Dynamic common correlated effects of financial inclusion on foreign direct investment: Evidence from East-Asia and Pacific countries

Abstract

This research explores the dynamic common correlated effects of financial inclusion on foreign direct investment (FDI) in East Asia and Pacific (EAP) countries. Traditional econometric methodologies overlook cross-sectional dependence and heterogeneity among countries, resulting in biased estimates. As a result, we use a unique method called DCCE, which can effectively address these problems. The short run and long-run estimates reveal that financial inclusion positively and significantly influences FDI in higher-income and overall EAP countries. Furthermore, in lower-income EAP countries, financial inclusion has an insignificant correlation with FDI, which becomes significant when an interaction term for institutional performance and financial inclusion is included. Hence, governments and policy makers in EAP economies should try to increase financial inclusion in order to attain an optimal and sustainable level of FDI inflows to enhance economic growth.

Keywords

• Cross-sectional dependence
• DCCE approach
• East Asia and Pacific countries
• Financial inclusion