Phantom FDI and the Limits of the Gravity Model: Evidence from OECD Economies

Given the substantial interest in international economic integration in recent years, this paper seeks to examine the determinants of Phantom FDI, investments into shell corporations with no real economic activities, for 21 OECD countries in 2017. The standard gravity model, which considers GDP and distance as the main determinants of cross-border flows, serves as the basis of this analysis. This model is augmented with several geographical, cultural and historical variables and data on corporate tax rates from the OECD. The main data for our model is collected from the Phantom FDI database created by Damgaard et al. (2019b), the CEPII's Gravity database and the OECD Tax Statistics database. Using an OLS regression model, this paper is not able to confirm the validity of the gravity model in 2017. Phantom FDI does not seem to be sensitive to the distance between the two countries, nor does the economic size of the destination economy appear to be an attractive force. Only the GDP of the host economy has a significant, positive impact. Furthermore, the paper finds that population in the host country, EU membership in the host country and common legal systems in both countries have a significant positive effect on Phantom FDI flows. Nevertheless, these results are subject to limitations as key economic assumptions are violated.