Systematic Review of Monetary Policy Effect on Foreign Direct Investment

Abstract

This chapter aims to survey researchers’ efforts in the literature on monetary policy and foreign direct investment (FDI), mapping the research landscape into a coherent taxonomy and identifying the policy’s fundamental characteristics. The survey, conducted in January 2018, presents an updated and state-of-the-art discussion on monetary policy and FDI research, with a specific focus on economic indicators rather than other factors like economic determinants, prosperity, integration, and growth in different countries. The survey searched for articles on monetary policy and FDI in four major databases: Science Direct, EBSCO host, Emerald Insight, and Web of Science (WoS). After filtering for duplicates and relevance, 137 papers were included in the final set. The findings indicate active and diverse research on monetary policy and FDI, making the survey a valuable resource for scholars seeking to explore available research options and gaps in this field.

1. Introduction

The foreign direct investment (FDI) is considered as one of the most important element to achieve the greatest level of growth and development in the developed and developing economy because of the role it plays in the economy of the host country [1]. According to [2] FDI has grown exponentially as a major form of international capital transfer over the past decade. Between 1980 and 1990, global FDI flows which can be defined as the cross-border outlay for acquisition corporate control or expansion of productive assets which almost tripled as compared to the size of FDI previous decade. It has become a major form of international borrowing for Japan and the United States as the largest lender and the borrower in the world, respectively. Direct investment has increased more rapidly later in the European countries. The host country provides an appropriate climate for foreign direct investment through economic policies that aim to attract a larger amount of foreign direct investment. Among these policies, monetary policy is one of the most important policies that can be used to attract foreign direct investment to the host country [3].

Monetary policy aims to ensure that the money supply is at a compatible level with the real income growth target, so that non-inflationary growth will be guaranteed [4]. Thus, the role of monetary policy in foreign direct investment aims to reduce the interest rate and required reserve on Commercial Banks in the host country and through the control on money supply approaches that can affect the size attraction [3].

The main objective of this paper is to systematically review the literature concerning the impact of monetary policy on the FDI. As such, mapping the research landscape form the literature into a coherent taxonomy, finding out along the way few features that characterize this emerging line of research.

2. Systematic review protocol

This section presents the systematic review protocol used in this paper which specifically includes the keywords selection method, information sources, study selection, section search, inclusion and eligibility criteria, and the data collection process. The review search was conducted from 2008 to 2018.

The most important keywords in the scope of this paper are “Monetary policy and FDI” which consider all monetary policy-related areas, including the economic growth, economic prosperity, economic integration, monetary policy tools, economic determinants, economic liberalization, capital flow, and the economic environment.

This paper chooses four digital databases to conduct the search for target articles. These databases are the EBSCO host, Science Direct, Emerald insight, and Web of Science (WoS) service. The rationale behind this selection is to cover both economic and financial literacy and provide a broader view of researchers’ efforts in a wide but relevant range of disciplines. The host academic institutions worldwide depend on this database as their core resource of scholarly information covering Academic Search Premier, Business Source Elite, and E-Journals which offer access to science, technical and economic journal articles indexing cross-disciplinary research in sciences, social sciences, economical, arts and humanities.

The process of study depends on searching the literature sources, followed by two repetitions of checking and filtering. The first repetitions excluded the duplicates and irrelevant papers by scanning the titles and abstracts, while the second iteration filtered the articles after a thorough full-text reading of the screened articles from the sources.

The search was conducted at the begging of 2018, in Science Direct, EBSCO host, Emerald insight, and Web of Science (WoS) databases via their search boxes used mixed keywords that contains “Monetary policy”, “Money Supply”, and “Foreign Direct Investment” in different variations, combined by the “OR” operator. The exact query text is shown at the top of Figure 1. The systematic review protocol further used the options in each search engine to exclude book chapters and other types of reports other than journal and conference articles that determines directly the stability of the economy. Is considered those venues the most probable to include up-to-date and proper scientific works relevant to this survey on the trend in economic environment, economic determinants, and economic liberalization.

Figure 1.

Systematic review process.

Every article that met the criteria listed in Figure 1 was included in the review. Setting an initial target of mapping the space of research on the economic environment, economic determinants and economic liberalization. After the initial removal of duplicate articles, papers were excluded in both iterations of screening and filtering if they did not fulfill the eligibility criteria. Examples of exclusion reasons include; first, the paper is non-English; secondly the papers that dealt with other economic topics such as oil price, cost management, and Commercial Banking; and thirdly the target is the monetary policy rather than other economic policies.

The inclusion criteria that have been used in the systematic review are as follows. Firstly, the paper is an English journal or conference article. Secondly, the main focus is the monetary policy and FDI, in either one or more of the following:

1. Surveying or reviewing the new trend of monetary policy and the foreign investment fields through FDI.

2. The article that used the most frequent model to analyze the data.

3. The article interest is in economic growth, economic prosperity, economic determinants, economic environment, economic integration and economic liberalization.

In order to facilitate further steps, a full list of all included articles, with their corresponding initial categories, was compiled from the various sources into a single EXCEL file. Full-text readings were performed and resulted in a large collection of highlights and comments on the surveyed works, as well as in a running classification of the papers into a refined taxonomy. All comments were saved followed by the process of tabulation, summarization, and description of the main findings. Sets of all relevant information including the full list of articles, their respective source databases, purposes, summary and description tables, and review sources. Were also recorded and saved.

3. Results

The initial query search resulted in 2018 articles where 43 articles are from Web of Science database, 718 articles are from Science Direct, 169 articles are from Emerald insight, and 1088 articles are from EBSCO host. Fifty-eight articles were duplicates among the four library databases. After scanning for the titles and abstracts, 1960 more articles were excluded, resulting in 137 articles. Full-text reading excluded 92 articles, leaving forty-five articles in the final included set. Those papers were read thoroughly for the purpose of finding a general map for the conducted research on this topic. These studies were divided according to the statistical model. It was found that 36% of the previous studies used the OLS model, 20% used ARDL model, 17.8% used VAR model, 17.8% used GMM model, and 8% used other models. The summary of the statistical model is show in Figure 2 below.

Figure 2.

Summary of statistical model used in previous studies.

4. Systematic literature survey

Based on the result of the study the most frequently used models are OLS and ARDL. As such, this section focused on the literature pertaining to these models.

4.1 OLS model literature

Soufan [5] survey the causal relationship between gross domestic product (GDP) and money supply (MS) in Jordan. In order to determine the direction of the relationship, the study use Granger causality test between the two variables during the period from 1978 until 2010. The result of this study shows that there is a causal relationship between the money supply and the gross domestic product, and the direction of this relation as from money supply to the gross domestic product, not vice versa. Therefore, the study concludes that there changes in the money supply in Jordan explain the causality changes in the gross domestic product and not vice versa.

Omanwa [6] studied on the factors that determine the Foreign Direct Investment (FDI) inflows particularly into the Kenyan economy for the period from 1996 to 2009 using annual data and utilize the OLS model to analyze its data. The main result of this article shows that the most significant factors in attracting FDI inflows into Kenya were the size of the market and the level of openness of the economy.

Cavallari and d’Addona [7] investigate the role of output fluctuations and exchange rate volatility in driving the United State (US) FDIs. The study used annual FDI flows from the US to 46 OECD countries from 1982 to 2009. They used panel estimator with random effects and corrected for heteroscedasticity in the residuals of the OLS model using Wooldridge test. The main finding of this paper is significant to the economic prosperity where the elasticity of production foreign investment is more elastic than in the economic recession. Therefore, an increase in exchange rate volatility, on the other hand, has a strong deterrent effect on the US foreign investments.

Mandeep and Renu [8] study the determinants of foreign direct investment in India, by using annual data for the period from 1990 to 2010. The study uses the Augmented Dickey–Fuller (ADF) test and Co-integration analysis to analyzing the variables. The main finding of this paper shows that the determinants of FDI differ from one country to another country depend on other incentives available in the country. The result indicates that trade openness; foreign exchange reserves, GDP and long-term debt have positive impact on FDI, while negative impacts of inflation and exchange rate on FDI have been noticed.

Elfakhani and Mackie [9] examine the main drivers which can explain the relative success of BRIC countries (Brazil, Russia, India, and China). Collectively and individually, in attracting foreign direct investment (FDI). The data over the full sampling period are from 1980 to 2008 and the analysis it by using GLM regression model. Social variables such as high population growth and educated labor and political variables account for 40% and 7% of the variance of FDI inflows to income, respectively. However, the result shows no significance relationship for economic variables. Interestingly, for a sub-period from 1999 to 2008, the importance of financial determinants such as large GDP economy, favorable net trade balance, controlled currency risk and sovereign debt risk drive inward FDI of 44% of the variance. The finding of this paper also shows that decreased in net FDI inflows on all financial, social and political variables through the analyzed period from 1980 to 2008, and the block regression concludes that the social variables account for 40% of the change in net inward FDI, followed by political variables which composes of 7%.

Abbes et al. [10] analyze the relationship between FDI and economic growth. The dataset consists of cross-country observations for 65 countries over the period of 1980 to 2010 periods. This study uses the FMOLS and DOLS to analyze its data. The result shows that the causal relationship between FDI and economic growth does not exist.

Sambhary and Rasheed [11] examine the influence of economic freedom on foreign direct investment (FDI) in 95 countries, over a six-year period from 1995 to 2000 using the generalized least square (GLS) model to analyze its data. The main finding of this paper indicates that in order to attract FDI, the best thing a government can do is to reduce its interference in the economy while, at the same time, protecting property rights and controlling the corruption.

Loris and Mary-Françoise [12] examines the impact of FDI inflows on industrialization in African countries. This paper used annual data for 49 countries over the period of 1980 to 2009. They analyze the data with autocorrelation and heteroskedasticity tests. The main finding of this study shows that the FDI inflows did not have a significant impact on the countries’ industrialization.

Boateng et al. [13] examine the government policy implications on FDI inflows in Norway. The paper used quarterly data from 1986 to 2009 and use Fully Modified OLS (FMOLS) to analyze the data. The main results show that money supply, inflation, unemployment and interest rate have significant negative results. Meanwhile the real GDP, sector GDP, exchange rate, and trade openness have a positive and significant impact on FDI inflows.

Hartwell and Michael [14] examine the presence of foreign financial institutions that helped to shape a better business environment over the long-run in emerging markets. The paper used annual country-level data on foreign bank entry and macroeconomic variables for approximately 107 developed and emerging countries for the period 1983–2012. The study used panel fully modified OLS model (PFMOLS) and panel dynamic ordinary least square (PDOLS) to analyze the data. The finding shows that the incursion of foreign banks in emerging markets has a positive effect on the broader business environment.

Lucke and Eichler [15] examine the determinants of bilateral FDI stocks, focusing on institutional and cultural factors. This study used panel data of 55 OECD countries from 1980 to 1997. The OLS results show that a devaluation of the home currency would lead to a decrease in foreign direct investment.

ChamTamsir [16] investigate the relationship between monetary integration, foreign direct investment (FDI) and trade in the West Africa particularly on the second monetary zone on FDI flows to zone member countries. The paper use Ordinary Least Squares (OLS) and fully-modified OLS (FMOLS) models to analyzing the data with annual time series spanning from 1980 to 2013. The finding shows that monetary integration positively enhances FDI inflows; it also revealed that monetary integration enhance trade; and FDI and trade are complementary.

Leoveanu [17] study the possible influence of the monetary policy decisions on ale flow of foreign direct investment in Romania for the period 2003 to 2014. They use an econometric analysis namely the Granger causality test to investigate the relationship between these variables. The result of this study show that the selected variables can be successfully used in the calibration of monetary policy decisions with the purpose to attract foreign investment in the country.

Alqalawi et al. [18] examine the effect of main monetary policy tools in Jordan on price and output level. The study used yearly data from Jordanian monetary sector that cover the period between 1993 until 2013 and use OLS model. The main result of this study indicates that monetary policy can maintain the value of money, considering that the value of money is the opposite of the general level of prices. In addition, it is found that inflation was partially imported, and imported inflation was lower than non-imported inflation due to the increased money supply.

Boateng et al. [19] examine the trends, patterns and the impact of cultural and home country macroeconomic influences, on Chinese cross-border mergers and acquisitions (CBM&A) as foreign entry strategy. The period of study was from 1998 to 2011 and the study use ordinary least squares model (OLSs). The result of this study suggests that CBM&A as a preferred mode of market entry provides a means for obtaining strategic resources to develop competitive advantages for the Chinese emerging market firms, and all independent variables play an important role in explaining the trends of CBM&A outflows by the Chinese firms.

Hermann et al. [20] analyze the relationship between central bank independence (CBI) and uncertainties of inflation by including the phenomena of exchange rates and foreign capital flows. There is two specific aim of this investigation. The first aim is to see whether uncertainty of inflation induces volatility of exchange rates, and vice versa, under differing degrees of CBI. Another aim is to explore whether the dynamics of the former relationship influence foreign capital flows in turn. The study was conducted 22 emerging countries through the period from 1968 to 2013 by using Granger causality. The results of the tests for high and low CBI country subgroups show interesting differences. For the high CBI countries, an uncertainty of inflation and uncertainty of exchange rates indicates that there is no causal relationship between them. However, a weak link runs from FDI to uncertainties of inflation in the long run. For the low CBI countries, there is strong evidence of causal links running from uncertainties of inflation to uncertainties of exchange rates on the one hand and to FDI flows on the other. In addition, there is an indication of a bi-directional causal link between FDI flows and exchange rates for these countries.

4.2 ARDL model literature

Bekhet and Matar [21] examine the short- and long-term equilibrium relationship between the stock price index (SPI) and the macroeconomic variables in Jordan. The study used annual data from 1978 to 2010 and analyzes it by using ARDL model. The main result of this paper shows that the ARDL approach indicate the existence of the long-term equilibrium relationship between the SPI and macroeconomic variables.

Shahbaz and Mafizur [22] explore the relationship between exports, financial development and economic growth in the case of Pakistan for the period of 1991 to 2012. The quarterly data for these periods were analyze using ARDL model. The results of this paper show the long-run co integration relation between exports, economic growth and financial development in case of Pakistan, that economic growth and financial development spur exports growth in Pakistan and Granger causality analysis reveals feedback hypothesis that exists between financial development and economic growth, financial development and exports and exports and economic growth.

Mugableh [23] investigates the relationships between FDI inflows and their determinants in Malaysia using annual time-series data from 1977 to 2012. The analysis using ARDL model shows that decreasing the consumer price index in Malaysia increases the value of FDI inflow and stabilizes the macroeconomic and financial environments. Furthermore, appreciation of exchange rates depresses the flow of FDI into Malaysia due to their negative effects on exports. Increases in output values stimulate the flow of FDI into Malaysia. The growth of gross domestic product in the host country improves the macroeconomic environment, which invites overseas investors. Finally, increasing the broadest money supply raises the domestic market capitalization of listed corporations, which induces international corporations’ confidence in the Malaysian financial system.

Bekhet and Al-Smadi [24] estimate the equilibrium relationships and to detect the directions of causality among Jordanian FDI inflows and their determinants. This paper uses the ARDL model to study the time seize data for the period from 1978 to 2012. The main results of this paper identify that there are long-run and short-run relationships among FDI and its determinants. Moreover, the Granger causality test recommends a deferent causal relationship among FDI and their determinants.

Lee [25] examines the short-run and long-run dynamic relationships between exchange rates and foreign direct investment (FDI) in Korea. Monthly data retrieved from the Bank of Korea from January 1999 to March 2012 are used. The main result using ARDL model shows evidence of a structural break from the global financial crisis of 2007–2009 shock to FDI flows in Korea.

Sunde [26] investigated economic growth as a function of foreign direct investment and exports in South Africa. The study uses annual data for the period from 1990 to 2014 and analyze it by using ARDL model to identify the long run relationship among the variables. The results confirmed co-integration between economic growth, foreign direct investment, and exports. This implies that economic growth, foreign direct investment, and exports move in the same direction trending upwards. On the other hand, the Granger causality (VECM) analysis for the short run relationship found unidirectional causality between economic growth and foreign direct investment running from foreign direct investment to economic growth, unidirectional causality between foreign direct investment and exports running from foreign direct investment to exports and bi-directional causality between economic growth and exports.

Durmaz [27] examine the determinants of foreign direct investment and concentrate on the linkage between democracy and foreign direct investment in Turkey. The data are from 1977 to 2011 and are using ARDL model. The findings show that, in the long run, FDI inflows have spillover effects on Turkey’s economy. Determinants such as improved freedom with better political rights and more civil liberties in the country will have structured a stable government with better policies and institutions. This paper satisfies the established need to study the democracy and FDI inflows link, which is necessary for an emerging market such as Turkey.

Mamunur et al. [28] investigate the determinants of FDI in the top 15 most competitive countries in the Asia Pacific region. This study used a time series and cross-sectional data from 2000 to 2013, by using ARDL model. The result of this paper indicates that FDI inflow is related positively to domestic market size, trade openness, and political stability, and inversely related to the inflation rate. Meanwhile GDP, openness, and political stability exhibit a significant long-run relationship with the FDI inflows.

5. Conclusion

This literature review aims to present updated and state-of-the-art discussion on the research about monetary policy and FDI and to highlight research trends in this area. This systematic review differs from previous reviews, due to focuses on evaluating the impact of monetary policy on FDI by using economic indicators only, and show the relationship between monetary policy and FDI, rather than on the economic determinants, economic prosperity, economic integration, economic growth, and the economic environment of developing and economically developed countries.

Furthermore, the study proposes taxonomy of related literature. Developing the taxonomy of literature in a research area, particularly, has several benefits. Taxonomy of published works organizes publications. A new researcher in monetary policy criteria, may discovered a large number of papers on the subject without any kind of structure and may fail to obtain an overview of this area. One of the advantages of this study is different papers could be review or examine to identify the tools and methods used in examine the relationship between monetary policy with FDI. Taxonomy of the related literature, as shown in Figure 2, could systematize these different studies and activities into a meaningful, manageable and coherent layout. The structure introduced by the taxonomy provides a researcher with important insights into the subject in one way through the utilize model.