Foreign Direct Investment in Services: Issues and Implications for Emerging Economies

Abstract

KEYWORDS: Foreign direct investment; Services sector; Financial development;

International trade; Economic growth

The Services sector has played an essential role in shaping the growth trajectory of emerging economies in the past three decades with their increased share in value-added. Foreign direct investments (FDI) flowing into emerging economies too increased manifold during the same time period. The present study attempts to analyse the issues and implications of foreign direct investment (FDI) in services, explicitly focusing on emerging economies, with particular emphasis on financial development, trade in services, and service sector growth. This study uses annual panel data with an observation from 1999-2016 for 25 emerging economies. Our results show that the variables that attract FDI in services do not vary much from financial to non-financial services. We find that financial development has positive and significant impacts on FDI in financial services in both the extreme cases, that is, economies that have either fast-growing or slow-growing services sector. Our results confirm the nonlinear asymmetric relationship between FDI in non-financial services and trade in services. This study finds that FDI in financial services has positive and significant impacts on trade in services, which implies a complementary relationship between FDI in financial services and trade in services. Concurrently, positive changes in FDI in non-financial services have adverse effects on trade in services in the long run, which indicates the substitutability of same with trade in services. We also observed that the growth effects of FDI vary across emerging economies as it has a positive impact on services sector value-added except in the 90th quantile. A more detailed sub sectoral analysis shows that the growth effects of FDI in services are mainly driven by FDI in financial services. The results highlight the need for emerging economies to focus on sector-specific FDI policies.