Role of foreign direct investment in estimating capital mobility: a reappraisal of Feldstein–Horioka puzzle

Abstract

As investment by nonresidents is not subject to inter-temporal budget constraint of the recipient country, it may not belong to Feldstein–Horioka equation. This article finds that capital mobility is remarkably high in both developed and developing countries when Foreign Direct Investment (FDI) is excluded from domestic investment. Moreover, economic openness and financial markets' liberalization are also found to have increased the degree of capital mobility.

Acknowledgements

The author is grateful to Ronald Balvers, Arabinda Basistha, Joshua Hall, Peter Leeson and Russell Sobel for their insightful comments on the earlier draft of this article.

Notes

¹In FH sense, a higher estimated value of the coefficient of savings rate indicates low capital mobility, whereas its lower value reflects high capital mobility.

²Subsequent research also finds high savings investment correlation in large as well as small economies, although this correlation is found to be relatively weaker for the latter (see, e.g. Wong, 1990; Mamingi, 1997; Keun-Yeob et al., 1999; Kasuga, 2004; Sinha and Sinha, 2004; Younas and Chakraborty, 2010).

³See, for example, Isaksson (2001), Georgopoulos and Hejazi (2005), Younas and Chakraborty (2010), Younas and Nandwa (2010).

⁴We also check the robustness of our results using Feasible Generalized Least Squares (FGLS). These findings are qualitatively the same and are available from author upon request.

⁵Data for all variables are broken into separate 5-year-data averages resulting in a total of 7 time periods.

⁶Gross savings is calculated as gross domestic product minus private and government consumption expenditure, whereas gross fixed capital formation consists of outlays on additions to the fixed assets of the economy, net changes in the level of inventories and net acquisitions of valuables, as defined in World Bank Development Indicators (WDI, 2007).

⁷The coefficient on savings rate is also called saving retention coefficient as it shows the extent to which an increase in domestic savings finances domestic investment.