Pull Factors of FDI: A Cross-Country Analysis of Advanced and Developing Countries

Abstract

Usual trend of FDI movement among the advanced economies (AE) has changed significantly in the past few decades and increasing volume of FDI flow to and from developing economies (DE) are also being witnessed. Intuitively, countries with stable macroeconomic situation, good development indicators with political stability and strong institutions attract more FDI flow. Based on the panel data of 22 countries of AE and DE for the period 2010-2012, this paper aims to examine the macroeconomic determinants of FDI flow for four broad groups (a) to AE from AE, (b) to AE from DE (c) to DE from AE and (d) to DE from DE. It is observed that the determinants of FDI flow varies significantly across the groups. Further, as FDI flow to a country partly depends on prevailing macroeconomic situation, collective information of macroeconomic determinants to FDI is captured in terms of a composite index (CI). CI is also used to rank the countries within the broad groups of FDI flow to understand the macroeconomic enabler in the host country to attract FDI. Moreover, correlation of a particular indicator with the CI reflect the intensity of influence of individual macroeconomic variable on FDI flow. This paper also contributes to the literature by way of proposing a methodology to circumvent multicollinearity issue which arises as selected determinants of FDI are found to be interrelated. It constructs composite indices (Primary Composite Index PCI and Secondary Composite Index SCI) by way of weighted linear combinations of the determinants with optimum weight structures in such a way that PCI and SCI are uncorrelated and together can explain the variation in FDI relatively better than the usual principal component analysis approach. The results indicate differences in the role played by macroeconomic variables in explaining the determinants of FDI flows from AE to AE, AE to DE, DE to AE and DE to DE.