Determinants of foreign direct investment in OECD member countries

The aim of this paper is to get an insight into the potential determinants of foreign direct investment (FDI) for a panel of ten OECD member countries over the period of 1985‐2009.

Granger causality tests have been implemented in the study to identify causalities, both in the short‐ and long‐run, between FDI and the variables that emerge as significant determinants of FDI during the regression analysis.

The fixed effects estimation indicates that market size, labor cost and quality of infrastructure yield significant coefficients in relation to FDI for the panel of countries under study. A bi‐directional short‐run relationship is established between market size and labor costs in the short‐run; whereas quality of infrastructure causes market size and labor costs in the short‐run. For the long‐run deviation of FDI from equilibrium, market size, labor costs and quality of infrastructure all bear the joint burden in the short‐run to re‐establish the equilibrium.

The research findings have a number of policy implications for the OECD countries in specific and other developed economies in general. Labor costs seem to affect the FDI decision on the part of investors; therefore, the countries with low labor costs are preferred by investors in order to reduce the cost of their business and products. Policies should be devised to reduce the labor costs and improve the equality of infrastructure in the country in order to attract more FDI into the economy and for quick adjustment purposes in case of shock to the system.

This paper investigates the relationship and significance of nine potential determinants of FDI in ten OECD member nations using panel data methods. The practices that are undertaken in developed and established economies are of vast significance to the economies that are in transition stages. The paper uncovers some important factors influencing FDI in the ten countries under study and provide a guide‐map for other developed countries.