Global competitiveness and capital flows: does stage of economic development and risk rating matter?^*

ABSTRACT

This paper closes a gap in the relevant literature by investigating the role of a country’s competitiveness on international capital mobility using robust panel multiple regressions with fixed and random effects. In this study, we use the Global Competitiveness Index to measure a country’s competitiveness level. The research empirically investigates the effect of competitiveness on cross-border capital flows, and shows how stages of economic development and country-specific risk ratings influence inflows and outflows of capital under the effect of competitiveness. Overall, we found that competitiveness has a positive and statistically significant impact on aggregated and disaggregated capital flows. However, the magnitude of its impact varies over different stages of development and across country risk levels.

KEYWORDS:

• Competitiveness
• capital flows
• stages of economic development
• country risk

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. Fratzscher (2012) shows that the heterogeneity effect by global factors on capital flows across countries is explained largely by the quality of institutions, country risk, and the strength of domestic macroeconomic fundamentals. In addition, Asiedu (2006) demonstrates that macroeconomic and political instability have a negative impact on foreign direct investment.

2. These studies used real effective exchange rate (REER) as an indicator for measuring competitiveness. REER can only be considered as an indicator for short-run competitiveness because in the long run competitiveness is measured by technological change, policy factors, and resource endowments (Bennett and Zarnic 2008; Monfort, 2008; Eyraud, 2009; Belke, Schnabl, and Zemanek 2013).

3. We have selected this period (2006–2014) because data on global competitiveness are available from 2006.

4. Gross capital flow has an advantage over net capital flow by differentiating the capital inflows and outflows (Forbes and Warnock 2012; Broner et al. 2013).

5. There are also some other sources (e.g. World Bank’s Ease of Doing Business) and international reports (e.g. Global Innovation Index, Corruption Perception Index) which can have a significant impact on capital flows and the study on other studies can also provide similar assessment results. However, we prefer to use Global Competitiveness Index reports (WEF) due to the classifying countries into the different stages of economic development, providing comparatively more comprehensive dataset for domestic factors (pillars), extensive coverage for the time and country, and consistency of reports for measuring Global Competitiveness Index scores.

6. See http://www.doingbusiness.org/custom-query.

7. In testing the effect of capital inflows on economic growth, Slesman, Baharumshah, and Wohar (2015) use the instrumental variable to avoid the endogeneity issue due to the possibility that better economic growth can attract capital inflows. Hwang et al. (2017) also consider capital flow episodes as endogenous variables in examining the effect of capital flow episodes on macroeconomic variables.

8. Bai (2013) provides the potential theories to explain the co-movement of CIF and COD.