Dynamic linkages between foreign direct investment and domestic investment: Evidence from emerging market economies

Abstract

This paper examines the long-run relationship between FDI inflows, FDI outflows and gross fixed capital formation, in a dynamic panel of 22 Asian, Latin American and other emerging market economies. Employing panel cointegration and causality tests, we find a mixed picture of these relationships across the three sub-samples. It is observed that a positive and significant long-run relationship exists between FDI inflows and fixed capital formation for Asian EMEs, suggesting a crowd-in effect. This finding is consistent with the complementary hypothesis of neoclassical macroeconomic growth model in which it is often thought that FDI inflows complement the domestic investment. The results for the relationship between FDI outflows and fixed capital formation indicate a significant negative long-run relationship for Asian and other EMEs. In addition, the long-run causality is observed to be bidirectional for both the samples. These results confirm the general, accepted view that FDI outflows reduce domestic investment.