Using Instrumental variable and Two-Stage Least Squares for Panel Data Models to Estimate the Interactions between Trade and FDI

Based on the early theories of the foreign direct investment (FDI), trade and FDI are substitutes while the new international trade theories emphasize the complementary relationship between trade and FDI. This introduces new aspects to model fundamental concepts such as increasing returns to scale, product differentiation, and technology differences among countries. This paper is an empirical study of the interaction between trade and FDI using data on inward FDI to the ECO and D8 countries. To end this, we use instrumental variable and generalized two-stage least squares (G2SLS) techniques for panel data models. The results show that there is a complementary relationship between trade and FDI. Moreover, GDP, exchange rate, population, inflation, and some convergences variables have significantly influence on trade and FDI.