Economic freedom, financial development, and foreign direct investment: A comparative study of developed and developing economies

Abstract

This research investigates the impact of economic freedom on foreign direct investment as well as the moderating role of financial development in this linkage. Employing international data from 161 countries from 1995 to 2020, we find that an improvement in economic freedom can increase foreign direct investment in developing countries. However, there is no significant evidence of a relationship between economic freedom and foreign direct investment in developed countries. Our further analysis shows that the positive nexus between economic freedom and foreign direct investment is less pronounced for countries with high financial development. Our findings are robust after addressing endogeneity by using a dynamic approach from a two-stage system GMM estimation. Overall, our study points to the presence of heterogeneity in the effect of economic freedom that addresses its benefits in developing countries, thereby providing implications for policymakers in attracting foreign investors.