Economic Freedom, Fiscal Rules on FDI Inflows: An Analysis of 24 Developing Countries

Abstract

Foreign Direct Investment (FDI) plays a crucial role in enhancing economic growth and development. It brings capital, technology, managerial skills, and employment opportunities to host countries. However, attracting FDI requires a conducive business environment characterized by economic freedom and effective fiscal institutions. This paper aims to explore the relationship between economic freedom, a new type of fiscal institutions named fiscal rules, and FDI inflows. It provides a comparative analysis of different countries and investigates the mechanisms through which economic freedom and fiscal institutions influence FDI. The panel data analysis employed in this study utilizes two estimation methods, namely the Random Effects Model (determined through the Hausman test) and the Two Stage Least Squares Method (to address endogeneity concerns). The empirical findings reveal several noteworthy insights. Firstly, GDP, trade openness, and gross fixed capital formation exhibit a positive relationship with FDI inflows, while inflation does not have a significant impact. Additionally, our research indicates that specific economic freedom sub-indicators, such as tax burden, monetary freedom, trade freedom, and financial freedom, positively influence FDI inflows. Conversely, the presence of expenditure rules is found to have a negative impact on FDI inflows. Furthermore, we explore the interactive effects of fiscal rules and economic sub-indicators on FDI inflows, providing further insights into the relationship between these factors.