Can FDI Increase Cooperation Among Nations? By

Currently there is a small, but growing, literature extending analysis of the conflict-trade relationship by introducing foreign direct investment (FDI). We present a formal model that illustrates how FDI can improve international relations, as does trade. We then proceed to test the model empirically adopting three innovations: First, we employ unique bilateral FDI data instead of systemic FDI used in most past studies. Second, we utilize a simultaneous two-equation estimation approach to account for the fact that multinational corporations typically invest only in politically stable countries. One equation defines FDI as determined by political stability, and the other defines international interactions as a function of FDI. Third, we employ new 1990-2000 Virtual Resource Associates (VRA) events data to measure cooperation and conflict between countries. Our empirical results show that foreign direct investment plays a similar role to trade in affecting international interactions. The policy implication of our findings is that further international cooperation in reducing barriers to both trade and capital flows can promote a more peaceful world