Interaction between Foreign Financial Services and Foreign Direct Investment in Transition Economies: An Empirical Analysis with Focus on the Manufacturing Sector

Abstract

This paper studies the nexus between financial and non-financial foreign direct investment and its effect on manufacturing value added in Transition Economies, which are members of the EU. Three questions, which are pointed out in the theoretical literature, are discussed in the paper. We investigate whether financial services foreign direct investment has an effect on non-financial foreign direct investment; whether banks follow their clients; and whether there is any effect of foreign direct investment on economic growth. Those questions are tackled with empirical analysis using a dataset for 9 Transition Economies over the period 1996-2007. For most regressions we apply GMM and for one regression 2SLS, to tackle the endogeneity problem. The empirical results lead to three important statements: Non-financial FDI is positively affected by financial services FDI and by market potential. Foreign banks in the EU Transition Economies are mainly driven by non-financial FDI and the capital intensity of a country. FDI crowds out domestic investment in the manufacturing sector.