Does investment climate matter to foreign direct investment? Evidence from OECD countries

Abstract

This study examines the impact of the investment climate, along with its macroeconomic determinants, on foreign direct investment (FDI) inflows using panel data from 38 OECD countries. The analysis incorporates the Economic Freedom Index (EFI) published by the Heritage Foundation as a key indicator of the investment climate. Employing the two-step System Generalized Method of Moments (System GMM) estimator, the findings provide robust evidence of a strong positive relationship between EFI and FDI inflows, highlighting the critical role of a favorable investment climate in attracting foreign investment. The results further indicate that labor force participation and trade openness have significant positive effects on FDI inflows, whereas inflation has a significant negative effect. In contrast, domestic investment does not have a statistically significant impact on FDI inflows. These findings underscore the importance of strengthening economic institutions to attract and sustain foreign investment. Accordingly, policymakers in OECD countries should prioritize regulatory efficiency, the protection of property rights, macroeconomic stability, and human capital development to foster a more attractive investment environment.