Immigrants as Economic Integrators

Transcription

1 Master Thesis Submitted for the degree of Master of Science in International Economic Consulting Immigrants as Economic Integrators - Evidence from Denmark. Authors Samuel Michael Olsen and Simon Weinberger Academic supervisor Philipp J. H. Schröder Aarhus University Aarhus, March 1 th, 2012

2 Abstract This thesis examines the influence of immigration on Danish import, export and FDI inflow between 1995 and In the period undertaken the share of the Danish population constituted of residents with a foreign background grew from 5,3% to 9,1%. The increased ethnic diversity makes it a very applicable and highly relevant case to analyze. The empirical analysis is founded in the potential reduction of trade barriers and the facilitation that immigrants can exhibit via their proficiencies and knowledge pertaining to their origin country. The model applied to investigate this is grounded in the augmented Gravity equation. The findings provide significant robust evidence and establish a causal relationship through a strong positive link between immigration and increased import, export and FDI inflow to Denmark. Furthermore, it is found that the linkage is stronger for import than export, varies in strength across product differentiation and origin country characteristics - institutional quality, economic development, continent and geographical distance. Moreover, the outcomes confirm that the knowledge possessed by immigrants actually encompasses to their descendants. Descendants are estimated to have a significant and positive influence on the level of Danish bilateral trade. The immigration policy reform conducted in 2001 was found not to have a significant and diminishing influence on the nexus between immigration and trade in the period after its commencement. The estimated effects from immigration are found to be autonomous due to the total lack of strategic actions and initiatives that seek to boost and enhance the effect from immigrants residing in Denmark. The study concludes that an immigrant network formation in Denmark is an applicable initiative to utilize the resources and knowledge possessed by immigrants. Keywords: Immigration, international trade, FDI inflow, immigration policy.

3 Contents Abstract Introduction Purpose and delimitations Structure and outline Theoretical background Trade models and international capital movements Immigrants and trade Immigration and foreign direct investments The role of individual characteristics Literature review Previous research on immigration and its potential effect on trade Previous literature of immigration and its effect on FDI inflow Clarification of the immigration cost paradox Labour mobility The cost paradox of immigration Immigration policy Immigration policy Historical Danish immigration policy Immigrants in Denmark Immigration Population heterogeneity Methodology and estimation strategy Scientific approach Gravity model Multilateral resistance Empirical specifications Regression specifications Interaction terms Rauch classification Reverse causality issues Econometric estimation methods Robustness test... 36

4 6.6 Sample Selection Analysis delimitation Dataset and model specification Time period and dependent variables Product classification by level of differentiation Independent variables Variable description Dummy variables Sensitivity analysis Variance Inflation Factor Heteroscedasticity Results Does immigration increase Danish international trade? Magnitude and importance of immigrants Immigration as an indirect trade instrument Institutional quality Economic gap Continents Immigrants as an information channel goods classification The role of descendants Immigration as a FDI inflow projector Immigration policy and time dimension Interpretation of the results practical aspects Robustness test Immigration-trade link check Partial conclusion Further research Trade barriers, Project Kosmopolit and utilization Exploitation and level of utilization in Denmark Project Kosmopolit a Swedish application and organization Danish trade obstacles Results, implications and recommendations Results application... 76

5 10.2 Bridging the gap - a strategic initiation An immigrant business network in Denmark Immigration policy Critics of the DREAM model Welfare implications The welfare state paradox The authors remarks Conclusion References Appendices List of tables Table 1 (Litterature review) Table 2 (Immigrants in Denmark) Table 3 (Variance of Inflation Factors) Table 4 (The effect of Immigrant on Danish Trade) Table 5 (The Effect of origin characteristics) Table 6 (The Effect of immigrants by level of product differentiation) Table 7 (The Effect of descendants on trade) Table 8 (The Effect of immigrants on FDI) Table 9 (Impact from the immigration policy reform in 2001) Table 10 (Robustness check) List of figures Figure 1 (Population heterogeneity in Denmark)... 26

6 1. Introduction At the moment five ministries, Ministry of Finance, Economic and Business Affairs, Interior and Health, Refugee, Immigration and Integration Affairs and Ministry of Employment, are finalizing their analysis of the economic consequences from immigration to Denmark. In April 2011 interim results were published. The subject of this thesis has its background and motivation in those presented results and can be viewed as contributions and comments upon the calculations to some of the related economic questions that it raises. The estimated annual costs in year 2010 from immigration, that is both immigrants and their descendants, from less developed nations was presented to be approximately 16 billion kroner per year 1 (Regeringens arbejdsgruppe, 2011), but this estimation has been widely criticized by specialists and experts due to a number of reasons pertaining to the foundation of the calculations. Among the weaknesses and shortcomings that have been pointed out are the omission of critical variables and a possible misspecification of the applied model. The absence of factors such as level of education and age may result in possible bias of the results. Due to the outlook of the population, 2 3 of the descendants are between 0-15 years old and thereby do not generate any direct revenue through taxes, the report is likely to give an inaccurate outcome. Additionally the model employed is static and therefore only gives a snapshot of the public financial costs such as present revenue and costs. Other critics conclude that the calculations just confirm what is already considered a known issue; immigrants have a lower participation rate than ethnic Danes (MM, 2011). Immigration policy has previously been a highly sensitive and contentious political and social issue in the western world but during the last decade the rhetoric in the public regarding immigrants and immigration policy has intensified. The costs that immigrants are calculated to impose on the host countries has been a common focus in political debates. Concerns about increased labour movements and its influence on the social services, welfare systems, labour market and cultural institutions have fostered the 1 This number composes of a net cost from immigrants and descendants of 4,0 billion DKK and 11,7 billion DKK, respectively. The numbers regarding developed countries is a surplus of 4,7 billion DKK and 2,5 billion DKK for immigrants and descendants, respectively. The numbers are based upon the newest calculations which are performed by the Danish Rationale Economic Agent model (DREAM). The computation was ordered by Center for Political Studies (CEPOS) (Regeringens arbejdsgruppe, 2011). 1

7 European governments to increase the restrictiveness of its immigration policy (White, 2007b) and (Hiller, 2011). Furthermore, international political and civil unrest and persistent economic disparity between developed and developing countries causes continued increase in future immigration pressure. Past tightened immigration policies indicate that immigration politically is not viewed as a potential part of the solution to the problems that Denmark faces in the coming years. This can prompt some adverse and detrimental effects on the outlook of the labour market. As is the case for many European countries in the forthcoming years Denmark is expected to have a considerable decrease in the labour supply due to a declining and ageing population (Coppel et al., 2001). The present situation with strong focus on the negative effects and costs imposed by immigrants has entailed limited attention to the contribution of possible benefits from immigration e.g. larger variety of products, lower wages in the service sector, increased trade integration etc. Previous studies and research have shown that immigrants bring some superior knowledge about culture, business policies, contacts, linguistic and about the regulatory environment of their country of origin. This expertise and unique know-how about their origin country can help lower trade costs between country of birth and country of residence by providing an information channel that reduces trade barriers and frictions, which can facilitate trade and investment relations (Hatzigeorgiou, 2010a). The dynamic effects and influence from immigrants described above and the deflected revenue have not been included in the calculations of the costs from immigration. These so-called indirect economic effects have previously been investigated and detected in a number of countries including Denmark. Calculating and quantifying the costs and benefits of a specific economic phenomenon is always a potential object for discussion due to the very nature of such an analysis - even if calculated accurately (White, 2009). Some factors are very difficult to monetize and the question about at what detail level the analysis should be based upon are both issues, which make findings across studies hard to compare directly. Nevertheless, regardless of this discussion the findings in this paper will contribute with some additive aspects of the phenomenon, which has been absent in earlier calculations and from the public and political debates in general. The outlined problem with the lack of awareness and attention towards the appointed benefits from immigration in Denmark is the starting point for this thesis. This research 2

8 will provide a better understanding of the competences that immigrants possess by quantitatively investigating the effect of immigration on the Danish international trade and FDI inflow and sketch a strategic initiative for a more optimal utilization. Organizing this knowledge in a more comprehensive way can support and remedy some of the problems that Denmark is to be confronted with in the near future. Applying the results can foster increased foreign trade and investments, create more jobs, induce higher growth and facilitate internationalization. This study and concretization of these additional effects should contribute to a broader and more complete perspective of the immigration picture in Denmark and accounting the net influence of immigrants. In the setting of policy formulations the understanding of such complex links is very important because increased immigration policy restrictiveness may discourage trade and foreign direct investments flows across borders. It should be stressed that this thesis is not political motivated. It is primarily founded in the situation outlined above, which reveals an interesting paradox. Immigration is calculated to be a financial burden to the Danish economy in 2010, despite the fact that immigration and free mobility of labour across borders are thought to be beneficial, theoretically. 1.1 Purpose and delimitations The specific purpose of the thesis is to investigate the theoretical links between immigration and import, export, and FDI inflow from the origin-countries in the case of Denmark. The study is founded in the augmented gravity equation where data on bilateral trade flows, export and import, and FDI inflow is applied from the period The thesis examines two main hypotheses, which both are formulated upon the relating theory. The first hypothesis pertains to the immigration-trade link and is listed below. H 1 : There is a positive relationship between the number of immigrants from a given country and Danish bilateral trade flows with that country. 3

9 The literature, which will be presented in detail in section 2.2, describes a large variety of theoretic channels through which immigrants influence the relationship between two countries and enhance their bilateral trade. The two most common channels are the transplanted bias effect and the network effect. The case of Denmark is further supported by (White, 2007b), who found a significant and positive immigration-trade link for Denmark investigating data from the period In order to establish a solid basis to infer that immigrants generate and strengthen Danish trade the following sub-hypotheses will be tested. These are founded in previous literature and theory and the overall aim is to investigate the possible heterogeneity in the immigration-trade link. Coefficients on immigrant stock variables are of greater magnitude if import is employed as the measure of trade as compared to when export is employed. The more institutional dissimilar Denmark is to its trade partners the stronger the immigration-trade link. The more economically dissimilar Denmark is to its trade partners the stronger the immigration-trade link. The immigration-trade link differs depending on regional location. The link between immigration and trade varies based on product type with the strength of the link increasing with the degree of product differentiation. There is a positive relationship between the number of descendants from a given country and Danish bilateral trade flows with that country. Analyzed in a standard trade-theoretical framework capital and labour should be substitutes, but as will be argued there is well founded background to state that the two factors flow in the same direction and a complementary relationship persists (Navaretti et al., 2007). The second main hypothesis builds on this. H 2 : There is a positive relationship between the number of immigrants from a given country and FDI inflow to Denmark from that country. When comparing the need for information in relation to FDI activities to international trade a much more detailed level of knowledge is required (Tong, 2005). FDI generally requires long-term focus and involvement of an extensive and diverse group of agents 4

10 (Javorcik et al., 2011). Derived from this immigrants are thought to have a stronger effect pertaining to FDI inflow than on trade. The following sub-hypothesis is based on this. The link between immigration and FDI inflow is stronger than the observed immigration-trade linkage. During the period investigated an immigration policy reform was conducted in Thus, this reform might change the annual immigrant inflow pattern to Denmark and thereby a possible alteration of the immigrant stock composition. This entails the possibility of shifts in the outlined nexus between the immigration and trade. This generates the following hypothesis. The immigration policy reform in 2001 has had a diminishing effect on the Danish immigration-trade link. The hypotheses will serve as the foundation for an examination of practical aspects that possibly have influenced the outcomes of the quantitative analysis. In the literature the effect from immigration is described as an autonomous effect and hence present without any concrete facilitation. To secure that the estimated elasticities exclusively represents an autonomous effect an investigation of the existing awareness of the subject is conducted. That is, whether immigrants strategically have been applied in the purpose of promoting and strengthening bilateral trade and FDI inflow to Denmark or not. Upon the examinations applicable recommendations are derived on how the outcomes can be integrated into practice. 1.2 Structure and outline The structure of the thesis is divided into four main parts. The first part serves as a theoretical foundation consisting of a presentation of relevant theory regarding immigration, bilateral trade flows and FDI inflow. Subsequent follows a review of previous research investigating the effect from immigration on trade and FDI inflow. Next follows a clarification of the calculated cost from immigration in Denmark, a description of Danish immigration policy in a historical perspective, and a descriptive 5

11 overview of immigrants in Denmark. The second part contains the choice of the econometric models applied and a description of the data the empirical analysis will be based on. This serves as the basis for third part, which is a presentation of the results from the different regressions and tests of the stated hypotheses. Along with the presentation of the results a description of how the results should be understood and the possible implications will be provided. The fourth and final part investigates practical aspects of the results and set the outcomes in to context and perspective on how the results can be applied in Denmark. 2. Theoretical background This section describes the theories that the empirical work is to be founded in. The first part describes the movements of trade, capital and labour flows in a theoretical context. The second part concerns the theory regarding immigration-trade link and the link between immigration and FDI. The primary focus is on the channels and mechanisms through which immigrants can influence bilateral trade relations and FDI inflows. 2.1 Trade models and international capital movements When analyzing the mobility of production factors capital and labour - The Heckscher Ohlin and The Ricardian Model are the typical models applied and have shown to be very applicable (Van Marrewijk, 2007). The relationship between capital and labour is traditionally examined by focusing on whether these are complementary or substitutes. Substitution can be defined as if the factors, capital and migration, seen from the perspective of a given location, move in opposite direction or as complements when they move in the same direction (Navaretti et al., 2007). The assumption behind the Heckscher Ohlin theorem is that production factors are immobile across trading partners. Analyzed in this perspective the exchange of goods is a way to get access of the scarcer production factor, which is incorporated in the imported goods (Malchow- Møller et al., 2009). Without the assumption of immobile production factors there would be no obvious economic reason for trade and factors would simply flow to where it is relative scarce and best remunerated. E.g. capital would flow to the labour abundant country and labour would flow to the capital abundant country. Consequently, price differentials would be reduced and the economic incentive for trade would consequently 6

12 diminish. As depicted, then in the Heckscher Ohlin theorem, trade works as a substitute for immobile production factors. In this outlined standard trade framework the relationship between migration and trade and migration and FDI is substitutional. Labour and capital are substitute ways to match workers and employers located in different countries (Navaretti et al., 2007). Analyzed in the settings of the Ricardian model the relationship is characterized as the exact opposite (Feenstra and Taylor, 2008). In this framework where the main reason for trade is explained by differences in technologies and productivity across countries a complementary relationship can be observed between capital and labour flows if factor movements are allowed. Due to these differences an economic incentive has been set up for capital and labour to flow where it can be employed most efficiently. Depending on which setting and model applied in the analysis dictate how trade and investments should move theoretically Immigrants and trade The theory presented above represents the traditional approaches when analyzing trade patterns and factor mobility. Empirical literature however has found a complementary relationship between capital and labour flows and that immigration can influence the directions and magnitude of this mechanism. Therefore, the description below can be viewed as extensions and contributions to the grounded trade models. At an aggregated level international labour mobility changes the labour supply in the host and origin country and thereby also the production of and the demand for goods in the two nations. As a consequence trade is increased, but substantial fixed costs are faced before initiating trade. Previous studies have noted that immigrants can influence and enhance trade. One of the pioneers to investigate and describe the theoretical channels through, which immigrants can influence the bilateral trade relationship between two countries was (Gould, 1994). The argument was that the level of trade is influenced by immigrants through two channels; the transplanted bias effect and the 2 These derivations are dependent on the type of FDI; horizontal or vertical. Theory predicts a substitutional link between horizontal FDI and trade - instead of exporting, the goods are produced locally. In the case of vertical FDI and trade a complementary relationship predicted. Vertical FDI can generate international trade flows due to export back to the FDI source country (Kim 2006). 7

13 network effect. When immigrants enter the host country they often tend to have a preference for familiar or home-country products. Moreover, foreign products often tend to differ in both quality and tastes compared to goods available in the host country. The unavailability of these differentiated products or satisfactory substitutes can potentially increase the import from the origin country, which is called the transplanted bias effect. Further, even though immigrants over time assimilate and adapt to the environment of the host country they often still maintain consumption of familiar products related to the culture and heritage. This can be seen as holding on to traditional values preserving their native heritage (Epstein and Gang, 2006). Additionally, the magnitude of this effect is dependent the size of the different immigrant stocks (Hatzigeorgiou, 2010a). The transplanted bias effect only relates to the increased flow of goods from the source country to the host country, which makes it solely having an impact on import to the country of residence. The network effect is sometimes described as twofold and works through the information or network mechanism. As oppose to the transplanted bias effect this can potentially both affect import and export. First, immigrants often have some unique knowledge about the markets and business contacts in their origin country. E.g. the network mechanism can induce greater trust when dealing with contacts in the country of origin due to a greater understanding of norms, procedures and business practices. This can establish a trust relationship between the residence country and the country of origin and thereby reduce communication and negotiation costs (Hatzigeorgiou, 2010a). Second, culture, colonial and historical ties, common language and knowledge of political and social institutions can reduce trading transaction costs. This can be reflected in knowledge in relation to products and characteristics in both host and origin country. In this way new trade opportunities can be revealed (Wagner et al., 2002). This is often referred to as, the information channel. Immigrants who are bilingual and share common language with residents in both host country and country of origin can facilitate the relation between the two countries by reducing information and communication barriers and frictions thereby reducing trading transaction cost (Gould, 1994). As described immigrants can reduce trading costs and these can be affected from different directions. The extra costs that arise compared to domestic trade are due to information asymmetries across borders. Difficulties of gathering reliable information 8

14 drive up the associated costs of import and export (Hatzigeorgiou, 2010b). National borders define political and legal environments, this constrain contract enforcement due to national sovereignty jurisdictions across borders (Rodrik, 2000). Limited contract enforcement and lack of information about how foreign markets function will in the same manner as transportation costs or tariffs induce trading transaction cost. Immigrants networks that possess superior knowledge about home country markets and business contacts can lower these costs. Furthermore, networks can possibly enforce cross-border contracts that alternatively would have been difficult to enforce or nonexistent, this mechanism is especially important in regions where the legal environment may be weak (Gould, 1994). It can be argued that strong ethnic networks allow for international trade despite a large moral hazard problem (Greif, 1993). The network effect and thereby the reduction in trading costs depends on the initial level of information available about the immigrants country of origin. Immigrants and their ability to influence and spread the knowledge is determined by different aspects such as integration into host country communities, duration of stay, level of education and the size of their community (Concalves and Africano, 2009). All together the two described channels can reduce trading transaction costs, which can foster trade relations between the host country and the immigrant s country of origin. Whereas the network effect affects both import and export the transplanted bias effect only influences import Immigration and foreign direct investments The effect and role of immigrants on FDI activities is to a great extend similar to the network effect outlined above where the formation of business links can stimulate and facilitate FDI flows to a particular location. When an investor is involved in an international transaction some informal and formal barriers have to be coped with. These barriers often concern difficulties related to the information regarding investment opportunities and the legal and regulatory environment across national borders. The difficulties associated with collecting the necessary information makes it costly, which might increase with greater distance and national borders. In sum, cross-country business and formal networks help overcome barriers and consequently stimulate mutually beneficial international transactions (Javorcik et al., 2011). Investing abroad often tend to include a wide range of people involved. That is suppliers, workers and 9

15 government officials, who require detailed level of knowledge about local markets. In total this will augment the complexity of the decisions and transactions compared to international trade (Dolman, 2007). FDI activities generally have the need of a longterm focus and collaboration with a diverse group of people. Immigration networks can establish the required links to achieve efficient distribution, procurement, transportation and satisfactory regulation (Kugler and Rapoport, 2006). Because long-term investments are thought to benefit relatively more from the lowered risk and costs due to immigration networks it can be argued that immigrants affect FDI flows to a greater degree than it is the case for international trade (Foad, 2011) The role of individual characteristics The role of immigrants and their ability to facilitate trade and influence trading transaction costs might depend on several different characteristics both individual, nonindividual and the type of product traded. Regarding the transplanted bias effect the intuition is that when products are homogenous there is little reason to prefer product from a specific country and the effect is expected to be stronger in the case of final or differentiated products. In the end, the preference approach can act as a stimulus to intra-industry trade (Concalves and Africano, 2009). The magnitude of the effect is larger the more dissimilar host- and source country are, fewer reasonable substitutes are available (White, 2007a). In addition to the network effect other aspects might influence the magnitude of the effect from immigration. Gould (1994) argued that the effect from immigration on trade could not be characterized by a constant elasticity relationship. Moreover, the effect from immigration is likely to be dependent on how much information about a certain economy that already exists in the host country. The more information about a nation or a market that the host country possesses the less value will an additional immigrant potentially add. This implies that the marginal effect from immigration on trade decreases with the size of the immigrant stock. The non-constant elasticity is further described by Head and Ries (1998), which measured the immigration-trade link based on the purpose of stay of the immigrant; family, refugee and independent. Herein is implicit assumed that the effect vary in magnitude with the group, independent expected to have the largest effect. This is based on the fact that these immigrants tend to be more skilled or educated than other groups of immigrants. The probability that a more skilled 10

16 immigrant possesses some superior knowledge and contacts relating to their country of origin seems more likely compared with the other groups e.g. refugee. Finally, the level of additional information that immigration contributes also depends on the characteristics of the country of origin. If the immigrant comes from a country with similar social and political institutions compared to the host country the amount of new information added might be limited. This is often the case for countries that share colonial or cultural ties, e.g. countries in the European Union (Blanes-Cristóbal, 2008). This underlines the role and importance of immigrants pertaining to knowledge about social and political institutions from dissimilar countries. In this setting an immigrant with a set of completely different characteristics can possess valuable information and therefore can reduce transaction costs more than an immigrant from a source country with similar institutional outlook. 3. Literature review This section seeks to give an overview of previous studies of the effects from immigration on trade and FDI inflow. The literature investigating the links have generally found that these effects are positive but that the estimates and size of these effects vary widely according to the period investigated, countries in focus, data applied and estimation method. The number of studies has grown over the past years and provided evidence for the existence of a significant positive immigration-trade link but the nexus between immigration and FDI inflow is still a relatively unexplored area. Different approaches have been pursued to empirically investigate these relationships but the majority of the work has been grounded in the augmented Gravity model. In general the variations in the results underline that these results are not transferable across time periods and countries. Additionally, the differences in the estimates can be explained due the lack of a specific grounded econometric approach; estimation methods simply differ across studies. 3.1 Previous research on immigration and its potential effect on trade Gould (1994) was one of the first to investigate the impact from immigration on US import and export in the period The results demonstrated that immigration had a positive influence on US trade and that the effect was stronger for export than 11

17 import. An additional conclusion derived was that the magnitude of the effect on immigration varied according to type of good traded with a stronger effect on consumer products than producer products. Head and Ries (1998) studied Canadian trade with partner countries and confirmed the positive influence from immigration on trade but in this analysis the effect on import was greater than on export. Subsequent, even though much of the empirical work is carried out with US in focus, similar studies have found a positive association between immigration and trade for other periods and countries that is (Girma and Yu, 2002) in United Kingdom, (Wagner et al., 2002) in Canada, (Blanes- Cristobal, 2003) in Spain, (Bryant et al., 2004) in New Zealand, (White, 2007b) in Denmark, (White and Tadesse, 2007) in Australia and (Hatzigeorgiou, 2010b) in Sweden. A study, particular relevant in the context of this thesis, is White (2007b) who tested the Danish immigrant-trade link in the period with 170 countries employed. Besides investigating the association between immigration and trade countries included in the analysis were classified according to their income and trade was divided by product differentiation. Differentiated products are characterized by potentially incomplete information this implication entails that an immigrant possess asymmetric information in relation to contacts and network connections, which is thought to diminish for homogenous products compared to differentiated products. The findings were a positive immigration-trade nexus and that the magnitude of the link varied across income classification and product differentiation. The greatest magnitude was found when considering countries classified as high income and weakest magnitude but still positive when examine low income countries. This aspect was further explored by Hatzigeorgiou (2010b), who examined the role of economic development since information failures are more common in poor countries. The findings showed that the level of economic development influenced the effect from immigration on Swedish export but not import. The results strengthened the hypothesis that the immigrationtrade link is stronger for immigrants originating from less developed countries than developed countries. The literature has further explored whether the effect from immigration varies according to several other origin country characteristics. The rationale is that social and institutional dissimilarity between the host and the origin country increases the strength of the immigrant-trade linkage. In this setting with large information asymmetry an immigrant from an institutionally and socially dissimilar 12

18 country is thought to be able to add more new information, which may boost trade to a larger degree than an immigrant from a similar country. A related subject here is corruption. Dunlevy (2006) suggested that the immigrant effect was greater on US trade when the political system of the origin country is more corrupt. In much of the previous empirical work it is assumed that the estimated influence of immigration is the same across all ethnicities but removing this restriction reveals that this might not be the case. Bandyopadhyay et al. (2008) investigated US export from 51 states to 29 countries and allowed for a country-specific effect with the result that the estimated effect only was significant for five countries, further that the effect was much larger than not restricted to be homogenous across countries. Person-specific characteristics and the role of education have also been tested. Blanes- Cristobal (2008) found supportive evidence that before immigrants were able to fully exploit contacts, network and the knowledge of their country of origin, the immigrants were required to have a certain level of education. This heterogeneity of skills was much in line with the results from Head and Ries (1998) in which the immigrant group independent, who was characterized by being relative more skilled than the other groups, had the most pronounced effect on trade. White and Tadesse (2007) analyzed the role of immigration policy on trade in relation to Australia. The examination was based on data from 101 Australian trading partners in the period investigating the influence of immigrants from nations afforded preference under the White Australia policy and nations not afforded; non-white Australia policy. Collectively, it was concluded that the abandonment of the White Australian policy had led to increased cultural diversity and thereby influenced the Australian trade patterns. It was argued that due to the effect from immigration on trade flows this is needed to be considered when formulating immigration policies. This is supported by several studies among them White (2009). Generally, the work done so far has found a significant and positive relationship between immigration and trade but also that the magnitude varied whether import or export was analyzed. The theory and literature were further explored and extended by including aspects pertaining to the role of individual and non-individual characteristics, product specifications and origin-country characteristics. Selected empirical papers are arranged in the table below. 13

19 Table 1 Literature of immigration stock elasticity on trade. Study Data Export (Gould 1994) US, 47 trading partner countries, (Head and Ries 1998) Canada, 136 trading partner countries, (Girma and Yu 2002) b UK, 48 trading partner countries, (Wagner, Head and Canada, 160 trading partner countries and Ries 2002) between five Canadian regions, (Blanes-Cristobal 2003) Spain, 40 trading partner countries, (Bardhan and US export from East and West Coast and Guhathakurta 2004) 51 trading partner countries, (Bryant, Genç, and Law New Zealand, more than 170 trading 2004) partner countries, (White 2007a) US, 73 trading partner countries, (White 2007b) Denmark, 170 trading partner countries, (White and Tadesse Australia, 101 trading partner countries, 2007) (Bandyopadhyay, Coughlin and Wall 2008) US, 29 trading partner countries, and Import elasticity elasticity 0,02 a 0,01 a 0,1 0,31 0,50 c 0,19 c 0,08 0,25 0,23 0,03 0,239 d Na 0,059 d,e 0,09 0,15 0,113 f 0,13 f 0,572 g 0,328 g 0,46 0,18 0,142 Na (Blanes-Cristobal 2008) Spain, 83 trading partner countries, ,28 0, (White 2009) US, 70 trading partner countries, ,204 g, h e, g, h 0, Notes: a The elasticities are calculated by (Wagner et al. 2002) b Elasticities are from the regression specification including a lagged dependent variable c Non-commonwealth countries d East and West Coast e Insignificant at 10% f Only immigrants from low income countries significantly influence trade g The effects are based on high income countries h Differentiated goods. 3.2 Previous literature of immigration and its effect on FDI inflow As pointed out in the theory part the literature exploring FDI inflow and immigration is relatively new, which is reflected in the scarcity and limited number of studies investigating the possible linkage. The prior work has primarily focused on the nexus between emigration and FDI outflows. Theoretically, channels through which immigrants can have an impact of FDI flows are double-sided and pertain to both inflow and outflow. The research solely focusing on immigration and FDI inflow is limited to a small number of sectorial case studies investigating the mechanisms through which 14

20 immigrants and FDI seem to complement each other e.g. in the software industry. 3 In this context immigrants are thought to evoke their influence via business networks and by integrating into business communities. This facilitation is not only restricted to skilled immigrants but also concern unskilled immigrants, who can convey information, which can contribute to relax information constraints on FDI e.g. about workers characteristics (Kugler and Rapoport, 2007). Tong (2005) studied ethnic Chinese networks in facilitating and promoting cross-border investments between countries. Developed Chinese migrant networks can serve as a center of information exchange between coethnic business people both on local, national and international level and the migrant networks can therefore be considered as a set of inter-connected networks at different levels. The analysis included 70 countries in the period around It was found that Chinese networks significantly increased FDI inflow and that the effect was larger in developed countries. The paper concluded that even though the results were based on Chinese networks it did not imply that the effectiveness only was valid and limited to this ethnic group. The effect of networking activities in promoting and facilitating investments between countries could play a significant role for other ethnic groups as well. Buch et al. (2003) estimated the link between stocks of inward and outward migration and FDI in the case of 16 German states. They found supportive evidence for a strong positive link between German emigrants and stocks of FDI abroad and a positive but weaker evidence for immigration of foreigners and inward FDI. The study found that cultural linkages in international economic relations were an important additional aspect to the traditional factors affecting international factors movements. An alternative approach to investigate the complementary relationship is in the perspective of emigration and FDI outflow. Findings from Kugler and Rapoport (2007), who studied US FDI outflows in 1990 and 2000, suggested that migration and FDI were contemporaneous substitutes and dynamic complementary. The impact varied according to school attainment with a more prone effect from migrants with the highest attainment. The exact same results were supported by Javorcik et al. (2006). As the above literature indicates immigration is not unilateral in its influence, but both FDI inflow and outflow can be influenced, simultaneously. Flisi and Murat (2009) analyzed this for five different countries with time spans going from 1990 to 2006 and found that immigration had a positive and robust effect on bilateral FDI for three countries both 3 Examples of sectorial studies are (Commander et al., 2004) and (Arora and Gambardella, 2004). 15

21 inward and outward. This was further supported by Gheasi et al. (2011), who tested the robustness of the relationship between migration and FDI based on a meta-analysis. The results confirmed that immigration had a positive impact on FDI on both inward and outward and that these impacts were higher when migrants were highly educated and skilled. Going through the literature the question of reverse causality arises - that is whether immigration influence FDI inflow or vice versa. Groznik (2003) examined net FDI flow into 21 developed, 14 emerging and 13 transition countries in the period with the rest of the world as source countries and found that immigration had a positive influence on FDI inflow. Based on FDI and migration flows between Canada and USA during the period the study concluded that not only did migration flows precede and help explain FDI flows by moving in the same direction but also that labour led capital. Similar results were found by Kim (2006), who investigated immigration, FDI inflow and import in the United States using data from The study found significant evidence that immigration both led and caused import and FDI inflows. The two studies collated indicate that international labour movements are a forecast of future FDI flows. 4 Lucas (1990) presented three explanations for the complementary relationship that were productivity- and human capital differences and labour market imperfections. Political instability, opaque regulations and the risk of appropriation all raise the cost of making long-term investments in foreign country. E.g. this might be the explanation why less capital flows are seen to developing countries. 4. Clarification of the immigration cost paradox This section pursues to clarify the paradox presented in the introduction. Immigration is calculated to be a financial burden to the Danish economy in 2010, even though in a theoretical context immigration and the free mobility of labour across borders are viewed to be beneficial. Furthermore, Danish immigration policy in a historical perspective will be presented. Prior and the presented calculations of the costs from 4 The results from the two studies and that immigration flows are a leading indicator of FDI flows are based on Granger causality tests. This test does not necessarily leads to the conclusion that movement of labour causes movements of FDI but only that immigration flows lead FDI flows. 16

22 immigration might be a part of the explanation for the development and transformation that the Danish immigration policy has undergone. 4.1 Labour mobility Effects from international migration flows are often seen as an integrated part of international trade theory. In a standard trade theory, like the presented Heckscher- Ohlin Theorem, labour is immobile across countries and trade works as substitute for migration flows (Moses and Letnes, 2004). Alternatively, in the case of free mobility the incentive and the economic reasoning is that factors will flow where it is the most productive. Labour will benefit thus obtaining a higher income and the host country benefit in that the more productive employment of the labour implies cheaper goods and services. The economic consequence from mobility of labour across countries is the same as for free trade between countries; production factors will locate where they are most productive (Poot and Strutt, 2010). Other beneficial effects also prevail to both the sending and receiving countries. While immigrants benefit from higher incomes due to a more optimal allocation the sending countries benefit through the increasing marginal product of labour and therefore higher wages of those left behind. Additionally, receiving countries benefit through the so-called immigration surplus that accrues to the owners of capital with complementing from of immigrants (Borjas, 1999b). Analyzing labour movements between countries in the Specific-Factors model it is assumed that only labour is a mobile factor in the short run whereas the factors, capital and land, are fixed. 5 The model predicts that immigration will lower wages in the country in which the workers arrive. As the wages fall due to immigration owners of the specific factors either capital or land will benefit through a rise in the marginal product of the specific factor. The assumption that capital and land are fixed is reasonable in the short run, but in the long run factors can flow between industries, which will change the effect of immigration on wages and rentals. When solely analyzing two of the three factors the long run model is similar to the Heckscher-Ohlin model. In the long run immigration can affect the output of a country by restructuring the country s industries; increasing the output of the labour-intensive industry and decrease the output of the capital-intensive industry. One of the implications in the short run is that native labour in the host country face competition from immigrants and 5 The following discussion most closely follows the structure in (Feenstra and Taylor 2008). 17

23 receives lower wages while owners of capital and land benefit from immigration (Feenstra and Taylor, 2008). This result is complemented by the simple framework stated by (Borjas, 1995). In this setting the calculated gains and losses differ across different groups in the population. Whether the native labour gain or lose depends on their productive endowments; natives, who have productive endowments that complement those of immigrants, gain, while natives, who have productive endowments that compete with those of immigrants, lose. The effect is that the host country benefit as long as natives and immigrants differ in their productive endowments bigger differences in endowments resulting in larger benefits. In conclusion this means that gains are not evenly distributed across population groups in a society due to the differences in endowments of the native labour. Summing up then there are overall gains to the host country. In total, the theories predict that labour moves to where it is the most productive and that there are gains to both the country of origin and the host country. Even though the economy as a whole gains from immigration then the unevenly distribution of the gains make some population groups very vulnerable. 4.2 The cost paradox of immigration With the basis in the theory described above it seems singular that immigration at a macro perspective is calculated to be a financial burden to the Danish economy. A more closely look upon the model used to compute the results reveals possible explanations why immigrants and their descendants have an overall negative impact on the public finances and differ from the predictions upon the theories. 6 The paradox arises due to the presence of existing welfare benefits and certain characteristics of immigrants. Investigating the characteristics of immigrants in Denmark elucidate why there is a financial burden in the setting of the DREAM model. The parameters in which immigrants distinguish compared to ethnic Danes with regard to economic conduct are primarily unemployment tendency, productivity when at work, and the extent to which they receive public transfers and enjoy individual public consumption (Schou, 2006). 7 Explanations for these immigrant characteristics are diverse among them labour market imperfections and welfare generosity. Labour market imperfections might originate in the relative shortage of unskilled jobs in Denmark and high minimum wage. These 6 A presentation of the model applied in the computation of the results follows in appendix A. 7 Even though this part is based on a study from 2006 the characteristics are still present today. 18

24 imperfections imply that differences in educational and linguistic skills lead to employment differences rather than wage differences between groups (Pedersen and Smith, 2002). An important aspect that affects the level of labour market integration is the duration of the residence in Denmark. The speed of the assimilation process to the same economic conduct as ethnic Danes varies according to the personal characteristics of the immigrant e.g. language skills, schooling and educational level (Husted et al., 2001). 8 An alternative explanation is that the high unemployment rate might be a reaction to the presence of a generous welfare system. For some immigrants during the period investigated there has been a large dis-incentive to work because of the weak or even negative financial incentive to work despite the relative high minimum wage in Denmark (Indvandring, integration og samfundsøkonomi, 2002). From a life cycle perspective certain features entail that the net costs to the public sector are not as large as could be expected based on the calculations of the costs from one year. Two explanations given are the age distribution at the time immigrants enter Denmark and the organization of the Danish welfare society. The point of time at which immigrants enter is often during their working-age years - on average approximately in the mid-twenties (Stephensen and Pedersen, 2002). An integrated part of the Danish welfare system is a pay-as-you go pension system. The basic point of this is that people engaged in active employment through taxes pay to the young and elderly people. In this way the arrangement of the pension system means that each generation through tax payments pay for its parental generation (Pedersen, 2004). The fact that this generation of immigrants does not carry their parental generation with them means that if the immigrants through taxes are able to pay for the public expenses associated with themselves and their descendants their presence will not affect the public finances negatively while in active employment. This relation between generations in Denmark diminishes the requirements of payments that immigrants have to the public sector in order not to be a financial burden. The positive contribution of the first generation of immigrants when shifted forward in the future gives the Danish economy a one-time gain (Schou, 2006). The conclusion is that even though the net contributions from immigrants are negative in a given year then over a life cycle immigration can influence 8 Participation rates of those who have spent more than 10 years in Denmark are around double of those who have been in the country two years or less (Roseveare and Jorgensen, 2004). 19

25 the public finances positively due payments from the following generations (Pedersen, 2004). 5. Immigration policy The following part is a description of the immigration policies conducted in Denmark. In the essence migration policy is an attempt to influence future immigration flows the growth and the composition of the immigration stocks - and henceforth the public finances. This is described in a separate passage because tightened immigration policies influence immigration flows which consequently might affect the nexuses between immigration and capital- and trade flows. Furthermore, viewing Danish immigration policy in a historical perspective is an explanatory aspect of the immigration stock outlook today and thereby possibly also Danish trade and FDI inflow relations. 5.1 Immigration policy When assessing whether the present immigration policy is optimal from a purely financial perspective and how it should be constructed in this setting a rule of thumb that has its background in Simon (1984) and Simon (1989) has been interpreted by DeVoretz (2004) is as follows: If the marginal immigrant makes a non-negative contribution to the treasury you continue to admit immigrants until the contribution goes to zero The rule simply states that as long as there is a positive effect to the public finances by an extra immigrant then the valid and current immigration policy should aim at increasing immigration. Obviously this rule is very simplified due to the presence of effects that do not affect the public finances but would be disregarded if the strictly following the rule. Nevertheless, the essence of the rule is whether the immigration under the present policies constitutes to a contribution or a financial burden to the country of residence. Additionally, it also explicitly addresses the immigration policy that should prevail considered from a strictly economic perspective. Based on this it can be argued that the present and previous immigration policy has not been efficiently framed. In this context the calculated costs stress the need of 20

26 investigating the present immigration and social policies to avoid a future financial burden Historical Danish immigration policy In a historical perspective the immigration policy in Denmark has undergone a radical transformation. In the period following the second world war Denmark had a very liberal immigration and social policy with relatively free immigration opportunities and a high requirement of being economic self-reliant. In this period immigrants in Denmark primarily came from other Scandinavian countries, Germany and United Kingdom. Up until the beginning of the 1970 s immigration into Denmark was economically motivated and labour that were able to provide for themselves had free entry. In these years Danish firms were permitted to hire and recruit workers with a foreign background due to the labour-market shortage with the main source countries being Turkey, Yugoslavia and Pakistan (Roseveare and Jorgensen, 2004). This liberal policy ended with the so-called guest worker stop in 1973 because of a rising unemployment. Many of the guest workers entering Denmark before the new regulations came into force did not emigrate back to their country of origin but resided in Denmark, permanently. Those immigrants residing permanently accelerated and acted as a catalyst to a new source of immigration due to the existing rules of the option regarding family reunion (Liebig, 2007). In the years after the immigration regulations were a mixture of national legislation and obligations in relation to the ratification of international refugee convention. In this period the group of de facto refugee and asylum seekers became very significant with Sri Lanka, Iran, Iraq and Lebanon being the primary origin countries and in the 1990 s Balkan, Afghanistan and Somalia. After 1983 the increased immigration gave rise to at the time present regulations and legislations towards an increased restrictiveness (Pedersen and Smith, 2002). The immigration policy revision in 1983 introduced legal claims on family unifications of children, spouses and parents plus the conception de facto refugee (Velfærdskommissionen, 2005a). 9 9 The conception de facto refugees concern refugees that cannot directly be categorized as a refugee according to the UN convention but where there are similar basses where the persons concerned are not ought to emigrate their origin countries. 21

27 The immigration policy reform in 2001 was a culmination of a general tendency up during the 1990 s. The shift in entry policy was motivated by the increasing immigration pressure and the relatively weak labour market integration. The generosity of the public income and welfare system along with the easy entry had created a welfare magnet and improved economic and social integration of immigrants already staying in Denmark before adding more newcomers (Roseveare and Jorgensen, 2004). The ideas of the reform are highlighted in three main principles. 10 First, immigrants from other Nordic source countries maintained free access to Denmark and without applying for residence permit. Second, immigrants from EU/EEA were allowed to come to Denmark for three months without residence permit or applying for a visa. Finally, other groups of immigrants could only get temporary or permanent residence if they had the status as a refugee, asylum seeker or family reunion. People of the last categorization were the group, which had attracted the most attention in the public debates. This was reflected in the tightening of immigration policy specifically towards this type of immigrations flows and immigrants from non-european countries. This selection process was likely to affect the characteristics of the immigrants e.g. in relation to educational skills and country of origin (Hiller, 2011). The impact of the reform was detected immediately; in 2002 there was a decrease in around 50% in applicants for asylum whereas it remained stable in the overall applicants in the European Union (Roseveare and Jorgensen, 2004). Immigration policy for an individual country is often dependent on international conventions and legislation e.g. for asylum seekers and refugees. Initiatives to regulate immigration regarding this type of flows are as a result very limited. A group that is not regulated by international legislation is family unification. This group constitutes the largest category of residence permits in Denmark. In order to employ this option severe requirements have to be satisfied by this group of immigrants. Consequently, this might be due to the lack of dependence and control regarding other type of immigrant inflow (Pedersen and Smith, 2002). The immigration policy transformation can be explained by the size of the immigration flows and the difficulties and challenges in relation to labour market integration and their usage of welfare and social benefits. The development of strong immigration pressure from less economic developed countries can be explained in a theoretical framework (Borjas, 1999a). Denmark is 10 This is the same division as made in (Pedersen and Smith, 2002). 22

28 characterized by a high and progressive tax pressure, a compressed wage structure universal and generous welfare and social benefits. The result is that the composition regarding immigration flow might induce a selectivity problem for the Danish economy, meaning that less skilled immigrants are attracted due to the magnetic welfare effects whereas skilled immigrants chose and prefer a country with higher rewards (Pedersen and Smith, 2002). 11 Over the years Denmark experienced a net emigration of high skilled labour, which can be viewed as the reversed case. The common tightening immigration policy presumably had caused fewer immigrants of all types among these also high educated immigrants. Thus this has strengthened the net emigration from Denmark (Økonomi- og Erhvervsministeriet 2003). The at the time government s long term goal was to ensure that immigrants should come to Denmark for the right reasons e.g. special qualifications, financial and cultural attractive (Økonomi- og Erhvervsministeriet, 2004). The immigration policy changes had entailed increased rigidity, which is why further changes were made in order to create the flexibility in the immigration procedures for immigrants with specific qualifications. Whether or not the presented rule of thumb on how an immigration policy should be formulated in an economic perspective has been applied as a guideline in the construction of Danish immigration policy in a historical perspective is difficult to answer definitively but it might have served as a benchmark. 5.2 Immigrants in Denmark This part outlines the development of immigrant stocks in Denmark and emphasizes why Denmark is an interesting case in relation to the subject of the thesis. The Danish population has during the period in focus, , gone from being a relative homogenous population to the current state where immigrants and descendants constitute for a substantial share of the total population going from 5,3% to 9,1% in the period investigated. The increased ethnic diversity of the Danish population makes it an applicable and highly relevant case to analyze. Moreover, this part connects immigration policy and historical events with the outlook of main immigrant stocks in Denmark. 11 This prediction is based on the assumption that immigration is guided by income-maximizing behavior. 23

29 5.2.1 Immigration Generally, the origin countries vary in their size of resident stocks and approximately 50% of the source countries have only a stock of 200 immigrants or less. On average during the period considered the immigrant stock from a particular country range from to numbers of immigrants in 1995 and 2008, respectively. The total average for the period is estimated to residents. Table 2 below shows the top 15 origin countries ranked by their immigrant stock in The following two columns are the computed average of the immigrant stock over the time span for that particular nation and the relative increase in the immigration stock over the 14 years. Table 2 Immigrants in Denmark. Country Immigrant stock 2008 Average immigrant stock Relative increase Turkey ,40 % 2. Germany ,81 % 3. Iraq ,38 % 4. Poland ,53 % 5. Bosnia-Herzegovina ,48 % 6. Yugoslavia ,75 % 7. Norway ,50 % 8. Sweden ,13 % 9. Lebanon ,50 % 10. Iran ,10 % 11. United Kingdom ,05 % 12. Pakistan 13. Somalia 14. Afghanistan 15. Vietnam Source: Danish Statistics and authors own compilation ,53 % 124,57 % 817,35 % 17,69 % The countries in the table account for approximately 62% of the total immigrant stock on in In 2008 the two main origin countries were Turkey and Germany. The fact that eight of the top 15 countries mentioned above are European countries highlights the existence of different motives for residing in Denmark, ranging from refugee and asylum seeker to work related immigration. Nevertheless, some of the largest stocks Norway, Sweden and United Kingdom are neighboring countries. 13 Focusing on the relative increase in the stocks over the time span unveil heterogeneity in the growth rates of the different origin countries. The countries with the largest increase are Bosnia-Herzegovina, Somalia, Iraq, Poland and Afghanistan. This composition of countries again reflects the distinct motives and incentives for 12 The majority of this group consists of stateless Palestinian that immigrated to Denmark in the period (Danmarks Statistik, 2010). 13 In general the duration of the residence for many of the immigrants from those countries is very short (Danmarks Statistik, 2011). 24

30 immigrating to Denmark. Whereas the development in the stocks of the origin nations Bosnia-Herzegovina, Somalia, Iraq and Afghanistan can be explain by their involvement in wars during the period this is not the case for Poland. 14 The expansion of the Polish resident stock in Denmark is registered in a very short period; from 2005 to 2008 with an absolute increase of more than people. This evolvement is primarily explained by the lack of Danish labour supply and the large inflow during those years is therefore presumed to be work related migration. 15 The presented table shows the size and development in the immigration top 15 immigration stocks over the period but whether it is the same people with a foreign background that are included in the stocks is hard establish. An indication of this is that during the period it was found that 25-34% of immigrants that came to Denmark in a given year were emigrated a year later. Additional, those who emigrated differed highly across origin-countries, with immigrants from western origin nation being more prone to emigrate (Danmarks Statistik, 2010) Population heterogeneity To give an indication of the heterogeneity of the Danish population in the period the following figure shows the development in annual immigration inflow and the growth in the immigrant and descendant stocks as a share of the total Danish population Bosnia-Herzegovina was in a military conflict from , civil war in Somalia, for Iraq the Gulf war in 1990 plus the regime and the invasion in 2003 and the intervention of Afghanistan in At these specific years or the following year a steep increase in the immigrant stocks were registered. Almost all immigrants from Iraq, Bosnia-Herzegovina, and Somalia are refugees. Of all immigrants in Denmark about 25% are categorized as refugees (Danmarks Statistik, 2010). 15 Moreover, this is influenced by the fact that Poland became a member of EU in year 2004 (Danmarks Statistik, 2010). 16 For immigrants from USA that came to Denmark during % of them had left again This number is 11 % and 4 % for the origin nations Iraq and Afghanistan, respectively (Danmarks Statistik, 2010). 17 See appendix B.2 for a full assessment and description of descendants. 25

31 Figure 1 Population heterogeneity in Denmark. 10,00% ,00% ,00% ,00% ,00% ,00% ,00% ,00% ,00% ,00% ,00% Immigrant share of total population Total share with foreign background Descendants share of total population Annual total inflow Source: Danish Statistics and authors own compilation. The blue graph, which is scaled to the secondary axis, shows the total number of annual immigrant inflow to Denmark. It reveals that there in the period was a decrease in the annual inflow, which was followed a very stable annual inflow in the years afterwards. Finally, from 2004 and onwards there was a steady increase going from an approximately annual inflow to almost in This development is of course highly correlated with the events mentioned in the preceding part. The red graph depicts what has already been presented that the total stock of immigrants in Denmark has increased. Measured as a share of the total Danish immigrant population this has increased from a little above 4% to around 7%. The same pattern is reflected when analyzing the size of the descendant stock as a share of the total population the green graph. This increases from 1 % in 1995 to around 2,2% in When investigating the size of the share of immigrants and descendant together it is found that during the period that the analysis undertakes the Danish population goes from being a relatively homogenous to more heterogeneous. This is grounded in the relative share of residents with a foreign background compared to the total Danish population the purple graph. Over the 14 years this share grew from 5,3% to 9,1%. It 26

32 is expected that the Danish population heterogeneity is growing in the future. Furthermore, immigrants from less developed countries historically have a higher fertility rate. In 2030 the share of the Danish population with a foreign background is projected to 14,5% (Velfærdskommissionen, 2005b). To recapitalize on the parts above, the development in the stock of foreign-born residents in Denmark are according to the theories described very likely to have had an influence on Danish bilateral trade relations and FDI inflow. In a nutshell that is what the empirical analysis of this thesis intends to investigate. Is there empirical supportive evidence for a positive effect from immigration on Danish bilateral trade flows and FDI inflow to Denmark? 6. Methodology and estimation strategy The upcoming section outlines the individual steps of the empirical approach to be pursued. This concerns the foundation for the analysis of bilateral trade flows and FDI inflow to Denmark, estimation strategy, econometric modelling and analysis delimitations. 6.1 Scientific approach The scientific methodology in this study is attributed to an economic approach. With immigration to Denmark as the focus of the research many possible aspects arise relating to other theoretical fields. This study is though restricted to solely focus on the economic relating to trade and FDI inflow. A systematic procedure has been ascribed in this process in pursuing to test the different hypotheses. The thesis is founded in three different information and data generating processes. First, a systematic examination of relevant literature has been performed serving as the foundation for the following parts. Second, the quantitative dataset is extracted from numerous standard databases of macro-economic statistics e.g. OECD, World Development Indicators, UNCTAD, World Heritage Foundation etc. Furthermore, the estimations are carried out based on econometric methods that are grounded in previous literature. Finally, the outcomes from the quantitative analysis have been investigated practically to determine if the estimated effects are autonomous or have been influenced actively. This effort involves 27

33 interviews, telephone interviews and mail correspondences. The recommendations outlined are also founded in this process. The individual methodologies will be described as they follow. 6.2 Gravity model The foundation for investigating the effect from immigration in Denmark is the Gravity model which has been widely used in empirical economics. In the simplest form the standard Gravity equation predicts that the volume of trade between countries is determined by the product of their economic masses ( ) and the distance between them ( ). The size of trade is proportional to the two countries relative sizes and inversely proportional to the distance between them. The relationship can be expressed as follows: = Trade between country i and country j, is here denoted by T ijt and A is the constant of proportionality. A higher partner country GDP implies greater export market for Denmark and an increased probability of Danish import. Similarly, higher Danish GDP indicates an increased capacity to both export and import and that transportation costs increase with increased distance (White and Tadesse, 2007). The first to apply the physical law of gravity to explain international trade flows was (Tinberg, 1962). The paper failed to establish a theoretical foundation for the assumptions of the model, but this has been developed and refined by several researchers, e.g. Anderson (1979), Helpman and Krugman (1985), Bergstrand (1985), Anderson and van Winncoop (2003). Theoretical derivations from the model are based on several assumptions, e.g. complete country specialization in production, identical and homothetic of constant elasticity of substitution type etc. However the model has also been clarified in a wider sense of traditional proportion factors (Deardroff, 1998). The Gravity model has not only shown to be one of the most successful economic models providing strong empirical results when investigating international trade flows, the theoretical foundation has also been approved since the introduction and is now well founded in modern economic theories regarding trade in imperfect substitutes (Frankel, 1997). Since the introduction of the standard Gravity model the specification has been 28

34 developed and augmented to include a large number and variety of explanatory factors that potential can influence trade. Prior analysis of the effect from immigration on trade and FDI flows has applied variations of the presented model, why it has been adopted in this study Multilateral resistance The Gravity model has been criticized widely, among the first to questioning the equation was Anderson (1979). The main point was that trade between two regions is decreasing in their bilateral trade barrier relative to the average barrier of the two regions trade to trade with all other partners. Inferring that the more resistant to trade with the surroundings a region is, the more it is pushed to trade with a given bilateral partner. This is often referred to as multilateral trade resistance. If this issue is neglected the consequence is misleading results due to omitted variable bias. Empirically, a remoteness index that is thought to explain if alternative markets or third country options are available is frequently applied. However this methodology is argued not to be satisfactory due to the little effectiveness in capturing trade barriers. Alternatively a country-specific fixed effect approach to control for multilateral trade resistance has been suggested (Anderson and Wincoop, 2003). Today this methodology is commonly an integrated part of investigating trade flows nonetheless this technique has been questioned and is still not fully resolved (Hatzigeorgiou, 2010b). Moenius et al. (2009) argues that the method suffers by several limitations, e.g. they find that multilateral resistance and consumer prices are either insignificant or negative, which are the opposite result that the theory would predict. Hence, this approach has not been adopted due the fact that it does not necessarily improve the specification. Finally, adopting this approach would exclude the possibility of exploiting the cross-sectional information in the data. 6.3 Empirical specifications When investigating the role of immigration in international trade flows the majority of previous studies have applied the augmented Gravity model with the inclusion of the immigrant stock as an additional explanatory variable. However, an exact regression specification and standard variable inclusion is however not defined and established. Additionally, empirical econometric estimation strategies vary across studies due to its 29

35 dependency on the outlook and type of data used (Genc et al., 2010). In this report two econometric estimation methods are applied that is Ordinary Least Squares and the Tobit method (Maximum Likelihood) due to their appropriateness in relation to the data outlook. Each method has its clear advantages and disadvantages why a part of the quantitative analysis is devoted to test the robustness of the results. The basis for the equations is grounded in (White, 2007b). The analysis of FDI inflow is a straightforward replication of the analysis for bilateral trade flows. The use of the Gravity model to estimate FDI inflow implies that trade and a FDI flows to a large extent complement each other driven by the same set of factors. Previous studies transferring the Gravity equation to model FDI flows have been very successful e.g. (Frankel and Wei, 1996), (Tong, 2005) and (Javoricik et al., 2009). The critical assumption for applying this approach is that trade and international factor mobility complement each other which are supported by empirical studies presented in the literature review and not as substitutes as standard trade models would predict. The Gravity model application when estimating the FDI inflow is grounded in this. This approach finds resonance in practice. In the descriptive investigation it is found that the major Danish trading partners are also the main FDI source countries. 18 Nevertheless, regardless of this the magnitude and importance of the independent variables is expected to vary across the estimations Regression specifications In the introduction two main hypotheses were presented with several sub-hypotheses. To test these, a number of regressions have been specified. First, a basic regression is set up with the dependent variable as either FDI inflow, import or export to country j depending on the regression. Basic regression: = h See appendix B1.and B.3 for a descriptive assessment of trade relations and FDI in Denmark. 30

36 Where: = Danish export, import or FDI inflow, depending on regression, = Immigrant stock by country of origin in Denmark, = GDP of country j, = Distance between Denmark and country j, = Population of country j, = European Union membership of country j (dummy variable), = WTO membership of country j (dummy variable), h = Change in exchange rate, = Financial integration of country j, = Military involvement of country j (dummy variable), = Regional trade agreement between DK and country j (dummy variable), = Landlocked country j (dummy variable), = Trade openness of country j, = Linguistic distance between English and the language of country j, = Error term. The main derivations are founded in this specification. The equation is further extended with inclusion of three variables corruption, business freedom and trade policy - so the regression takes the form: Extended regression: = Same as above, but where: + + h = Corruption in country j, = Business freedom in country j, = Trade policy in country j. A new aspect that will be investigated in this relation is the role and influence from descendants. To analyse whether some of the knowledge that immigrants possess pertaining to their origin-country actually encompasses to new generations is to be approached by including descendant stock in Denmark instead of immigrant stock 31

37 applying the exact same specifications basic and extended regressions. In general, when running the regressions year and continent (region) fixed effect are included Interaction terms In order to test the effect of immigrants in different contexts specific equations adjusted in the purpose to the sub-hypotheses have been set up. The primary econometric methodology applied in this relation is inclusion of interaction terms consisting of immigrant stocks and the variable of interest. The interaction terms are generated by multiplying the metric variable indicating the immigration stock coming from a specific source country (i) in a specific year (t), with the different areas of interest. The basic regression is used as a starting point whereupon adjusted to the specific hypothesis. This approach allows testing for different magnitudes of the effect from immigrants for different types of immigrants. Because of the aggregated nature of the data in the sample, immigrants will be characterised by the characteristics of their origin country. This strategy implies that the stock of immigrants from the same country all together will receive the same attributes being the attributes of their home country the specific year. Further, that the characteristics of an immigrant stock are subject to change during the time period of the investigation if their home country develops. The presumption is that the effect from immigration is influenced by origin country characteristics will be investigated in relation to institutional quality, economic gap, regional location and distance. Previous literature have employed different approaches in measuring social similarity and institutional quality between countries, e.g. per capita income (White, 2009), countries favored by preferential immigration policy (White and Tadesse, 2007), and commonwealth and non-commonwealth (Girma and Yu, 2002). Instead of subscribing social similarity to one specific variable then all together the factors in focus will reflect an aspect of and influence from social similarity. In this study institutional quality is measured by the three variables: corruption, business freedom, trade policy. Economic gap is measured by the difference in GDP per capita between Denmark and the partner nation, geographical location by the belonging continent to the partner country and distance. Despite being incomplete measures then all together this is supposed to be the base to derive robust conclusions. To investigate the impact from the conducted immigration policy reform an interaction term between 32

38 the immigrant stock and a year is constructed. The year dummy takes the value one reflecting the period and zero when the period is considered Rauch classification To test whether the immigration-trade link varies based on type of product with a stronger link with a higher degree of product differentiation - is examined by employing the method developed by Rauch (1999). Applying this methodology tests the possible heterogeneity in the immigration-trade link by the degree of product differentiation. The assumption for this classification is that information asymmetry diminishes for homogenous products compared to differentiated goods. Trade data specified at the SITC Rev. 2, 4-digit level are divided into three categories: differentiated, referencepriced and organized exchange goods. In this classification process two standards can be applied - liberal or conservative. The liberal standard is characterized as being more stringent in the classification of differentiated goods. However both standards will be employed for both import and export. Reference-priced are defined as goods listed in trade publications whereas organized exchange goods are products traded on actual exchanges. The two classifications are often considered as homogenous products due to their characteristics being substitutable. The last category differentiated products are not traded on either exchanges or listed in trade publications due to the level of differentiated characteristics. Rauch (1999) argues that the organized markets regarding homogeneous goods minimize the search cost while this is opposite for differentiated goods because these are not sold on organized markets and search costs will therefore be considerably higher. The links between immigration and trade are argued to vary based on product type with the strength of the link increasing with the degree of product differentiation. This methodology is by far the most applied method in empirical studies why it also has been adopted in this thesis. In total this ends up in 12 equations where the dependent variable is specified as one of the three product categories applying one of the approaches with either import or export data. By running the regressions separately makes it possible to test whether the effect from immigration differs. 33

39 6.3.4 Reverse causality issues When specifying the equations reverse causality is a critical issue. Investigating the effect of immigration on the different dependent variables it is assumed that the size of the immigrant stock affect these variables. This and the direction of causation in the specified equations are grounded in the following rationales. First, literature examining international migration flows has not produced any evidence of trade flows being a significant determinant of migration flows. Migration theory explains that the decision to emigrate is based on whether the benefits exceed the associated costs (Brettell and Hollifield, 2008). The economic rationale is that migrants follow a willingness to maximize their utility. 19 With the economic theory as the basis it is not anticipated that immigrant s decision to move to Denmark is grounded in preexisting trade relations between the country of origin and Denmark. Second, and as described in relation to immigration policy, the size of immigration to Denmark is almost predefined due to binding immigration quotas. Consequently, immigration is more exogenous than the preexisting bilateral flows of trade (Hatzigeorgiou, 2010b). Moreover, it has been detected that migrant stocks are exogenous to the levels of bilateral trade (Hatzigeorgiou, 2010a). The description above stresses why finding a satisfactory instrumental variable to solve any endogeneity issues with regards to immigration was not adopted in this thesis. Founded in previous investigations examining the direction of causation and the theory pertaining to migrant flows it is not anticipated that the direction should run in the opposite direction in the case of Denmark. This direction of causation is assumed to be the same for FDI inflow cf. literature review and (Groznik, 2003) and (Kim, 2006). 6.4 Econometric estimation methods In the estimation process two different econometric methods have been applied as the primary estimation techniques - OLS and Tobit. The choice of procedure originates in the outlook of the data applied in the individual regressions, cf. data description in section 7. When using trade data on an aggregated level, which concerns the immigration-trade link, with interaction terms included and for descendants the OLS 19 Obviously, this economic rationale to maximize the overall utility does not regard refugees. E.g. immigration from Iraq and Afghanistan. 34

40 method is the primary approach. This is due to high quality of the data applied. Independent of whether import or export is regarded trade is observed and registered in every year for every country. In the data set regarding trade at SITC Rev. 2, 4-digit level and for Danish FDI inflow a numerous of zeros and blank observations are present, which is why the Tobit method has been selected to be the preferable approach. These characteristics are especially present for data on FDI inflow to Denmark. 20 The dependent variables have all been transformed into the natural logarithm. In this process observed values must not be equal to zero or else it will occur as undefined causing selection bias due to the exclusion of zero observations. In order to avoid any misspecification in the regressions when applying the Tobit method an approach developed by Eichengreen and Irwin (1995) and Co et al. (2004) is adopted. Application of this methodology entails that the value one is added to the dependent variable. Expressed mathematically, then for zero trade values after the natural logarithm transformation the value is still retained when taking ln(1+value). For large values ln(1+value) ln(value) and a constant elasticities correlation is assumed to be preserved. Missing values, which especially are present in data for Rauch classifications, reference-priced and organized exchange goods, and for FDI inflow, are not treated in the same manner. 21 If the value of one was added to all observations including, the missing values in the data sets, these would count as a zero observation in the regressions. However, it is not reasonable to infer that the many missing values in fact are zero observations. In the FDI dataset the majority of the partner countries have only reported FDI values for the years whereas the missing values in the Rauch dataset originate from the high specification level (SITC 4-digit level) of the trade data. Interpreting log-linearized parameters of a model estimated by Ordinary Least Squares (OLS) as elasticities has been custom, but this method has been criticised of neglecting the implications of Jensen s inequality (Jensen, 1906). The mathematical inequality states that the expected value of the logarithm of a random variable is different from the logarithm to the expect value of the same random variable. This has been subject of substantial attention when estimating Gravity models or constant elasticity models in 20 This data outlook might be due to the limited number of source countries that Denmark receives FDI from. See appendix B.3 for a full descriptive overview. 21 See appendix D for a description of the Rauch data. 35

41 general. Silva and Tenreyro (2006) argue that in presence of heteroscedasticity the loglinearization of the empirical model leads to inconsistent elasticities. They focus on the issues of the implacability of log-transforming zero-observations, and arguing that if the variance of the error is non-constant (heteroscedastic) then the non-linear transformation of the error term will make it generally correlated with the independent variables resulting in misleading results from an OLS regression. A possible misspecification of the functional form can possibly lead to highly misleading results (Anderson and van Wincoop, 2004). Grounded in prior studies it has however assessed by the authors that the OLS and the Tobit model are the best-suited estimation methods for this study. A robustness test is performed to check the robustness of the results across different estimations methods. 6.5 Robustness test To test whether the estimated outcomes are statistically robust across different econometric models several approaches are applied. First, using the Gravity model as the foundation for the empirical analysis and applying fixed effect is diverging. The discrepancy is originated in the attributes of the econometric approach that is factors that are constant over time cannot be an integrated part of the examination. The presence of time invariance causes the exclusion of specific variables such as distance, GDP, language etc. which constitutes to a main part of the foundation for the Gravity model. Consequently, the results can be subjective to endogeneity problem causing inconsistency and biased results. This is caused if unobservable aspects influence Danish bilateral trade flows and are correlated with the immigrants stock. E.g. strong historical and cultural ties between Denmark and other Scandinavian countries are unobserved, which might have impact leading to both large trade and immigration flows. Furthermore, the specification might suffer from unobservable factors that are biasing the results. The application of fixed effect eliminates omitted variable bias in the outcomes. The empirical discussion regarding the optimal econometric approach is an on-going process where some authors favour OLS, e.g. (Bandyopadhyay et al., 2008) and some fixed effect, e.g. (Cheng and Wall, 2005). Due to the disagreement and as described earlier that the application of country-specific fixed effect would eliminate all the between-country variations in our data, which is the very object of the study, the OLS estimation is the main method. Second, following previous literature, e.g. (Gould, 36

42 1994) and (Girma and Yu, 2002), the static regressions are estimated in a dynamic version too in which the specification has a lagged dependent variable included. This checks if the positive influence from immigration sustains in both the static and dynamic model with year dummies being dropped. Besides taking account of the effects from trade history and inertia this additionally controls for nonstationarity in model even with this not expected to be a problem due to the length of the time periods 14 (Blanes-Cristóbal, 2003). A consequence of this approach is that one fourteenth of the observations have to be dropped in order to perform the test. Finally, to test whether the impact from immigration is solely driven by a subset of countries implying that the effect differ across countries and in significance. Herein is assumed that the magnitude of the relation between Denmark and the country of origin is heterogeneous. This is will be tested by running the regressions excluding the five countries that have the largest immigrant stock residing in Denmark when running the regressions. 22 Although, this test does not determines which immigrant stocks that do not have significant effect. 6.6 Sample Selection The inclusion of countries in the dataset is based on the precondition whether the country has citizens residing in Denmark in a given year during the period covered. Because the countries are selected with regards to an independent variable - the immigrant stock the risk of bias is not assumed to be as critical as if the selection criterion was based on a dependent variable. Moreover, the number of countries with whom Denmark has a trade relation, which are left out of the dataset as a consequence of the selection criterion, is very small. All together selection bias is not considered as a critical issue. 6.7 Analysis delimitation This thesis is delimitated to focus solely on specific areas in relation to the influence of immigrants residing in Denmark. Some of these delimitations are intentional grounded while others are based on empirical choices and data specifications. First, the empirical analysis only applies commodity and merchandise trade statistics. Trade in service is not an integrated part of the analysis due to the lack of data availability. From what is 22 The countries are Turkey, Germany, Iraq, Poland and Bosnia-Herzegovina. 37

43 known to the authors, this area has not yet been analysed in the context of immigration and therefore this sphere is considered as a highly interesting topic for further research. Second, the empirical examination is limited to focus exclusively upon the effect from immigration on imports and exports, by level of product differentiation and FDI inflow. Furthermore, the aspect and impact of Danes residing in foreign countries is not an integrated part either. The channels and mechanisms investigated in the empirical analysis is the exact same situation as the depicted case for immigrants residing in Denmark. Danish citizens emigrating possess the same potential and possibility of influencing Danish bilateral trade and investment relations as immigrants in Denmark. Due to lack of accessibility of person-specific data on immigrants in Denmark restricts the analysis and extend of this aspect. As is the case for trade in services this is a topic for further research. Third, due to the aggregate nature of the data the estimated effect from immigration is an average impact from increasing the total number of immigrants in a specific period. This means that the estimated elasticity is a composition of all types and numbers of immigrants arrived to Denmark over the period. Previous literature, e.g. (Head and Ries, 1998), has found statistical robust evidence that the influence from immigrants differ in magnitude by type refugee, asylum seeker, family unification, independent. This facet is further influenced by immigrants that reside in Denmark for a period of time and then emigrate later on. Data on immigrant s time of duration in Denmark is not available the consequence is that it is not possible to be certain whether immigrants arriving in previous years are still living in Denmark in the forthcoming year. The potentially large substitution or turnover of immigrants in the immigration stocks can influence the link of trade and investment relations. E.g. if an immigrant is arriving in period zero and have gone abroad again in period one while a new immigrant have arrived the two immigrants stocks will be identical over the time period resulting in that the immigrant will have less time to develop and exploit their influence on imports, exports and FDI inflow. Nevertheless, regardless of this it is reasonable to infer that the majority of immigrants staying in Denmark in one period are also residing in Denmark one period ahead therefore the stocks of immigrants are thought to be the best variable available. Overall, the delimitations made intentional or unintentional are not regarded to evoke any significant or influential bias in the results. 38

44 7. Dataset and model specification The following part is a description of the dataset applied in the quantitative analysis this includes an explanatory statement for the variable inclusion and special characteristics. This pursues to give an overview of the empirical analysis and to support the validity of the outcomes. With regards to the econometric purpose and increasing the applicability the majority of the variables have been transformed into the natural logarithm. Besides the aim of fulfilling statistical assumptions this makes the interpretation more convenient Time period and dependent variables The time span of the investigation is limited to focus on the period This time period is based on three main considerations. First, a similar investigation with Denmark as the country in focus using data from has been published whereas this study applies more recent data. Second, going further back than 1995 would restrict the data availability. Third, a specific aspect has been crucial. The effect from the previously described Danish immigration policy reform in 2001 is of special interest due to its potential effect on the nexus between immigration and trade. The time period covers years both before and after the reform making possible implications from the policy alteration reflected in the data. In total, the number of years (14) covered gives a large set of observations, which is desirable in finding statistical robust evidence. Due to the focus and number of hypotheses the dependent variable comprises of three individual data sets; merchandise import and export by partner country on aggregated level, commodity import and export by partner country on 4-digit Standard Industrial Trade Classification industry level (SITC Rev. 2, 4-digit level), and FDI inflow to Denmark by partner country. One limitation with commodity trade data classified by SITC Rev. 2 at the 4-digit level is the lack of classified imports and exports statistics relating to specific nations. All countries do simply not trade with all commodities during all years and not all countries report their trade at this relatively high level of specification. 24 This characteristic is even more prone for data regarding FDI inflow. An examination of this data unveils that for a large set of countries the data is either not 23 See appendix C.1 for an overview of the data. 24 For full assessment of method and classification process see Appendix D. 39

45 reported or no capital inflow is received in the given year. 25 All values in the three data sets are expressed in current US dollar but have been normalized into constant US$ 2000 dollar based on US GDP deflators. Additional, lagged dependent variables have been constructed in order to take account of the effects from trade history and inertia (Eichengreen and Irwin, 1996). The application of these variables is a part of the robustness test Product classification by level of differentiation 26 Following the goods classification method developed by Rauch (1999) the data set consisting of import and export data is classified on 4-digit SITC Rev. 2 level is divided into three groups; differentiated, reference-priced or organized exchange goods using both a conservative and liberal approach. 27 When investigating the data from the OECD statistical database a mismatch between the SITC codes in the collected data and the corresponding codes in the classification scheme was found. The 4-digit SITC Rev. 2 table contains 1024 categories, which is the revision that the method originally was developed on, while only traded categories are present in the dataset. 28 When comparing the list of either exported or imported goods 78 SITC categories were found to have no corresponding category in the classification scheme. The group of non-classifiable goods account for a substantial share of the total value of trade 2,76 % and 3,40 % for exports and imports respectively. In order to reduce the amount of unclassified products the same approach as originally developed and applied by Rauch (1999) was taken on. However, an exact replication of the method was not an applicable approach, why an alternative method was used in the process an ad hoc classification. Applying this classification of all the 78 categories could potentially lead to a bias of the results, why the approach was restricted to as few categories as possible. Only products codes that confidentially could be categorized were classified. The method resulted in the classification of 14 categories out of the 78 un-classified categories, which in total accounted for 66,26 % of the value of total un-classified group. The authors are 25 Approximately 53% and 26% of the observations are missing and zero-observations, respectively. 26 For a full assessment of the classification method and classification process see appendix D. 27 The scheme used to classify the goods is from Jon Haveman s website: 28 The Rauch classification scheme contains categories and 779 categories are registered in the trade data. 40

46 convinced that this method dealing with the issue of non-classified goods contains a minimum risk of bias. 7.2 Independent variables The estimations are grounded in the Gravity model, where trade flows are explained by the economic masses of the two countries and the distance between them. The equation has been augmented by including additional explanatory variables pertaining to partner countries. Explanatory factors concerning Denmark are not included in the specifications. Trade flow analysis is often done on an overall bilateral level e.g. trade flows in Europe, but the present analysis is delimited only to focus on FDI inflow and trade flows in and out of Denmark. Integrating variables that consider both countries in the equation is primarily appropriate when several relationships are examined and not as in this case with one specific country as the basis. Moreover, due to the length of the time period in focus 14 years aspects pertaining to Denmark possess little variation resulting in insignificant estimates. In general, explanatory variables not included in the specification is captured and reflected in the intercept of the estimation Variable description As argued, trade and FDI are thought to complement each other and therefore driven by the same factors. Due to this the following description of the explanatory variables and their influence on the dependent variables is applicable to all regressions on the entire set of dependent variables considered. Geographical distance: Geographical distance is used as a proxy to explain the role of transportation costs and capturing international transaction costs. Moreover, distance increases upfront information and transaction costs due to its impendence on flows of information and products (Rauch, 1999). Analysis of distance has found trade to almost be inversely proportionate to distance. A mean elasticity of 0,9 was established by Disdier and Head (2008). The distance between Denmark and the different trading partners is calculated as the distance between the biggest cities of the two countries weighted with the share of the population of city in the overall country population. In accordance with the Gravity model the factor is expected to have a negative effect. The 41

47 data is collected from Centre d Etudes Prospectives et d Informations Internationales - (CEPII). GDP: Gross domestic product represents economic masses. A high economic mass implies both a greater potential export market but also an increased possibility of Danish imports from the given country. The values are expressed in constant year 2000 US dollars. In accordance with the Gravity model the factor is expected to have a positive influence the level of trade between two nations is proportional to the product of their economic size. The data is collected from World Development Indicators database. Population: The number of inhabitants in the trading partner country is included and collected from World Development Indicators database. The variable is expected to have to have positive influence. Danish immigration and descendant stock: The variable immigration is the number of immigrants residing in Denmark from country j during year t collected from Statistics Denmark. The definition of an immigrant applied for the statistical division is as follows from Danish Statistics and Ministry of Refugees, Immigrants and Integration: A person is Danish if at least one the parents both have Danish citizenship and are born in Denmark. Thus, it has no significance if the person is a Danish citizens or born in Denmark. If the person is not a Dane then the person will be classified as follows: An immigrant if born abroad Descendant if born in Denmark As the definition unveils then an immigrant is a foreigner if born abroad while a descendant is a foreigner born in Denmark. Moreover, it appears that citizenship is without significance pertaining to the statistical definition of immigrants and descendants. This means that immigrants and descendants that obtain Danish citizenship still occur as an immigrants and descendants in the statistics of the immigrant stock Immigrants and descendants from Greenland and Faroe Island have been dropped due to their membership of the Danish national community. Persons from those countries are therefore ensured the right of a Danish citizenship. 42

48 During the period investigated some of the origin countries included do not exist anymore or do not exist through the whole time span. This concerns Yugoslavia, Serbia and Montenegro. Yugoslavia only exists in the period hereafter it is renamed to Serbia & Montenegro. Because this strictly concerns renaming the country immigrants from Serbia and Montenegro are simply added to the stock of Yugoslavian immigrants. Serbia & Montenegro was a joint country up until 2006 hereafter is was further divided up into two countries namely Serbia and Montenegro. The immigrant stocks from the two countries Montenegro and Serbia are added to the stock that consists of immigrants from Yugoslavia and Serbia and Montenegro. The product is an immigrant stock that consists of immigrants from Serbia, Yugoslavia and Montenegro. The stock is named Yugoslavia through the whole period. Another example of a former economy is the Soviet Union. 30 This Immigrant stock has been divided by the individual population share of each country as distributional key. The Soviet Union immigrant stock has been allocated and added to the individual countries immigrant stock based on their relative population size in The same methodology has been applied in relation to Czechoslovakia. Czechoslovakia only exists up until the year 1993 and hereafter divided into the two countries Czech Republic and Slovakia. This procedure can have caused bias in the results e.g. inaccurate division of immigration stock. This possible inexact specification may result in an imprecise estimated link between Denmark and these origin countries. In total this is not expected to be of any significance due to the number of countries included and thereby does not cause any concern of bias and non-representative results. Exchange rate: Measures the change in Denmark and the given country s exchange rate expressed as foreign currency unit per Danish Kroner in the given year. This factor represents the terms of trade effect (White, 2007b). The data are collected from the UNCTAD statistical database. An increase in the exchange rate signals that Danish Kroner is increasing (decreasing) in its value and thereby making Danish goods relatively more (less) expensive. The expected sign is therefore dependent on whether import, export or FDI inflow is considered. A positive relative change between the two 30 This concerns Russia, Georgia, Ukraine, Moldova, Belarus, Armenia, Azerbaijan, Kazakhstan, Uzbekistan, Turkmenistan, Kyrgyzstan, Tajikistan, Estonia, Latvia, and Lithuania. 31 Due to the population size of Russia most of the immigrants from the Soviet Union approx. 50% - have been added to the Russian immigration stock. 43

49 years is consequently expected to have a negative impact on export and positive on import. Financial Integration: To take account of the level of financial integration in the partner country the net stock of foreign direct investments to GDP has been included (White, 2007b). A higher level of financial integration is expected to have a positive influence. The data is collected from the UNCTAD statistical database. Trade openness: Trade integration for partner countries is measured by import plus export in a given year relative to its GDP. A high level of integration measures a country s overall propensity for trade, furthermore countries tend to trade more with nations that are well global trade integrated (Head and Ries, 1998). An additional aspect is that it may reflect the presence and level of trading infrastructure. The variable is expected to have positive influence and data is collected from World Development Indicators database. Linguistic distance: Studies including language as an explanatory variable in bilateral trade flows often apply the methodology whether the two countries share the same dominant common language or whether English is an official language, e.g. (Dunlevy and Hutchinson, 1999). This approach is not applicable when examining Danish trade relations because Danish is not spoken anywhere else in the world why the method linguistic distance is adopted. Previous research using linguistic distance in describing bilateral trade flows have shown that the further away a country s language is from English the lower will the trade be. Hence, linguistic distance is thought to impede bilateral trade due to the increased communication costs (Hutchinson, 2003). Linguistic distance is a quantitative measure of the distance between English and other languages. This measurement explains the differences in the difficulty of learning another language as the distance between origin country language and English (Chiswick and Miller, 2004). The language scores are measured on a scale going from 1-3 with one being the most distant. In general the assigned language scores to Denmark (2,25) and the neighbor countries like Norway (3,0) and Sweden (3,0) are very high signaling that these are the least distant from English. Due to these similarities the same scores measuring this difference between English and the foreign country language are applied as a proxy for common language in the empirical estimation. For appropriateness of measuring linguistic distance the language scores have been reversed 1/language 44

50 score. In composing the data countries have been assigned the language scores according to the official and dominant language. If a country has more than one official language and one of them is English, English has been assigned as the official language. If none of the multiple official languages is English, the country has not been assigned any linguistic score. It is anticipated that the more distant the official language is from English has a negative impact (Hutchinson, 2003). 32 Corruption: The data for corruption is extracted from Transparency International database. The level of corruption is measured on an index - Corruption Perception Index (CPI) on a scale from 1-10, with 1 being the highest level corruption and 10 the lowest level of corruption. For interpretational reasons the index been reversed resulting in a scale where 10 represents the highest level of corruption and 1 being the lowest perceived level of corruption. A high score and high level of corruption is expected to have a negative impact (Bandyopadhyay and Roy, 2007). Business freedom: Business freedom is an index of the ability to start, operate, and close a business. It represents the overall burden of regulation as well as the efficiency of government in the regulatory process in trading partner countries. The data is sourced in the study Doing Business from the World Bank. The index is composed on ten different factors, which are equally weighted. E.g. how many days it takes to start a business, costs of starting a business etc. A high score is expected to be positive correlated with the trade between Denmark and the partner country (Hatzigeorgiou, 2010b). 33 Trade policy: The factor business freedom is another of the variables that are supposed to reflect institutional quality of the partner country. The data is sourced in the World Heritage Foundation, which has constructed an index based on data from the World Bank, WTO, US Department of Commerce and Transparency International. The index is a composite measure of the absence of tariff and non-tariff barriers that affect imports and exports of goods and services. The numbers calculated are measured on scale going from zero to 100 with zero being the worst and 100 the best. It is anticipated that the 32 See appendix C.2 for a full description. 33 See appendix C.2 for a full description. 45

51 degree of freedom of trade is positively correlated with the trade between Denmark and the partner country (Hatzigeorgiou, 2010b) Dummy variables Numerous explanatory factors are expressed as dummy variables. This regards; war, landlocked, regional trade agreement, EU membership, WTO membership, income classification gap, continent, and year. Year dummies have been constructed and are based on capturing any macroeconomic fluctuations or policy changes that might influence in the given year. Moreover, that the simultaneous growth in trade and immigration does not influence the results. Year 1995 is used as a base year implying that the coefficients are all relative to this base (Hatzigeorgiou, 2010b). War: The variable indicates whether the partner country during the given year was involved a military conflict. The data are collected from the homepage of Global Security, which is based on the war definition from the United Nations. 35 The variable is expected to have a negative coefficient due to the impedance of effectively contract enforcement and inhibiting trade (White, 2007b). Countries not involved in a military conflict are applied as the base. Landlocked: A landlocked country is defined as a country entirely enclosed by land or whose coastline lies on closed seas. Of the countries included in the analysis 42 of them are classified as landlocked. The factor inclusion is grounded in the importance of a country s possible accessibility of international infrastructure e.g. to trade via shipping. It is anticipated that the geographic position impedes trade with Denmark and thereby also expected to have negative effect (White, 2007b). Countries not classified as landlocked is in the base group. Regional trade agreement (RTA): The variable signals whether the partner country has a regional free trade agreement with Denmark during the period. This solely concerns agreements beyond the ones through EU. The variable is expected to have a positive correlation with the size of trade flow. Countries not having a RTA are used as the base group. 34 See appendix C.2 for a full description. 35 The United Nations define major wars as military conflicts inflicting 1,000 battlefield deaths per year. 46

52 EU membership and WTO membership: The variable signals whether the partner country is a member of EU and WTO, respectively. The variables capture potential trade effects associated with political, social and economic linkages (White, 2007b). It is anticipated that being a member of the organization has a positive influence of the bilateral trade relation. Countries not being a member are used as the base group. Income classification gap: All countries are divided into four categories dependent on the annual gap in GDP per capita in constant US$ 2000 between trading partner and Denmark. The four groups are constructed pertaining to the size of gap in GDP per capita. The categories are as follows: Less than zero - US$ (414 observations - 16,63 %) 2. LEG: US$ US$ (1544 observations - 62,03 %) 3. MEG: US$ US$ (193 observations - 7,75 %) 4. HEG: US$ infinity (338 observations - 13,58 %) Where LEG is low economic gap, MEG is medium economic gap and HEG is high economic gap. The method applied is grounded in the country categorization made by World Bank based on GNI per capita thresholds. 37 This classification scheme is appropriate when studying several trade relations in an international perspective. Applying the methodology with Denmark as the base makes the interpretation more convenient and instead of speaking in generalities this is solely focused on the dissimilarity between Denmark and the partner country. The countries classified in group number one (most similar to Denmark) are used as the base group in the regressions. 38 Continent: The countries included are classified into six groups in accordance with their geographical position obtained via World Atlas. The six groups are (number of countries): Asia (45), Africa (53), Europe (44), North America (23), South America (12) 36 The parentheses show the number of observations in each group as well as the share of the total number of observations. 37 World Bank classification scheme is based on four groups with the following 2008 thresholds: Low income countries; GNI per capita of US$ 1005 or less, lower middle income countries; GNI per capita between US$1006 and US$ 3,975, upper middle income countries had GNI per capita between US$ 3,976 and US$ 12,275, and high income countries had GNI above US$ 12, This variable is only applied as an interaction with immigrant stock to test the hypothesis regarding gap in economic development. The abbreviations, e.g. LEG, indicate the size of economic gap least/medium/high economic gap which will be referred to in the quantitative analysis. 47

53 and Oceania (9). Because European countries are expected to be the most similar with Denmark this group is used the basis in the analysis. This specification is very useful in capturing any characteristics that are specific and constant pertaining to that region which possibly can influence the Danish trade relation, e.g. factor endowments (Hatzigeorgiou, 2010b). See appendix C.3 for a full list of included countries. 7.3 Sensitivity analysis 39 Before starting the empirical analysis several test has been carried out, this regards tests for assumptions, multicollinearity and heteroscedasticity. This will serve as a foundation for correct derivations from the analysis Variance Inflation Factor To check the significance of multicollinearity problems in the regressions a variance of inflation factor (VIF) test has been carried out. This test measures how much of the variance of the estimated coefficients are increased due to collinearity issues. The obtained factors for all the independent variables are interpreted as the standard error of the coefficient for the different independent variables that will be inflated with a factor ( ). Neter, Wasserman and Kutner (1990) recommend focusing on the values larger than 10, which indicates that multicollinearity is a potential problem. Resulting in standard errors inflated with a factor of 10 = 3,16. The table below shows the largest VIF for the regressions on aggregate trade with the immigrant stock included as specified in the basic regression in section Table 3 Variance of Inflation Factors basic regression on export and import. Export Import Variable name VIF 1/VIF Variable name VIF 1/VIF Africa 9,19 0,109 Africa 8,83 0,113 Distance (ln) 7,77 0,129 Distance (ln) 7,85 0,127 Asia 7,27 0,138 Asia 7,24 0,138 North America 7,20 0,139 North America 7,02 0,142 South America 6,11 0,164 South America 6,00 0,166 GDP (ln) 5,99 1,667 GDP (ln) 5,72 0,175 Oceania 5,10 0,196 Population (ln) 4,78 0, A full assessment of all the tests can be found in appendix (CD; C1). 48

54 Both regressions show VIF values close to the critical limit, but this is not exceeded and therefore not considered as a critical issue. See appendix (CD; C1) for VIF statistics for all performed regressions Heteroscedasticity The presence of heteroscedasticity does not directly lead to biased estimates of an OLS regression (Wooldridge, 2006). The critical consequence of the presence of heteroscedasticity is the resulting bias of and this has a direct influence of the standard errors of the estimated coefficients, which implicates that the t-statistics is not valid. The OLS t-statistics simply do not have a t-distribution as well as the F- and LM statistic no longer have their asymptotic chi-squared distributions in the presence of heteroscedasticity (Wooldridge, 2006). This has critical implications for the tests of hypotheses. Presence of heteroscedasticity is tested by the Cook-Weisberg test, which has the STATA syntax hettest. The test is defined as follows: ( )= ( ), where is the residual from the regression, z is and the hypothesis to test is : =0. If the test fails to reject the variance of the error term is constant and there is no issue with heteroscedasticity - See appendix (CD; C2) for the test statistics. Several of the estimated regressions show signs of heteroscedasticity when tested. In order to correct for the observed heteroscedasticity in the data set standards errors that are robust against heteroscedasticity are generated and inference will be based upon these. In STATA the robust standard errors are created with the Huber-White sandwich method. When the standard errors are robust the regressions will provide useful results even in situations with the presence of heteroscedasticity when the sample is large. 8. Results The following is an examination of the results regarding to the hypotheses presented in the introduction. The basis for the model specification is founded in the regression presented in White (2007b), which investigates the Danish immigration-trade link in the 49

55 period Hereafter, additional explanatory variables have been added making the regression more extended and specified in the objective to analyze the stated hypotheses. 8.1 Does immigration increase Danish international trade? Three regressions have been carried out in order to test the first main hypothesis, being a basic augmented Gravity regression without the immigrant stock as explanatory variable (no. 1 and 4), a basic equation with the inclusion of immigrant stock and (no. 2 and 5) and an extended equation with three additional explanatory factors pertaining to institutional quality in the partner country (no. 3 and 6). Each of these regressions has been conducted for both export and import. 40 Table 4 The effect of immigrants on Danish international trade OLS estimation. Export Import No. (1) (2) (3) (4) (5) (6) Immigrants 0,129*** 0,079*** 0,328*** 0,311*** (0,016) (0,021) (0,039) (0,052) GDP Partner 0,861*** 0,833*** 0,719*** 1,116*** 1,035*** 0,869*** (0,021) (0,021) (0,025) (0,052) (0,052) (0,079) Distance -0,919*** -0,790*** -0,752*** -0,164 0,187-0,116 (0,055) (0,056) (0,060) (0,135) (0,140) (0,148) Population 0,018-0,052** 0,058* 0,237*** 0,077 0,291*** Partner (0,025) (0,024) (0,034) (0,062) (0,064) (0,098) European Union 0,360*** 0,368*** 0,211** 0,678*** 0,670*** 0,221 (0,077) (0,077) (0,085) (0,155) (0,159) (0,178) WTO member -0,028 0,023 0,061 0,381** 0,490*** 1,004*** (0,065) (0,066) (0,078) (0,148) (0,148) (0,212) Exchange rate -0,006-0,008 0,013 0,091*** 0,065*** 0,067*** Financial integration (0,008) (0,008) (0,009) (0,019) (0,019) (0,022) 0,280*** 0,274*** 0,394*** 0,235** 0,214* 0,162 (0,040) (0,039) (0,102) (0,111) (0,112) (0,228) Military conflict -0,291*** -0,316*** -0,297*** 0,136 0,071 0,071 (0,049) (0,046) (0,045) (0,126) (0,118) (0,111) RTA -0,221*** -0,371*** -0,305*** 0,373** -0,035-0,448** (0,073) (0,075) (0,068) (0,168) (0,168) (0,169) Landlocked -0,538*** -0,386*** -0,636*** -0,174 0,209 0,069 (0,051) (0,054) (0,065) (0,131) (0,139) (0,171) Trade openness -0,001 0,025-0,085 0,586*** 0,631*** 0,986*** (0,067) (0,067) (0,082) (0,169) (0,168) (0,183) Linguistic distance -0,289*** -0,206*** -0,111*** -0,350*** -0,136 0,042 (0,040) (0,040) (0,051) (0,101) (0,101) (0,121) Corruption -0,336*** -0,655*** (0,052) (0,108) 40 See appendix B.1 for a descriptive assessment of Danish international trade. 50

56 Business 0,196* 0,413 Freedom (0,117) (0,332) Trade policy 0,202-0,999*** (0,129) (0,296) Constant 4,609*** 4,440*** 4,236*** -12,037*** -12,602*** -7,812*** (0,549) (0,527) (0,841) (1,373) (1,338) (2,067) Time fixed Yes Yes Yes Yes Yes Yes effects Region fixed Yes Yes Yes Yes Yes Yes effects N R 2 0,909 0,914 0,943 0,773 0,785 0,836 Note: Robust standard errors are placed in brackets underneath the estimated coefficient. ***/**/* signals the level of significance that is either 1/5/10%. Overall the number of significant estimates is higher for export than for import, which is also reflected in the amount of the total variation explained in import and export R 2. This might cohere with the methodical choice of not including explanatory variables regarding Denmark in the specification that are important in a foreign country point of view when exporting, e.g. Danish GDP and size of the Danish population. The regressions conducted unveil to a large extend the expected signs as argued in the data description but also some interesting and deviating outcomes have been estimated. The variables trading partner s GDP, EU membership, and financial integration are significant and have a positive effect on the bilateral aggregated trade level. Comparing the estimates for GDP with the other coefficients in the model this variable has a very high magnitude. The opposite is found for linguistic distance, which has a significant and negative impact independent of whether import or export are regarded, this is not the case for other explanatory variables in the regressions. This establishes that the more distant the official language in the trading partner nation is from English, has a negative influence on the bilateral trade between Denmark and the specific country. The variables distance, military conflict, and landlocked are all significant and negative but only for export. These impacts are influenced by the Danish trade pattern and the type of goods that are mainly exported differentiated goods. The fact that if the trade partner has a regional trade agreement (RTA) with Denmark beyond EU has a negative impact on export is closely related to the number and type of countries that Denmark have trade regional agreements with. These are mainly nations that are economically dissimilar compared to Denmark. 41 The factors WTO membership, exchange rate, trade 41 In period concerned then in total Denmark has a RTA with 26 countries. Among them are countries as Syria, Lebanon, and Morocco. 51

57 openness are all significant and positive but only for Danish import. The insignificance and signs of some of the outcomes whether import or export is considered are more or less surprising. This especially concerns distance, WTO membership, military conflict, RTA, landlocked, and trade openness. The estimated results from immigration on export and import respectively show a positive and statistically significant influence on bilateral trade relationships between Denmark and the immigrant origin country. For both export and import the coefficient of the immigrant stock variable is positive and significant with estimated elasticities on 0,129% and 0,328% for export and import, respectively. In total, the outcomes clearly suggest and confirm the hypothesis that there is a positive relationship between the number of immigrants and the level of Danish bilateral trade. When comparing the estimates from immigration with the effect of traditional trade policy, here represented by membership of WTO and EU, it is reasonable to infer that immigration is an important aspect when explaining the level of Danish international trade. Although, there is evidence of a statistical significant influence from immigration the explanatory power that the inclusion of the immigrant stock brings to the specified model is not of greater magnitude. Comparing the total explained variance in the models R 2 - before and after the inclusion of the immigrant stock as an explanatory variable only displays a minor rise. With that being said, the specifications show their relevance by explaining a very significant share of the complete variance both within export and import. The third and extended estimation includes three variables to control for institutional quality in the trading partner countries; corruption, business freedom and trade policy. In these estimations the strong effect from immigration consists with a high level of significance. When comparing the coefficient with the previous estimation the effect from immigration is diminished a little. Considering the three extra variables corruption is significant for both import and export whereas an advantageous trade policy in a partner nation only concerns import. A favorable business climate is positive and significant for export. The magnitudes of the estimates exhibit their large impact on trade, which particular regards import. When comparing the significant measures of institutional quality and coefficients with the ditto WTO- and EU membership their relevance and importance in describing trade relations are underlined. With WTO membership and trade policy being insignificant, which is almost the case for business freedom in relation to Danish export as well; a natural deduction is that Danish export is 52

58 independent of the business conditions. The pivotal point is the level of corruption in a trading partner country and how it functions. Surprisingly, an open trade policy has a negative influence on import, which intuitively does not make sense. The factor should be viewed from a foreign point of view that is a more favorable trade policy in the origin countries is thought to have a positive influence of the nation s level of export. Nevertheless, this cannot be confirmed in the case of Denmark. A comparable study, (Hatzigeorgiou, 2010b), uses the same three variables of institutional quality but in the case of Sweden and also finds a negative estimate though being insignificant Magnitude and importance of immigrants It is noticed that import is influenced more by the immigration than export is. The coefficient for import is approximately 150 % greater than for export, which can be explained by several reasons. 42 First, the explanation often given and presented in the theory part is that immigrants have a preference for familiar goods from their country of origin. The unavailability of these products or satisfactory substitutes can potentially increase the import from the source country. The magnitude of the transplanted bias effect or inherent preference effect among immigrants is however dependent on the size of the immigrant share of the total population in Denmark. Second, it might be the case that foreign-born people residing in Denmark are in a better position to lower or eliminate information barriers that are more important for import than for export. Moreover, the distinct resources and knowledge that immigrants possess with regards to their origin country might benefit import companies more than exporting firms. Third, the influence on the number of traded varieties extensive margin of import is greater than of the corresponding impact on export. In other words this intimates that the presence of foreign-born people in Denmark increases the likelihood of establishing more importing firms relative to exporting. Finally, it is reasonable to assume that in a country like Denmark it is easier to start of up an import business than to do export businesses to foreign markets where immigrants have their contacts and competences. The business environment and conditions in Denmark are simply better to operate in The number is based on: ((0,328/0,129)-1)*100 = 154%. 43 The numbers regarding institutional quality in Denmark in 2008 are the as follow. Corruption: 9,3 - lowest level in the world together with Sweden and New Zealand. Business freedom: 99,9 highest score together with New Zealand. Trade policy: 86,0 - top-10 score. 53

59 In total, this confirms the stated hypothesis that the effect from immigration is stronger regarding import than export. 8.2 Immigration as an indirect trade instrument The effect from immigration probably interacts with factors such as trade policy, economic development, and continent. This means that the influence on trade from immigration is combined with these country-specific factors. As presented earlier methodologically this is tested by the inclusion of interacting immigrant stocks with these country-specific variables. The estimated elasticities are based on the basic specification from table 4. The table below presents the estimates. Table 5 Effect of origin country characteristic OLS estimation. 44 Export Import Institutional quality Immigrants x Corruption -0,416*** -0,457*** (0,050) (0,090) Immigrants x Business Freedom 0,214** 0,830*** (0,093) (0,233) Immigrants x Trade Policy 0,293*** 0,026 (0,098) (0,227) Time fixed effects Yes Yes Region fixed effects No No N R 2 0,939 0,818 Economic gap Immigrants x LEG 0,061*** 0,102*** (0,012) (0,026) Immigrants x MEG -0,003 0,138*** (0,009) (0,022) Immigrants x HEG -0,007 0,137*** (0,015) (0,037) Time fixed effects Yes Yes Region fixed effects No No N R 2 0,910 0,761 Continent Immigrants x Africa 0,081*** -0,079** (0,015) (0,032) Immigrants x Asia 0,095*** 0,085*** (0,013) (0,031) Immigrants x North America 0,051** -0,019 (0,022) (0,047) Immigrants x South America 0,065*** 0,221*** (0,019) (0,044) Immigrants x Oceania 0,169*** 0,300*** (0,032) (0,070) Time fixed effects Yes Yes 44 See appendix F (Table 11, 12, 13 and 14) for a full overview of the estimates on all explanatory variables. 54

60 Region fixed effects No No N R 2 0,913 0,769 Geographical distance Immigrants x distance 0,129*** 0,387*** (0,017) (0,039) Time fixed effects Yes Yes Region fixed effects No No N R 2 0,867 0,762 Note: Robust standard errors are placed underneath the estimated coefficient. ***/**/* signals the level of significance that is either 1/5/10% Institutional quality Measuring institutional quality by the level of corruption the estimated results are in exact opposition to the stated hypothesis and the intuitive comprehension that a higher level of corruption is associated with a larger effect from immigrants. The effect from foreign-born residents in Denmark is stronger for both import and export the lower level of corruption in the origin-countries. With that being said this does not mean that partner countries with a very high level of corruption makes the influence from immigration insignificant only that the influence is stronger the lower level of corruption. There might be several reasons for this observation. First, if the immigrant originates from a country where corruption is widespread in the formal business network the immigrant might not be that applicable. In a corrupt country it is likely not enough to have many good business contacts; knowing the right people is simply a premise. Additionally, it can be argued that corrupt people have no or very little incentive to immigrate, why they are underrepresented in the data. Finally, the trade flows from countries with high levels of corruption might not be fully registered in the statistics, completely due to the informal nature of the business climate. The second facet investigated is business freedom. These outcomes are significant and positive for both export and import indicating the effect from immigration on the level of Danish bilateral trade is dependent on how advantageous the business climate is in the origin-countries. Moreover, immigrants originating from a country with a satisfactory business climate are simply in a better position to influence Danish bilateral trade relations and in particular import. Interpretational this is not in line with the hypothesis stated that immigrants have a stronger influence the lower level of business freedom in their origin country. The opposite relation is found. An explanation for this is that even though the investigated facilitating effect is as a way to overcome tough 55

61 complications and trade barriers it indicates that some level of business climate in the partner country is a prerequisite. The final aspect of institutional quality examined is the influence of trade policy in the source countries. The estimates are only significant for export where a positive coefficient is found. This signals that immigrants residing in Denmark exert a greater influence on export the more favorable trade policy the origin nation has. Again this rejects the expected impact from immigration. The deductions from this part indicate that the magnitude and influence that immigrants exert is very dependent on the characteristics of their country of origin. A high level of corruption reduces the effect from immigration to Denmark. This is also the situation for business freedom with regards to both export and import and for trade policy pertaining to export. The estimated outcomes show that the impact of the trading partner countries influence trade with Denmark beyond the direct channels. The aspects have an indirect impact on the trade creating effect from immigration in Denmark and thereby the magnitude for bilateral trade. In sum the three parts of institutional quality considered in the case of Danish trading partners provide robust evidence relating to the hypothesis. All three aspects corruption, business freedom and trade policy - reject the hypothesis that immigrants exert a stronger influence the lower level of institutional quality in the trading partner country. Moreover, assuming that Denmark has a high level of institutional quality, this conclusively infers that immigration has a greater effect on Danish bilateral trade the more institutional similar the origin-nation is. The magnitude of the positive association from immigration on Danish bilateral trade relationship is simply reliant on some predefined determined conditions in the source countries. The tests of the effect from institutional quality are performed on a regression with all three parameters interacted with the immigration stock included. This approach is adopted from (Hatzigeorgiou, 2010b), who investigated similar hypotheses. As it can be seen in Appendix (CD; C1.3) the VIF statistics show high levels of multicollinearity. As described in section this implies that the standard error of the estimated coefficient is inflated substantially, which will interfere with the t-test regarding the significance of the estimates. When inflating the standard errors by a factor the coefficients are still found to be significant. Alternatively, the regressions could be run with one interaction term included at a time. It is though the authors clear opinion that the approach applied provides the most accurate outcomes. 56

62 8.2.2 Economic gap The next step investigates the relevance of immigrants in relation to the level of economic gap between Denmark and the trading partner. This interaction is in direct line with the presented theory, that trade and information barriers are larger and more frequent in less developed nations. The reference category is countries that are considered economical similar to Denmark. The estimated effects show that the level of economic gap between Denmark and the trading partner differ for import and export. Immigrants only exert a positive impact on export when the trade flow is directed to a nation categorized as the most economic similar compared to Denmark - LEG. 45 This might cohere with the main type of goods that Denmark export; differentiated goods. Less economically developed nations simply do not have the same preference pattern as Denmark and this is of course highly correlated with the level of income. The opposite situation is present regarding import, here the gap in economic development is positive and stronger the more dissimilar the trading partner nation is though the difference in the effects from medium and high dissimilar nations are approximately of the same magnitude. This is very much in line with the transplanted bias effect that when the dissimilarity increases satisfactory substitutes are basically not available. In sum the results partly confirm the presented hypothesis that the trade effect from immigrants in the case of Denmark is stronger for economic dissimilar nations than similar countries. It is found that the effect from immigration is stronger on import the larger the gap between Denmark and the origin-country. This is though not present pertaining to export here the trading partner cannot be too economic dissimilar. This can more or less bee seen as empirical evidence and description of the Danish trade pattern; import from economic dissimilar countries and export to similar countries. Furthermore, it is expected that the contribution in terms of lower trade costs and trade promotion of foreign-born people residing in Denmark from similar economic countries is not as additive as for dissimilar nations. As described in the theory part formal channels for obtaining the needed information are often limited in those groups of countries. 45 In the data description this was described as a GDP gap between US$ US$

63 8.2.3 Continents To examine whether the effect from immigration differ depending on regional location of the partner country, continent dummy variables have been interacted with the immigrant stocks. Countries in the sample have been categorized according to six continents with Europe used as the base - that is all other categories are compared to Europe. Compared to Europe the results reveal that the impact from immigration differs across origin-continents. In general the elasticities are higher for import than export, which are in line with previous findings. Focusing on import immigrants from the continents Asia, South America and Oceania have a positive and significant impact whereas the effect from immigration from Africa has a negative influence on import compared to a European immigration. The strongest influence is from Oceania and South America. For export all continent coefficients are positive and significant with Oceania having the strongest impact. In total the continent of origin significantly affects the effect from immigration on trade. The fact that the effects differ across continents indicate some sort of heterogeneity regarding countries in the sample. E.g. the effect from immigrants with a North American background is insignificant pertaining to import, which can be explained as the reversed case of the transplanted bias effect. Danish citizens and foreign-born residents with a North American background have much the same preference as Danes; satisfactory substitutes are already available in Denmark. For export the additional information, knowledge and contacts that immigrants add to promote and strengthen Danish export to certain continents are particular relevant for Oceania, Asia and Africa. This is further supported by the elasticity on export for North America immigrants, which is the weakest estimated effect. The information brought does simply not contribute or add to the information that already exists in Denmark. The more information about a nation or a market that is possessed the less value will an additional immigrant add. 46 The continent Oceania, which is dominated by the nations Australia and New Zealand, is found to have the strongest effect for both export and import. This strength might be explained by a well-established trade relationship already in place between Denmark and this continent why large elasticities are estimated and subscribed to the relative little immigrant stock from this region. 46 This is similar to the descriptions in section and 10.1, which will follow, where it is argued that the effect from immigration on trade cannot be characterized by a constant elasticity relationship. 58

64 To further investigate trading partner division by continents the interaction between immigration and distance has also been examined. Immigration-trade theory suggests that people with a foreign background can reduce trade barriers by facilitating information flows between the countries. In this relation it is proposed that the effect from immigrants on bilateral trade is of greater magnitude the more geographical distant the trading partner is. This is confirmed for both import and export, which are positive and significant. Import is greater affected by the level of distance to the origin-countries than export. In the context of continents the strongest effects from immigrants were also estimated on the most geographical distant regions. In total this confirms the proposed hypothesis that the immigration-trade link differs depending on regional location with the strongest link being estimated for the continent Oceania. This derivation is further supported by the interaction of geographical distance, which also confirms the theory that information barriers are of greater magnitude the more geographical distant the trading partner is. 8.3 Immigrants as a channel of information The argumentation for the positive effect from immigration is that the proficiencies that foreign-born residents possess facilitate and reduce information barriers, which in the end enhance export, import and FDI inflow levels. To test the hypothesis that the significant effect is derived through the information channel trade data are divided up into three categories according to the Rauch classification differentiated goods, referenced-priced goods and homogenous goods. 47 If this hypothesis consists it should be confirmed that the effect is especially strong for goods particular dependent on low information barriers differentiated goods and a less strong effect for referencedpriced and homogenous goods. The outcomes are based on the basic specification similar to those in table 4. The results of estimating the equations employing the three categories, differentiated, reference-priced and organized exchange trade value with both a conservative and a liberal classification are presented below. 47 See appendix D for a full assessment of the Rauch classification. 59

65 Table 6 Effect of immigrants by level of product differentiation on Danish international trade Tobit estimation. 48 Conservative Classification Liberal Classification Differentiated Referencepriced Homogenous Differentiated Referencepriced Homogenous Export 0,163*** 0,144*** 0,073 0,160*** 0,156*** 0,053 (0,017) (0,028) (0,068) (0,017) (0,026) (0,043) Import 0,181*** 0,113 0,424*** 0,189*** 0,174*** 0,382*** (0,039) (0,075) (0,076) (0,039) (0,056) (0,063) Note: Robust standard errors are placed underneath the estimated coefficient. ***/**/* signals the level of significance that is either 1/5/10%. In general, the estimates are consistent across the two divisions of the classification system. Whether the elasticities on Danish export confirms the hypothesis that is an increasing immigrant effect the more differentiated the good considered is doubtful. To infer whether the estimates across the three classification categories are significantly different from each other t-tests have been performed. According to these the estimates are all significantly different from each other, except in the case for Import differentiated and reference priced (liberal). 49 The elasticities for homogenous goods are insignificant while being significant for reference-priced and differentiated indicating some form of heterogeneity in the information channel. The estimated elasticities are in line with what has already been deduced namely that immigration has a stronger effect on Danish import than export and this effect seems to be strongest in relation to the goods categorized as homogenous or least differentiated. The insignificant estimate of export on homogenous goods might correspond with the low level of Danish export in this category thereby decreasing the number of observations. Coefficients on import totally rejects the hypothesis, elasticities on homogenous goods are much stronger than for differentiated goods. The estimates regarding import should be taken with caution due to the possibility of bias. If the consideration of import should make completely sense, Danish citizens living abroad should be included. 50 In sum this does not give a clear-cut picture that the way immigrants mainly influence bilateral trade levels is through the information channel. It is concluded that the estimates elasticities support and partly confirm the hypothesis stated that the immigration effect primarily work through the information channel for export but not for import. 48 See appendix F (Table 14 & 15) for a full specification of all explanatory variables included. 49 Se appendix E for performed t-tests. 50 This closely follows the discussion in part 6.7 thesis delimitations. 60

66 8.4 The role of descendants 51 The role and influence of descendants in relation to bilateral trade relations to their origin country is a new and uninvestigated area. The examination is grounded in and originates from the authors interactions process with Swedish interest parties cf. appendix G.4. From here it was argued and deducted that the ties, contacts, bilingual skills, preference of goods etc. to the origin country actually encompasses to the next generations. Moreover, several sources argued that descendants compared to their parents are more adapted and integrated to the society that they have grown up in and therefore are in better position to take advantage and utilize the relation to their country of origin. Therefore the same regressions as carried out for immigrants in table 4 have been estimated but with descendants instead. The table below shows the results from the estimations. Table 7 Effect of descendants on Danish foreign trade OLS estimation. 52 Export Import No. (1) (2) (3) (4) Descendants 0,083*** 0,038** 0,154*** 0,113** (0,014) (0,016) (0,033) (0,039) Corruption -0,350*** -0,746*** (0,054) (0,122) Business freedom 0,211 0,506 (0,117) (0,373) Trade policy 0,211-0,870*** (0,136) (0,310) Constant 4,164*** 4,105*** -11,435*** -8,140*** (0,547) (0,878) (1,436) (2,227) Time fixed effects Yes Yes Yes Yes Region fixed Yes Yes Yes Yes effects N R 2 0,921 0,943 0,783 0,823 Note: Robust standard errors are placed underneath the estimated coefficient. ***/**/* signals the level of significance that is either 1/5/10%. Regression without descendants for export and import are not submitted due to the consistency with the outcomes with regards to immigrants in table 4. The results show that descendants have a positive and significant influence on both Danish import and export and the effect is stronger for import than on export. These outcomes confirm the hypothesis that there is a positive relationship between the number of descendants from a given country and Danish bilateral trade flows with that country. Moreover, what has only been experienced in practice in Sweden is also 51 See appendix B.2 for a full descriptive overview of descendants in Denmark. 52 See appendix F (table 17) for a full overview of all explanatory variables and estimates from the regressions. 61

67 transferrable to Denmark. The effect from descendants has to be taken with caution due to the high evident correlation between immigrants and descendants. This entails that to some degree the inclusion of new generations instead of first generation immigration explain part of the same variation in the bilateral trade flows as immigrants. Nevertheless, regardless of that the estimates are highly significant inferring the existence of a positive effect from descendants but that the elasticities are not completely definitive. Estimates on other explanatory variables are in line with what has previously been presented pertaining to immigrants. Even with the reservations made the investigation of the role and positive influence of descendants on Danish bilateral trade relationships has unveiled and contributed with a new aspect to the already grounded theory regarding the immigration-trade link. Further analysis on how the competences and knowledge actually encompasses from immigrants to new generations and a more exact clarification focusing directly on the descendants as a trade facilitator and initiator might be very relevant especially with the growing stock of descendants in Denmark. As presented earlier previous literature (Head and Ries, 1998) has found the impact from immigration to vary in magnitude by type immigration refugee, family and independent. This aspect might influence what encompasses on to further generations. Moreover, even with an expected diversity in encompassed knowledge this does not exclude a specific group of descendants to obtain any information, skills and know-how in relation to their source country or to facilitate the bilateral relationship between Denmark and the origin country. To put this in perspective it is found that every second descendant is a child after a refugee (Danmarks Statistik, 2010). An additional feature to mention - as also presented in the introduction - is the age distribution among next generations of immigrants; 2/3 are 15 years old or younger in 2010 and only every 10 th descendant is over the age of 30 (Danmarks Statistik, 2011). This is an important point due to the difficulty of exploiting knowledge when not being an integrated part of the labour market. In the upcoming years with the gradually introduction and ageing of the significant share of descendants there is a large potential of a more efficient utilization of the resources due to their adapted behavior relating to the Danish society. Finally, as presented in section the size of descendant stock in Denmark has grown rapidly over the period investigated and furthermore that the descendants stocks are concentrated around a limited number of 62

68 origin countries. 53 All together it is reasonable to infer that the influence from descendants will increase in the nearest future. 8.5 Immigration as a FDI inflow projector 54 In the introduction and the subsequent presentation of the hypothesis it was specified that immigration and FDI inflow in the case of Denmark is postulated to be positively associated. Moreover, it was stated that the effect from immigration should be stronger than with regards to trade due larger information requirements. The table below presents the results from the Tobit estimation carried out on FDI inflow in Denmark from the basic (no. 1) and extended (no. 2) specifications similar to the regressions in table 4. Table 8 Effect of immigrants on FDI inflow to Denmark Tobit estimation. 55 No. (1) (2) Immigrant 1,718*** 1,318** (0,528) (0,599) Corruption -3,132*** (1,200) Business Freedom 2,044 (3,304) Trade policy -7,508* (3,869) Constant -98,973*** -83,708*** (15,347) (23,171) Time fixed effects Yes Yes Region fixed effects Yes Yes N R 2 0,155 0,158 Note: Robust standard errors are placed underneath the estimated coefficient. ***/**/* signals the level of significance that is either 1/5/10%. From the estimation and presented results a significant and positive effect from immigration is found on Danish FDI inflow in the period. Moreover, comparing the two estimated effects - immigration-trade link and immigration-fdi inflow link - a much stronger influence of immigration regarding FDI inflow in Denmark is found independent of whether import or export are considered. Despite the elasticities are based on two different estimation methods OLS and Maximum likelihood (Tobit) then in total this confirms both the stated hypotheses; the link between immigrants and FDI inflow is significantly positive and is stronger than the link observed between 53 See appendix B.2 for a full descriptive overview of descendants in Denmark. 54 See appendix B.3 for a descriptive assessment of FDI in Denmark. 55 See appendix F (table 18) for a full overview of all explanatory variables and estimates from the regressions. 63

69 immigrations and trade. With that being said then as presented in the theory part FDI and the whole background for investigating FDI is more voluminous in the number of influential aspects that needs to be considered compared to trade. This is reflected in the amount of total explained variance in the specifications. Based on the above significant and positive outcome from immigration on Danish FDI inflow and previous literature e.g. (Groznik, 2003) and (Kim, 2006) it is reasonable to infer that immigration is a leading and predictive indicator of FDI. Despite not being empirically tested this result adds to the increased complexity and area that needs to be considered in immigration policy formulation. Due to the outlook of the data the derivations from the estimated regressions have to be taken with caution cf. section on data description. A higher level of data quality that is an exact determination of the amount of FDI received from all source nations at given time would increase the credibility. The majority of the received Danish FDI is sourced in OECD or European countries whereas the stocks of immigrants are a lot more diversified. As described in the literature review the effect from immigration is not necessarily one-dimensional. Previous studies have found immigration influence both FDI inflow and outflow. Which effect that dominates is a topic for further research. Nevertheless, all together the estimations indicate that immigrants residing in Denmark have played a significant and positive role of the increased level of FDI and FDI stock construction that Denmark has undergone in the period As the outlined conclusions signal FDI inflow into Denmark is a topic that needs thorough and extensive investigation. Particular areas such as person-specific characteristics, occupation and level of education might be relevant to include. 8.6 Immigration policy and time dimension As argued the Danish immigration policy reform in 2001 is a focus due to its potential effect on the nexuses described. This is based on the change in the immigration pattern type and number. Estimating and isolating the exact impact of this policy reform is very laborious due to other viable macroeconomic alterations e.g. changes in the general trade environment etc. This makes it hard to argue that a possible significant alteration in the influence from immigration found is directly derived from the policy change and 64

70 does not reflect other events. An attempt to investigate whether a significant effect from the change in immigration policy statistically can be detected a constructing of an interaction term between the immigrant stocks and a year dummy, which takes the value one reflecting the period and zero when the period is considered. The estimates for export and import in the table below are based on the basic equation as presented in table 4. Table 9 Impact from the immigration policy reform in 2001 OLS estimation. 56 Export Import Immigration policy reform Immigrant X Year dummy after ,012** 0,041*** (0,006) (0,013) Constant 4,198*** -12,980*** (0,559) (1,379) Time fixed effects No No Region fixed effects Yes Yes N R 2 0,908 0,774 Note: Robust standard errors are placed underneath the estimated coefficient. ***/**/* signals the level of significance that is either 1/5/10%. The outcomes are both significant and positive. The results are in exact opposition to what was anticipated. The consequence of the conducted immigration policy reform in 2001 was thought to diminish the effect from immigration due to the change in immigration patterns. The results assessed expose the weakness of the method applied. As mentioned above this method is very simplified, which makes it difficult to derive definitive evidence subscribed to one specific change, this is highly likely to be the case in this context. An explanation for the outcomes is that during the period after 2001 Danish international trade grew rapidly, which might be the development that is reflected or has influenced the estimates. 57 A natural consequence of this simple quantitative investigation is that it cannot be inferred that the conducted reform has had a significant diminishing effect on the linkage between immigration and trade. The effect from the alteration has not been strong enough to statistically detect an impact this might also be correlated with the aggregated nature of the data. First and foremost a tightening of the immigration policy will have an impact of the future immigration inflow pattern regarding type and number and thereby the future outlook of the immigration stock in Denmark. To detect a changed effect from 56 See appendix F (table 19) for a full overview of all explanatory variables and estimates from the regressions. 57 See appendix B.1 for full assessment of Danish international trade. 65

71 immigration the total characteristics of the immigration stock has to change significantly. The stock of immigrants is accumulated over a substantially longer period than and detecting a significant change in the immigration stock is likely not to be observed in the seven-year period after the policy change. To give an indication of whether or not the influence on Danish bilateral trade relationships from immigration changes or vary over time the results from this study is compared with White (2007b), who investigated the Danish immigration-trade in the period Even with these outcomes not being directly comparable due to the different model specifications and datasets this gives an indication of the variation in the link over time. White (2007b) estimated the elasticities on export and import to be 0,572% and 0,328%, respectively. These differ significantly from what has been estimated in this study export and import elasticities of 0,129% 0,328%, respectively. This could be an indication of a reduced effect from immigration on bilateral trade relationships and influence by other viable macroeconomic alterations. E.g. the effect and effectiveness of networking might decrease caused by the development of new technologies that make information exchange faster, easier and less costly. Furthermore, person-specific aspects such as type of occupation, sectors, sex, age, level of education and duration of stay that might have a significant influence on the magnitude of the effect. In total the outcomes do not provide conclusive and robust evidence that the immigration policy have had an diminishing effect on the strength of the Danish immigration-trade link in the period investigated. 8.7 Interpretation of the results practical aspects When interpreting the outcomes certain aspects and features of the estimated empirical results are relevant to discuss when going from a strictly theoretical context to a practical understanding. The specified econometric model predicts that when increasing the number of immigrants or descendant by specific number the trade and FDI inflow volume would change by an exact amount. In a purely theoretical context this should be an immediate effect but that might not be the case in practice and therefore an inaccurate interpretation. The impact and influence of immigrants and descendants on a country s global trade and financial integration should be viewed as an ongoing process over time. The speed at which foreign-born people are able to exert an influential 66

72 impact is highly dependent on their adaption of Danish economic conduct, e.g. labour market integration, occupation, education, etc. Important facets in this relation are the duration of the immigrants stay in Denmark and immigrant stock turnover. The evidence found is likely to underestimates the possible potential of immigrants. This will be investigated in the next part that is whether the results are autonomous or have been influenced by strategic initiatives and actions that seek to develop and exploit knowledge of immigrants. The outcomes from actions that apply immigrants to strength and promote trade and financial integration are purely dependent on the focus of the initiative import, export or FDI inflow. Finally, the quantitative analysis increases the width in which aspects and situation immigrant can play a significant role but also in situations where it might be optimal to efficiently apply their knowledge and knowhow. In total the results reveal a resource, which possesses a large potential. The consequence of this is an increased complexity in producing the most efficient immigration policy. 8.8 Robustness test The empirical results presented have undergone a robustness test to validate and secure that the outcomes are consistent across estimation methods. Due to the fact that the results may suffer from different critique points e.g. bias and inconsistency. Furthermore, the outcomes may depend on the very nature of the Gravity model and methodical choice. This part comprises of a robustness check regarding import and export Immigration-trade link check The table below shows the estimated effects on export and import respectively based on the basic specification as presented in table 4. As presented in the methodology part two estimation methods have been applied that is a dynamic model with a lagged dependent variable included, a fixed effect regression and without the five largest immigrant stock nations (drop-5) These are: Turkey, Germany, Iraq, Poland and Bosnia-Herzegovina. 67

73 Table 10 Robustness check OLS estimation. 59 Export Import Dynamic Fixed effect 5-drop Dynamic Fixed effect 5-drop Immigrant 0,082*** 0,154*** 0,158*** 0,113*** 0,208** 0,378*** (0,018) (0,045) (0,017) (0,033) (0,105) (0,041) Lagged dep. 0,099*** 0,670*** Var. (0,014) (0,033) Constant 6,115*** 4,891*** -5,693*** -51,688*** -12,80*** (0,775) (0,547) (1,619) (11,760) (1,415) Time fixed No Yes No Yes effects Region fixed Yes Yes Yes Yes effects N R 2 0,912 0,314 0,788 0,881 0,657 0,775 Note: Robust standard errors are placed underneath the estimated coefficient. ***/**/* signals the level of significance that is either 1/5/10%. In the fixed effect estimations all time invariant variables are excluded why time and region fixed effect have not been stated. Across the methods and in general the presented results show that a significant and positive link between immigration and import and export is observed and maintained. The influence from immigration on Danish import and export are all found positive and significant. Moreover, comparing the elasticities from the OLS estimation only minor variations within in the estimates are found. In total this does not cause or foster any concern of biased results or in specific; endogeneity issues due to unobservable aspects influence Danish bilateral trade flows and are correlated with the immigrants stock. The regressions performed without the five biggest immigrant stocks show that even when leaving out these countries a positive and significant effect on trade from immigration can be detected. Further, it seems that the estimated effect is bigger for both import and export with the exclusion of the biggest immigrant stocks. This can be interpreted and as previously mentioned as a sign of non-constant elasticities. The effect from immigration is likely to dependent on how much information about a certain economy that already exists in the host country. Moreover, this reveals that the immigration-trade linkages for the individual countries are a heterogeneous. In total, a positive link between immigration and Danish trade is observed and confirmed and therefore the interpretations and conclusions made so far are intact. Whereas this only concern a robustness test on the Danish immigration-trade link at an aggregated level a robustness test of all the regressions have been carried out. In the 59 A full view of all estimates of explanatory variables can be found in appendix F (table 20). 68

74 cases of the Rauch classification OLS estimation has been performed as well otherwise all the same estimations methods have been applied regarding every specification in the analysis. All outputs from this sequence can be found in appendix (CD; B). The conclusion is that the result so far and thereby also the deductions are retained and confirmed. 8.9 Partial conclusion This section has presented the results from the empirical analysis with regards to the defined hypotheses in the introduction. Based upon this it is inferred that the outcomes consistently have provided conclusive robust evidence of a causal relationship between immigrants and the level of Danish import, export and FDI inflow to Denmark. Immigrants residing in Denmark in the period have played a significant and positive role in strengthen and promoting Danish bilateral trade relations and investment opportunities in Denmark. Whether or not this has happened autonomously as theory has suggested will be investigated in section 9. The majority of the specified propositions were confirmed but some deviating outcomes were also found. This especially regards institutional quality, economic development gap and immigration policy. A better level of institutional quality in the origin-countries was argued to be negatively correlated with effect from immigration; empirical evidence rejects this. The exact opposite was found for all three aspects of institutional quality; corruption, business freedom and trade policy. The derivation upon this is that the impact of the trading partner countries influences Danish trade relations beyond the direct channels. These aspects influences the trade creating effect from immigration in Denmark and thereby the magnitude for bilateral trade. Furthermore, the larger the difference in economic development between the trading partner and Denmark was thought to be positively correlated with the influence from people with a foreign background. The confirmation of this theoretical proposition depends on whether export or import is considered. The larger the gap in economic development the larger the influence on import whereas a positive impact on export is only found when the gap in economic similarity is not too large. This is linked to the type of products that Danish export consists of and the type of goods available to immigrants residing in Denmark the transplanted bias. Despite being incomplete measures then the four interacted aspects in general all together reflect 69

75 some kind of social similarity or dissimilarity between Denmark and its trading partners which influences the strength of the immigration-trade linkage. The individual interactions reveal in which relations and context this is present and especially relevant. The quantitative investigation of the conducted immigration policy reform did not provide supported evidence to conclude that its commencement has had an impact on the immigration-trade linkage. The estimates were positive signaling that the alteration should have had an encouraging impact. It was concluded that the outlook of outcomes could be subscribed to the inaccurate method applied and reflected other macroeconomic events and trends during the period Further research The empirical investigations have fostered some areas that need further in-depth research and analysis to clarify the exact relationship, effect and consequences. Much of the focuses should naturally be on immigrant-specific characteristics that are by type of residence permit refugee, asylum seeker, independent and how immigrants spread and take advantage of their knowledge and competences in the Danish society. Furthermore, aspects such as type of occupation, sectors, sex, age, level of education and duration of stay that might have a significant influence on the magnitude of the effect. Whereas this is centered on immigrant characteristics an analysis of the correlation and influence of alternative levels might be relevant. In relation to trade this concerns trade in services, which has not been considered in the study. The relevancy of this aspect is underlined by the fact that Danish trade in service accounts for a significant part of the total annual trade. Furthermore and relation to FDI inflow an investigation at different fragmentation levels, e.g. vertical, horizontal etc., and how labour and capital move in this specific context would be a confirmation of whether traditional theory on factor movements still hold. 9. Trade barriers, Project Kosmopolit and utilization This section seeks to investigate whether it is plausible to conclude that the estimated effects are solely autonomous or whether the links have been influenced actively by strategic initiatives. Furthermore, this part exemplifies an opportunity on how to bridge 70

76 the gap between the theory and a practical application. Much of this is sourced in the understanding and experience from Project Kosmopolit in Sweden, which is an effort to utilize the competences and knowhow brought by immigrants. This part has three things in focus; the exploitation of the immigrant stock in Denmark, Danish trade barriers and the Swedish Project Kosmopolit. 9.1 Exploitation and level of utilization in Denmark In the introduction it was presented that the focus in Denmark predominantly is on the negative effects, consequences and costs that immigrants impose to the host country which have entailed limited attention to the benefits. The knowledge and competences that immigrants possess can contribute to address some of the biggest challenges that Denmark faces e.g. prospective low growth rates. This underlines the importance of exhibiting and applying immigrant resources. In order to investigate and explore to what extend immigrants have been or are organized and applied in Denmark several interest parties, organizations and groups were contacted. Among these Dansk Industri, Invest in Denmark, Væksthus Midtjylland, Eksportforeningen, and Ministry of Foreign Affairs. The clear impression derived from this process was that this is not a topic, which has received any attention at all. None of the contacted parties were familiar with the application of immigrants in strengthening and promoting Danish trade relations. Numerous explanations for the absence of attention were given. The most common was the little know-how on how immigrants can be applied in different international business processes and the little knowledge about the empirical work done. The fact that there in the empirical analysis was found a positive link between immigration and the level of international trade and FDI inflow to Denmark makes it is reasonable to conclude that even with the lack of focus from official side the positive effect sustain and the determined relationships can be defined as autonomous. Despite this, thus one immigrant network was found Novum. 60 This network, which is supported by interest organizations and the former Ministry for Foreigners and Integration, is an initiative, which purpose is to collect and organize well-educated immigrants residing in Denmark. The initiative was founded in 2009, why it still makes sense to conclude that the estimated effects from immigration in the period

77 on Danish trade and FDI inflow relations are autonomous. Furthermore, none of the contacted parties were familiar with this network signaling the very limited application at this point. 9.2 Project Kosmopolit a Swedish application and organization 61 The Swedish project, Project Kosmopolit, was organized by the Swedish Ministry of Foreign Affairs, initiated in 2007 and consolidated in The initiative is an attempt to benefit precisely from the areas of expertise that immigrants possess. The background for the project was the understanding of how dependent the future job creation and prosperity of the Swedish economy is on trade openness and global economic integration. The effort focuses on consolidating and smoothing the process for companies to grow through exports and imports independent of international, regional or bilateral negotiations by lowering trade and investment costs (Regeringskansliet, 2009). The initiative was thought as a supplementary instrument to apply in the new situation and challenges after the economic crisis. During the crisis the unemployment raised and economic growth declined, which resulted in an increased global protectionism and less economic openness. Due to the difficulty of restoring transparency and predictability through conventional methods Project Kosmopolit was a different approach in lowering trade costs and maximizing market shares for Swedish firms. The new situation simply disclosed that further vigorous efforts were needed to strengthen Swedish companies opportunity to trade. Efforts were primarily aimed at small and medium size enterprises (SME) due to their level of growth on the international market, but before engaging in foreign trade some significant fixed costs and barriers have to be circumvented. The internationalization process often goes beyond the core business expertise e.g. specific conditions in individual countries, law, regulations, language etc. Project Kosmopolit was a way to diminish or bypass some of the costs associated with international trade and strengthen the utilization of immigrants (Regeringen, 2010). Before initiating the project, in-depth research of the underlying channels by which immigrants influence trade flows was needed. Research showed that exchange of information in social networks was a significant driver. The positive correlation 61 This part is based on interviews, mail correspondence and official papers regarding the project. The different sources can be found in appendix G. 72

78 between immigration and trade largely depends on the existence of such social networks, the strength of the networking, information flows within the networks and interactions between the networks and the community. The main problem was identified to be the lack of immigrant and business networks and their natural interaction with Swedish companies. This resulted in the establishment of six networks all across the country and cooperation with other networks in Sweden. The idea of the network formation was that the collaboration with Swedish companies should help and promote export (Appendix G.5; Swedish Ministry of Foreign Affairs, 2011). Later on in the process additional devices have been launched to support and complement the initiated activities, e.g. a tool skill bank, which aim is to gather knowledge in one place and thereby increase the accessibility and practicability of specific skills and information. Through the broad networks the necessary skill-set can be accessed, enabling trade at a higher speed and a more efficiently when operating in the foreign markets. The networks are a platform for cooperation and supporting organizations assuring longterm engagement with the companies in order to establish sustainable business development. In total the whole organization exists of interest parties, corporations, immigrants, descendants, ethnic Swedes etc. Even though the project is the first of its kind and still is in a development process it has already unveiled its applicability and some of its potential benefits. This has entailed serious interest from the OECD and the British government who wants to copy the idea. 9.3 Danish trade obstacles 62 Denmark is often considered as a small open economy, but an examination of the trade level has shown an unexplored trade potential (Økonomi- og Erhvervsministeriet, 2003). The lack of trade exploitation even exists when taking numerous Danish factors and characteristics into account. Further, reports have shown that the unused potential is larger for imports than exports. Special characteristics that distinct Denmark from other countries are the high number of SME, the size of the public sector and the level of trade of services. A large variety of costs can arise in connection with international trade, especially in the initiation phase. Due to these start-up costs the share of exporting SMEs is 62 The presented barriers will be the ones who can be influenced by immigrants in relation to strategic initiatives. 73

79 substantially smaller than it is the case for bigger firms. This is explained by the fact that large firms have larger resources to overcome the costs. Such costs are exemplified by language and cultural barriers, law enforcement etc. 63 Consequently, the negative correlation between a country s level of foreign trade and the number of SME s is a possible and reasonable explanation for the relative low degree of exploiting the Danish trade potential (Økonomi- og Erhvervsministeriet, 2002). The negative effect in Denmark is to a degree offset by the fact that a lot of the SMEs work as a supplier for companies that do export. The under-utilized potential of imports and exports do not regard specific sectors or industries thus this indicates that the barriers that impede the level of trade are general. An investigation across OECD countries reveals that the formal general conditions in Denmark are good even though they can be improved. An exposition is that there are other barriers that are not considered in the measurement across OECD countries. In general investigations on Danish import barriers have identified several obstacles that foreign firms have to cope and which impede the level of import. 64 Analyzed in the object of immigrant proficiencies the impediments that can be reduced are very limited because these are centered on general conditions in Denmark, e.g. the size of the Danish market. Moreover, the level of competition in many industries is characterized as low. In total the unused import potential together with the lack of competition signals that import barriers efficiently preclude foreign firms in that low competitiveness should attract foreign companies due to the possibility of a high return (Økonomi- og Erhvervsministeriet, 2003). Examination of Danish exports barriers have shown that these are more receptive to be reduced by the influence of immigrants. Five impediments have been identified, which are: Export not being a part of the firm s strategy, Excessively high costs, Special factors or condition in the foreign market, Problems in finding a foreign partner, Insufficiently information about market conditions. 63 In comparison with the OECD average Denmark does not have a relatively larger size of SME s. 64 The depicted barriers for both import and export are from the report Growth through globalization, (Økonomi- og Erhvervsministeriet, 2003). 74

80 It is highlighted that especially for SME s it is apparent that absence of concrete knowledge about circumstances and conditions on foreign markets impede their initiatives. These barriers do not influence large companies to the same degree due to their experience of managing international business processes (Økonomi- og Erhvervsministeriet, 2003). Although the presented barriers pertain to export they might as well impede Danish import. From a foreign firm point of view the identified barriers in foreign market might as well be present in Denmark. The result is that if the barriers mentioned in relation to import together with export barriers can be reduced in Denmark, then this is expected to have a positive impact on the level of international trade. Generally, companies know how to handle the barriers but often this action is too demanding. Reasons why companies do not surmount trade barriers is explained by e.g. the lack of resources and time, other priorities, lack of sufficient know-how to solve the problems (Erhvervs- og Byggestyrelsen, 2003). In an international comparison Denmark receives the amount of FDI that is to be expected based on the level economic and institutional conditions. Many of the described barriers above that harm and impede Danish international trade can correspondingly influence the FDI inflow into Denmark. As it is the case for trade barriers, Denmark has some of the lowest formal FDI barriers among OECD countries. Although, joint conditions indicate that there in the general framework are impediments that affect the level of FDI inflow Results, implications and recommendations The quantitative analysis and the description of the actions and focus in Sweden together with the highlighted barriers to trade and FDI inflow in Denmark have given an insight in the process of going from strictly theoretical context to a practical applicable model. Based on this exposition it is possible to give some general recommendations on how the knowledge gathered can be applied in practice. Moreover, a discussion 65 Some of these conditions could be: relative high wage level, taxes, not being a part of the EURO and corporate taxation. 75

81 regarding the implications and consequences of the outcomes from the empirical analysis on the Danish welfare and immigration policy will follow Results application The empirical analysis has provided strong robust evidence of a positive effect from immigration on Danish bilateral trade relations that is both a strengthening and promoting impact. Based on the estimated elasticities a 10% increase in the immigrant stock from a specific country will on average increase Danish export and import by 1,29% and 3,28%, respectively. In this setting an increase in the Danish stock of immigrants by persons will result in an increased export and import of roughly 2,1 billion DKK and 5,5 billion DKK, respectively. 66 Seen in this perspective the total immigration stock in Denmark from 2007 to 2008 increased by approx people. 67 The effect from descendants is not a part of the calculations resulting in a possible underestimation of the real impact. This might seem overwhelming and the monetary effect should not be taken too strictly. As previous literature has pointed out the end result of increased immigration depends on which effect that dominates imports or exports. Consequently, a trade deficit can result in a currency depreciation pressure, which will lower the real income for Denmark (Head and Ries, 1998). This contemplation is not thought as a problem in this specific context. The recommendations should not be seen as unconditionally pro increased immigration. The main message is, that latent resources already exist in Denmark, which can be organized and applied in a more efficiently manner than the current state. This application and initiative can be solely focusing on export, as is the case for Project Kosmopolit. An implicit assumption for the calculations is that the marginal effect from increased immigration is characterized by a constant elasticity regardless of the level of trade and number of immigrants residing in Denmark. Realistically, this is hard to assume, which is underlined by the change in magnitude of the immigration-trade link discussed in relation to the immigration policy reform and the regression without the top-5 immigration countries in the empirical analysis. In practice, the magnitude of the elasticity might be dependent on how much new knowledge and information that are 66 The calculations are based on 2008 numbers: total immigration stock in Denmark is , commodity export value is US$ millions, import commodity value is and an exchange rate of 5 Danish Kroner per US$. 67 Based on this number the values that can be subscribed from immigration on Danish export and import are 3,5 billion DKK and 9,2 billion DKK, respectively. 76

82 added to the stock of information and knowledge that already is possessed in Denmark. Naturally, the estimated elasticities are highly correlated with the information and knowledge contribution in the period and therefore a decreasing marginal effect from immigration on trade is more reasonable. 68 From the quantitative analysis several outcomes underlines and stresses the need for complementary instruments that assist in the process of job creation and growth in Denmark in that context immigrants are especially relevant. First, trading partners countries being a member of WTO or having a RTA with Denmark have not been a significant Danish export driver only EU membership has had a significant and positive effect. This means that in the period undertaken traditional instruments applied to reduce trade barriers have not contributed to increased Danish export Bridging the gap - a strategic initiation During the period undertaken the process of reducing trade barriers and obstacles has concentrated on traditional formal trade barriers. Several initiatives have been introduced but these are more or less focused on traditional tools. 69 This is partly explained by the fact that informal barriers are often hard to target and not exact defined. With the robust evidence a theoretical solid foundation is now present for supplementary initiatives that seek to reduce trade impediments. By improving conditions and creating a platform for immigrants residing in Denmark to spread their knowledge and proficiencies can facilitate and initiate trade and FDI inflow. This step will be independent of international, regional or bilateral negotiations, which from the empirical analysis have proved not to have a significant influence on Danish export. The description in the previous section depicts some of the barriers that curtail Danish and foreign firms to utilize their potential trade and FDI inflow level. The background and motivation for the Swedish initiative was very similar to the present Danish situation, which makes the setup of an immigrant network very transferable and applicable. That is an un-utilized trade potential for Danish SME s, the lack of immigrant networks, and a supplementary instrument to traditional trade policy. The 68 Gould (1994) tests for a decreasing marginal effect on trade from increased immigration for US and 47 trading partners in the period but only provides limited evidence for this relationship. 69 An example of this is Konkurrenceevnepakken published in 2002 by the government at that time. This was an attempt to improve SME s utilization of export potential. 77

83 listed trade barriers unveil the existence of numerous processes and aspects in which immigrants can exert their influence in relation to trade and investments. The general characteristic that companies across industries and sectors do not exploit their trade potential fully consequently makes the initiatives more useful. Instead of targeting just one specific industry the role immigrants theoretically can influence and be applied in all industries and in a variety of situations. This outcome makes the potential and probable impact from strategic initiatives very large, which of cause implies an optimal and efficient immigrant setup. Transforming strictly theoretical results that are relatively unexplored into practical actions in the most efficient way is a complicated and complex assignment, which requires an in-depth analysis that concerns many aspects. The width of influential factors makes an approach that fits all country non-existent. Consequently, the lack of non-transferability of a general setup that works under all conditions and circumstances means that the setup has to be developed and adapted to the changes in the surroundings to work efficiently. The propounded initiatives should not be regarded as final answers or a best practice but more as a suggested proposal that is applicable in the situation in Denmark. Consequently, an immigrant network formation should not be perceived as a definitive and the most efficient answer but as a starting point on how immigrant proficiencies can be utilized. Identification of other problem areas and obstacles that can be targeted more proficiently should not be restricted by the organization of the setup. In relation to how and under which circumstances that immigrants can be applied, detecting a significant and positive relationship on a theoretical level is not a premise or precondition. Countries that have residing immigrants all have the possibility to employ and make use of their proficiencies pertaining to their origin country. It should be underlined that the recommendations in this report should not be viewed as a substitute alternative for traditional tools to raise the level of Danish trade but more as a supplementary instrument. Strategic initiatives focusing on the reducing trade barriers can directly or indirectly also influence the amount of FDI inflow in Denmark. Directly through the network effect and information channel but also via some derived side-effects from increased trade. The level of competitiveness, productivity and FDI inflow is positive correlated, due to the low input price level, which ceteris paribus makes it more favorable and attractive to 78

84 do business. 70 As explained the import level in Denmark is not as high as anticipated, moreover is Denmark characterized by a low level of competiveness. In total this means that initiatives and actions that diminish import barriers in Denmark presumably can improve the competitiveness level in Denmark and thereby indirectly the amount of capital inflow (Økonomi- og Erhvervsministeriet, 2003). Increased import and FDI inflow can strengthen the dynamic in sectors and industries, which helps them to utilize the global opportunities and increase the overall specialization process in Denmark (Økonomi- og Erhvervsministeriet, 2004) An immigrant network in Denmark It is recommended that immigrants should receive more attention in future when introducing new initiatives that focus on facilitating and reducing Danish trade barriers. A concrete action and recommendation is an immigrant network formation in Denmark. This is based on the described trade barriers but also the fact that Danish firms already apply their contacts and network in trading processes in reducing obstacles (Erhvervs- og Byggestyrelsen, 2003). This confirms that a network formation is an appropriate instrument to remedy trade barriers and process frictions. An immigrant network formation can be beneficial in a large variety of settings but having the right associates in the network is a pivotal point, e.g. the right immigrants can increase Denmark s market access to strategic markets (appendix G.2; EksportRådet, 2011). From the empirical analysis it was found that immigrants differ in the magnitude on the immigration-trade link. Based on this background information of some specific characteristics about trading partner nations it is possible to setup some guidelines of who will be particular relevant to have included in the network, which immigrants have the strongest influence on Danish trade. From the empirical investigation the following standards are especially relevant and should be considered in the network formation due to their importance pertaining to export. Immigrants originating from a country with a favorable level of institutional quality have a stronger effect on trade. For export this regards all three aspects considered corruption, business freedom and trade policy whereas this only concern corruption and business freedom for import. Furthermore, the immigrant source-nation 70 However a low level of competitiveness can also attract foreign capital due to the high possibility of profit (Økonomi- og Erhvervsministeriet, 2003). 79

85 should not be too economic dissimilar in order to have a positive and significant effect on export. Finally, the strongest impact from immigration is found for foreign-born people who originate from the continents Oceania and Asia. Even though these immigrant characteristics empirically have been pointed out to be the most influential on Danish export this does not exclude the participation of foreign-born residents with different characteristics. This regards corporations representatives, descendants, ethnic Danes, associations etc. The potential of an immigrant network is difficult to estimate due to its limited period of existence and lack of evaluation on Projekt Kosmopolit. Nevertheless, after being in contact with network participants in Sweden at different levels have revealed high expectations. The monetary costs associated with Projekt Kosmopolit are relatively small compared to the benefits. The project had an initial budget of four million SEK. The figure below illustrates and collects how the whole immigrant network formation and process is thought to elapse Immigration policy The findings presented provide valuable information and reveal the complexity in relation to immigration due to its large variety of aspects that are influenced. The empirical analysis highlights some areas regarding to immigration policy that needs to be considered. First, having found robust evidence of a significant effect from immigration on Danish trade and FDI inflow it is rational and reasonable to infer that the restrictiveness of the immigration policy influences bilateral trade relations to a greater or lesser degree. A consequence of the previously described immigration policy reform in 2001 is a reduction and change in the type of annual immigration inflow to Denmark. It is found that the exerted influence varies by level of economic dissimilarity and continent. Thus, the lack of consideration of these findings would result in an immigration policy formulation that would favor immigrants from countries that are economic similar to Denmark due to the smaller associated public costs from this group of immigrants. Through a strategic configuration of the immigration policy it is possible to increase the bilateral trade level via increasing the number of foreign-born people from these countries. This observation is especially applicable in relation to future growth markets, e.g. the BRIC nations and Asian countries. 80

86 A crucial aspect of the described scenario from an increase in the total immigration stock and which earlier has been appointed is the immigrant stock turnover. 71 As argued the influence from immigration on trade and FDI inflow is highly correlated with the labour market integration, which again is dependent on the duration of stay in Denmark. Consequently, foreign-born people who only stay in Denmark shortly will hardly exert any significant influence on Danish trade and FDI relations. Pertaining to boost these linkages a policy focus should therefore be on sustaining a larger part of the immigrants for a longer period in Denmark Critics of the DREAM model As described in the introduction, immigration and immigration policy in Denmark is a contentious and sensitive topic. The depicted situation emphasizes the need and importance for a model that accounts for all effects that immigration have on their host economies. The size of the Danish annual immigration inflow together with a stock of people with a foreign background is a very challenging political and social issue, which causes some economic effects. The investigated topic is only two of many dynamic benefits from immigration. Supplementary associated effects might be additions to the national stock of human capital, cultural and ethnic diversity. The positive externalities found here indicate that a more complete measure of accounting for the net impact from immigration needs to be considered. The critics upon the method applied in the calculations of the annual costs from immigration, presented in the introduction, are supported by the findings in the empirical analysis. The computed annual public costs are too simplified due the model s lack of extensiveness in areas considered this includes both costs and benefits. These findings will contribute with some additive aspects, which have been absent from the calculations and public and political debates in general. Even with precise calculations of associated costs and benefits from immigration not all aspects can easily be quantified. The results in this examination of the monetary influence from immigration on trade and FDI inflow are not directly comparable with the stated costs. First, the monetary effects are based on two completely different 71 In the period % of the immigrants that came to Denmark in a given year were emigrated a year later. Furthermore, the annual immigrant inflow in 2008 was about whereas the immigrant stock grew by less than indicating that a large number of people with a foreign background have emigrated again (Danmarks Statistik, 2010). 81

87 settings. Moreover, even though some factors are difficult to monetize e.g. greater cultural and ethnic diversity, such areas would be needed to quantify when calculating the total annual costs from immigration in Denmark. Furthermore the positive influence that immigrants exert on trade and FDI inflow is associated with some side effects both negative and positive. A thorough examination and exact quantification requires a very detailed dataset and is beyond the scope of this report. Summing up, then the derivations from the empirical work is that the DREAM model is too simplified in taking account of benefits and costs from immigration in Denmark. Furthermore the annual computed costs to the Danish society from immigration are inaccurate and might be over-estimated Welfare implications The findings provide robust evidence and underline the need to consider the role and influence of immigration in a larger extend than has been the case, previously. Focus and recognition of foreign-born people can be an additional instrument in raising future overall welfare. The positive effect can be further accelerated if right initiatives and conditions that seek to exploit the knowledge and competences that immigrants possess are taken. The increased globalization has created both opportunities and challenges, which are reflected in difficulties relating to the labour market. This development creates some groups that will benefit while others will lose. Thus, this entails specific challenges to secure and sustain that the vulnerable groups can perpetrate on the labour market hereunder also immigrants. Pointing forward, the structural changes that are influenced by trade and FDI inflow demands adaptability and flexibility to efficiently benefit from the new opportunities. Founded on this makes it reasonable to claim that globalization impede the maintenance of the current welfare model therefore this needs to be accommodated to future challenges (Velfærdskommissionen, 2005). The presented recommendations can be an assisting and contributing part in addressing these challenges. Being a part of an immigrant network can play an important role in increasing the speed at which immigrants connect and integrate into the Danish labour market. The consequence of deeper and more rapid labour market integration might weaken the ties to the immigrant s origin-countries but may strengthen and make more pervasive of a business community (Murat and Flisi, 2007). Initiation of a project with 82

88 focus on immigrant s beneficiaries can be a sub-step in adapting immigrants to the Danish economic conduct. Being in a network can increase the pace of labour market integration unveiling their skills towards companies in specific relations and getting the right contacts. In the long run political willingness and initiatives that focus on aspects in which immigrants can benefit and contribute to address the challenges relating to the Danish welfare society and labour market. Even though this study only involves one host economy, Denmark, the results is likely to be transferable to other nations at least as a basis for a discussion on how to exploit and apply the under-utilized resource of immigrants in raising the welfare. The fact that the estimated result is an autonomous effect infers that a robust statistical foundation is not pivotal for initiations that seek to structure the application of immigrant proficiencies. In a global perspective, the application of the findings in this study will not only be beneficiary for Denmark but also for its trading partners. Due to the trade creating effect both imports and exports - and especially the strong impact from immigrants from less economicly developed countries have the potential not only to positively benefit Denmark but the origin nations as well. Increased trade levels with less economic developed countries constitute in this perspective a great opportunity to contribute to raise the living standards in these countries. At a national level the impact will be limited but as already mentioned the idea of immigrant network formation and utilization have been discussed at OECD level. Corporation and implementation at this stage possess excessive possibilities and perspective to exert a significant positive influence on future prosperity in these nations The welfare state paradox Adjusting to avert the present negative contribution to the public finances from immigrants and their descendants unveil a potential economic gain. If recapitulating on the characteristics of immigrants, the outlook of the Danish pension system, and the calculated financial costs from immigration in total indicates that a more successful labour market integration of immigrants possess a large potential return. This return will comprise of both immigrants and their descendant who will experience a higher level of wealth but also for the native inhabitants. The premise is that the current behavior and conduct between immigrants and ethnic Danes is not retained in the future (Pedersen, 2003). 83

89 Suggestions proposed to address this often concerns initiatives in relation to integration incentives. These actions might conflict with some of the ground pillars of the Danish welfare system, which is based on the principle that social benefits and services are universal and available to all residents in Denmark. These services and benefits are primarily financed through taxes and not based on previous individual contributions. A potential way to remedy the present situation but also a way to secure the foundation for central elements of the welfare state in the long run is a general discussion of which elements of the welfare state that should be considered expendable and which should not. The situation can be phrased as a paradox where the answer to save the welfare state in the long run is to dismantle it or break its main principles (Pedersen and Smith, 2002) The authors remarks This study reveals that an application and interpretation of the static DREAM model is problematic even when the method and basis are correct. Obviously, the model has its relevance in pointing out problem areas, e.g. labour market issues, but the simplicity of the model induces that the political and public debates regarding immigration gets very little nuanced. It is the authors stance that the problem is not so much the model itself but more how the results are being interpreted and applied politically - as an argument for increased immigration restrictiveness. A more general debate on the arrangement and organization of the welfare state and its principles might be more relevant. Exposing a certain population group as a financial burden can easily be done with the premise solely based on monetary terms, but a discussion of how immigration is turned into a financial surplus should also have its relevance in this context. Applying the model in this respect does not solute any future Danish challenges. On contrary, a focus with a view of foreign-born residents as being a part of the solution is more beneficial. However, this should and does not foreclose a discussion regarding future Danish immigration policy construction. A tightened immigration policy does not address the present public costs from immigrants residing in Denmark but only reduces the proportions of future costs. It is hoped that the empirical evidence in this report can contribute to a more nuanced public debate but even more importantly that this highlights that this as an area which needs more attention and research. Furthermore, that this motivates to an increased 84

90 focus on how immigrants can be applied strategically in relation to the economic integration. Danish trade policy cannot exclusively be based on traditional trade policy in order to obtain increased foreign markets shares. With the empirical foundation clarified the missing link is a political willingness to take the last step. In this respect an immigrant network has great perspectives and a great signaling effect. 11. Conclusion This thesis has examined the effect from immigration on Danish import, export and FDI inflow between 1995 and The study was motivated by a calculation of the annual costs from immigration in 2010 and the paradox why immigration is calculated as a financial burden to the Danish economy, when labour movements in a theoretical context is thought to be beneficial. It was clarified that the computed costs primarily originated from immigrant characteristics, labour market imperfections and welfare generosity. Furthermore, the transformation and development of Danish immigration policy was elucidated in a historical perspective. It was argued that the conducted immigration policy could explain a significant share of the present immigrant stock outlook today and thereby potential trade relations and FDI inflow source countries. Moreover, the relevance of the topic and the analysis was underlined based on the increased ethnic diversity of the Danish population in the period undertaken.. Data for Denmark and 186 partner countries in the period was applied in the specification of an augmented Gravity model. In general, the empirical analysis has provided statistically robust evidence of a positive effect from immigration on Danish export, import and FDI inflow. Moreover, a stronger effect for import than for export was found, which confirmed the stated hypothesis. To investigate whether the strength of the immigration-linkage varied across origin country characteristics several sub-hypotheses covering different aspects of the source countries were investigated. The test included: institutional quality, economic development, continent and geographical distance. A better level of institutional quality in the origincountries was argued to be negatively correlated with the effect from immigration; empirical evidence rejects this. The exact opposite was found in all three aspects of institutional quality; corruption, business freedom and trade policy. The derivation upon 85

91 this was that the impact of the trading partner countries influences Danish trade relations beyond the direct channels. These aspects influences the trade creating effect from immigration in Denmark and thereby the magnitude for bilateral trade. Furthermore, the larger the gap in economic development between the trading partner and Denmark was argued to be positively correlated with the influence from people with a foreign background. The confirmation of this theoretical proposition depended on whether export or import was considered. The larger the gap in economic development the larger the influence on import whereas a positive impact on export was only found when the gap in economic similarity is not too large. It was confirmed that the immigration-trade linkage did differ dependent on regional location. The strength of the effect pertaining to the continent differed for both export and import, but in both settings the region Oceania had the strongest link. This aspect was further investigated by the distance between Denmark and the trading partner with larger barriers and a stronger link the more distant the continent is thereby a positive correlation. The relationship was confirmed for both import and export. Moreover, this was might explained why the effect was strongest for most distant trading partner nations. The information channel was also investigated by classification of traded goods employing the method developed by Rauch (1999). These outcomes confirmed the hypothesis that the link between immigration and trade varies based on product type with the strength of the link increasing with the degree of product differentiation for export but not for import. A new area investigated in this relation is the role of descendants. Based on practical experiences that the knowledge regarding origin countries actually encompass to next generations a specified regressions were carried out. Both for import and export a positive and significant effect was identified. The test for the stated hypotheses regarding FDI inflow investigated if there was a positive relationship between immigration and FDI inflow to Denmark and if the link was stronger than for trade due to the larger information asymmetry. Both of these propositions were confirmed. The final aspect investigated was whether the immigration policy reform conducted in 2001 has had a diminishing effect on the immigration-trade link. The outcomes were positive and significant and exact opposition to what was anticipated. These results were subscribed to the method applied and other macro-economic alterations during the period. Consequently, the estimates were interpreted as insignificant and the hypothesis 86

92 was rejected that the reform has had a statistical impact on the nexus between immigration and trade in the period after its commencement. Due to the data outlook and methodologically choices a robustness check was carried out to test whether the results differed across different specifications and estimation methods. This approach consistently confirmed the existence of causal relationships and that the coefficients more or less were independent of estimation technique applied. Theory has suggested that the effects from immigration on trade are an autonomous effect. To examine whether this was a reasonable derivation based on the period and data analyzed an investigation of the existence of practical and strategically setups that seek to exploit the knowledge of immigrants was carried out. The conclusion from the practical investigation was that the estimated results found were to be an autonomous effect due to the total lack of strategic actions and initiatives that should influence the effect from immigrants residing Denmark in the years examined. Moreover, it was argued that the positive effect from immigration on trade and FDI inflow can be enhanced further if the strategic initiatives were implemented. In this relation foreign-born people can serve as a supplementary instrument for job creation, growth and future prosperity in Denmark. The empirical analysis motivated for an increased focus on immigrants and how to exploit their knowledge and proficiencies most efficiently. It was recommended that an immigrant network formation in Denmark is a suitable initiative. This was based on the similarities and background for the Swedish project, Project Kosmopolit, and the present situation in Denmark. Summarizing on the thesis as a whole it was argued that the model applied to calculate the annual financial impact from immigration in Denmark was too simplified; this concerned both costs and benefits. The study suggested that the effects from immigration on trade and FDI inflow to Denmark are additional aspects, which should be an integrated part and accounted for when analyzing the total impact from immigration. 87

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