The Impact of Foreign Direct Investment from Major Source Countries on Turkish Trade with the European Union

The available literature on the relationship between foreign direct investment (FDI) and trade has so far shown mixed results. Although traditional trade theory showed that factor movements and trade are a perfect substitute, new trade and FDI theories argue that factor movements and trade can be either a substitute or complementary to each other, depending on the types of investment made by multinational enterprises (MNEs) and macroeconomic policies used by the host countries. This paper attempts to test empirically the existence of a long-run relationship between inward FDI and the trade performance of Turkey over the period 1976-2006 by applying the multivariate cointegration technique of Johansen and Juselius (1990). In particular, the effects of FDI from major source countries (i.e., the US, Japan, and the EU) are examined to see whether they have different impacts on Turkish trade with the EU. The results of the long-run export supply model indicate that both Japanese and EU FDI play a significant role in the level of Turkish exports to the EU market, while US FDI causes a reduction in the level of Turkish exports to the EU. Similarly, the results of the long-run import demand model show that EU FDI contributes the level of Turkish imports from the EU by raising demands for intermediate and capital goods from the home market, while Japanese FDI led to a decrease in the level of Turkish imports from the EU market.