This study empirically investigates the impact of Korean multinational enterprise(MNE)s’ outward foreign direct investment(FDI) on intra-industry trade at the various levels of aggregations, such as intra-industry trade at the Korean Industrial Standard Classification(KSIC) middle level, and at the KSIC low level. Using firm-level panel data covering Korean MNEs’ FDI to US and China during the period between 2001 and 2009, this study finds a positive and significant relationship between intra-industry trade and FDI at the KSIC middle level, even after controlling for intra-industry firm heterogeneity, the role of factor and skill endowments at the industry level, and home and host country trade costs.
 

In particular, the size of Korean MNE’s outward FDI accounts for about 32% of intra-industry trade in Korean manufacturing between 2004 and 2009. The impact of FDI on intra-industry trade is stronger at the high-technology sectors such as electricity, electronics and motor vehicles than at the other manufacturing sectors. The complementarity between intra-industry trade and outward FDI suggests that Korean MNEs’ outward FDI enhances the cooperative production relationship between its foreign affiliates and Korean domestic firms. Moreover, the positive impact of Korean MNEs’ FDI on intra-industry trade may lead the increase of small and medium size domestic firm’s production and employment associated with the greater volume of trade.

What are the impact of outward foreign direct investment to domestic firms? Does MNE’s outward FDI bring positive effects on the intra-industry trade between home country and its trading partners? While the structural changes of industrial organization in Korea are expected along with the impending approval of Korea-US free trade agreement, the volume of Korean MNE’s outward FDI has risen rapidly for the past decade. Economists argue that outward FDI may substitute domestic production and foreign exports, and home country rather increases reversely imports from foreign affiliates located in its long-standing trading partners. In contrast, the empirical evidence on the relationship between outward FDI and intra-industry trade is thin. Thus, this paper attempts to explore the extent to which Korean MNE’s outward FDI affects intra-industry trade in manufacturing sector and more specifically at the high-technology sector such as electricity, electronics and motor vehicles.

The empirical analysis of this study is based upon two strands of economic literature. on the one hand, economists explain the determinants of foreign direct investment. Multinational firms’ decision of foreign direct investment is related to three factors: product fragmentation, jointness of knowledge capital, and knowledge intensity. Depending on factor/knowledge endowment and trade and investment costs, multinational firms decide to where to build or acquire a foreign plant and where to sell its products. According to the new trade and investment theory, the role of country and industry characteristics such as market size, knowledge endowment, home and host country trade costs are crucial to understand the variations of foreign direct investment.

on the other hand, intra-industry trade within/between firms across countries are affected by plant-level fixed costs, capital intensity, market share, R&D intensity, and intra-industry firm heterogeneity. Since international trade and investment are affected by similar country-, industry-, and firm-level characteristics, there may exist complementarity between intra-industry trade and outward foreign direct investment. This study combines the theoretical foundations of intra-industry trade and outward foreign direct investment, and empirically examines how outward FDI affects intra-industry trade.

This study hypothesizes that intra-industry trade grows faster in industries in which MNE activity in terms of outward FDI is expanding. Micro-level panel data on a sample of Korean MNEs’ outward FDI from the Export-Import Bank of Korea (Korea Eximbank) are used. System GMM econometric method is applied to run dynamic panel data regression. The new and robust firm-level evidence suggests that the larger Korean MNE’ outward FDI leads significant intra-industry trade gains for small and medium size domestic firms. And its impact on intra-industry trade in manufacturing sector happens relatively suddenly within two years.

Korean MNE’s outward FDI explains about 32% of intra-industry trade growth of Korean domestic firms in manufacturing sector. This finding shows that the size of positive effects of outward FDI is economically significant. Thus, enhancing the cooperative relationship between Korean MNE’s foreign affiliates and domestic firms is important. Furthermore, the positive impact of outward FDI may spillover the dynamic gains of intra-industry trade to all firms in manufacturing sector.
 

The complementarity between intra-industry trade and outward FDI may help adjust manufacturing sector to increase market size given the fixed level of domestic aggregate demand. Outward FDI may sow seeds to reap a plentiful harvest for domestic firms. Thus, it may be used as an alternative to surpass the limitation of small domestic aggregate demand in Korean economy.