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Testing Mundell's Intuition of Endogenous OCA Theory

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Author Info

  • Warin, Thierry

    ()
    (Middlebury College)

  • Wunnava, Phanindra V.

    ()
    (Middlebury College)

  • Janicki, Hubert

    ()
    (Arizona State University)

Abstract

This paper presents an empirical assessment of the endogenous optimum currency area theory. Frankel and Rose (1998) study the endogeneity of a currency union through the lens of international trade flows. Our study extends Frankel and Rose's model by using FDI flows to test the original theory developed by Mundell in 1973. A gravity model is used to empirically assess the effectiveness of the convergence criteria by examining location specific advantages that guide multinational investment within the European Union. A fixed effects model based on a panel data of foreign direct investment (FDI) flows within the EU-15 shows that horizontal investment promotes the diffusion of the production process across the national border. Specifically, our results suggest that economic convergence ensured by belonging to the common currency area helps double FDI flows.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 3739.

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Length: 26 pages
Date of creation: Sep 2008
Date of revision:
Publication status: published in: Review of International Economics, 2009, 17 (1), 74-89
Handle: RePEc:iza:izadps:dp3739

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Keywords: endogenous optimum currency area; gravity model; economic integration;

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References

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  1. Helpman, Elhanan, 1984. "A Simple Theory of International Trade with Multinational Corporations," Journal of Political Economy, University of Chicago Press, vol. 92(3), pages 451-71, June.
  2. M Arellano & O Bover, 1990. "Another Look at the Instrumental Variable Estimation of Error-Components Models," CEP Discussion Papers dp0007, Centre for Economic Performance, LSE.
  3. Markusen, James R. & Venables, Anthony J., 2000. "The theory of endowment, intra-industry and multi-national trade," Journal of International Economics, Elsevier, vol. 52(2), pages 209-234, December.
  4. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 277-97, April.
  5. Frankel, Jeffrey A & Rose, Andrew K, 1996. "The Endogeneity of the Optimum Currency Area Criteria," CEPR Discussion Papers 1473, C.E.P.R. Discussion Papers.
  6. De Grauwe, Paul & Mongelli, Francesco Paolo, 2005. "Endogeneities of optimum currency areas: what brings countries sharing a single currency closer together?," Working Paper Series 0468, European Central Bank.
  7. Paul Brenton & Francesca Di Mauro & Matthias Lücke, 1999. "Economic Integration and FDI: An Empirical Analysis of Foreign Investment in the EU and in Central and Eastern Europe," Empirica, Springer, vol. 26(2), pages 95-121, June.
  8. Hubert Janicki & Phanindra Wunnava, 2004. "Determinants of foreign direct investment: empirical evidence from EU accession candidates," Applied Economics, Taylor & Francis Journals, vol. 36(5), pages 505-509.
  9. Markusen, James R. & Venables, Anthony J., 1998. "Multinational firms and the new trade theory," Journal of International Economics, Elsevier, vol. 46(2), pages 183-203, December.
  10. Bhargava, A & Franzini, L & Narendranathan, W, 1982. "Serial Correlation and the Fixed Effects Model," Review of Economic Studies, Wiley Blackwell, vol. 49(4), pages 533-49, October.
  11. Jeffrey Frankel & Andrew Rose, 2002. "An Estimate Of The Effect Of Common Currencies On Trade And Income," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 437-466, May.
  12. Peter Egger & Michael Pfaffermayr, 2004. "Foreign Direct Investment and European Integration in the 1990s," The World Economy, Wiley Blackwell, vol. 27(1), pages 99-110, 01.
  13. Baltagi, Badi H. & Wu, Ping X., 1999. "Unequally Spaced Panel Data Regressions With Ar(1) Disturbances," Econometric Theory, Cambridge University Press, vol. 15(06), pages 814-823, December.
  14. Baltagi, Badi H. & Egger, Peter & Pfaffermayr, Michael, 2003. "A generalized design for bilateral trade flow models," Economics Letters, Elsevier, vol. 80(3), pages 391-397, September.
  15. Jacques J. Polak, 1996. "Is APEC a Natural Regional Trading Bloc? A Critique of the ‘Gravity Model’of International Trade," The World Economy, Wiley Blackwell, vol. 19(5), pages 533-543, 09.
  16. Robert C. Feenstra, . "Facts And Fallacies About Foreign Direct Investment," Department of Economics 98-04, California Davis - Department of Economics.
  17. Markusen, James R., 1984. "Multinationals, multi-plant economies, and the gains from trade," Journal of International Economics, Elsevier, vol. 16(3-4), pages 205-226, May.
  18. Helpman, Elhanan, 1987. "Imperfect competition and international trade: Evidence from fourteen industrial countries," Journal of the Japanese and International Economies, Elsevier, vol. 1(1), pages 62-81, March.
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Cited by:
  1. Moshi Optat Herman & Kirsten Wandschneider & Thierry Warin & Phanindra Wunnava, 2011. "Southern African Economic Integration: Evidence from an Augmented Gravity Model," The African Finance Journal, Africagrowth Institute, vol. 13(1), pages 1-13.
  2. Axel Berger & Matthias Busse & Peter Nunnenkamp & Martin Roy, 2010. "Do Trade and Investment Agreements Lead to More FDI? Accounting for Key Provisions Inside the Black Box," Kiel Working Papers 1647, Kiel Institute for the World Economy.
  3. Peter Nunnenkamp & Maximiliano Sosa Andrés & Krishna Chaitanya Vadlamannati & Andreas Waldkirch, 2012. "What Drives India’s Outward FDI?," Kiel Working Papers 1800, Kiel Institute for the World Economy.
  4. Sosa Andrés, Maximiliano & Nunnenkamp, Peter & Busse, Matthias, 2012. "What drives FDI from non-traditional sources? A comparative analysis of the determinants of bilateral FDI flows," Economics Discussion Papers 2012-52, Kiel Institute for the World Economy.
  5. Philipp Hühne & Birgit Meyer & Peter Nunnenkamp, 2013. "Who Benefits from Aid for Trade? Comparing the Effects on Recipient versus Donor Exports," Kiel Working Papers 1852, Kiel Institute for the World Economy.
  6. Krzysztof Beck, 2013. "Determinants of Business Cycles Synchronization in the European Union and the Euro Area," Equilibrium, Uniwersytet Mikolaja Kopernika, vol. 8, pages 25-48.
  7. Zaenal Mutaqin & Masaru Ichihashi, 2013. "Widening and Deepening Economic Integration Impact on Bilateral Trade in the Eurozone and ASEAN," IDEC DP2 Series 3-3, Hiroshima University, Graduate School for International Development and Cooperation (IDEC).
  8. Praussello, Franco, 2012. "The Theory of Endogenous Optimum Currency Areas: A Critical Note - La teoria delle aree monetarie ottimali endogene: una nota critica," Economia Internazionale / International Economics, Camera di Commercio di Genova, vol. 65(1), pages 83-95.

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