Foreign Direct Investment and External Financing Conditions: Evidence from Normal and Crisis Times

Abstract

In this paper, we investigate the effects that external financing conditions in source and destination countries have on foreign direct investment (FDI) in normal and crisis times, using a difference‐in‐differences approach. We find that the financial development of the source and destination countries has a strong positive impact on the relative volume of FDI in financially vulnerable sectors in normal times. However, during the 2008–2010 global financial crisis, the relative volume of FDI in financially vulnerable sectors fell relatively more in financially developed source and destination countries, most notably if these countries experienced a credit crisis.

Does foreign direct investments in financial services induce financial development? Lessons from emerging economies

“…However, it should be noted that there exists vast empirical literature, which examines the effects of FDI on financial development. A stratum of the existing literature which deals with cross-country evidence shows that the results are mostly in tandem with the theoretical expectation that FDI promotes financial development or a bidirectional relationship (Alfaro et al, 2004;Azman-Saini, Law, & Ahmad, 2010;Desbordes & Wei, 2017;Shan, 2002). Azman-Saini et al (2010) employ the threshold regression model to estimate the dynamic relationship between economic growth, FDI and financial markets.…”

“…The inflow of financial services FDI to the host countries would affect financial development, and these economies are more vulnerable to international financial shocks. Desbordes and Wei (2017) point out that the source and host economies' financial development jointly clout FDI through access to foreign finance and indirectly improving economic growth. Chinn and Ito (2006) suggest that a higher level of financial openness directly and indirectly influences the legal and institutional development in emerging markets than in developing economies.…”

“…Desbordes and Wei (2017) find that source and destination economies' financial development jointly boost FDI flows directly and indirectly by enlarging access to external finance and accelerating economic development, respectively. A large section of the existing literature shows that financial market development is a crucial determinant of FDI inflows, which acts as a catalyst in absorbing FDI spillovers for economic growth (Alfaro, Chanda, Kalemli‐Ozcan, & Sayek, 2004; Azman‐Saini & Law, 2010; Moshirian, 2006).…”

“…Research on FDI and financial development has generally focused on aggregate FDI and FDI in the manufacturing sector (Alfaro et al, 2004; Desbordes & Wei, 2017; Hermes & Lensink, 2003; Sahin & Ege, 2015). Further, a large section of the literature on the impacts of FDI on financial development focused on developed economies.…”

Home-country export regulations, credit markets, and corruption: implications for different types of internationalization

“…Our results also suggest that strengthening credit markets may support both exports and OFDI. One specific cluster of costs that firms face in internationalization relates to the fixed and sunk costs when exploring and venturing into foreign markets (Desbordes and Wei, 2017). They often rely on credits or capital from external sources to finance their upfront costs.…”