On the investigation of the nexus between Financial Development and FDI: evidence by income level

Abstract

The current study scrutinizes the relationship between financial development (FD) and foreign direct investment (FDI) over a period of 17 years and on a sample of 135 countries, including 44 high income, 34 upper middle income, 35 lower-middle income and 22 low-income countries. To represent the financial development, we employ a novel proxy which takes the financial system in its multidimensionality representing the depth, efficiency, access to financial markets and institutions. The estimation results for high income and upper middle-income countries indicate that FD is a key determinant for FDI entries. Nevertheless, results for low income and lower-middle income countries, are negative and ambiguous. This could be explained by the financial fragility of these countries as the majority of them, especially those which belong to the low-income countries panel, are underdeveloped. Thus, they fail to effectively perform their financial functions and allocate financial resources. Therefore, policymakers and governments should be more concerned about the financial markets and institutions of their economies in order to make them attractive at the international level.