Are Foreign Investments Replacing Domestic Investments? – Evidence from Finnish Manufacturing

This study analyses the relationship between firms’ foreign and domestic investments using a panel dataset containing 218 Finnish manufacturing firms during the years 1998-2002. The study examines whether foreign investments increase or decrease domestic investments and whether the effect varies between investments directed to developed markets or emerging markets. Financial constraints’ effect on the relationship is also investigated. The empirical part estimates an empirical investment equation following Bond and Meghir (1994). The estimations are carried out using the GMM (Generalised Method of Moments) instrumental variables method, which allows for endogenoity in the explanatory variables. The main result of the study is that foreign investments’ effect on domestic investments varies depending on the direction of the investments and the firm’s financial position. Foreign investments conducted by financially unconstrained firms increase domestic investments substantially where as emerging market investments of financially constrained firms decrease domestic investments moderately.