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Abstract

The Armington elasticity of substitution captures the trade-off interaction between imports and domestic sales. Recently, foreign direct investment (FDI) has become a significant source of international investment. This study incorporates the effect of horizontal FDI in this elasticity. Including FDI affects the modeling and value of the trade elasticity, providing new insights on the behavior of U.S. firms vis-a-vis the tradeoff between horizontal FDI and exports. This new Armington elasticity of substitution estimates provide a lower value than predecessors. This means that the impacts of a trade policy (such as tariffs) are expected to be lower due to FDI substitution.

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