Similar findings come from Crescenzi, Di Cataldo and Giua (2021), who leverage a survey on national and subnational IPAs in Europe to evaluate the impact of IPA sectoral targeting on announcements of greenfield FDI projects, using both a difference-in-difference and synthetic control methods approach. They find that IPAs help to attract FDI even in advanced economies. They further find that sub-national IPAs are more effective than national IPAs and speculate that this is because their proximity to investors helps them to better address their investment concerns. Finally, an innovative new study by Volpe Martincus et al. (2020) expansd the focus from sectoral to firm-level targeting. The authors use firm-level data on both location decision and IPA assistance status to assess the effectiveness of IPA facilitation on attracting foreign firms in Costa Rica and Uruguay over the period 2000-2016. They find evidence that investment promotion strongly increases the probability that an MNC locates in the host country.

# **FDI Gravity Models**

A separate literature relevant for the analysis of IPA effectiveness relates to gravity models to study FDI flows. These models originate in international trade, and use the metaphor of Newton’s law of universal gravitation to predict that trade flows between countries is a function of two main variables: their size (more economic activity predicts more trade) and their distance (greater physical/cultural distance and trade frictions predict less trade). Gravity models build on solid theoretical foundations that make them particularly appropriate for counterfactual analysis, such as quantifying the effects of trade policy (Yotov et al. 2016). Their predictive power is another reason why these models have grown in popularity. Empirical gravity equations of trade flows consistently deliver a remarkable fit of between 60 and 90 percent with aggregate data as well as with sectoral data for both goods and services (Yotov et al. 2016).

New trade gravity models also hold additional insights for FDI analysis. In their seminal paper, Anderson and van Wincoop (2003) demonstrate that traditional gravity equations can overstate the effect of trade frictions on trade flows because they ignore the fact that countries operate in a multilateral world. That is – a change in the trade cost (say, a tariff) between countries A and B also affects the trade flows of countries A and B with all their other trading partners (because it may create or divert trade flows). New or ‘structural’ gravity models distinguish themselves by directly accounting for this multilateral resistance (MR) effect, and are therefore considered more robust and accurate in evaluating policy reforms. The issue of multilateral resistance is also clearly present within foreign investment dynamics. For example, investment climate reforms or IPA promotion efforts in host country A would affect its relative competitiveness compared to other host countries and can shift FDI across such countries. As such, new gravity models also hold theoretical and empirical benefits to study FDI dynamics.

The economic literature has recently started to apply gravity models to FDI. In a literature review of FDI determinants, Blonigen (2005) noted that “As with trade flows, a gravity specification actually fits crosscountry data on FDI reasonably well”. Kox and Rojas-Romagosa (2020) note that “given the success of the gravity trade model, one wonders why it has not yet become part of the standard empirical toolkit for the analysis of international patterns in bilateral FDI”. Part of the challenge here lies with the absence of tractable models, but a more important constraint has been the availability of bilateral direct investment data. Fortunately, more countries are now reporting detailed bilateral FDI statistics,<sup>2</sup> which is leading to the increased popularity of studying FDI in a gravity context. A recent example of this is Kox and RojasRomagosa (2020) which uses a structural gravity model of FDI to estimate the potential impact of preferential trade agreements (PTAs) on the bilateral FDI stocks and flows between the countries signing.

> 2 Examples include the US Bureau of Economic Analysis, the OECD’s BMD4 database and EUROSTAT’s BPM6 data sets.

5