To observe the different investment-smoothing behavior between the VFDI and HFDI, we can compare Equations 38 and 48, respectively, which I restate here as follows:
On the contrary, in the case of HFDI an increase in domestic inflation only affects the net benefit of domestic investment.
Multinational enterprises that undertake HFDI change the domestically and foreign-financed FDI in the same direction; whereas, MNEs that undertake VFDI change the domestically and foreign-financed FDI possibly either in the same direction or in the opposite direction, depending on the substitutability of the factors of production.
In case of an increase in the foreign inflation tax, the direct effect on domestically and foreign source-financed FDI is the same across VFDI and HFDI.
Significant differences in the investment-smoothing behavior of MNEs investing in the form of VFDI and HFDI are suggestive of the importance of improving data collection that allows for differentiating between VFDI and HFDI.
The discussion of VFDI is provided in Chapter 4 of Navaretti and Venables (2004), while a discussion of HFDI is provided in Chapter 3 of the same book.
21) There are also models of HFDI that do not require high trade costs to explain FDI, but FDI is used by the multinationals as a way of diversifying production locations to reduce risk or to equate marginal costs across different production locations.
22) Because the two goods are the same in the HFDI case, I drop the notation of Z, which is replaced by good X*, where the asterisk reflects the foreign variables.