While foreign direct investment (FDI) is known to be the most stable type of international capital flows, it may be particularly susceptible to heightened uncertainty because of its high fixed costs. We investigate the effect of domestic policy uncertainty on FDI inflows into 16 host countries using the OECD bilateral FDI panel data set and the economic policy uncertainty index from 1985 to 2013. The bilateral structure of the data enables us to disentangle pull factors of FDI from its push factors, thereby obtaining a cleaner causal identification of the higher domestic policy uncertainty effect. To alleviate remaining endogeneity concerns, we use the timing of “exogenous” elections as an instrument. We find that domestic policy uncertainty in a host country robustly reduces the FDI inflows, with the effect being larger in countries with less financial development.
Bibliographical noteFunding Information:
We would like to thank an anonymous referee and the editor (Ronald Davies) for their valuable comments. We also have benefited from comments by Jaebin Ahn, Joshua Aizenman, Juyoung Cheong, Gabriele Ciminelli, Gian Maria Milesi‑Ferretti, Hayato Kato, and Yabin Wang. We thank Junhyeok Shin for excellent research assistance. The views expressed are those of the authors and do not necessarily represent those of the IMF or its policy. Any remaining errors are the authors' sole responsibility. This work was supported by the Yonsei University Research Grant of 2020.
© 2020 John Wiley & Sons Ltd
All Science Journal Classification (ASJC) codes
- Geography, Planning and Development