992; further, their share in total manufacturing employment
also increased from 3.5% in 1977 to about 11.6% in 1992.1 Observations on the
growing importance of foreign firms have sparked debates as to the costs and
benefits of foreign firms direct participation in US industries. Proponents of FDI
point to the additional employment or the superior technology that foreign firms
bring into the US. Those worried about the growing presence of foreign firms
argue that these employment effects tend to be small since most FDI are through
the buy-out of existing US firms; there is also concern that FDI into the US means
foreign appropriation of US technology. Studies on the effect of FDI on the US
economy mostly focus on employment, technology and trade balance issues (see,
e.g., Young and Steigerwald, 1990; Kogut and Chang, 1991; Orr, 1991). There has
been little done to study the effect of FDI on margins.
The margins effect of imports into the US is well studied. Empirically, there is
consensus that imports are a source of competitive discipline (see Caves, 1985, for
a survey). In particular, this discipline is larger in more concentrated industries.
This result is robust in most single- and simultaneous equations models using US
and non-US data.2 Except for de Ghellinck, Geroski and Jacquemins (GGJ
hereafter) (1988) study of a panel of 82 three-digit Belgian manufacturing
industries for 19731978, the imports-as-market discipline hypothesis has not
been extended to account for FDI. This paper makes its contribution by
incorporating FDI into the imports-as-market discipline literature. Perhaps one
factor that may have hindered our ability to address the relationship between FDI
and margins is the lack of detailed and usable data on foreign affiliates share in
US output or value added.3 The International Trade Administration (ITA) has an
annual listing of FDI occurrences at the four-digit SIC level which dates back to
1974. This data set can serve as a good proxy for foreign firms direct participation
in US production and allows one to investigate the US product market competition
effects of imports and FDI.
In the single equation two-way fixed effects regressions, greenfield FDI has no

The Bureau of Economic Analysis defines a US affiliate as a US business enterprise which a

single foreign person owns or controls, directly or indirectly, 10% or more of the voting securities of an
incorporated business enterprise or the equivalent interest in an unincorporated business enterprise.
2
For example, Domowitz et al. (1986) (DHP hereafter) and Katics and Petersen (1994) use US data.

Levinsohn (1993), Jacquemin and Sapir (1991), Stalhammar

(1991) and De Ghellinck et al. (1988) use
non-US data.
3
The US Bureau of Economic Analysis has made available four-digit SIC level data on the
value-added share of US affiliates of foreign firms in domestic production starting in 1988. This data
set would have been the ideal data for our analysis. However, data are suppressed in several cases and
are consistently available only for about 110 four-digit SIC industries.

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165

significant effect on margins. There is some indication that non-greenfield FDI

affect margins and the effect is found to depend on the level of industry
concentration. Since some authors have found simultaneity between margins, trade
and concentration ratios, the margins equation is also estimated using two-stage
least-squares for fixed effects panel.4 When endogeneity is taken into account, both
greenfield and non-greenfield FDI occurrences significantly affect margins. New
plant FDI seems to increase the margins of industries with low levels of
concentration. Greenfield FDI typically involves new facilities and entrants would
adopt the best available technology which makes them more efficient and
contribute to an increase in industry margins. However, beyond some critical
level, the competitive effect of FDI predominates (margins decline). This is
consistent with the findings of the imports-as-market discipline literature where
. . . the competitive discipline of imports is conditional upon potentially noncompetitive conditions among domestic producers. There has to be something to
discipline. (See Caves, 1985, p. 379) With regard to lagged FDI, only its
interaction with CR is significant and the coefficient happens to be positive.
Margins rise with industry concentration. Perhaps this is indicative of foreign firms
deploying firm-specific assets upon entry and this knowledge spills over domestically with a lag and the potential technological spillovers may be larger in
concentrated industries. The results for non-greenfield FDI indicate that the effect
on margins is less immediate; it appears with a lag of two periods. One possible
explanation for this is that it takes time for firms to integrate their existing and
acquired human and technological resources. Any efficiency benefits appear with a
lag. The interaction between one-period lagged FDI and CR is significantly
negative. This again is consistent with the findings of the imports-as-market
discipline literature. Although some interesting findings are found, the issue
requires more study because the interpretations are based on assumptions made
about the motivations behind FDI; no attempt is made to test these motivations. A
better understanding of the motives will strengthen the conclusions found in this
paper.
To put the empirical analysis in perspective, the next section reviews some
theoretical models that address the question of why firms invest abroad. This is
because the effect of FDI on product market competitiveness may depend on
firms motivations for entering foreign markets. In Section 3, some of the
econometric issues involved in the empirical investigation will be reviewed and
then the models estimated will be discussed. Results are presented and analyzed in
detail in Section 4. Section 5 contains some concluding comments.

See, for example, Martin (1979), Geroski (1982) and Stalhammar

(1991). These papers are briefly
reviewed in Section 3.

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C.Y. Co / Int. J. Ind. Organ. 19 (2001) 163 183

2. FDI and host country industry margins: the connection

Firms entry mode choices into foreign markets depend on the interactions
among ownership, location and internalization factors.5 Firms are typically
assumed to possess firm-specific advantages (e.g., superior technology) that allow
them to overcome the operational advantages of host country firms. These firms
have the option of deploying these firm-specific advantages themselves or
licensing these out. The former is typically preferred because the latter option
involves additional costs, such as, contract enforcement cost. These two factors
interact with location factors. These location factors can be policies that encourage
FDI (e.g., investment incentives), or location-specific disadvantages (e.g., tariffs)
that induce firms to engage in FDI production instead of exporting. When foreign
entrants deploy their firm-specific advantages, the effect of FDI on margins
depends on whether some incumbents exit. If there is no exit by incumbents (and
demand is stable), new plant FDI can lead to lower margins because this type of
FDI increases domestic capacity and production, ceteris paribus, leads to lower
prices and margins.6 On the other hand, margins may rise if foreign entrants adopt
the latest technology which can translate to an increase in industry margins.
Benefits from superior foreign technologies can also spillover to domestic firms;
contributing to a rise in margins too.7
Besides these traditional explanations, policymakers in the US and Europe have
recently raised the possibility that firms may engage in FDI to take advantage of
existing host country technologies or technical capabilities. That is, foreign firms
may be sourcing host country technologies. The sourcing argument is made given
the observation that the bulk of FDI is through mergers and acquisitions. For
example, about 70% of the FDI inflows to developed countries during 198690 is
through acquisitions (UNCTAD, 1994). The academic profession has also looked
at the issue and there are some empirical evidence supporting the sourcing motive
for some types of FDI.8 As Neven and Siotis (1996) point out, firms would

This is Dunnings (1988) OLI paradigm. See Caves (1996) and Markusen (1995) for recent surveys
of the FDI literature.
6
This result follows from Horstmann and Markusens (1992) model where firms are assumed to
compete in quantity.
7
Wang and Blomstrom (1992) develop a model that endogenizes the age and rate of foreign firm
technology (assumed to be superior) transfer. One implication of their model is that spillovers from FDI
can make domestic firms more efficient; hence industry margins can rise with FDI. See Blomstrom and
Kokko (1996) for an extensive review of the FDI and spillover literature.
8
To test the sourcing argument, Kogut and Chang (1991) used the difference in industry R&D
intensities between host and source countries. A significant positive coefficient is taken to be an
indication of sourcing as the motive for FDI. Controlling for other factors, they find some evidence that
the Japanese enter into joint ventures with US companies to source some US technological advantage.
Following Kogut and Chang (1991), Neven and Siotis (1996) also find some indication that technology
sourcing may be the motive behind US and Japanese FDI into four EC member countries for 198489.

C.Y. Co / Int. J. Ind. Organ. 19 (2001) 163 183

167

probably engage in non-greenfield FDI (e.g., acquisitions, joint ventures) to take

advantage of spillovers emanating from the local industry. Under the sourcing
motive, domestic technology is assumed to be superior, hence, industry-wide
margins are expected to fall initially if existing host country assets are taken over
by less knowledgeable foreign firms. Margins may rise once foreign firms are
able to learn the technology that they have acquired.9
One approach in getting a handle on the issue is to look into the temporal nature
of FDI, the industries and countries involved. These details may give insights as to
both the motives for FDI and their consequent effects on margins. The annual
breakdown of the FDI counts for selected industries appear in Table 1. For the
period 198290, almost 5271% of new plant FDI are concentrated in food

Table 1
Number of FDI by type of investments a
Food and
Kindred
SIC 20
Greenfield FDI
1982
1983
1984
1985
1986
1987
1988
1989
1990
Total, 198290

Chemicals
& Allied
SIC 28

Industrial
Mach.
SIC 35

Electronic
Oth Elec
SIC 36

Transport
Equip.
SIC 37

Total b

2
7
5
2
6
6
2
7
9
46

14
21
16
11
16
23
7
6
9
123

7
15
11
8
9
20
9
9
4
92

7
14
20
10
13
12
12
13
8
109

2
11
10
12
13
22
15
12
19
114

52
107
90
63
92
141
86
80
69
780

Non-Greenfield FDI
1982
12
1983
11
1984
18
1985
23
1986
33
1987
41
1988
38
1989
34
1990
21
Total, 198290
231

25
29
38
46
50
53
52
66
48
407

34
41
28
39
50
84
74
45
40
435

26
47
49
38
50
89
51
61
54
465

9
9
17
4
9
22
20
19
14
123

167
246
245
289
335
476
407
380
305
2850

Note: These are calculated from ITAs Foreign Direct Investment in the United States, various
years.
b
Includes these five industries and all other manufacturing SIC industries.
9

I wish to thank an anonymous referee for suggesting that I consider the possible motivations behind
FDI for explaning the observed margins effect of FDI.

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C.Y. Co / Int. J. Ind. Organ. 19 (2001) 163 183

(SIC20), chemicals (SIC28), machinery (SIC35), electrical (SIC36) and transport

(SIC37) equipments.10 The same five two-digit SIC industries received the most
non-greenfield FDI. They comprised about 5263% of the total non-greenfield
FDI for the period. The same sets of countries are involved in both greenfield and
non-greenfield FDI.11 An interesting pattern is that non-greenfield FDI (from all
source countries) does not seem to precede greenfield FDI. That is, we do not
observe a concentration of non-greenfield entries first, then followed by greenfield
entries. Foreign firms taken as a whole seem to use both modes of entry at the
same time.12 These industries differ in that the number of greenfield and nongreenfield FDI counts are almost the same in transport equipment (SIC37) while in
the other industries, greenfield FDI is between 20 and 30% of non-greenfield FDI
counts. Interestingly, in 1987, the four-firm concentration rate for transport
equipment is about 52%, while the rates for the other industries fall between 11
and 19%. This pattern suggests that the margins effect of FDI may depend on the
industrys concentration rate. An industrys foreign entry mode mix may be a
function of the industrys concentration rate. This suggests that even if foreign
firms have firm-specific advantages, if they are to compete effectively in highly
concentrated industries, they may need to complement their new plant entries by
entering into joint ventures with (or acquiring) domestic incumbents. It does seem
natural then to test whether the practice of the imports-as-market discipline
literature of including an interaction term between import share and concentration
rate applies to FDI too. This and other issues are explored in the next section. The
econometric models used are also discussed in detail.

3. Empirical issues and model specification

A two-way fixed effects panel model is employed in the estimation of the
margins equation. Data used cover the period from 19821990 for 448 four-digit

10
One should note that using some other measure (e.g., the share of US affiliates to total US value
added) will show high foreign concentration in chemicals (SIC28), stone, clay and glass (SIC32),
electronics (SIC36) and primary metals (SIC33), so these numbers should be interpreted with caution
(See Graham and Krugman, 1995, p. 43).
11
The top greenfield investors with the number of occurrences for the period in parentheses are:
Japan (271), Germany (49), UK (35), Canada (24), France (23) and The Netherlands (10). For
non-greenfield, the country rankings are: Japan (614), UK (309), Germany (166), Canada (126), France
(105) and The Netherlands (67).
12
The identities of the entrants need to be known for this statement to be precise; perhaps different
firms are involved in the different entry modes. However, it does seem quite interesting that a simple
panel regression of current greenfield FDI against lagged non-greenfield FDI (up to three periods) has
an R 2 value of 0.17 and positive significant coefficients; and a similar panel regressing current
non-greenfield FDI on lagged greenfield FDI (up to three periods) has an R 2 value of 0.28 and
significant positive coefficients. These results taken together seem to suggest complementarity
between both modes.

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169

SIC industries.13 This approach mitigates the concern raised against the use of
cross-section data in industry analysis which result in biased coefficient estimates
because of omitted variables and / or measurement errors (See Schmalensee, 1989,
for a survey). The specification used is similar to that used by DHP (1986) and
includes a measure of foreign participation via FDI.14 This single margins equation
is
PCM it 5 ai 1 gt 1 b 9Xit 1 it , i 5 1, . . . ,N; t 5 1, . . . , T

(1)

where PCM is price-cost margins, the matrix X contains industry four-firm

concentration rates (CR), growth of industry sales (GROWTH), investment
output ratio (KO), an openness measure (OPEN), the number of FDI occurrences
for the period (FDI), one- and two-period lagged FDI (LFDI and L2FDI) and
interaction terms between CR and import shares (IMP]CR), between CR and
GROWTH (GR]CR) and between CR and KO (KO]CR). Each of the FDI
variables is also interacted with CR. is an error term identically and independently distributed over i and t. a and g represent industry-specific fixed (at
the two-digit SIC level) and time effects, respectively.
Although the relationship between PCM and CR is found to be weak
empirically (but the relationship is statistically significant), there is a well
established theoretical relationship between the two variables.15 For example,
under the assumption of some barriers to entry, it is possible to observe higher
margins in more concentrated industries. Alternatively, higher margins could result

Table 2
Descriptive statistics a
Variables

Mean

Standard
deviation

PCM
CR
OPEN
IMPSH
AD
GROWTH
KO
SCALE
SKILL

0.289
39.55
58.98
12.98
0.048
4.210
3.012
10.47
21.90

0.096
20.52
27.17
14.78
0.214
13.78
2.012
56.01
6.619

Source: authors calculations.

13

All data are based on 1972 SIC definition which are available for 448 (out of 450) industries.
These are described in detail in Appendix A. Table 2 contains the descriptive statistics of the data used.
Unavailability of data for some years meant unbalanced panels must be employed.
14
See Table 7 in DHP (1986, p. 13).
15
As most industrial economists now realize (see Schmalensee, 1989, for a review), these two
variables are endogenous to each other and the direction of causality is not as clear as once thought.

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C.Y. Co / Int. J. Ind. Organ. 19 (2001) 163 183

from a smaller number of firms sharing the market which perhaps can make
collusion easier, hence margins are expected to be larger in more concentrated
industries. GROWTH is included to account for the possibility that in the
short-run, increases in demand may lead to higher prices and margins. This
variable is interacted with CR to test if the effect of demand changes on margins is
likely to be larger in more concentrated industries. KO is included to control for
differences in margins due to investmentoutput intensity. This is used as a proxy

for capital intensity following Martin (1979), DHP (1986) and Stalhammar
(1991)
to name a few. This effect may differ across industries with different concentration
levels, hence, it is interacted with CR.
Because of trade- and / or FDI-related discipline, margins are expected to be
lower in industries which are more open. OPEN (5imports / imports1exports) is
included to capture the effect of both exports and imports on margins.16 While the
effect of OPEN on margins is ambiguous by construction, it nonetheless can give
us impressions as to how changes in trade- related discipline can affect margins.
As pointed out by GGJ (1988), an industry exposed to foreign competition is
uncompetitive when imports comprise a large share of external transactions
(imports1exports). For example, as the variable approaches one (OPEN increases), exports approach zero (one reason could be higher domestic relative to
world prices so more output is sold domestically). But it is unclear how a drop in
exports affects margins. The effect also depends on what happens to the level of
imports. If imports rise, margins can decline. As OPEN approaches zero (OPEN
declines), imports by the industry approach zero (one reason could be because
tariffs increase the cost of exporting to the market), ceteris paribus, margins can
rise. However, if this is accompanied by changes in the export and domestic
market sales mix, the effect on margins depends on the price differential in the two
markets.
A common practice in the imports-as-market discipline literature is the inclusion
of an interaction term between import share (IMPSH) and CR, call this IMP CR. It
]
is included to capture differences in the effect of imports across industries with
varying concentration rates. A negative coefficient implies that imports would
have larger competitive effects in more concentrated industries. This non-linear
effect has been empirically confirmed (see Geroski and Jacquemin, 1981, for a
theoretical treatment). For example, using a panel consisting of 185 four-digit SIC
US industries from 1958 to 1981, DHP (1986) find that import competition
reduces pricecost margins significantly in concentrated industries using OLS.

16
Ideally, we would like to include imports as a percentage of total shipments and exports as a
percentage of total shipments separately. These two variables are treated as endogenous variables in
simultaneous equation systems studying margins. Because of the limited number of exogenous industry
characteristics available, identification concerns resulted in the creation of the OPEN variable. A
similar approach is used by GGJ (1988).

C.Y. Co / Int. J. Ind. Organ. 19 (2001) 163 183

171

That is, the interaction term between industry import share and four-firm
concentration ratio is negative.
Three definitions of the FDI variable are used in the estimation.17 This
distinction is made since greenfield FDI involves the building of new plants that
expand production capacity. Other types of investments, such as mergers / acquisitions, involve only the transfer of ownership from existing domestic producers to
foreign firms. As reviewed in the previous section, different types of FDI may be
motivated by different factors and thereby may have different effects on margins.
Current, one- and two-period lagged FDI are included to account for the nature of
how the FDI data are collected and to allow for the possibility that projects may
take 13 years from project initiation to completion, hence the effects of FDI
appear with a lag.18 Following the imports-as-market discipline practice of
including an interaction between IMPSH and CR, it seems natural to introduce
variables where FDI is interacted with CR. These variables would capture the
differential impacts of FDI on industries with different concentration rates.
The second econometric issue to consider is the potential endogeneity between
some of the variables. For example, industry concentration has been found to
influence and is influenced by industry margins; and there is some evidence of
simultaneity between imports and margins (see Martin, 1979; Geroski, 1982; and
Schmalensee, 1989, for a survey). Further, there is some evidence that import and
export shares are endogenous in a system of equations investigating industry
margins. Geroski (1982) finds that import and export shares are endogenous using

US and UK data, respectively; while Stalhammar

(1991) cannot reject the null
hypothesis that export and import shares are exogenous using Swedish industry
data. A four-equation simultaneous panel is used to account for the potential
simultaneity between margins, concentration ratios and industry exposure to
foreign competition. In addition to the margins equation presented above, the
following equations are included in the system:
CR it 5 a2i 1 g2t 1 b 92 Sit 1 2it

i 5 1, . . . ,N; t 5 1, . . . , T

OPEN it 5 a3i 1 g3t 1 b 93 Zit 1 3it

(2)
(3)

17
The FDI data are taken from ITAs Foreign Direct Investment in the United States. This
publication lists FDI projects that show signs of completion (not actual completions); for example,
ground breaking in the case of new plants. See Appendix A for a detailed discussion of this data set.
18
The time it takes to complete projects vary from industry to industry; and, it also varies according
to the type of transaction. For example, according to JAMA (Japan Automobile Manufacturers
Association), Toyota Motor Manufacturing, USA, Inc., was founded on January 1986 and the
production start-up date for their Georgetown, Kentucky, plant was July 1988. This investment is
recorded in 1986 by ITA as new plant investment. New United Motor Manufacturing, Inc. (NUMMI),
a joint venture between Toyota and General Motors was founded on February 1984 and the production
start-up date for the Chevrolet Nova was December 1984. This investment is recorded in 1984 by the
ITA as a joint venture.

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C.Y. Co / Int. J. Ind. Organ. 19 (2001) 163 183

FDI it 5 a4i 1 g4t 1 b 94 Q it 1 4it ,

(4)

where the variables on the left hand side are assumed to be endogenous variables
in the system. The definitions of , a and g are similar to those in Eq. (1).
Matrix S in Eq. (2) includes PCM, GROWTH and average plant scale
(SCALE). A positive relationship between margins and concentration is possible.
Industries with high margins have the most incentive to maintain these margins by
keeping potential competitors out; hence, one would more likely observe these
industries to be more concentrated than otherwise. If growth in demand facilitates
entry into an industry, then CR may decline with industry growth. In the empirical
implementation, SCALE is defined as value added per plant; this is the best
available proxy for plant level scale-related entry barrier. The effect of SCALE on
concentration is ambiguous. Larger plant level entry barriers (SCALE) may
sustain high concentration levels. However, a negative relationship is equally
probable. Industries with low SCALE values appear concentrated perhaps because
of the importance of firm level barriers to entry (e.g., advertising) relative to plant
level barriers. It then appears that industries with relatively small plants (SCALE)
are highly concentrated. However, as Schmalensee (1989) points out, in the
concentration equation, the more appropriate proxy may be firm level entry
barriers rather than plant level entry barriers. This suggests that in addition to
SCALE, one should perhaps include a variable that controls for firm-level entry
barriers. The unavailability of firm-level data, such as advertising, call for some
caution in interpreting the results.
Matrix Z in Eq. (3) contains PCM, FDI, LFDI, L2FDI, the number of
anti-dumping petitions in year t (AD) and t21 (LAGAD). Industries with higher
margins are expected to attract more competition from abroad. Current and lagged
FDI are included since trade and FDI can be either substitutes or complements.
AD and LAGAD are included to control for the effects of trade restraints.19 The
effect of AD petitions on imports is ambiguous. Prusa (1997) finds that US
imports from countries named in the petitions decline, but imports from unnamed
countries rise. The sign of the coefficient depends on the magnitudes of these two
effects.
Finally, in Eq. (4), matrix Q contains PCM, payroll cost per employee (SKILL),
KO and SCALE. Industries with higher margins are expected to attract more FDI.
The other three factors represent barriers to entry for any firm. Multinational
enterprises (MNEs) usually have firm specific advantages (e.g., advance technologies) which require a more skilled workforce. A positive coefficient is

19

Ideally, effective protection rates are desired. But these measures are available only for a limited
set of four-digit SIC industries (See Hufbauer et al., 1986). The passage of the Trade Agreement Act of
1979 resulted in significant changes in anti-dumping laws. For the AD data to be consistent, data
starting in 1980 are used (See Staiger and Wolak, 1994, for a review of AD laws in the US).

C.Y. Co / Int. J. Ind. Organ. 19 (2001) 163 183

173

expected from SKILL, a proxy for what Markusen (1995) calls knowledge capital.
MNEs are usually found in technically complex industries which normally would
require a relatively large amount of physical capital investment. The investment
output ratio (KO) is used as a proxy for industry physical capital investment
requirements. Industries which are capital intensive would attract more FDI.
SCALE is included to control for industry differences in plant-level fixed cost
requirements. A positive coefficient is expected. As a Commerce Department
study (US, 1993) points out, FDI is more likely in industries that require large
plant-level fixed costs because having a large operation allows them to spread
costs (such as learning the host countrys language and business practices) over a
larger output volume.
The results for both the single equation fixed effects and the two-stage
least-squares fixed effects are presented and discussed in the next section.

4. Analyses of results
Table 3 contains the single equation two-way fixed effects regressions for the
margins equation.20 Model A includes all types of FDI occurrences; model B uses
new plant FDI counts only; and model C includes other types of investments. Both
current and lagged FDI are included as regressors.
FDI and its lagged values are insignificant in Model B; it appears that greenfield
FDI has no statistically significant effect on margins.21 It was argued that under the
assumption of no exit by incumbents, new plant FDI should lead to lower industry
margins because this type of FDI increase domestic capacity and production. If
some domestic establishments (or plants) close given foreign entry, supply will not
increase and margins may not be affected. There is some evidence of plant
closures. Table 4 lists changes in the number of establishments between 1982 and
1987 for industries which received large number of FDI occurrences. The table
also contains the average margins in 197881 and 198891 for these industries.
No clear pattern emerges as to the relationship between FDI occurrences, the
change in the number of establishments and margins. Margins are not significantly
affected by greenfield FDI possibly because the expected fall in margins due to
increases in capacity is countered by a rise in margins in those industries that
experienced net declines in the number of plants.
The coefficients for FDI and LFDI are both positive and statistically significant

20
Greenes Limdep Version 7 is used in all regressions. The two-way fixed effects model is judged
appropriate versus OLS using likelihood ratio tests.
21
Other lagged structures (one period lag only and up to three period lags) for FDI were tried and the
results are qualitatively the same as those in Table 3. The results are also qualitatively similar if all
interaction terms are excluded from the regression. These results are available upon request.

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C.Y. Co / Int. J. Ind. Organ. 19 (2001) 163 183

Table 3
Fixed effects regression results: pricecost margins a

CR
OPEN
IMP CR
]
GROW
KO
GRO CR
]
KO CR
]
FDI
LFDI
L2FDI
FDICR
LFDICR
L2FDICR
Adjusted R 2
F-stat
No. of observations

Model A

Model B

Model C

1.5577*
(0.1398)
0.5432*
(0.0617)
20.0201*
(0.0024)
0.1206
(0.2412)
10.4410*
(1.8577)
0.0183*
(0.0047)
20.1331*
(0.0376)
5.3663**
(2.4225)
6.5460*
(2.5312)
3.5603
(2.4524)
20.1175**
(0.0543)
20.1160**
(0.0586)
20.0280
(0.0554)
0.363
55.66
3833

1.4531*
(0.1398)
0.5216*
(0.0620)
20.0196*
(0.0025)
0.1945
(0.2430)
12.1690*
(1.8783)
0.0170*
(0.0048)
20.1612*
(0.0380)
2.4529
(6.010)
7.8482
(6.099)
5.4185
(5.0576)
20.0917
(0.1238)
20.1237
(0.1285)
20.0706
(0.1126)
0.353
53.26
3833

1.5726*
(0.1400)
0.5471*
(0.0616)
20.0202*
(0.0024)
0.1277
(0.2408)
10.7280*
(1.8470)
0.0182*
(0.0047)
20.1387*
(0.0374)
7.1444*
(2.7790)
7.5342*
(2.8969)
4.8737
(2.9870)
20.1470**
(0.0644)
20.1396**
(0.0678)
20.0414
(0.0690)
0.365
56.10
3833

Notes: The coefficients and their standard errors above are scaled by 1000. The numbers in
parentheses are standard errors. *, ** and *** denote significant at 1, 5 and 10%, respectively. In
Model A, FDI, LFDI, L2FDI include all types of FDI occurrences; in Model B, only new plant FDI
occurrences are counted. The FDI data used in estimating Model C include the following types:
merger / acquisition, equity increase, joint venture, plant expansion, and other FDI types. Estimated
coefficients for the industry / time dummy variables are excluded in the table. Likelihood ratio tests
indicate that the two-way fixed effects model is appropriate.

and their interactions with concentration are significantly negative in Models A

and C (see Table 3). The significant interaction terms imply that the effect of FDI
depends on the level of concentration. Let us focus on the results for nongreenfield FDI. In model C, at concentration levels below 48.60 and 53.97%, for
FDI and LFDI, respectively, the values of the partial derivatives are positive.22

22
For model C, PCM / FDI50.007144420.0001473CR; and PCM / LFDI50.00753422
0.00013963CR. Setting each equal to zero result in these critical concentration rates.

C.Y. Co / Int. J. Ind. Organ. 19 (2001) 163 183

175

Table 4
Average industry margins, plant closures and FDI occurrences a
SIC

3714
3674
2821
3079
3711
3651
3861
2869
3662
2819
3841
2813
2833
2911
3541
3679
2834
3573
3585
3621

Average PCM

Number of establishments b

7881

8891

Change (198287)

Change (%)

NEWFDI

OTHFDI

0.22478
0.37292
0.25921
0.27813
0.12748
0.24221
0.48060
0.31481
0.31653
0.36566
0.39831
0.47338
0.44285
0.12083
0.33613
0.27619
0.52464
0.33337
0.27902
0.30401

0.21039
0.44430 c
0.31332 c
0.28666
0.23177 c
0.15906 d
0.54816 c
0.38435 c
0.34176 c
0.42546 c
0.44501 c
0.52154 c
0.39871 d
0.14372
0.26128 d
0.28798
0.61223 c
0.32165
0.27058
0.30210

387
87
40
383
58
2100
28
211
77
17
277
31
23
290
2525
389
49
113
27
210

15.99
11.36
9.09
3.29
16.34
220.92
21.01
21.60
3.22
2.64
32.25
5.51
21.32
220.79
255.73
10.32
7.17
6.50
3.12
22.12

82
27
23
21
16
15
14
12
11
11
10
10
10
10
10
9
9
9
9
9

61
71
60
53
24
37
14
27
48
48
36
13
14
31
22
70
44
92
10
10

FDI occurrences (8191)

Authors calculations. Source of the original data: ITA, Foreign Direct Investment in the United
States, various years. Feenstras US Exports and Imports Database; Bartelman Becker-Grays Industry
Productivity Database; 1987 and 1992 Census of Manufactures Subject Series-Concentration Ratios in
Manufacturing.
b
Establishments by the Census definition is a single physical location where business is conducted
or where services or industrial operations are performed.
c
A significant increase at the 5% level.
d
A significant decrease at the 5% level.

Margins rise with FDI at relatively low levels of concentration. For an industry
with a concentration rate of 39.55% (the average rate), every one non-greenfield
FDI (LFDI) lead to an increase in current (lagged) period margins of about 0.0013
(0.0020), statistically controlling for everything else. These changes translate to
about 0.45% [(0.0013 / 0.2890)3100] and 0.69% [(0.0020 / 0.2890)3100] of the
average industry margins.
As mentioned, some of the regressors used in Eq. (1) may themselves be
endogenous. If so, these panel estimates may be biased if simultaneity among
variables is not accounted for. A series of exogeneity tests using Spencer and
Berks (1981) methodology is performed since it is generally the case that the
coefficient estimates in simultaneous systems are highly dependent on assumptions
made about variable endogeneity. This methodology is a single equation test
where the null hypothesis is that a variable x* is exogeneous. It requires two
separate regressions: first, x* is treated as an endogenous variable in the system

176

C.Y. Co / Int. J. Ind. Organ. 19 (2001) 163 183

(call the coefficient estimates b ); then, x* is treated as exogenous (call the

coefficient estimates b ). If the calculated Wald statistic, ( b 2 b )9hVar[ b ] 2
Var[ b ]j 21 ( b 2 b ), is significant, then the null of exogeneity is rejected. The
exogeneity tests indicate that concentration rate and openness are endogenous in
the margins equation; FDI is found to be endogenous only in model B.23 For
completeness, the endogeneity of PCM in Eqs. (2)(4) need to be confirmed. The
null of exogeneity is rejected in all models; there is evidence that PCM is
endogenous in Eqs. (2)(4).
The regression results for Eq. (1) under the above assumptions appear in Table
4.24 The presence of interaction terms involving endogenous and exogenous
variables complicate its estimation. Kelejian (1971) derived a variant of two-stage
least-squares (TSLS) in systems that include nonlinear endogenous variables as
regressors. In general, these interaction terms are considered endogenous and will
require instruments; however, the number of equations in the system will not
increase (see Greene, 1997, p. 733). The rank condition for identification is three,
which Eq. (1) satisfies. The instruments used are the linear, square and cross
products of all exogenous variables in the system (stage one). These instruments
are then used in the second stage estimation of Eq. (1).25 The correlations between
the endogenous variables and their corresponding instruments range from 0.50 to
0.96, indicating the appropriateness of the instruments.
When endogeneity is taken into account, there is some evidence that both types
of FDI affect margins (see Table 5). When significant, the coefficient estimates of
FDI and its lagged values are positive; whereas the coefficient estimates of the
interactions between FDI and CR for the most part are negative. The margins
effect of greenfield FDI seems to be more immediate than that of non-greenfield
FDI (that is, FDI is significant in model B, whereas L2FDI is significant in model
C); the potential differential impact of FDI due to industry concentration suggests
a similar story (that is, FDICR and LFDICR are significant in model B, whereas
LFDICR is significant in model C). These results seem counter-intuitive at first

23
A detailed explanation of the exogeneity tests is available from the author. As suggested by an
anonymous referee, a possible reason why FDI is endogenous only in model B is because new plant
FDI alters the domestic market structure, whereas acquisitions (a component of non-greenfield FDI)
only involves the transfer of ownership of existing facilities.
24
Limdeps two-stage least-squares for fixed effects model is used in the estimation (see Greene,
1995, p. 302). To focus discussions, only the estimates of Eq. (1) will be presented below. The interest
in Eqs. (2)(4) are not the coefficient estimates, but the fitted values of regressing each of their
dependent variables against all exogenous variables in the system. These fitted values are then used as
instruments in the second stage estimation of Eq. (1). Results for Eqs. (2)(4) are available from the
author.
25
In models with non-linear endogenous variables, Kelejian (1971) showed that a polynomial of a
certain degree exists such that the instruments from the first stage are linearly independent of the other
exogenous regressors found in the equation of interest.

C.Y. Co / Int. J. Ind. Organ. 19 (2001) 163 183

177

Table 5
Two-stage fixed effects panel regression results: pricecost margins a

CRb
OPEN b
IMP CRb
]
GROW
KO
GRO CRb
]
KO CRb
]
FDI c
LFDI
L2FDI
FDICRb
LFDICRb
L2FDICRb
Adjusted R 2
No. of observations

Model A

Model B

Model C

0.8288**
(0.4482)
1.3711*
(0.4615)
20.0708*
(0.0115)
21.2317**
(0.5885)
28.0465
(6.1357)
0.0452*
(0.0121)
0.2742**
(0.1327)
0.0137
(0.0254)
9.5244**
(4.8414)
12.1800*
(4.5337)
20.1706
(0.1197)
20.2495**
(0.1218)
0.0330
(0.0492)
0.2307
3833

0.7868***
(0.4708)
1.2107**
(0.5221)
20.0609*
(0.0119)
20.5567
(0.6143)
210.905
(6.7157)
0.0320**
(0.0127)
0.3388**
(0.1448)
79.724*
(30.668)
216.062
(14.170)
210.143
(11.554)
22.0386*
(0.6328)
0.6506**
(0.3315)
0.4363
(0.2765)
0.2207
3833

0.8482**
(0.4479)
1.5066*
(0.4780)
20.0752*
(0.0113)
21.329**
(0.5834)
26.2788
(5.8491)
0.0472*
(0.0120)
0.2374***
(0.1264)
0.0377
(0.0310)
7.6454
(5.5548)
13.726*
(5.3264)
20.1250
(0.1394)
20.2719***
(0.1479)
0.0332
(0.0672)
0.2245
3833

a
Notes: The coefficients and their standard errors above are scaled by 1000. The numbers in
parentheses are standard errors. *, ** and *** denote significant at 1, 5 and 10%, respectively. See
notes for Table 1 for definitions of FDI data.
b
Instrumental variables.
c
Instrumental variable for Model B only. Estimated coefficients for the industry / time dummy
variables are excluded in the table. Likelihood ratio tests indicate that the two-way fixed effects is
appropriate.

considering that the lag from project initiation to completion is longer for
greenfield FDI.
Consider the results for greenfield FDI. The coefficient for FDI is significantly
positive; and the interaction term between current FDI and CR is significantly
negative. The partial derivative of the margins equation with respect to current
FDI, PCM / FDI50.07972420.00203863CR, indicates that margins rise with
FDI in industries with relatively low levels of concentration (at concentration
levels below 38.91%). A possible explanation for this result is as follows.
Greenfield FDI involves new facilities, hence foreign entrants would adopt the best

178

C.Y. Co / Int. J. Ind. Organ. 19 (2001) 163 183

available technology. This makes them more efficient and their efficiency may
increase industry margins. However, beyond some critical concentration level,
the competitive effect of FDI predominates (margins decline). This result is
consistent with the findings of the imports-as-market discipline literature where the
disciplining effect of imports is conditional upon the existence of potentially
non-competitive conditions, such as high concentration (See Caves, 1985). To
get a sense of the economic significance of this effect, the partial derivative is
evaluated at the average concentration rate (39.55%). For an industry with this
concentration level, the result shows that for every one greenfield FDI, margins
fall by about 0.0009; this translates to about 0.31% [(0.0009 / 0.2890)3100] for an
industry with average margins. With regard to lagged FDI, only its interaction with
CR is significant and the coefficient happens to be positive. Margins rise with
industry concentration. Perhaps this is indicative of foreign firms deploying
firm-specific assets upon entry and these knowledge spill over domestically with a
lag. The result further implies that potential technological spillovers may be larger
in more concentrated industries. This is not surprising considering that these
industries tend to invest more in research and development (R&D) and may have
more innovations that can spill over into the host market.26 Given the shortness of
the period considered, the spillover part of the story should be viewed with caution
and deserves more study; 27 especially since we do not yet completely understand
the real motivations behind firm entry into foreign markets.
To get a better appreciation of the results, consider the breakdown of the overall
industry margins into the margins of purely domestic and purely foreign plants.
Ideally, a comparison between the margins of domestic and foreign plants must be
made in the pre-FDI surge (197881) period. If domestic margins are significantly
larger (suggestive of superior domestic technology), then succeeding foreign entry
may be due to sourcing of US technology. If the pre-FDI surge margins of foreign
plants are significantly higher (suggestive of superior foreign technology), then
succeeding foreign entry may be due to deployment of foreign firm-specific
advantages. Unfortunately, such direct comparisons are not possible since data for
purely foreign plants are not available for years earlier than 1988.28 A second-best
approach is the following exercise. Consider industries that experienced an
increase in the overall margins in the post-FDI surge (198891) period. This

26

This is a controversial point. Several studies have empirically confirmed a small positive impact of
concentration on R&D; however, a negative impact has also been found (see Kamien and Schwartz,
1982, for a review). That is, while the benefits to innovation may be large in concentrated industries, it
is also possible that firms in concentrated industries may not feel the pressure to innovate.
27
Although, Mansfield (1985) estimates that around 70% of technical innovations diffuse in the
industry within a year.
28
See Footnote 3. Information are available only for 201 four-digit SIC industries, hence succeeding
comparisons and discussions are based only on these industries.

C.Y. Co / Int. J. Ind. Organ. 19 (2001) 163 183

179

Table 6
FDI in these industries are potentially motivated by deployment of foreign firm-specific advantages a
SIC

2816
2821
2824
2844
2869

Average PCM

Number of establishments

FDI occurrences
(8191)

7881
Overall

8891
Overall

8891
Domestic

8891
Foreign

Change
(198287)

Change
(%)

New

Other

0.29341
0.25921
0.26489
0.58244
0.31481

0.48585
0.31332
0.38578
0.62058
0.38435

0.36087
0.30048
0.32451
0.61563
0.36049

0.55915
0.35041
0.42013
0.63956
0.41018

214
40
2
55
211

213.21
9.09
2.86
8.61
21.60

5
23
2
5
12

8
60
13
23
27

a
Source: Authors calculations. Source of the original data: ITA, Foreign Direct Investment in the
United States, various years. Feenstras US Exports and Imports Database; Bartelman Becker-Gray s
Industry Productivity Database; 1987 and 1992 Census of Manufactures Subject Series-Concentration
Ratios in Manufacturing.

coupled with a significantly higher margins for foreign plants in the post-FDI
surge period imply that FDI may be motivated by firm-specific advantages. Table
6 contains a partial list of industries where these conditions are satisfied.29 Logic
suggests that there should be enough foreign presence for FDI to affect overall
industry margins. The list could be shortened to include only those industries that
received substantial new plant FDI for the period. These industries are plastics
materials and resins (SIC2821) and industrial organic chemicals, n.e.c. (SIC2869).
Interestingly in model C, current and one-period lagged FDI are not statistically
significant (see Table 5). Logic suggests that if foreign firm non-greenfield FDI is
motivated by sourcing, the (negative) effect on margins would be immediate;
margins are expected to decline because US assets are taken over by less
knowledgeable foreign firms. One possible explanation why the coefficients for
both current and one-period lagged FDI are insignificant is that sourcing may not
have been the motive behind FDI; otherwise a decline in margins should have
been observed. The positive effect on margins appears with a two-period lag
because foreign acquirees need time to learn the technology that they have
acquired and / or integrate their human and technological resources. In some cases,
there may be a clash of corporate cultures that needs ironing out. All these need
time to resolve. The only interaction term between FDI and CR that is statistically
significant is the one for one-period lagged FDI. The negative coefficient implies
that the competitive effect of FDI appears with a lag and that the effect is larger in
more concentrated industries. The explanations offered should again be viewed as

29
Due to space limitations the table includes those four-digit SIC industries that belong to food,
chemicals, machinery, electrical and transport equipment. The complete list of industries is available
from the author upon request.

180

C.Y. Co / Int. J. Ind. Organ. 19 (2001) 163 183

tentative because it assumes that the motivation behind non-greenfield FDI is not
technology sourcing; since there is some evidence that some types of FDI are
motivated by sourcing, more research is needed in this area.
Turning to the coefficients of other variables, in the three models estimated,
controlling for an industrys openness to foreign competition, margins are larger in
concentrated industries; this is consistent with the findings of most of the studies
reviewed in Section 3. The OPEN variable is positive and statistically significant.
As OPEN increases, that is, as it moves towards one, margins rise. As mentioned
in the previous section, as OPEN1, exports0 and presumably more is sold in
the local market. Depending on what happens to the level of imports, the effect on
margins is theoretically ambiguous. If imports decline at a faster rate than exports
then margins can rise, as indicated by the result. The interaction term IMP]CR is
significantly negative. This implies that imports disciplining impact is larger in
more concentrated industries. In model A, for an industry with an average
concentration rate, the marginal effect of a one percentage point increase in import
share is about a 0.0008 drop in margins, controlling for other factors.30 This result
is consistent with the findings in the imports-as-market discipline literature.
Finally, the interaction between the investmentoutput ratio and the concentration
rate (KO]CR) has the expected positive sign and is statistically significant in all
models. Recall that the investmentoutput ratio is used as a proxy for barriers to
entry. The result implies that keeping capital intensity constant, margins rise with
industry concentration. This contrasts with the estimates found when the endogeneity of the concentration rate, openness and FDI were ignored.

5. Conclusion
The results using both single equation fixed effects and two-stage least-squares
fixed effects for panels on the margins equation are consistent with earlier findings
that did not include FDI. For example, imports have a larger competitive effect in
precisely those industries that need disciplining (those with high concentration).
The paper offers a much needed extension to the imports-as-market discipline
hypothesis by taking account of FDI using US data. The results from the two-stage
least-squares for a fixed effects panel indicate that the effect of FDI depends on the
industrys concentration rate. It was suggested that the observed margins effect
may be indicative of the motivations behind FDI. One of the interesting pattern in
the data is that the greenfield and non-greenfield FDI mix of an industry is a

30

Take the derivative of the margins equation with respect to IMPSH, PCM / IMPSH5 2
0.00002013CR; at the average concentration rate, this is 0.000794. Katics and Petersen (1994) find a
comparable figure for this variable; from their results, a one percentage point increase in imports is
associated with a decline in margins of 0.00158.

C.Y. Co / Int. J. Ind. Organ. 19 (2001) 163 183

181

function of the industrys concentration rate, consistent with our findings that the
margins effect of FDI depends on concentration. This warrants further investigation. Another possible extension to the current paper is to test whether the
R&D activities of US firms in the 1980s is in response to the surge in FDI into the
US during the same period.

Acknowledgements
I would like to thank Bruce Blonigen, Ira Gang, Tom Prusa, Charles Romeo,
Mark Strazicich, participants at the UCF Department of Economics brown bag
seminar and the 1996 Southeastern International Trade Conference for useful
discussions, comments and suggestions. I am also grateful to Bruce for sharing the
anti-dumping data and to an anonymous referee whose comments and suggestions
have greatly improved this paper. All remaining errors are mine.

Appendix A. Data Sources

Pricecost margins, capitaloutput ratio, skill level and plant scale measures are
calculated using data from Bartelsman, E., Becker, R. and Gray, W., 1996, NBER
Productivity Database, NBER Technical Working Paper No. 205. This data set
uses the 1972 SIC definitions. Pricecost margins are calculated using DHPs
(1986) definition: PCM5(value of sales1change in inventories2payroll2cost of
materials) /(value of sales1change in inventories). Using Census data, this is
equivalent to (value added2payroll) /(value added1cost of materials). Capital
output ratio is new capital expenditures divided by industry shipments; skill level
is payroll cost per employee (in thousand dollars) and plant-scale is value added
per establishment (in million dollars).
The US affiliates and US owned businesses margins are calculated using data
from the US Department of Commerce, Bureau of Economic Analysis, various
years, Foreign Direct Investment in the United States: Establishment Data for
Manufacturing (GPO, Washington, DC).
Four-firm concentration measures are from the Census of Manufactures Subject
Series- Concentration Ratios in Manufacturing. CR and the number of establishments are available only in Census years. CR series for years other than Census
years are derived using simple interpolation techniques. These also use 1972 SIC
definitions.
Import and export values at the four-digit SIC (1972 SIC definition) level are
taken from Feenstra, R., 1996, US Imports, 1972 1994: Data and Concordances,
NBER Working Paper 5515 and Feenstra, R., 1997, US Exports, 1972 1994: With
State Exports and Other US Data, NBER Working Paper 5990.
Anti-dumping petition counts are from the International Trade Administration.

182

C.Y. Co / Int. J. Ind. Organ. 19 (2001) 163 183

The antidumping data I use start in 1980 because of significant changes in AD law
with the passage of the Trade Agreement Act of 1979.
The FDI data are taken from US Department of Commerce, International Trade
Administration, various years, Foreign Direct Investment in the United States
(GPO, Washington, DC). This publication lists all completed FDI transactions for
the year identified from public sources. The ITA identifies the type of investments
made: merger / acquisition, equity increase, joint venture, plant expansion, new
plant or others. It further identifies the four-digit SIC code of the investment, the
nationality of the investor, the location of the investment and in some cases, the
total amount of the investment.

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