Determinants of foreign direct investment and its relationship to economic growth

Field: Economics, Econometrics and Finance (Social Sciences)

Foreign Direct Investment (FDI) has been widely treated in a specific way or as part of strategy theories, in definition and in econometric models and has also been studied in many different aspects and approaches. \nThis dissertation first embarks on a wide ranging review of theories of variables; it then empirically explores and studies the various economic, political and geographical determinants of FDI in the world economy. It also includes an assessment of the relationship between FDI and economic growth. \nTo achieve that, this thesis incorporates into the theoretical models more than 56 variables that are standard in the economic literature to capture the economic political and geographical determinants of FDI. Rather than relying on specific theories of FDI determinants, we take an agnostic stance and examine them all simultaneously under a united eclectic framework .This work is based on a new panel data set that covers 168 countries located in different world regions of the world for the period 1970-2006. No previous study covers and analyses such a wide range of fundamentals in such a large dataset. \nWe first analyse the determinants of FDI using standard panel methods. Then we employ the recent extreme bounds analysis (EBA) approach, of Learner (1985), Sala-i-Martin (1997) which is imperfect but useful method to deal with model uncertainty. We apply this approach where we account for all possible combinations of explanatory factors to identify “robust” determinants of FDI. \nTo the best of our knowledge, this approach has not been applied before within such large datasets to examine the robustness of the determinants of FDI. Indeed, the majority of applications of EBA are in the growth literature. The findings significantly outperform existing ones as endogeneity bias and model uncertainty are controlled for in that context. \nAmong the main conclusions, we show that FDI inflows depends on market size and market growth, established bilateral trade, openness of the host country, bilateral investment treaties, cultural proximity, corporate taxes and the quality of institutions. Our results are consistent with the predictions of the theoretical models. \nBased on these results, another empirical chapter tests the causality between FDI and economic growth. We contribute to the literature by applying Granger non causality tests using the Fisher (1948), Hurlin (2004) and Hanck (2008) methods in heterogeneous panel data. The empirical evidence reported in this chapter supports and shows that there is no causality between FDI inflows and economic growth in both directions. Our results suggest that the relationship between the two variables is perhaps too complex to be identified in a bivariate Granger causality framework. \nFurther to this work we investigate whether FDI can be considered as a new growth determinant. We extend the augmented Solow growth model and its Mankiw-Romer-Weil specification to include FDI to GDP ratio as a variable of interest. Extreme bound analysis growth regressions confirm that FDI, initial income and human capital have a robust positive effect on long-term growth. \nOver all, the major contribution of this thesis is to provide a better understanding of the determinants of FDI and to analyse the interrelationship between FDI and economic growth.