Foreign Direct Investment Inflows, Financial Development and Political Risk: Evidence from Developing Countries




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De Montfort University


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Peer reviewed


This thesis examines the interrelationship between foreign direct investment (FDI) inflows, financial system development and political risk by using panel data consisting of 76 developing countries over the period 1998 to 2017. Analysis is conducted by using panel econometric techniques (i.e., OLS, fixed effects and dynamic system GMM). Based on our research questions, the analysis reveals three key sets of findings. Firstly, the results suggest that financial system development has a positive and significant impact on FDI inflows. Also, it is observed that a country’s previous history of FDI inflows is a good sign for foreign investors to invest in that country. Secondly, the results show that only the interaction term between finance (banking sector credit) and political risk (military in politics) has a negative and significant impact on FDI inflows. Further analysis suggests that the marginal effects of financial system development on FDI inflows vary at different levels of military in politics, and these effects are both statistically and economically significant. However, we find no evidence to suggest that composite political risk variables moderate the relationship between finance and FDI inflows. Thirdly, it is found that control of corruption and regulatory quality are the main institutional drivers of FDI inflows in the developing world. Finally, the study also finds that, although government effectiveness, rule of law, and voice and accountability have a positive and significant impact on foreign direct investment inflows, their statistical significance varies across different estimation regimes. These results are robust to alternative measures of FDI inflows, finance, and political risk.





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