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Essays on foreign direct investment (FDI) : determinants, impact on growth and volatility

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posted on 2024-05-01, 05:57 authored by Habibul Hasan, SM

This thesis presents research into the potential determinants of foreign direct investment (FDI), the effect of FDI on economic growth, and the factors that affect the volatility pattern of FDI in developing economies. This thesis gives a complete picture of FDI-growth dynamics in developing economies. The thesis is organized into three different but interrelated studies drawing on the same data sample. The sample covers the period from 1980 to 2017, divided into two time periods, and uses a dynamic panel data model. A generalized method of moments (GMM) estimation is applied, which is superior in the empirical literature to address omitted variable bias, unobserved heterogeneity, measurement error, and endogeneity issues. The initial estimation for the first study is completed using a two-step system GMM, while iterated GMM confirms the robustness of the findings. Dynamic volatility measures of FDI and other variables are obtained using each rolling window, AR(3), ARIMA, and EGARCH methods and compiled to construct panel datasets. To address the problems of serial correlation, spatial correlation, and heteroskedasticity of errors, the final estimation is done using fixed-effect regression with Driscoll-Kraay standard errors correction.

The findings of this first study suggest that lagged FDI, gross domestic product (GDP), trade openness, and infrastructure (land telephone) are positive and significant determinants to attract FDI. At the same time, the real effective exchange rate (appreciation) and labor force significantly deter FDI flow in the first period. However, although lagged FDI, GDP, domestic investment, and inflation support FDI flow, financial development significantly hurts the flow in the second period. Therefore, during the early phase of development, FDI seems to be market-seeking and horizontal in nature, enhanced by depreciating exchange rates and a low-skilled labor force.

In the same vein, the insignificant role of human capital, infrastructure, market size (population size), and institutional factors in the recent period reflect the poor quality of FDI flowing into developing countries with varying motivations across time. Our findings demonstrate a lower convergence or catch-up rate (1.1%) in the second period, while the long-run multiplier effect is 12.82 times higher than in the first period.

The empirical findings of the growth equation imply that although economies having a large population and located away from the equator may experience significant negative growth, lagged GDP, domestic investment, and availability of labor force promote growth in the first period. Accordingly, estimation of the second sample reveals that lagged GDP, FDI, domestic investment, trade openness, infrastructure (mobile telephone), appreciated currency, labor force, and financial development promote growth in developing economies. The positive FDI-growth relationship, the crowding-in (complementary) effect of FDI on domestic investment, along with the growing importance of macroeconomic variables is relevant to the principles of standard growth theories. However, the smaller coefficient on FDI is likely due to the poor level of human capital, which is insignificant throughout the samples. This result suggests a weak absorptive capacity or transmission channel of advanced technology & managerial skills in developing economies. Hence, these economies receive comparatively poor-quality FDI. The catch-up rate (46.6%) in developing countries is higher in the first period, which reduces to 27.9% with a higher long-run multiplier effect of 3.58 in recent times. This result suggests that developing economies tend to grow faster in the first period, and the importance of the explanatory variables increases in the long run.

The findings of the third study demonstrate that push and pull factors are more important to explain the observed volatility patterns in FDI after the global financial crisis (GFC). The results highlight the importance of the global, macroeconomic (in levels), and volatility of financial development variables as determinants of FDI volatility, especially in the post-GFC period. Our empirical analysis reveals some challenges for policymakers in pursuance to address capital flow volatility. For instance, the global factors and the volatility of the world growth rate, global liquidity, and the S&P 500 index are significant determinants of capital volatility in the first period. Among the domestic factors, FDI, domestic growth rate, economic development, inflation, and liquid liability (as well as the volatility of growth rate, trade openness, inflation, bank credit, and liquid liability) are significant volatility determinants in the first period. Although significant, the global factors show a contradictory effect across the methods in the second period, and their volatilities help reduce capital volatility (except US inflation volatility). Domestic growth rate, reserve accumulation, trade openness, inflation, real exchange rate, and a well-developed financial/banking system (private credit and bank assets) seem to reduce capital flow volatility. While economic development (GDP per capita) reveals an inverted U-shaped relationship, its volatility reduces the volatility of FDI. The volatility of trade openness, inflation, and private credit increases capital volatility, and that of domestic growth rate, exchange rate, and foreign exchange reserve reduces capital volatility in developing countries.

In summary, our study provides evidence of poor quality, and vertical (bilateral) FDI flow into the export-oriented sectors in developing countries. Although FDI has a crowd-in effect on domestic investment, its contribution to growth is less impressive. It is because these economies have a comparatively low level of absorptive capacity for high-quality FDI. Hence, higher domestic growth and more FDI inflow are found to lower the stability of FDI flow. Appreciated currency and inflation reduce FDI flow, but their volatilities stabilize the flow, trade openness is conducive for FDI and growth, while its volatility destabilizes the flow. The positive role of a well-developed banking system in promoting growth and reducing volatility found in this study is consistent with the empirical literature. Lastly, the growing importance of variables in the recent period across the study suggests the importance of maintaining a conducive business environment to promote economic growth and development in developing economies by attracting a stable and high-quality flow of capital.


History

Sub-type

  • PhD Thesis

Pagination

xvii, 229 pages

Department/School

Tasmanian School of Business and Economics

Publisher

University of Tasmania

Publication status

  • Unpublished

Event title

Graduation

Date of Event (Start Date)

2022-12-17

Rights statement

Copyright 2022 the author.

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