Journal of Common Market Studies, 2011

JCMS 2011 Volume 49. Number 2. pp. 463483 DOI: 10.1111/j.1468-5965.2010.02124.
The Effects on American Foreign Direct Investment in the United Kingdom from Not Adopting the Euro*
jcms_2124 463..484
MARCOS SANSO-NAVARRO
Universidad de Zaragoza
Abstract
The decision of the United Kingdom not to adopt the common European currency can be understood as a policy intervention in a single country within the European Union. The aim of this article is to analyse the consequences of this decision on the foreign direct investment received by this country. This is done by the application of a synthetic control method designed for policy evaluation. As a result, evidence of a signicant cost in terms of inward foreign direct investment from the United States is obtained.
Introduction There has been growing interest in analysing the effects of euro adoption on European monetary union (EMU) member countries in recent years. Although a wide array of variables have been considered, interest has mainly focused on aspects related to investment and trade issues: foreign exchange risk exposures (Bartram and Karolyi, 2006), nancial market dependence (Bartram et al., 2007), rms investment rates (Bris et al., 2006), trade ows (Baldwin and Taglioni, 2007; Brouwer et al., 2008) and foreign direct investment (FDI) (Petroulas, 2007; Schiavo, 2007; Taylor, 2008; Brouwer et al.,
* The author has beneted from the helpful comments of an anonymous referee. Financial support from Ministerio de Educacin y Ciencia (SEJ2006-14397 project) and the Regional Government of Aragn (ADETRE Research Group) is acknowledged.
2011 The Author(s) JCMS: Journal of Common Market Studies 2011 Blackwell Publishing Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA
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2008; De Sousa and Lochard, forthcoming). This article aims to contribute to the literature on the relationship between EMU membership and FDI from a different perspective. The main difference with respect to existing studies is that this article focuses on the consequences of not adopting the euro in a single country. Using a comparative case study, the assessment of the effects on inward FDI from the United States is made for the most controversial euro non-enrolment case: the United Kingdom. The importance of the relationship between EMU membership and the FDI received by the United Kingdom can be inferred from the Five Economic Tests (Her Majestys Treasury, 1997, 2003; see also Artis, 2006) conducted by the British authorities in order to decide whether or not to adopt the euro. They consisted of answering the following questions: 1. Were the business cycles and economic structures of all potential members compatible enough to evolve comfortably with a common interest rate on a permanent basis? 2. Was there sufcient exibility to deal with future problems? 3. Would joining the EMU create better conditions for rms making longterm decisions to invest in Britain? 4. What impact would EMU membership have on the competitive position of the United Kingdoms nancial services industry?1 5. Summarizing, will joining the EMU promote higher growth, stability and employment? The third test is directly related to the question posed in this article, and was mainly motivated by the fact that Britain received the highest FDI inows as a percentage of the GDP among the European Union (EU) members, especially for inward FDI coming from outside Europe. According to the recently established Export-Platform FDI patterns (Ekholm et al., 2007), the decision not to join the EMU should have dissuaded American and Japanese investors from considering the United Kingdom as a gateway into the European market. Furthermore, the impact of the EMU on FDI became one of the key issues in the economic debate2 between those who saw major advantages in the outs adopting the euro and those who saw more costs than benets (Barr et al., 2003). Our approach considers the decision adopted by the British authorities of not joining the euro as a policy intervention in a single country within the EU. This perspective allows us to assess the effects on FDI by means of a synthetic control method (Abadie and Gardeazbal, 2003; Abadie et al., 2010) that is
Particularly thinking of the Citys wholesale markets. Some examples of related independent reports are Layard et al. (2002), Begg et al. (2003) and the references therein.
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2011 The Author(s) JCMS: Journal of Common Market Studies 2011 Blackwell Publishing Ltd
THE EFFECTS ON AMERICAN FOREIGN DIRECT INVESTMENT IN THE UNITED KINGDOM
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suitable for the evaluation of policy measures implemented at a country level.3 The main result of this assessment is that there exists a signicant cost derived from this decision in terms of inward FDI from the United States. The magnitude of this estimated effect is compared and integrated with studies about the inuence of EMU membership on FDI that have been carried out with different methodologies and data sources. The rest of this article is structured as follows. Section I briey reviews the literature on the relationship between EMU membership and FDI. Section II describes the main features of the synthetic control method applied, while section III deals with its empirical implementation in our context. Section IV develops a preliminary analysis of FDI ows time-series for selected EU countries, presents the results obtained from the policy evaluation and draws inferences about their signicance. Finally, the article concludes with a discussion of the estimated effects. I. EMU and FDI: The Background Early assessments of the effects of not joining the euro on Britains inward FDI appeared around four years after the start of the third stage of the EMU. Their main limitation was that data availability did not allow strong conclusions to be drawn. This was aggravated by the fact that FDI ows are highly variable. A summary of the studies dealing with the relationship between the EMU and FDI reviewed in this section is reported in Table 1. In the evaluation of the Five Economic Tests conducted by the British Treasury (Her Majestys Treasury, 2003), it was recognized that Britains share of FDI ows from the rest of the world to the EU decreased after the start of the EMU. In addition, it was emphasized that this fall coincided with an increase in the ows received by the EMU member countries. Similar arguments were put forward by Layard et al. (2002) who argued that the above-mentioned share had more than halved in the period 19992001 with respect to the two previous years. Another study reaching the same conclusion is Begg et al. (2003). Furthermore, Barr et al. (2003) concluded that half of this fall was related to an increase in the relative investment costs of the United Kingdom but did not attribute any effect to being outside the EMU. Given that these studies analysed the shares of total FDI received by the EU, they reected worse behaviour than the EMU countries. Empirical studies about the positive effects of the EMU on the FDI received by its member countries have appeared in recent years. De Sousa and
3 Another recent study analysing the economic consequences of not joining the euro is Pesaran et al. (2007). These authors estimate the effects on output and prices in the United Kingdom and Sweden using a Global VAR framework.
Table 1: Summary of the Literature Examining EMU Effects on FDI
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Authors
FDI measure
Data sources
Sample period 19972001 19982001 19982001 19982001 19992001 19982001 19952001 19922005 EMU EMU Gravity specication Panel within estimation Gravity regressions Differences-in-differences All Non-EU EU UK UK UK Descriptive analysis All All UK EMU Descriptive analysis All US UK UK Descriptive analysis -11 -29 -60 75 -43 -50 No effect 31 62 16 11 8 Gravity specication Fixed effects panel estimation Tobit model EMU UK and Denmark EU entrants in 2004 Error-component gravity models Simulated scenarios Descriptive analysis Extrapolated log-linear trends Positive All UK Descriptive analysis -54
Home countries
Host countries
Methodology
EMU effect (%)
Layard et al. (2002)
Share of ows into EU
European Commission and Eurostat
Barr et al. (2003)
Share of stocks in EU Share of US ows into EU
UNCTAD Bureau of Economic Analysis
Begg et al. (2003)
Eurostat
Her Majestys Treasury (2003)
Share of ows within EU
UNCTAD Eurostat Eurostat
De Sousa and Lochard (2009) 19922001 EMU Non-EMU 19802001 OECD EMU Non-EMU Non-EMU EMU EMU
Bilateral stocks
International Direct Investment Database
Bilateral ows
2011 The Author(s) JCMS: Journal of Common Market Studies 2011 Blackwell Publishing Ltd EMU OECD 19902004 19942003 19802003 OECD Positive No effect 18.530
Petroulas (2007)
Inward ows
Eurostat
Schiavo (2007)
Bilateral ows
Brouwer et al. (2008)
Outward stocks
Taylor (2008)
Bilateral ows
Eurostat
Flows as % of GDP
OECD and UK Ofce of National Statistics
EMU Non-EMU EMU Non-EMU EMU Non-EMU
EMU EMU EMU EMU UK UK
80282 227517 -1270 95263 112 -28
Source: Authors own data.
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Lochard (forthcoming) developed a theoretical model for bilateral FDI stocks that led to a gravity-like specication made up of four components: inward effect (origin), outward effect (destination), bilateral effect (transaction costs) and multilateral effect (alternative locations). Using data from 21 OECD countries in the period 19922005 and panel estimation techniques, they established that the adoption of the euro increased intra-EMU FDI stocks by around 31 per cent. According to Barr et al. (2003), the corresponding effect on FDI ows is more than double (62 per cent) that on stocks. Moreover, they found that the magnitude of these positive effects was higher in the peripheral countries. Using the same specication, Petroulas (2007) obtained a positive effect of the EMU on inward FDI ows of 16 per cent within the eurozone using a sample of 18 developed countries for the years 19922001 and a differences-in-differences approach. Furthermore, spillover effects to and from non-EMU countries were found. Thus, these two studies have established the global effects of the euro on FDI. Schiavo (2007) studied the link between currency unions and cross-border investment through the reduction in exchange rate uncertainty. He found a positive effect of the EMU on FDI ows not only for its members even after controlling for exchange rate volatility in an empirical linear gravity model. The sample consisted of 22 OECD countries in the period 19802001. In addition, he did not nd any adverse effect on the inward investment ows received by the United Kingdom and Denmark as a consequence of their decision to stay outside the euro. A similar specication augmented with distance-related variables was used by Brouwer et al. (2008) in order to predict the implications on (trade and) FDI of a potential EMU enlargement to the countries that joined the EU in 2004. Using an unbalanced panel of outward bilateral FDI stocks for 29 countries in 19902004, the simulated effects were between 18.5 and 30 per cent. A recent exhaustive analysis using several data sources and a time span of more than 20 years is carried out in Taylor (2008) who reports a broad array of impact magnitudes for the 12 EMU countries, the United Kingdom, Japan and the United States. Among many other conclusions, this author states that most of the FDI inows within the eurozone after 1999 were a consequence of the end-of-century takeover boom. However, he also recognizes that the EMU has stimulated FDI inows in the eurozone from the other major investing countries. In addition, it is established that Britains inows from countries other than the EU members were 28 per cent below trend after the introduction of the euro. The main caveat is that this author calculated these trends with data prior to 1999 using log-linear trends from a standard OLS t. Resulting estimates are used as a counterfactual for the subsequent years. In addition, there are no inferences about the signicance of the reported effects.
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This article aims to contribute to this literature by assessing the effects of the United Kingdom not joining the euro on the FDI received from the United States using a comparative case study. To do so, the British decision is considered as a policy intervention in a single country within the EU. For this reason, the consequences derived are estimated by the application of a synthetic control method for policy evaluation described in the following section. II. Policy Evaluation Using Synthetic Controls Comparative case studies are commonly used to estimate the effects of policy interventions. These studies compare the evolution of the variables under scrutiny in the case of one agent affected by the policy (treated) with the evolution of the same variables in a group of unaffected agents (controls).4 The main difculties when applying this approach are, rst, how to choose the units of comparison, and second, the uncertainty related to the ability of the controls to reproduce the counterfactual situation of interest. The proposal in Abadie and Gardeazbal (2003) is an appealing datadriven procedure to build a control group for the study of policies implemented at country level. Its main idea is that a combination of countries is expected to provide a better counterfactual for the treated country than a single one. In the rest of this section, the model used by Abadie et al. (2010) to explain the applicability of synthetic controls in comparative case studies is briey described as well as its empirical implementation. Assume that we have information about J + 1 (i = 1, . . . , J + 1) countries during T time periods. The rst of them (i = 1) is the one to which the intervention analysed has been applied after a certain date T0 (1 T0 < T). Therefore, we have J countries that can be labelled as potential controls. Let YitN be the variable of interest observed in absence of policy intervention for country i at period t and Y1It its corresponding values for the treated country during the implementation period (t {T0 + 1, . . . , T}). Assuming that the intervention has no effect before its implementation, 1t = Y1It Y1N t is the policy effect in the treated country. This allows us to express the observed outcome Yit for country i in period t as:
Yit = YitN + it Dit 1 if i = 1 and t > T0 Dit = 0 otherwise

4
(1)
In fact, our case is the study of a no intervention policy. The difference is established by the group of comparison (the donor pool).
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N We want to estimate 1t = Y1t Y1N t , which is equivalent to estimating Y1t . N With this objective in mind, a factor model is specied for Yit :
YitN = t + Z i t + t i + it
(2)
where: dt is an unknown common factor with the same effect on all countries; Zi(1 r) are the observed explanatory factors; qt(r 1) includes unknown parameters; lt(1 F) are the unobserved common factors; mi(F 1) are the unknown loadings of the unobserved common factors; and eit is the error term, assumed to have a zero mean for all i.
1t = Y1t w* This structure is used to propose j Y jt as an estimator for a1t

(t {T0 + 1, . . . , T}), where w* j denotes the j - th element of a (J 1) vector W* of weights. Therefore, an estimation of the counterfactual situation for the treated country in the post-intervention period is obtained as a linear combination of the outcomes in the potential controls:
j =2
J +1
1N * Y t {T0 + 1,, T } t = w j Y jt ;
j =2
J +1
(3)
This estimator will be unbiased if W* is obtained solving the following optimization problem:
min X1 0W
W
= (X1 0W )V ( X1 0W )
(4)
subject to the following constraints on the weights:
w* for j 0; * w* 2 + + wJ +1 = 1
where:
j = 2,, J + 1
(5)
X1 = ( Z1 , Y11 ,, Y1M ) 0 = ( X 2 , X 3 ,, X J +1); X i = ( Z iYi1 ,, Yi M ); i = 2,, J + 1

jY w* j =2 J +1 1 j J +1 j =2 J +1 j =2
(6)
= Y ,, w* jY
1 1
M j
= Y1
and
j Z j = Z1 w*
X1 is a (k 1) vector of pre-intervention (t T0) characteristics in the treated country, c0 its equivalent (k J) matrix for the potential controls and Yi1 , . . . , Yi M are M linear functions of the outcomes before the policy was
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implemented in a given country i satisfying M F. V is a diagonal, positive and semidenite (k k) matrix determined by the predictive power of the explanatory variables during the pre-intervention period. In the application below, we assume the presence of a single unobserved common factor with different effects on each country and that the linear function of the pre-intervention outcomes in (6) is the simple average (M = F = 1). W in (4), conditional on V, is searched for among all the possible combinations using a fully nested optimization procedure.5 Three different starting points for V have been considered in order to avoid local minima: equal-weighted, regression-based and determined by maximum likelihood. The measure of FDI inows from the US into a given country (Yi) will be introduced in the following section. Moreover, a justication of the variables included in the vector of observed explanatory factors (Zi) will also be given in accordance with existing empirical studies and evidence about FDI determinants. III. FDI Determinants: Data Sources and Variable Construction Traditional theoretical models of FDI distinguished between vertical (Helpman, 1984) and horizontal (Markusen, 1984) motivations for the behaviour of multinational enterprises. These two approaches were later reconciled in the knowledge-capital model (see Markusen, 2002) and more complex strategies have recently appeared in the literature (see Baltagi et al., 2007, for a review). An empirical literature on FDI determinants has developed on the basis of all these theoretical models. The exhaustive survey on this issue in Blonigen (2005) contains two ideas that will be useful for the purpose of this article. First, it is observed that FDI tends to be horizontal and between industrialized countries. Second, a gravity specication ts cross-sectional FDI ows data quite accurately. The measure of FDI that will be analysed below is the American capital outows to the United Kingdom and the potential control countries as a percentage of their GDP. These FDI ows data have been obtained from the Bureau of Economic Analysis and refer to the period 19862006.6 They include equity capital transactions, reinvested earnings and intercompany
5
This methodology has been applied in the subsequent analysis using the Stata version of the related software provided by Jens Hainmueller in his homepage. Two missing values for Portugal (1989 and 1990) and one for Spain (1995) have been interpolated using the TRAMO/SEATS Econometric Package.
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debt transactions and are measured on an historical-cost basis.7 Current GDPs, in PPP terms, have been extracted from the World Banks World Development Indicators database. The variables used as FDI determinants have been selected according to the modied gravity specication in Blonigen et al. (2007). First, the host countrys GDP and population have been included in order to reect its potential market size. These data have also been extracted from the World Development Indicators database. In addition, note that GDP data are expressed in constant 2005 PPP terms. Openness has been included as a measure of trade costs. It is equal to the sum of exports plus imports over GDP, is expressed in constant terms and has been extracted from the Penn World Table (v.6.2). Educational skills in the host country have been proxied by the average years of schooling for people over 25 from the Barro and Lee (2001) database.8 The distance to the United States has also been considered and comes from the Centre dEtudes, Prospectives et dInformations Internationales. Finally, a variable reecting the EU surrounding market potential of a country has also been included. For a given year, it has been calculated as an inverse-distance weighted-sum of the GDPs in other EU countries. Summarizing, the variables of interest that will be analysed below are the American FDI ows to a given country as a percentage of its GDP. The explanatory factors in Zi are the following variables referring to the host country: constant GDP in PPP terms, population, distance to the United States, openness, educational skills and a measure of the EU surrounding market potential. IV. Assessing the Effects on American FDI Flows to the United Kingdom Derived from Euro Non-adoption Preliminary Analysis: Testing for a Break in Trend Before applying the policy evaluation method to the FDI ows data, their time-series properties, both in the United Kingdom and its potential controls, have been analysed. The latter are the EU members in 1986 that joined the
This is the only way that detailed data by country are provided by the Bureau of Economic Analysis (BEA). As can be observed in Table 1, there are other databases from which American FDI outows to a given country can be obtained (Eurostat and International Direct Investment Database). However, the data compiled by the BEA allow us to work with a balanced panel with the least need for interpolation and the greatest number of potential controls. 8 This variable is reported in the database every ve years. Following Blonigen et al. (2007), it has been transformed to a yearly frequency using linear interpolation.
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third stage of the EMU in 1999.9 We test for the presence of a single break in the trend of the American FDI inows as a percentage of GDP. Three different techniques have been applied with this aim. The rst one is the SupF test for a structural change of unknown date in regression models developed by Andrews (1993). The second one follows Bai and Perron (1998) and determines whether or not a trend shift is present by the use of information criteria. In order to apply these two methods, the deterministic component has been considered to be made up of a constant and a trend. The statistical signicance of a change in the coefcient of the latter term is analysed. An interesting alternative technique has been recently proposed by Perron and Yabu (2009). It consists of a powerful test for a structural change in the trend of a univariate time-series that does not depend on its order of integration. In line with the two methods previously described, it has been applied looking for a structural change in slope. Structural break testing results are found in Table 2. The SupF test statistic for each country is reported in the second column of Table 2. There is evidence of a break in the trend only for Belgium and the United Kingdom. These breaks are statistically signicant at the 1 per cent level. Therefore, the null hypothesis of no structural break cannot be rejected in the other cases at a signicance level smaller than or equal to 10 per cent. These ndings are corroborated by the application of both the Akaike and Schwartz information criteria. Results from the application of the Exp test by Perron and Yabu (2009)10 are reported in the fourth column. In line with the results presented above, they also give evidence of a structural change in slope for both Belgium and the United Kingdom at the 1 per cent signicance level. In addition, the null of no break in trend is rejected for Portugal at the 5 per cent signicance level. Perron and Zhu (2005) demonstrated that a consistent estimation of the break dates can be obtained by the minimization of the sum of squared residuals. This has been done for a regression of the analysed series on a constant, a time trend and a slope shift dummy. Estimated break dates are presented in the sixth column of Table 2. All of them are located at the end of the sample period analysed, the earliest being one corresponding to the United Kingdom which is suggested to be the year 2000. Break dates for Belgium and Portugal are 2003 and 2002, respectively. Once the presence of structural breaks has been tested for and their dates determined, the corresponding trends have been tted using OLS regressions.
9
The exception is Luxembourg due to the lack of educational skills data. Therefore, the EMU donor pool is made up of Belgium, France, Germany, Ireland, Italy, the Netherlands, Portugal and Spain. 10 The author acknowledges Tomoyoshi Yabu for allowing the use of his code.
Table 2: Structural Break in Trend Testing. US FDI Flows to Selected EU Countries (% GDP), 19862006
Exp test 6.48*** 0.69 -0.15 0.17 -0.11 0.03 2.86** -0.06 48.97*** 4.65 0.39 7.05 2003 2002 2000 0.25 0.18*** 0.05 0.09 1.11 0.79 0.14* 0.09 0.18 0.03 1 10-3 0.01*** 3 10-3 0.21** 0.08 2 10-6 0.01 0.13*** SSR Break date Constant Trend1 Trend2 0.43** 3 10-3 -0.38***
SupF test
AIC / BIC
Belgium France Germany Italy Ireland Netherlands Portugal Spain United Kingdom
12.82*** 0.71 0.56 4.08 0.12 2.74 1.12 0.75 40.68***
1 0 0 0 0 0 0 0 1
Source: Authors own calculations. Note: ***, ** and * statistically signicant at the 1, 5 and 10% levels, respectively.
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The results are in the last three columns of Table 2. It can be appreciated that all of them are upward trends except that followed by the series of FDI ows to the United Kingdom after the shift in the year 2000. In the latter case, the slope coefcient is negative and highly signicant. Both the observed American FDI ows to a given country as a percentage of its GDP and their estimated trends are plotted in Figure 1. While the American FDI ows to the selected EMU countries have maintained, if not increased, their upward trend, this has not been the case for the United Kingdom. This variable has, in fact, followed a decreasing path after the third stage of EMU started. In addition, an important increase in the trend of the FDI ows to Belgium is also observed in the nal years of the sample period. The signicance and magnitude of the Portuguese trend shift is lower. Finally, it should be noted that some of the estimated upward trends could be approximated by a shift towards a higher level in the aftermath of the euro. This seems to be the case for Germany and Ireland,11 but could perfectly apply to the Netherlands and Spain. Results from the Synthetic Control Approach As pointed out before, an estimation of the American FDI ows into the United Kingdom that would have taken place if it had adopted the euro can be obtained through the application of the synthetic control method. This subsection presents the results. Weights assigned to each country in the EMU donor pool when constructing the synthetic United Kingdom are found in Table 3. The counterfactual situation that best resembles the evolution of observed American FDI ows into Britain before the third stage of the EMU is built as a linear combination of those received by four countries. Not surprisingly, the highest weight corresponds to Germany (0.43). The other three countries from which the synthetic United Kingdom has been constructed are the Netherlands (0.22), Ireland (0.18) and France (0.17). Apart from the countries selected and the weights assigned to them in order to construct the synthetic control, the suitability of the applied technique in this context can also be inferred from Table 4. Average values of the FDI determinants in the period 198698 for the United Kingdom and its EMU synthetic counterpart are shown in its second and third columns, respectively. It can be observed that the synthetic control has mean values for the explanatory variables relatively close to those in the United Kingdom before 1999.
11
The Irish government set up aggressive scal measures in order to attract FDI.
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Figure 1: US FDI Flows to Selected EU Countries (% GDP, Bold) and Estimated Trend (Dotted)
Source: Authors own calculations.
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Table 3: Weights Assigned to Selected EMU Countries in Order to Construct the Synthetic UK
Belgium France Germany Ireland Italy Netherlands 0.22 Portugal 0 Spain 0
0 0.17 0.43 0.18 0 Root Mean Square Prediction Error (RMSPE) = 0.63
Table 4: Mean Values for the FDI Determinants in the UK and Its Synthetic Control in the Pre-intervention Period (198698)
United Kingdom GDP Population Distance to the US Openness Education EU surrounding market potential
Synthetic United Kingdom from EMU countries 1.23 1012 4.83 107 6282.61 68.67 8.86 1.13 1010
1.35 1012 5.76 107 5901.34 44.01 8.86 1.28 1010
This is especially true with regard to educational skills. The biggest difference in relative terms corresponds to openness. The main results obtained from the synthetic control approach are displayed in Figure 2 where the evolution of the observed values for American FDI ows to the United Kingdom and those corresponding to its synthetic counterpart are plotted. As mentioned before, these ows followed an upward trend in the period 198699 reaching several peaks in the years 1989, 1993 and 1999. However, this increasing trend was reversed in 2000. To give an idea of the extent of this fall, the share of FDI inows as a percentage of GDP in 2001 was almost the same as that received in 1991. Moreover, it should be noted that the percentage of FDI inows at the end of the pre-intervention period has never been equalled since then. Estimated FDI ows for the synthetic United Kingdom also follow an upward trend after 1990. Furthermore, they closely resemble the evolution of those really observed. There is a little difference since their values are slightly lower than the real ones and the last peak is reached one year earlier. Contrary to the experience of observed American FDI ows to the United Kingdom, those corresponding to the synthetic control maintain the steadily increasing path that began in 1990 instead of changing their trend after 1999. This
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Figure 2: US FDI Flows to the UK (% GDP, Bold) and Synthetic Control Constructed from Selected EMU Countries (Dotted)
3 2 1 0 1 2 1986 1991 1996 2001 2006
impression is conrmed by the three methods described in the previous subsection.12 As a result, the share of FDI ows as percentage of GDP corresponding to the synthetic United Kingdom constructed from EMU countries is generally higher than that really observed from the year 2000 onwards. The exception is the year 2005 when the synthetic control experiences a sharp drop. Although something similar happened in the United Kingdom, the magnitude was smaller. As can be observed in Figure 1, the American FDI ows received by several EMU countries also fell that year. These reductions were especially important for Ireland and the Netherlands, but their causes were different. While, in Ireland, it was a consequence of the reduction in the indebtness of Irish afliates to their American parents, the fall in the Netherlands was driven by the fact that reinvested earnings turned highly negative a consequence of tax incentives provided by the American Job Creation Act of 2004 (Koncz and Yorgason, 2006). Moreover, it should be noted that this data point is considered to be an additive outlier13 in the corresponding
12 Obtained statistics are 1.42 and 0.30 for the supF and Exp tests, respectively. In neither of these two cases can the null of no structural break be rejected at a signicance level lower than 10 per cent. These conclusions are corroborated by the Akaike and Schwartz information criteria. 13 An aberrant data point with a cause outside the intrinsic economic environment that generates the time series data (Franses and Van Dijk, 2000).
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time-series of these two countries by the detection procedure proposed in Chen and Liu (1993). This conclusion also applies to the synthetic United Kingdom and is reasonable since Ireland and the Netherlands account for 40 per cent of it. However, this test does not detect any additive outlier in the observed FDI ows to the United Kingdom. The highest negative difference between the observed American FDI ows into the United Kingdom and those predicted by the synthetic control corresponds to the nal year of the period analysed. While American FDI ows to the United Kingdom represented 0.98 per cent of its GDP, the percentage for the synthetic control was 2.78 per cent. This is equivalent to saying that the policy evaluation method applied suggests that British FDI inows from the United States in 2006 are around 65 per cent lower than if the country had adopted the euro. Taking into account the whole post-EMU period, the gap between the trends followed by the FDI ows to the United Kingdom and its synthetic control increases after 2000. The average decrease for the years 200006 is 15.40 per cent.14 It can be concluded from the results presented above that the decision not to join the third stage of the EMU has had an important negative effect on British inward investment from the United States in comparison to the 1986 EU members that joined the European single currency in 1999. These results contrast with those by Schiavo (2007) who did not nd any adverse effect on the FDI ows received by the United Kingdom. This might be related both to the different time span (19802001) and the origin of the FDI ows (OECD countries) considered. However, the magnitude of this estimated effect is in line with the fall in the share of American ows into the EU corresponding to the United Kingdom reported by Barr et al. (2003) until the year 2001 and the share of FDI inows from non-EMU countries into Britain as a percentage of its GDP until 2003 in Taylor (2008).15 An important difference between Taylors article and this one is that he uses estimations up to a certain date in order to construct counterfactual scenarios for future time periods. A case study seems to be a more appropriate framework with which to estimate causal effects derived from a certain event. Moreover, the synthetic control method applied in this article is valid under more exible conditions than alternative techniques like the differences-in-differences approach used in Petroulas (2007).
This average negative impact increases to 36.15 per cent if the outlier in 2005 is neglected. The average gap predicted by the synthetic control method after 1999 is equal to -25.48 per cent until 2001 and -30.13 per cent until 2003. These gures should be compared with those reported in Table 1.
15
14
479
Evaluating the Robustness and Signicance of the Estimated Effects I should begin by noting that the use of total GDP as an FDI ows determinant when applying the synthetic control policy evaluation method could raise concerns. This is because this variable might have been affected by the policy intervention analysed and, hence, endogeneity problems could arise. As an alternative, the same analysis as before has been carried out using GDP per capita. The reason is that this variable should be less inuenced by the EMU than total GDP itself. The results from this robustness check do not signicantly change with respect to those previously presented.16 The rst difference found is that Belgium replaces France as a country from which the synthetic control is constructed. Germany reduces its weight and represents 62 per cent with Belgium. The remaining 38 per cent is also distributed evenly between Ireland and the Netherlands. In spite of this change in the composition of the synthetic control, its evolution during the whole sample period is very similar to that displayed in Figure 2. As was also the case before, the average estimated negative gap in 200006 is equal to 15 per cent with this alternative specication. One way of testing for the signicance of the differences between the observed series for the country studied and its synthetic control is by applying the Matched-Pairs Signed-Ranks test by Wilcoxon (1945). This nonparametric test between two related samples is often used to compare scores of data collected before and after an experimental manipulation. It is an alternative to the paired Students t-test when the data cannot be assumed to be normally distributed. Under the null hypothesis, the median of the differences is expected to be zero. In our context, instead of comparing individuals, the observational units will be time periods. Results obtained from the comparison of the observed values for American FDI ows to the United Kingdom as a percentage of its GDP and those predicted by the synthetic control method are shown in Table 5. When considering the whole post-intervention period, the null hypothesis cannot be rejected at the 10 per cent signicance level. Although this test can be used with sample sizes as small as the case analysed here, it is expected to have low power. This could be exacerbated in the presence of outliers. Because of this, the test has been applied to the whole post-intervention period excluding the year 2005. Now, the null hypothesis of a median difference equal to zero is rejected at the 5 per cent signicance level. Therefore, these ndings allow us to state that the predicted values for American FDI ows to the United Kingdom by the synthetic control are signicantly different to those really observed in most of the years after the euro started.
16
Further details are available from the author upon request.
480
Table 5: Wilcoxon Matched-Pairs Signed-Rank Test. Differences between Observed US FDI Flows to the UK (% GDP) and Its Synthetic Control
Post-intervention period All Except 2005 Number of observations Positive Negative Total 2 1 5 5 7 6 W+ 8 1 W20 20 Test statistic -1.01 -1.99**
Source: Authors own calculations. Note: ** Statistically signicant at the 5% level.
Figure 3: US FDI Flows to the UK (% GDP, Bold) and Fitted Trend for the Synthetic Control Constructed from Selected EMU Countries (Dotted, 2 serror Bands)
3.5
2.5
1.5
0.5
0.5
1986
1991
1996
2001
2006
As an alternative, the observed FDI ows can be compared with the estimated trend of their synthetic control. These results are plotted in Figure 3. Bands representing 2 times the standard deviation of the estimation errors are also reported. The observed ows are inside the bands in most of the pre-intervention period. The values outside the limits are always above the upper band and correspond to the peaks of the years 1989, 1993 and 1999. In addition, the FDI ows are generally above the trend because the estimated slope for the synthetic control is less steep than that of the observed ows before the break. These ndings change in the post-intervention period, when observed FDI ows are systematically below the estimated trend after 2000. Moreover, they fall below the lower band in all the years except 2003 and 2004.
481
Nonetheless, they are very close to the lower limit in these two cases. Finally, it should also be noted that Figure 3 reects the divergent trend followed after the start of the third stage of the EMU by the American FDI ows in the United Kingdom and that predicted by the policy evaluation method. Summarizing, it can be concluded that the results presented throughout this subsection corroborate the robustness and signicance of the estimated negative effect on the FDI ows from the United States received by the United Kingdom after the launch of the euro derived from its decision to stay out. Conclusions This article has shown evidence of a structural break in the trend of FDI ows received by the United Kingdom from the United States after the start of the third stage of EMU. This break led the FDI ows to turn their upward trend in 2000 into a decreasing path. More interestingly, this observation is only found for this country of all the selected countries that had been EU members since 1986. All these countries, that later joined the EMU, have maintained, if not increased, their upward trends. The results obtained from the application of a synthetic control method designed for policy evaluation suggest that, on average, the American FDI ows to the United Kingdom as a percentage of its GDP have been 15 per cent smaller than if this country had adopted the euro after 1999. The estimated magnitude of this effect is much higher in some periods, reaching 65 per cent in the nal year of the sample analysed. The signicance of the estimated effects has been analysed using formal statistical tests. Moreover, its magnitude has been adequately compared and integrated into the literature analysing the effects of the EMU on FDI. I nd that it is similar to some of those already established for FDI ows in the United Kingdom from the United States and other non-EMU countries. In addition to the wider sample period analysed, the main difference is that this article uses a methodology that allows us to estimate causal effects under more exible conditions than alternative policy evaluation methods used in previous studies.
Correspondence: Marcos Sanso-Navarro Departamento de Anlisis Econmico Facultad de Ciencias Econmicas y Empresariales Gran Va, 2. 50005, Zaragoza (Spain) Tel (+34) 976761000 Ext. 4629. Fax (+34) 976761996 email marcossn@unizar.es. Homepage http://dae.unizar.es/marcossn/index.html.
482 References
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JCMS 2011 Volume 49. Number 2. pp. 463483 DOI: 10.1111/j.1468-5965.2010.02124.

THE EFFECTS ON AMERICAN FOREIGN DIRECT INVESTMENT IN THE UNITED KINGDOM

Table 1: Summary of the Literature Examining EMU Effects on FDI

EMU effect (%)

Layard et al. (2002)

Share of ows into EU

European Commission and Eurostat

Barr et al. (2003)

Share of stocks in EU Share of US ows into EU

UNCTAD Bureau of Economic Analysis

Begg et al. (2003)

Share of ows into EU

Her Majestys Treasury (2003)

Share of ows into EU

Share of ows within EU

UNCTAD Eurostat Eurostat

International Direct Investment Database

International Direct Investment Database

Brouwer et al. (2008)

International Direct Investment Database

OECD and UK Ofce of National Statistics

EMU Non-EMU EMU Non-EMU EMU Non-EMU

EMU EMU EMU EMU UK UK

80282 227517 -1270 95263 112 -28

Source: Authors own data.

THE EFFECTS ON AMERICAN FOREIGN DIRECT INVESTMENT IN THE UNITED KINGDOM

Yit = YitN + it Dit 1 if i = 1 and t > T0 Dit = 0 otherwise

THE EFFECTS ON AMERICAN FOREIGN DIRECT INVESTMENT IN THE UNITED KINGDOM

1t = Y1t w* This structure is used to propose j Y jt as an estimator for a1t

subject to the following constraints on the weights:

X1 = ( Z1 , Y11 ,, Y1M ) 0 = ( X 2 , X 3 ,, X J +1); X i = ( Z iYi1 ,, Yi M ); i = 2,, J + 1

THE EFFECTS ON AMERICAN FOREIGN DIRECT INVESTMENT IN THE UNITED KINGDOM

12.82*** 0.71 0.56 4.08 0.12 2.74 1.12 0.75 40.68***

THE EFFECTS ON AMERICAN FOREIGN DIRECT INVESTMENT IN THE UNITED KINGDOM

THE EFFECTS ON AMERICAN FOREIGN DIRECT INVESTMENT IN THE UNITED KINGDOM

Source: Authors own calculations.

1.35 1012 5.76 107 5901.34 44.01 8.86 1.28 1010

THE EFFECTS ON AMERICAN FOREIGN DIRECT INVESTMENT IN THE UNITED KINGDOM

3 2 1 0 1 2 1986 1991 1996 2001 2006

Source: Authors own calculations.

THE EFFECTS ON AMERICAN FOREIGN DIRECT INVESTMENT IN THE UNITED KINGDOM

Further details are available from the author upon request.

Source: Authors own calculations. Note: ** Statistically signicant at the 5% level.

Source: Authors own calculations.

THE EFFECTS ON AMERICAN FOREIGN DIRECT INVESTMENT IN THE UNITED KINGDOM

THE EFFECTS ON AMERICAN FOREIGN DIRECT INVESTMENT IN THE UNITED KINGDOM

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12.82* 0.71 0.56 4.08 0.12 2.74 1.12 0.75 40.68*