INTRODUCTION
Practical Motivation andResearchProblems
When a country receives substantial aid from a donor, it tends to recognize the donor's generosity, foster cooperation, and create a favorable legal environment for the donor's enterprises (Kimura & Todo, 2010; Rodrik, 1995, p 25) This aid enhances the country's social and economic infrastructure, leading to improvements in human capital and total factor productivity (Harms & Lutz, 2006) Consequently, the recipient nation becomes more competitive, attracting foreign direct investment (FDI) from other countries While foreign aid is generally considered a significant driver of private capital inflows that promote growth, technology, and employment in the host country, research has not consistently demonstrated a strong relationship between foreign aid and FDI (Alesina & Dollar, 2000; Harms & Lutz, 2006).
HarmsandLutz(2006)suggestthatoneshouldconsidertheroleofpoliticalandinstitutionalcha racteristicswhenquantifyingthisrelationship.Indeed,institutionalqualityoft h e h o s t countryit selfi s a n importantdirectmagneto f privatecapitalinflows.Abundantempiricalstudieshavepointe doutthenegativecausalityofabadinstitutiontotheinflowsofFDI.Ironically,severalcountrieswhich areperceivedash a v i n g highcorruptiona n d l o w political,institutionalprofilesstillhavelargeinfl owsofFDI(Habib&Leon,2002).
Intheaspectofmodeling,theinfluenceofforeignaidonFDIisdifficulttoestimateduet o t h e pr oblemso f simultaneitya n d reversecausality.Byu s i n g laggedvariablesa s instruments,2SLSa n d GMMmethods,t o somee x t e n t , couldalleviates u c h e n d o g e n e i t y However,thetreatment ispurelytechnicalanddoesnot reflectthenatureoftheproblems.Asiedu,J i n , a n d Nandwa( 2 0 0
9 ) proposea simultaneousequationsmodelthatcoulds o l v e t h e s e problems.Inthisapproac h,foreignaidandFDIaredeterminedatthesametime,ande a c h of them isthedeterminantof theother.Whilethedualapproachis undoubtedly asuperbi d e a , theappliedmodelandtheresultsofthisresearchnonethelesscontainsomeflawsandc ontradictions.First,thereisnoinstitutionaldeterminantintheaidequation.Second,inthea i d eq uation,t h e positivecoefficiento f FDIc o u l d b e interpretedthatwhileforeigna i d r e d u c e s FDI,FDIcould,however,increaseforeignaid.
Research Objectives
(2009)andvisualizetheintricaterelationshipbetweenforeignaidandFDI,whichmightcomprisesi multaneityandreversecausality.Withregardtopurposes,whileAsieduetal.
(2009)focuso n thealleviatingroleofforeignaidontheadverseeffectofexpropriationriskonF DI,weconcentrateontheeffectofforeignaidon finalFDI.Withr eg ar d tosamples,weuseboth l ow-incomea n d middle-incomesubsamplest o s u p p o r t ouranalysis,whereasitisonlythelow- incomecountriesinAsieduetal.
(2009).IncomparisonwithHarmsandLutz(2006),wea p p l y adifferentmodelwithdifferentprox iesofvariablesandamorerecentperiodtoassesst h e effectofforeignaidonFDI.
This article explores the intricate relationship between foreign aid and foreign direct investment (FDI) by utilizing a specified model and relevant data It aims to determine whether multilateral aid can effectively lead to increased FDI Additionally, the research contributes empirical evidence regarding the influence of institutions on FDI, particularly examining if stronger institutions can attract more investment, as suggested by existing theories and studies Furthermore, the paper assesses the significance of various institutional measures on FDI, while also investigating whether factors such as democracy, corruption control, and political stability enhance a country's ability to receive foreign aid.
Structure
InChapter2,thispaperbrieflyreviewsatradetheorywhichiswidelyusedtoexplaintheinvestmen tdecisionofforeigninvestorsandsomeempiricalresultsbasedonthistheory.Wemainlyconcentrate onthepapersthathaveinstitutionsandforeignaidasthedeterminantsofprivatecapitalinflows.InCh apter3,weexplainthedual- approachframeworkandtheregressionmodel.Thevariablesandd a t a sourcesarealsodescribedi n t h i s chapter.Theempiricalfindingsa n d associatedexplanationsa r e locatedi n Chapter4 Chapte r5 recapitulatestheresultsformakingpolicy andresearch.
LITERATUREREVIEW
WefirstreviewtheOLItheoryontheinvestmentdecisionofforeigninvestors;thenwecomeinto thepapers mentioninginstitutionsandforeignaidasseparateexplanatoryvariableso f FDI;n e x t , weh a v e a l o o k o n theresearchwhichembedst h e politicala n d institutionalfactorsintot h e influenceo f foreigna i do n FDI.Lastly,wesummarizetheinstitutional measureswhichmightaffectforeignaid.
Dunning's OLI paradigm, developed in 1988, 1998, and 2001, serves as a comprehensive framework for understanding foreign investment activities The "O" component highlights ownership advantages, focusing on the comparative benefits that enable firms to expand internationally In examining this component, we gain insights into product characteristics and firm capabilities The "L" component addresses location advantages, which pertain to the availability of human and natural resources, favorable production conditions, research opportunities, and market size in the host country Lastly, the "I" component emphasizes internalization advantages, which involve strategies to reduce transaction costs as firms evaluate the choice between importing intermediate products and integrating foreign suppliers into their production processes This analysis is crucial for firms when selecting investment destinations.
Politicalandinstitutionalfactorsofthehostcountryareconsideredasthelocationadvantagesi n t heOLIframework.Theinfluencemechanismo f t h e s e factorso n foreigninvestorsarementionedi n t h e paperss u c h a s Habiba n d Leon(2002)a n d Dunninga n d Lundan(2008).Ontheempirica lside,HabibandLeon(2002)findout a negativerelationshipbetweencorruptionlevelsinthehostcountriesandtheirinflowsofFDI.Accordi ngtoHabib andLeon,foreign investorsmightseecorruptionasviolatingsocialand professionalethicsa n d increasingunnecessarycosts.1M o r e o v e r , payingbribesisstrictlyprohibitedinthehomecountriesofs omeforeigninvestorssuchastheUnitedStates (Hines,1995).
Bussea nd Hefeker(2007)examinet he impactsofgovernmentstability,law a nd order,a b s e n c e ofinternala n d externalconflicts,lacko f e t h n i c t e n s i o n s , controlo f corruption,de mocracy,a n d bureaucraticperformanceo n FDIinflowst odevelopingcountriesi n thep e r i o d 1984-
2003.Thep a p e r doess h o w positiverelationshipsbetweens u c h measuresa n d privatecapitalinfl ows.Withthesameperiodofresearch,Bénassy-Quéré,Coupet,andMayer
(2007)usethegravitymodeltotesttheinfluencesofvariousinstitutionaldataonFDIstocks.I n gener al,acountryowninghigherinstitutionalqualitywouldhavealargeraggregatestocko f FDI,a n d h i g h e r institutionaldistancebetweent h e homec o u n t r y andt h e h o s t c o u n t r y lowerstheFD Istockof theformerinthe latter.Inotherwords,bad institutionalmeasureswouldhinderFDItoa country.Forexample,oneoftheresultsinAsieduetal.
(2009)isthatexpropriationriskrestrainstheinvestmentdecisionofforeignenterprises.Thesampleso f thisresearch are low-incomeandSub-SaharanAfricancountries.
Ont h e otherh a n d , t h e numbero f researchstudiesthatfindo u t b a d institutionsa s a n incenti veofFDIisquitelimited.EggerandWinner(2005)showtheempiricalevidenceont h e positivere lationshipbetweencorruptionandinwardFDI.Theresearchusesasampleofb o t h developedan ddevelopingcountriesintheperiod1995-
The impact of foreign aid on foreign direct investment (FDI) remains ambiguous, with some studies suggesting that it can have both positive and adverse effects These contradictory effects may manifest as infrastructure improvements or rent-seeking behaviors While numerous research efforts have failed to establish a significant link between aggregate aid and FDI, some studies, such as those by Selaya and Sunesen, highlight a prevailing positive influence Conversely, the role of bilateral aid in attracting FDI is more pronounced, as evidenced by research from Rodrik and Kimura & Todo In contrast, no empirical evidence supports the notion that multilateral aid can directly enhance FDI Additionally, research by Asiedu et al has revealed negative coefficients for aggregate, bilateral, and multilateral aid in FDI regressions, particularly in low-income and Sub-Saharan African countries.
Harms and Lutz (2006) investigate the complex relationship between foreign aid and foreign direct investment (FDI) by incorporating institutional variables and employing various estimation techniques across different time periods and country groups Despite their efforts, they find that, on average, foreign aid does not significantly impact FDI However, they identify a noteworthy finding: in countries with high regulatory hindrances and low institutional quality, foreign aid positively influences FDI This effect arises because foreign aid helps mitigate expropriation risks, thereby encouraging foreign investment in these nations Additionally, the interaction between expropriation risk and foreign aid shows a positive coefficient, further supporting this conclusion.
( 2 0 0 9 ) meanst h a t expropriationr i s k ispositivelyaddedtotheeffectofforeignaidonFDI.Given thenegativecoefficientofforeigna i d a t theb e g i n n i n g , theincreaseofexpropriationr i s k leve l,t o somee x t e n t , couldmakeforeignaidmovinginthesamedirectionwithFDI,althoughexpro priationisperceivedasab a d practice.
Inregardtoinstitutionaldeterminantsofforeignaid, AlesinaandDollar(2000),Dollara n d L evin(2006)h a v e c o n s e n s u s ont h e positiveimpactofdemocracy.Corruptionlevel,however,i s no t foundtoultimatelyaffectthedecisiono f a majorityo f d o n o r s (Alesina& Weder,2002).
MODEL AND DATA
Dual-ApproachFramework
Figure1graphicallyillustratestheinfluenceofinstitutionsonforeignaidandFDI,andt h e in teractionbetweenthesetwoforeigninflows.Theformerinducessimultaneityandthelattercause sreversecausality.Solidarrowsarethefociofthispaper.Inthe bottomofthefigure,institutionsaret hemajorfactorsof bothFDIandforeignaid.TheOLItheorysuggestst h a t abetterinstitutioncouldhavemoreFDIinfl ows.Similarly,foreignaidmightbe disbursedmoretoacountrywithbettergovernance.Hence, 2 positive. and 2 areexpectedtobe
1 Inc a s e o f multilaterala i d , i t aimst o enhancet h e sociala n d economicinfrastructuresa n di s typicallythoughta s creatingt h e “infrastructureeffect.
The impact of multilateral aid may not be immediate, as it often does not result in instant improvements in infrastructure or attract foreign investors in the short run, even when countries A and B have similar conditions and institutional measures This is because multilateral aid is generally not aimed at supporting specific industries but rather serves informational and conditional policy functions that can indirectly protect foreign investors in recipient countries Consequently, this paper introduces the concept of the "institutional effect" of multilateral aid, highlighting that while it can safeguard foreign investors, it does not alter the institutional framework of a country in the short term.
Incaseofbilateralaid,besidesproductivesectors,anumberofitsprojectsarealsoforinfrastruct uraldevelopment,anditshouldalsohavethesameinfrastructureeffectasthatofmultilateralaid.In addition,bilateralaidhasitsownspecialeffectwhichisknowntogreasebilateralprivatecapitalinflo wsandisreferredtoasthe“vanguardeffect.”Itisnoticedthatt h e vanguardeffecto f bilaterala i d i sq ui te similart o th e institutionaleffecto f multilateral aid, but onlyappliedforbilateralinvestors.Thecoefficient 1 isconjecturedtobepositivein bothcasesofforeignaid.Theimpactlevelisexpectedtovarysystematicallyamong
Rodrik(1995)fordetaileddiscussionontherolesofmultilateralaid. governmentsh a v i n g differentperformances.Therefore,themarginaleffecto f f o r e i g n aid couldb e expresseda s a linearfunctiono f institutions,i.e.
Thei d e a o f puttingpoliticala n d institutionalvariablesi n t o t h e effecto f foreignaido n FDIw a s firstemploye dbyHarmsandLutz(2006).
Foreign Direct Investment (FDI) can influence foreign aid through both direct and indirect mechanisms The direct mechanism is particularly relevant for understanding short-term bilateral aid flows, as increased FDI in a host country incentivizes the home country’s government to allocate more aid to that location While it’s not mandatory for the home country to do so, countries often welcome FDI, and the economic ties can reflect the diplomatic relationships between nations In contrast, multilateral donors typically do not consider FDI levels in recipient countries In summary, in the short run, the impact of FDI inflows can lead to a positive coefficient in the bilateral aid equation, while remaining neutral in the context of multilateral aid.
In the long run, Foreign Direct Investment (FDI) can significantly influence both bilateral and multilateral aid By enhancing GDP growth and GDP per capita, FDI can ultimately reduce a host country's reliance on concessional loans or grants from donors This transformation of FDI inflows into national wealth suggests that the coefficients of FDI in aid equations may become negative over time, indicating a decreased need for foreign aid as the host country becomes more self-sufficient.
The impact of foreign direct investment (FDI) on foreign aid can be influenced by the quality of institutions within a country Research indicates that various institutional factors, such as democracy and corruption, significantly affect GDP growth and GDP per capita (Acemoglu et al., 2014; Barro, 1996; Mauro, 1995) By incorporating institutional variables into the FDI inflow coefficient, we can assess how effectively an economy utilizes FDI and reduces its dependence on foreign assistance.
3 Some conditionsthatFDIcauseseconomicgrowtharehumancapital(Borensztein,DeGregorio,&Lee,1998) ,absoluteandrelativenature ofFDI(Alfaro,2003;Mello,1999),andtradepolicy(Balasubramanyam,Salisu,&Sapsford,1996).
Dual-ApproachDynamics-BalancedModel
Fromthedual-approachframeworkabove,wehave thegeneraldual-approachmodel: fdi aid f 1 ( 1 aid, 2 insf, 1 others), f 2 ( 1 fdi , 2 insa, 2 others).
ThismodelaugmentsthesimultaneousequationsmodelofAsieduetal.(2009)byaddingthe politicalandinstitutionaldeterminant,reg ressionis insa, int h e a i d equations.Thedetailedmodelfor infdigdp it 1 aidgdp it 2 insf it 1 infdigdp i,t1 11 gdpgrow i,t2 12 utilcom i, t2
lngd ppc lngdppc 2 it 1 it 2 it 2 i,t 1 21 i,t 2 22 i,t 2 (4) where infdigdp i t
23 debtgdp i,t 2 24 lnpop it u 2it , ist h e n e t inflowso f foreignd i r e c t investment,a n d aidgdp it ist h e net inflowsofofficialdevelopmentassistance(ODA)tocountryiinyeart.Bothfiguresarein percentageofGDP.Thefirstlagofaidinflowsintheaidequations, aidgdp i,t 1, isamajor differenceincomparisonwiththepreviousresearchofAsieduetal.
(2009).Itcouldbeaddedb e c a u s e foreignaidisdisbursedgraduallywiththecompletenessofpr ojects.Togetherwith thefirstl a g o f FDIinflows, infdigdp i,t 1 , thisadditionmakest h e systemo f twoequations balanced,thusthemodelisreferredtoasdual-approachdynamics-balancedmodel 4
(2009),b u t someadjustmentsaremade.IntheFDIequation,theproxyofeconomicinfrastructurei st h e totaldensityofcommunicationutilities(utilcom),whichiscomprisedoftelephonelines,
4 Some papers usingthefirstlagofFDIasan explanatoryvariableareAsiedu etal.
(2009),BusseandHefeker(2007),Jensen(2003),andGastanaga,Nugent,andPashamova(1998). mobilecellular,andinternetsubscribers.However,theincreaseofcurrentFDIinflowsmightp r o v o k e theusageofcommunicationsystem.Thus,welagthisvariabletoavoidtheinteractionwithth edependentvariableanditsfirstlagintheright-handsideoftheequation.
Thetrade openness(tradeopen) asmeasuredbythetotalexportsandimportsoverGDPis alsolaggedtwoperiodsbecausethereisadirectcontributionofFDItothisvariableinthesameye ar.Asforeigninvestorsexpandtheirbusinessactivitiestoothercountries,eitherint h e formofgre enfieldormergera n d acquisition,t h e y a r e morelikelyt o e x p o r t machines,equipment,materials, andexpertsto,andimportfinalproductsfromthehostcountry.Alsot h e consumptiono f expatria tesraisesthein-border-exportscomponento f t h e destinationc o u n t r y
Asdepicted inFigure1,FDIinflowscould affecttheGDPgrowthofacountry withint h a t year,sogdpgrowi salsolaggedtwotimestoeliminatethereversecontributionofFDIinflowsintot hisexplanatoryvariable.Finally,theinstitutionsthatmightaffectFDIinflows
(insf) areregulatoryquality,controlofcorruption,governmentefficiency,ruleoflaw,and politicalstability.Theimpactoftheseinstitutionalmeasureswillbeexaminedseparatelyint h e regr ession.
Intheaidequations,toavoidthe componentrelationshipofforeignaidand FDIinthe currentGDPp e r capita,wel a g thevariable lngdppc Apartfromt h e projectednegative relationshipbetweentheincomelevelofacountryandtheamountofaidthatitreceives,wea l s o e xpectthatthedecreasingratedoesnotholdconstant,inparticulardiminishes.Hence,t h e quadr aticcomponentofl n g d p p c i sadded.Thesecondmacrovariablewhichisdebtover
Moreover,thedebtinthepastismoreappropriatetobeadeterminantofaiddisbursementsint h e future. Thepoliticalandinstitutionalvariablesofforeignaid(insa) aresupposedtobe democracy,controlofcorruption,andgovernmentefficiency.Asademographicfactor, population(lnpop) isusedbecauseitcouldcreatethesmall-countryeffectontheinflowsof foreignaid.Withthesameinstitutionsandotherthingsequal,acountrywithlowerpopulationism orehomogenousandmorelikely toreceivethesupportofforeigncommunity.
NetFDIinflows(%GDP) 3.693 7.374 3,711 3.628 9.731 3.733 5.498 Aggregateaid(%GDP) 9.129 13.28 3,827 16.14 14.77 4.787 10.06 Bilateralaid(%GDP) 6.119 10.42 3,827 10.27 10.96 3.546 9.178 Multilateralaid(%GDP) 3.020 4.596 3,815 5.871 5.825 1.247 2.227 Regulatoryquality -0.494 0.714 1,922 -0.866 0.614 -0.264 0.674 Controlofcorruption -0.480 0.642 1,928 -0.737 0.557 -0.321 0.639 Governmentefficiency -0.499 0.656 1,922 -0.865 0.582 -0.272 0.595
Note:Ful l sample(144countries)includeslow-income(54 countries)andmiddle- income(90 countries)subsamples.
Thetargetsampleo f t h i s s t u d y i s low-a n d middle- incomecountriesbecausemosto f t h e s e countrieshavereceivedforeignaid.Thecountryclassific ationsbasedonGNIpercapitaa r e oftheWorldBankandcapturedin2013 6The macrodataaremost lytakenfromWorldDevelopmentIndicators(WorldBank,2014)andWorldEconomicOutlook(IM F,2014).Theinstitutionald a t a whichi s a d o p t e d fromWorldwideGovernanceIndicators(Worl dBank,2 0 1 2 )includesregulatoryquality,controlofcorruption,governmentefficiency,ruleofla w, andpoliticalstability.Duetothetemporallimitationofdata,theresearchperiodisnarroweddownto1996-2012.Inaddition,weusedemocracyscorefromFreedomHousetodiversify
5 Dudley andMontmarquette( 1 9 7 6 ) discussi n detailt h e relationshipbetweensmallcountryandforeignaid.
2013incomeclassificationsoftheWorldBankarelowincome(nomorethan1,035US$),middleincome(1,036-12,615US$),andhighincome(nolessthan12,616US$). thesourcesofthesesubjectivevariables.Table1summarizesthedescriptivestatistics.Moredetailsof thevariables andthedatasourcesareshowninTableA1(AppendixA).
RESULTS
Independent MarginalEffectsbetweenInstitutions,ForeignAid,andFDI
Table 2 presents the regression results based on the DADB model, with Panel A detailing the base regression for various types of foreign aid: aggregate (AA), bilateral (BA), and multilateral (MA) The analysis focuses on three key variables: FDI inflows, foreign aid, and institutional quality In the FDI equation, five institutional measures—rule of law, regulatory quality, control of corruption, government efficiency, and political stability—are evaluated individually, all showing a positive influence on FDI inflows Panel A of Table 3 reports the coefficients and significance levels for the full sample, revealing that, aside from government performance, all other institutional and political factors significantly attract more FDI, with significance levels of at least 5 percent Notably, the quality of regulation in the private sector has the most substantial impact on the investment decisions of multinational enterprises (MNEs), indicating that a one-point increase in this measure correlates with a 0.66 percentage point rise in FDI inflows.
The principal component analysis (PCA) is utilized to create a composite institutional index, denoted as INSF, which reflects the impact of government policies on promoting foreign direct investment (FDI) This index will be incorporated in subsequent FDI-related regressions By consolidating these measures, we not only streamline the analysis but also acknowledge that these factors often correlate Generally, effective governance is associated with strong rule of law, regulatory quality, control of corruption, and government efficiency, while minimizing risks such as political instability, civil unrest, and external conflicts.
Bilateral aid positively influences foreign direct investment (FDI), as indicated by a coefficient of 0.18 in the FDI equation, aligning with Rodrik's findings from 1995 In contrast, multilateralaid demonstrates a significantly larger effect, with a coefficient of 0.39, attracting foreign investors from a broader range of countries compared to bilateral aid, which primarily benefits donor nations The analysis of low-income and middle-income subsamples reveals that the impact of foreign aid on FDI is more than double in low-income countries, although institutional effects on FDI are negligible in this group This disparity may stem from a perceived institutional threshold that foreign investors consider; if a host country's institutions fall below this threshold, differences are overlooked Moreover, the extended vanguard effect of bilateral aid and the institutional impact of multilateralaid play crucial roles in low-income countries, where compliance with international regulations fosters greater confidence among foreign investors, particularly as these nations receive higher average foreign aid compared to their middle-income counterparts.
Othercontrolvariablesi n t h e FDIequationarestatisticallysignificanta n d havet h e e x p e c t e d signs.WhenGDPgrowthortradeopennessincreasesby1percentageofGDP,then e t inflo wso f FDIa f t e r twoy e a r s c o u l d b e higherb y 0.06o r 0 0 1 percentageo f GDP,respectively Whenthetotalnumberoftelephonelines,mobilesubscribers,andinternetusersi s higherby10unit sper100people,privatecapitalinflowsinthenexttwoyearscouldbelargerby
Int h e a i d equations,theinsignificantcoefficientso f FDIinflowsi n t h e s e c o n d parto f colum ns(1),(2),and(3)ofTable2illustratethenon- impactofFDIonforeignaid.Itmeanst h a t acountrywithmoreFDIdoesnotnecessarilyhavemor eorlessofbilateralormultilateralaid Inotherwords,althoughFDIcould motivatemoreaidfrom somespecificd o n o r s , t h e totalso f bilaterala i d inflowsbetweenrecipientcountriesa r e n o t ultimatelydifferentduetotheirtotalreceivedFDI.ThisresultisinlinewiththestatementofAlesi naa n d Dollar (2000):thereis norelationshipbetweenFDIandforeignaid.
The Democracy Index, which assesses political rights and civil liberties, significantly influences the distribution of both bilateral and multilateral foreign aid Countries with higher levels of freedom receive more foreign aid, as indicated by negative coefficients Additionally, factors such as corruption control and political stability also affect aid disbursements from donors Notably, empirical findings suggest that increased corruption leads to a decrease in foreign aid, contrasting with previous research by Alesina and Weder (2002) Furthermore, the impact of political stability is found to be more substantial than that of corruption control To further analyze governance indicators, we developed the INSA composite institutional index, which helps identify factors that enhance a country's ability to attract foreign aid The effects of foreign direct investment (FDI) and institutional quality on aid in low-income and middle-income countries are summarized in the latter sections of Table 3.
Othercontrolvariablesi n t h e aidequationshavestatisticallysignificantimpacto n t h e distributi ono f foreigna i d Thesquaredcomponento f t h e incomelevelimpliesn o t o n l y a negativemargina leffectbutalsoadiminishingrateofthiseffect.Additionally,theincomel e v e l i s muchmorese nsitivea n d significantint h e multilateralaidequationthani n t h e bilateralaidversion.Thisfigur eprovesthetargetofreducingpovertyofmultilateralorganizations.Finally,acountrywithmorede btorlowerpopulationismoreopenandlikelyt o l o o k forthehelp offoreigncounterpartsandinternationalorganizations.
ReliabilityandRobustnessChecks
Inthispart,wec h e c k t h e reliabilitya n d t h e robustnessoft h e specifiedmodel.Thereliabili tycheckisdonebynotlaggingthecontrolvariablesofthetwoequations.Besidesthesmaller- sampleapproachmentionedabove,therobustnesscheckisundertakenbythreemoreexperiments.Fi rst,acontrolvariableisremovedfrom thespecification.Secondexperimentist h e insertionofsomeirrelevantvariables.Third,different methodsofregression— whicharePOLS,differenceGMM(Arellano& Bond,1 9 9 1 ),a n d s y s t e m GMM(Blundell& B o n d , 1 9 9 8 )—areappliedseparatelytoeachofthe equations.
(9)]ofTable2reportstheresultswhenwedonotlagthecontrolvariables.Therea r e severalreasonst h a t t h e lagv e r s i o n i s morereliablet h a n t h e n o n - l a g v e r s i o n o f thespecification.First,theeffecto f GDPg r ow t h i n t h e non- lagspecificationisattenuatedto0.05,incomparisonwith0.06inthelagspecification.Thisattenuation iscaused
real bythefeedbackofthedependentvariable.Theprocedureofreversecausalityisexplainedasfollowi ng.GDPgrowth,whichrepresentstheproductionandconsumptioncapabilitiesofaneconomy,ison eofthemostimportantcriteriawhenMNEschooseacountrytoinvest.Theh i g h e r GDPgrowth o f a c o u n t r y , themoreopportunitiesa r e thattheinvestmentc o u l d b e a b s o r b e d andt u r n e d intoprofits.Int u r n , whenforeigni n v e s t o r s decidet o expandt h e i r b u s i n e s s t o a hi gher- growthcountry,t h e y a l s o contributetot h e productiono f g o o d s a n d serviceswithinthatcount ry.Asaresult,GDP growthisspirallyaffectedbyFDIinflows.
Tomathematicallyillustratet h e attenuatedcoefficiento f a positivelyfeedback-affected explanatoryvariable x,let denoteaself-changeofthisassumedexogenousvariableas
real y/x.Next,thechange yofyenlargestheself-changeofxanadditionalamount
x nominal xx feed Thecoefficientofx whichweobtainin themultivariate regressionofyis
Int h i s case,wehave nominal 0.05, real 0.06,and h0.05/0.060.83
Itmeansthat, whentaking into accountthe reversecausalityofFDIinflows,themarginaleffectofGDPgrowthis downward-biasedandequalto 83percentofitsrealmagnitude.
Second,incontrasttoGDPgrowth,thecoefficientoftradeopennessinthenon- adjustedspecificationismuchlargerandmoresignificantthanthatintheadjustedspecification.This phenomenonoccurswhenxoryisthecomponentofeachother.Supposethattheeffectofx onyis ,t h u s theeffectrelationshipisyx
Inaddition,duetothecomponentialnature betweenyandx,thecomponentrelationshipis yb x Themultivariateregressionofyonx wouldgenerateacombinationas y(b)x.
Therefore,thecoefficientoftheend ogenous variablexincreasesinthevalueifthecomponentrelationshipispositive(b0) Moreover, thesignificancelevelsalwaysincreasea s a resulto f directcomponents,eitherpositiveo r negative,in theregression.Inour case, wehave 0.01and b0.03.Similarly,asmallcomponentrelationshipcouldalsobefou ndbetweentheamountofdebtandtheinflowsof aidi n t h e aidequationso f t h e n o n - a d j u s t e d specification.Foreigna i d i s a c o m p o n e n t o f s o v e r e i g n debtwithinthesameye ar.
Third,amodeloraspecificationisconsideredmorereliablewhenitsregressioncoefficientsares tabledespitechangesintheproxiesofothervariables.Onthiscriterion,thetwo- lagspecificationisalittlebetterthanthenon- lagcounterpart.ThecoefficientoflagofFDIvariablei n t h e formeri s stablea t t h e value0 5 6 , i n s p i t e o f t h e foreigna i d proxies,whereasthati n t h e latterfluctuatesbetween0.54a n d 0 5 5 Fou rth,wed o n o t empiricallypreferthenon-lagspecificationbecauseitislessrobustthanthetwo- lagversion.AsseeninPanelD (Table2 ) , t h e coefficiento f INSFi n d e x becomesinsignifican tafterutilcomi sremovedfromthemodel.
Next,wet u r n o u r attentiont o t h e robustnessc h e c k s First,weremovesomec o n t r o l v ariablesfromt h e model,whicha r eutilcomi nt h e FDIe q u a t i o n andl n p o p i nt h e a i d equations.TheresultsarereportedinPanelB,G,andHofTable2.Inthecaseofutilcom,allo f thecont rolvariableswhichmightshareitsroleintheFDIequation—
GDPgrowth,tradeo p e n n e s s , andthelagofFDIinflows— increasesignificantlyintheirimpacts.Incontrast,thecoefficientsofourvariablesofinterest— INSFindexandforeignaid— aredownwardbiased.ThecoefficientofINSFindexbecomesunstable.Nevertheless,theirimpacts onFDIinflowsremainsignificant,andtheimpactofmultilateralaidstilldoublesthatofbilateralaid. Therei s notmuchchange inthethree aidequations withthis omissionofutilcom.Inthecas eofl n p o p,theabsenceofthisdemographicvariablejustinducestheroleofcontrolofcorruptiona n d political stabilityinhavingmoreforeignaid.
In this analysis, we incorporate additional variables into the base specification of the ADB model Specifically, we include the money stock (M2) in the FDI equation and the inflation rate in the aid equations, alongside the young and old dependency ratios of the working-age population The results, presented in Panels E and F, indicate that while domestic financial development, inflation, and the younger dependency ratio show no significant relevance, the older dependency ratio exhibits some indirect relevance This ratio may reflect factors such as human capital, living conditions, and future debt repayment capabilities On one hand, strong human capital and favorable living conditions can attract foreign investment, while on the other hand, a lower ability of the elderly population to work and repay debts may raise concerns for bilateral donors In the regression analysis, the coefficients of the old dependency ratio in both the FDI and bilateral aid equations are noteworthy.
Incolumn( 1 4 ) , e v e n thought h e coefficientoff r e e d o m i n t h e bilateralaidequationr e d u c e s inthesize,from-0.15to-
0.08,comparedtothebaseregressionincolumn(2), itssignificancelevelalsodecreases.Thus,the roleoffreedomcouldbeplausibleinbilateralaiddisbursements.SuchsituationsalsooccurwithINSFi ndexandcommunicationutilitiesintheFDIequation[PanelF,column(16)] 7For othercasesinPanelEandF,thecoefficientsandtheirsignificancelevelsarealmostunchanged.
7 The coefficients(t-statistics)ofcommunicationutilitiesare.009(2.67)incolumn(1)and.005(1.38) incolumn(16).
Note:3SLSestimation,t- statisticsinparentheses,***p