Evidence on the impact of exchange rate regimes on bilateral FDI flows

Abstract

Purpose The purpose of this paper is to investigate the impact of a menu of country‐pair exchange rate regime combinations upon bilateral foreign direct investment (FDI) flows. Design/methodology/approach The authors use panel data from 27 OECD and non‐OECD high income countries for the period 1980 to 2003. Instrumental variable estimation of a dynamic panel model within a system generalised methods of moments framework allows us to control for both potential correlation issues and endogeneity bias. Findings This paper finds that a currency union is the policy framework most conducive to cross‐border investment. Being a member of EMU also appears to spur greater FDI flows with countries floating their currency vis‐à‐vis the default regime of a double‐float. Country‐pair regime combinations involving one country fixing its currency and the other floating or being a member of EMU, are found not to be more pro‐FDI than the default regime combination. For country‐pairs fixing or pegging their currency to each other, the effect on bilateral FDI flows is the least consistent across alternative specifications and, hence, the most ambiguous. Originality/value The contribution is also distinguished by the comparative use of recently developed “natural” or de facto exchange rate regime classification schemes, in addition to the de jure classification published by the IMF.

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