Do Financial Development, Institutional Quality and Natural Resources Matter the Outward FDI of G7 Countries? A Panel Gravity Model Approach
[ad_1]
1. Introduction
The global growth of foreign capital flows, as well as the expanding magnitudes of foreign direct investment (FDI) inflows in recent years, have prompted governments—in both developed as well as developing countries alike—to attract multinational enterprises (MNEs) with various intensive packages to gain access to their resources, market access, capital technology, skills, and other benefits, to accelerate the process of their development. Furthermore, it is generally acknowledged that FDI tends to stimulate economic growth in the target country by increasing the rate of capital formation and indirectly leading to human capital growth, technical transfers, and increased competitiveness [1,2].
As a result, host governments around the world have prioritized FDI as a vital source of foreign money for a country’s economic development and industrialization, a crucial instrument to the socio-economic transformation and restructuring [1,2,3,4,5,6,7,8], as well as an important source for economic sustainability [9]. Indeed, researchers widely agree that while large amounts of FDI inflows can sustain the economic growth of the host countries, they may not always have spillover effects that boost the competitiveness and productivity of all companies, including domestic ones, and have a favorable and notable impact on their economic development [2,4,6].
However, to increase FDI in their countries, several host countries have made significant efforts and continue to do so to ensure long-term political and economic stability and draw in more foreign investors [9]. Many of these countries, such as Latin American countries, have now lowered their institutional and legislative barriers to grant foreign investors access to all areas of their economies [10,11]. After the pandemic crisis, confirming the significant role that FDI plays in their economic recovery strategies, developing economies continued to adopt measures that were primarily designed to liberalize, promote, or ease investment. Mining, energy, finance, transportation, and telecommunications have all taken steps toward liberalization. Several countries have simplified administrative procedures for investors or expanded incentive programs for investment [12]. Though they grew more slowly than those in developed regions, FDI flows to developing nations still rose by 30% to $837 billion. However, FDI to developing countries is disproportionally distributed, with $83 billion going to Africa from $39 billion in 2020, $619 billion flowing into Asia regions (which accounts for 40% of global FDI), and 56% to $134 billion going to Latin America and the Caribbean [13].
Since policy efforts to attract FDI have had varying degrees of success across countries, this study examines the factors that account for these differences in FDI to host countries, particularly those from the world’s advanced economies, like G7 nations. These latter focused on investing more in host countries with well-developed financial systems, sound institutions, and natural resources, which have significant impacts on foreign investors’ motivation. For example, the outward FDI flows from G7 nations to host countries have recorded expansion from $57,000 billion in 2010 to $98,500 billion in 2020. In this respect, numerous studies have shown that investment in natural resources, including non-fuel and fuel resources, has recently been a substantial factor in FDI flows from most origin nations [14,15,16,17]. Other studies also suggested that better institutions and sound governance infrastructure of host countries are some of the leading determinants of the outward FDI [18,19,20,21,22] and, hence, investment in natural resources with a better institutional environment is likely to attract more foreign investors into countries rich in natural resources [23,24,25,26]. The importance of financial markets and institutions in attracting FDI has also received particular attention in FDI research, meaning that well-developed financial systems in host countries encourage FDI inflows [27,28,29,30]. However, Dunning [31] contended that foreign investors have become more susceptible to institutional quality as their motivations have switched from market and resource-seeking to efficiency-seeking.
Though the growing number of papers looking at the determinants of FDI, there is still scope for further research into the roles played by financial development, institutional quality, and natural resources in fostering economic sustainability. To fill this evidence gap, this paper examines the factors that influence inward FDI with an emphasis on financial development, natural resources, and institutional quality. However, the vulnerability of the financial system and the weakness of the public institutions of host countries discourage foreign investors and may have negative spillovers on their businesses. The primary objective of this study is to discover how the G7 firms’ investment decisions are influenced by the host countries’ financial institutions, natural resources, and institutional quality during the sample period of 2002–2021. One can see that in recent years, the G7 nations have become more open to institutions when making choices about foreign investments. On the other side, it is well-known that the investments of G7 nations are dependent on the availability of natural resources (such as metal, ore, and fuel) in the host countries. Since the institutional quality and natural resource endowment of host countries do matter for the outward FDI of G7 nations, as several host countries converge in terms of natural resources and institutions, they will be able to receive more FDI from G7 nations.
The present study makes several contributions to the body of literature. First, to the best of our knowledge, this is the first explanation of the phenomena of the moderating impact of institutions in terms of institutional quality and institutional distance in the natural resources–FDI nexus and finance–FDI nexus. Second, in addition to the six institutional quality indicators created by Kaufmann et al. [32], we employ the corruption perception index (CPI) as an additional moderator variable [26,33,34] to explain whether governance and institutional quality factors of host countries influence the G7’s outward FDI. Third, this study employs the most comprehensive proxy for measuring the logistics performance of a host country–the logistics performance index [35,36]. Moreover, to cover the complexity and multidimensionality of the financial system, we rely on the IMF’s financial development index, which considers the accessibility, efficiency, and depth of financial institutions and markets. This index is the most complete measure of financial development [37]. Fourth, for a robustness check, we follow Aleksynska and Havrylchyk [23] and Le and Kim [38] by considering positive and negative institutional distance as additional variables to discriminate among FDI in host countries with better or poorer institutions than at home countries. Finally, we make use of data on recent inward FDI stocks from 2002 to 2021, which covers 45 host countries and 7 (G7) source countries. The dynamic panel gravity models with two-step system generalized method of moments (GMM) estimations are used to efficiently handle the endogeneity issue.
5. Conclusions and Policy Implications
Even though there are existing growing studies looking at FDI’s drivers, other factors, including a country’s NR, IQ, ID, and FD, continue to have greater impacts on how appealing a country is to FDI. By using a gravity model approach based on system GMM estimators, we contribute to the literature by examining the moderating effects of both IQ and ID in the FD–FDI and NR–FDI relationships, individually and in terms of interaction, and discussing their significant implications on the G7’s FDI outflows to 45 host countries over the 2002–2021 period. Our empirical findings reveal that each of the considered IQ factors has a positive and significant impact on the G7’s outward FDI. Besides, all IQ factors that interact with FD have been shown to have a favorable and significant impact on the G7’s outward FDI. Focusing on ID, our robustness analysis shows that the impact of ID varies depending on whether host countries have superior or poorer institutions. However, we discover that ID might be viewed as a motivating factor if investors from the G7 countries invest in host countries with improved institutions. This is most likely a result of the “asset-seeking” nature of FDI, in which new investors purchase innovative technologies, trademarks, and intellectual property, which are more likely to be found in favorable institutional environments characterized by political stability, strong property rights, and low levels of corruption. In contrast, we find that investors from the G7 countries are discouraged not just by the poor institutions in the host countries but also by the ID between them and the host countries since they choose to invest in countries with an institutional environment fairly similar to their own. However, we discover that in the unlikely event that the host countries have abundant NR and well-established financial systems, which are important drivers of the G7’s outward FDI, the negative effect of ID can be mitigated. Moreover, it shows a significant positive connection between per capita GDP, POP size, as well as the logistics infrastructure, and G7’s outward FDI, indicating that countries with higher income levels, low labor costs, and advanced technological infrastructure receive and host more FDI.
This study provides some policy implications. First, financial institutions’ development with good governance in host countries should be ensured and open the scope for foreign investment, which would eventually motivate investors to increase their capital investments in these countries. More specifically, access to financial resources should be a top priority for host governments, and this should be supported by measures that improve the effectiveness and investor-friendliness of their stock markets. Second, to grant foreign investors access to all areas of their economies, host governments should reduce their institutional and legislative barriers and improve their business environments by streamlining the investment process by eliminating pointless procedures, resolving the issue of inadequate synchronization between the different countries, developing updating laws and legislation to effectively protect investors’ rights and minimize their risk, and increasing transparency of the investment process. An incentive package, including tax and non-tax subsidies, is a policy to allow foreign investment and encourage businesses to establish a base in the host country. Third, FDI has channelized technical know-how in the economy, thus promoting human capital development by providing technical expertise and supplying skilled human resources. Therefore, it is essential to have effective institutional development and sound governance practices for fostering the persistent inflows of FDI into the host economies. Fourth, generally, numerous host countries have abundant natural resources and good governance, which are basic requirements for FDI. However, it seems that joint policies for both natural resources—fuel resources and Ores and metals resources—and institutions weaken FDI flows. Accordingly, host governments should make separate policies for institutions and natural resources to prevent this and boost their economic advantages. Fifth, strengthening the financial system and increasing bilateral FDI stocks may be accomplished through a combination of factors, including macroeconomic policies, financial conditions, and technological innovations. Finally, it is advised that policymakers in host countries should improve the quality of their logistics infrastructure, such as ports, railroads, and information technology, to more actively support FDI.
[ad_2]
