Risk dimensions, risk clusters, and foreign direct investments in developing countries

Abstract

We analyse four risk dimensions of inward FDI alongside economic growth for forty-eight developing countries for the period 2000–2019 using Fixed Effects, and System GMM models. After controlling for potential endogeneity issues, the results show that economic growth and currency rate have robust positive effect on FDI inflows, whereas inflation rate and financial risk have negative impacts. Political risk both at the contemporaneous and lagged terms had inconsistent results. The nexus between FDI and risk dimensions emends significantly with the risk cluster analysis that finds a strong interplay among financial and currency risks having economic growth in the centre. Results suggest that countries with stable economic growth can cover for an extent (‘U’ shaped relationship) of inflation, currency, and financial risks. The worse possible countries are the ones with unstable political condition, which cannot be mitigated by higher economic growth. We propose a two-layer FDI decision typology that includes country-specific endogenous and non-country specific exogenous factors in primary and secondary layers, respectively. Using a location-risk typology, we relate our discussions on the locational advantage from the eclectic paradigm with the approaches to risk management in international investment.