CEPR Research Training Network
The Analysis of International Capital Markets:

Understanding Europe's Role in the Global Economy

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Helga Kristjánsdóttir
BS, MS Econ and MBA

EPRU

Economic Policy Research Unit
University of Copenhagen
University of Iceland
28th of August 2002
Overview
  • I am doing empirical research on foreign direct investment (FDI) into Iceland.
  • The existing theory on FDI has primarily been developed for large countries. Here is an opportunity to see how this theory predicts for small countries.
  • What makes this research interesting is that its done for a small country, geographically distant from other countries, and secondly its based on brand new data on FDI in Iceland.

A Panel Data Analysis of Foreign Direct Investment in Iceland
  • This paper takes a popular equation on FDI, the gravity equation and applies it to Iceland.
  • Want to determine whether different pattern is observed for small countries compared to large countries.
  • Estimates are based on 1989-1999 panel data.
  • Results indicate that there is a fixed difference between investment made by the source countries, trade blocs and between sectors of allocation. Also, that the size effects appear to be different for Iceland from what theory predicts.

The Knowledge-Capital Model and Small Countries
  • People have moved away from using the Gravity Equation to using the Knowledge-Capital Model.
  • One of the reasons is because the Knowledge-Capital Model is based on a theory that accounts for both horizontal and vertical investment.
  • Carr, Markusen and Maskus came up with the Knowledge-Capital Model (AER, 2001). They used a range of parameters for size and relative endowments to develop the model.
  • My results are not as conclusive as their results. It seems as the theory they developed for large countries doesn’t do so well for small countries.
  • Estimates for the Knowledge-Capital indicate that Iceland’s location in the Edgeworth box maybe different from the general case.

The figure shows potential location of Iceland in the Edgeworth box
The Edgeworth Box





Determinants of FDI in the Power Intensive Industry in Iceland
  • Iceland is not necessarily typical for a small country, since lots of FDI goes into one particular industry, the power intensive industry.
  • Estimate panel data on FDI share, in the major industries of investment, over a period of 11 years.
  • Done as to determine how important the power intensive industry is compared to other industries.
  • Find that different forces seem to matter for different industries.
  • This might explain why the investment pattern in Iceland is different from the general case.
  • Might be that in earlier research the KCM didn’t predict so well because of different driving forces of investment, rather than the KCM doesn’t work well for small countries.