European Central Bank publishes working paper finding aggregate FDI gravity models mask sector-level distance effects

The European Central Bank has published Working Paper No. 3245, in which the authors re-examine foreign direct investment through a gravity model using sector-level data. The paper, which explicitly does not represent ECB views, finds that aggregate and pooled FDI gravity models can obscure important sector differences, particularly in how strongly distance affects investment and in whether observed patterns are more consistent with horizontal or vertical FDI motives. At an aggregate level, distance is negatively associated with FDI, but that result masks wide variation across sectors. Using the MREID dataset with 2-digit NAICS sector coverage, the study examines FDI across 25 sectors over 2010 to 2020, with the final empirical sample covering 145 countries after data exclusions. Aggregate and pooled sectoral models produce broadly similar results, suggesting little econometric aggregation bias, and the negative overall distance effect remains robust across alternative specifications, richer fixed effects and controls for other distance-related factors, including geopolitical distance. Separate sector regressions, however, show materially different distance elasticities, including a positive coefficient for warehouse and storage, while sectors such as utilities, transportation and some services show stronger negative effects. The paper also finds that simple sector characteristics such as goods versus services, skill intensity, global value chain upstreamness and trade costs explain little of this variation, indicating that sector-specific FDI patterns are more complex than standard aggregate models suggest.