Business cycle determinants of US foreign direct investments

Abstract

This article investigates the role of output fluctuations and exchange rate volatility in driving US FDIs. Using a sample of 46 economies over the period 1982 to 2009, we provide the evidence of a positive relation between US FDI and host country's cyclical conditions. Allowing for asymmetry over the business cycle, we find that the output elasticity of foreign investments is higher in booms than in recessions. An increase in exchange rate volatility, on the other hand, has a strong deterrent effect on US foreign investments. This effect is fairly stable over the business cycle.

Keywords:

• FDI
• business cycle
• cyclical output
• exchange rate volatility

JEL Classification:

• F21
• E22
• F42

Notes

¹ They typically focus on factors that are relatively persistent over time. These include various measures of business attractiveness, ranging from market size to cultural ties and institutional variables, as well as proxies of the cost of foreign market access. Comprehensive surveys of the literature include Razin and Sadka (2007), Blonigen (2005) and Blonigen and Piger (2010), among others.

² Stevens (1998) shows that the relation between FDI and exchange rates is highly unstable. Cushman (1985, 1988), Goldberg and Kolstad (1995) and Zhang (2003) find a positive effect of exchange rate volatility on FDI. Evidence of a negative effect is provided, among others, by Campa (1993) and Chakrabarti and Scholnick (2002).

³ See, among others, Helpman et al. (2004), Russ (2007), Cavallari (2007, 2010) and Lewis (2010).

⁴ See Russ (2012) and Russ and Lubik (2012)

⁵ Focusing on the business cycle in the source country, for example, Wang and Wong (2007) find that an increase in output volatility reduces FDI outflows, especially among OECD countries. In this vein, Levy Yeyati et al. (2007) find that FDI flows from developed towards developing countries move counter-cyclically with respect to both output and interest rate cycles in the source country. Considering the business cycle in the host country, Buch and Lipponer (2005) document that German FDI move in a counter-cyclical way.

⁶ The Hausman test rejects the null that the fixed and random effect models are equivalent with a p-value of 0.93. The Breusch Pagan test does not reject the null of random effects against the alternative OLS model. Post-estimation tests reject the hypothesis of autocorrelation in the residuals (Wooldridge test) while not rejecting that of heteroscedasticity (log-likelihood ratio test).

⁷ http://www.bea.gov.

⁸ The list of the countries includes all the OECD current members (cf. http://www.oecd.org) excluding Chile, Estonia, Slovak Republic and Slovenia. No OECD members included in the data set are Argentina, Brazil, China, Hong Kong, India, Indonesia, Jamaica, Kuwait, Panama, Peru, Philippines, Romania, Russia, Saudi Arabia, Singapore, Thailand and Venezuela.

⁹ All control variables except GDP and inflation are taken from Andrew Rose's webpage at www.haas.berkeley.edu/ arose

¹⁰ The drop in the average amount of FDI is as large as .