This paper presents a non-monotonic relationship between foreign direct investment and trade based on the idea that, although FDI eliminates trade costs on the final good, the investing firm has to bear increased trade costs on an intermediate good.

Although empirical evidence shows that the relationship between foreign direct investment (FDI) and trade is complex, theories of international investment (both vertical and horizontal) present simple patterns of relation. By allowing for different locations of vertically-related stages of...