Phantom FDI: A Structural Gravity Analysis Using MREID

Foreign direct investment (FDI) measured by public sources includes investments made by firms for financial and accounting related (or nonproduction-based) reasons, typically concentrated in offshore financial centers (OFCs). Recent studies suggest that profit-shifting may also occur in non-OFC regions. Consequently, many datasets used to understand the economic factors behind a firm’s decision to shift production activities across countries may still contain such “phantom FDI.” As a result, researchers have developed analytical methods to remove phantom FDI flows and improve the accuracy of FDI measures. In this paper, we propose a structural gravity approach to identify and measure phantom FDI using the new Multinational Revenue, Employment, and Investment Database (MREID). We use this approach to provide estimates of phantom FDI for a number of developed countries in our sample. Our baseline results are then validated using an alternative production-function approach.