An empirical analysis of the impact of three important aspects of Eclectic Paradigm on Foreign Direct Investment (FDI)

Abstract

The main objective of the paper is to empirically examine the impact of three important aspects of Eclectic Paradigm that is ownership, location and internalization on FDI inflows by using different variables for each sub-paradigm. This study examines the relevant variables over the last couple of decades for 196 countries for the period of 1970–2009. The variables of eclectic paradigm are tested first with pooled OLS estimation method and then with panel data analysis by using fixed-effects regressions. This study finds that the variable of trademark, signifying the ownership aspects of investing firms, seems to highly affect FDI inflows. Among location-specific factors, the variable of openness to international trade significantly encourages trade oriented FDI inflows in the country as predicted by earlier empirical literature. The variables of government consumption and gross capital formation both have important implications on FDI inflows. Further, education of the local population has an important influence on direct investments. Similarly, the availability of industrial resources and access to domestic credit resources play a key role in the investment location decisions of multinational corporations. In terms of internalization, countries with English and French legal systems are found significantly affecting inward investments, pointing to the confidence of investors in these systems due to the better quality of intellectual property rights, law enforcement and legal protection of investment rights. This study finds the evidence that if governments want to attract FDI, they need to avoid excessive government spending, as prodigal public expenditure discourage FDI inflows. In order to attract more FDI, governments should invest in the education of the labour force to make human capital more valuable, in the development of infrastructure facilities and set up a legal environment that is conducive to attracting international investors.