This paper analyses the effects of distance as a common determinant of exports and FDI in a three-factor New Trade Theory model, assuming that distance affects both pure trade costs and plant set-up costs. Exports and FDI are not necessarily substitutes with respect to distance, since the predicted impact depends on its importance for fixed plant set-up costs relative to transportation costs and on the relative importance of vertical MNEs. For the empirical specification, we suggest that the impact of time-invariant variables such as distance is most appropriately analysed in a Hausman-Taylor SUR model. We apply our model to industry-level data of bilateral outward FDI stocks and exports of the US and Germany.
