Trade Facilitation and Location of Foreign Direct Investment

Amiti and Javorcik (2008) found that access to markets and access to suppliers are the most important factors affecting entry decisions by foreign investors. The influence of market and supplier access on FDI location decisions was four times greater than that of production costs. Trade, investment, and production patterns in production chains are also partly determined by agglomeration and dispersion effects across countries and commodities. Kimura, Takahashi, and Hayakawa (2007) found that geographical distance reduces trade in machinery parts and components much less in East Asia than in Europe. This implies that the service link costs associated with international production fragmentation are substantially lower in East Asia than in Europe, contributing to large differences in the development of international production and distribution networks.

Trade facilitation has an indirect impact on FDI inflows by lowering the cost of spreading production across several countries in order to take advantage of their comparative advantages. Increased FDI, in turn, can further boost regional trade, adding to the direct effect of improvements in trade facilitation across borders. If the advantages of scattering production across economies in a region outweigh those from concentrating it together, trade facilitation makes FDI complementary to trade. For instance, in Southeast Asia's electronics industry, where components are generally small and light (relative to value added) with relatively lower transport costs, cross-border production networks proliferated in the 1990s. This can create a virtuous cycle of trade facilitation, trade, and investment that fosters increased trade and economic growth.

To compete for larger shares of regional supply chains, countries have striven to improve their trade services. In Malaysia, for instance, the government has actively promoted infrastructure development in order to strengthen its competitive and comparative advantage. Since the mid-1980s, Malaysia has pursued an FDI-led, export-oriented development strategy, with FDI contributing to the economy's integration in global production networks. Malaysia has enhanced its geographical attractiveness to foreign firms as a key link in global supply chains through infrastructure development and the resulting high-quality production and trade services.

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