Comparative advantage, cross-border mergers and merger waves: international economics meets industrial organization

Perhaps the most striking aspect of the current phase of globalization is the increased importance of foreign direct investment (FDI). This is not only true at the global level but also at the regional level. It is clear that the process of economic integration in the European Union has boosted FDI for the EU countries. In the field of international economics, the modeling of FDI has been high on the research agenda in recent years and clear progress has been made in understanding the determinants and effects of FDI (see for instance Barba-Navaretti and Venables (2004) for an overview). The new theoretical insights are, however, not always in line with the facts. One important puzzle in this respect is precisely the fact that economic integration or, in modeling terms, a fall in trade costs has been accompanied by an increase in FDI. From the data we know that so-called horizontal FDI, that is FDI undertaken for market size considerations, is the dominant form of FDI, but theory tells us that a fall in trade costs should go along with a decrease in horizontal FDI. Lower trade costs, ceteris paribus, make it more profitable for firms to serve foreign markets via exports instead of setting up their own production in these markets.