The Impact of Foreign Direct Investment on Financial Development: New Evidence from Panel Cointegration and Causality Analysis

Abstract

Foreign direct investment (FDI) is seen as a prerequisite for gaining and maintaining competitiveness. Simultaneously, the relationship between FDI and financial development (FD) has important implications for the researched economy and its competitiveness. This domain has not been sufficiently investigated, with diverse and contradictory findings evident in the literature. Therefore, this study investigates the effect of FDI on FD for the selected 102 Belt and Road Initiative countries on four continents: Asia, Europe, Africa, and Latin America. Based on data from 1990 to 2017, a set of quantitative techniques, including feasible generalized least squares, and augmented mean group techniques, were used in this study. Our findings indicate that FDI, trade openness, government consumption, and inflation have a statistically significant relationship with FD. FDI, trade openness, and government consumption increased FD in Asia, Europe, and Latin America but decreased in Africa. Inflation shows a negative influence on FD in all continents. Furthermore, the Dumitrescu–Harlin panel causality test confirms a two-way causality relationship among FDI, trade openness, and FD in Asia and Europe. In contrast, a unidirectional relationship exists between FDI and FD in Latin America. The income-wise results reveal that low- and middle-income countries attract more FDI than high-income countries due to high factor costs. These empirical results provide new insights for policymakers, presenting several policy implications for FD competitiveness in the reference regions.