Foreign direct investment and macroeconomic risk

Motivated by the macroeconomic fluctuations and policy regime switches frequently observed in developing countries, this paper provides cross country-industry evidence on the links between a host country's macro risks and foreign direct investment (FDI) activities. For each industry I measure vertical FDI share as a ratio of exports to a parent country relative to local sales by foreign affiliates. Using a panel sample from 1989 to 1999, I find that FDI activities of US multinationals in industries with higher share of vertical FDI respond disproportionately more to negative effects of macro-level demand, supply, and sovereign risks. However, when institutional quality and total FDI share of the host country are sufficiently low, the merits of cross-industry vertical versus horizontal FDI in response to macro risks disappear. Journal of Comparative Economics 35 (3) (2007) 509-519.