Procedia Economics and Finance 3 (2012) 1012 – 1017

Emerging Markets Queries in Finance and Business

The Impact of the Recent Global Crisis on Foreign Direct

Investment. Evidence from Central and Eastern European
Countries
Adina Dorneana,*, Vasile I b
, Dumitru-Cristian Oaneac
a, b
of Iasi, Carol I Boulevard no.11, Iasi 700505, Romania
c
Chief Analytics Officer, BC Web Technologies LTD, 5 Fowey Avenue, London IG4 5JT , U. K.

Abstract

Few studies have investigated the relationship between the recent global financial and economic crisis and FDI flows. This
paper aims to analyze such a relationship for Central and Eastern European countries (EU members). The crisis had a major
impact on capital flows to the region, although the magnitude of the impact differed notably, depending on the type of
capital inflows and the receiving country. In order to highlight this, we use a regression model and panel data methodology,
trying to find if there is some difference between the analyzed countries. The results will be very useful if there is a pattern
for different countries regarding the main effect of the financial crisis and the interaction with economic growth over the
FDI. Taking into consideration the fact that we found that economic growth has a significant influence over the level of FDI
and, moreover, a positive influence, the present study is very important in supporting the regulatory environment of those
specific countries, in order to attract more FDI, as a solution for recovery of the economies affected by crisis.

© 2012 The©Authors.
2012 Published
Published byby Elsevier
Elsevier Ltd.access
Ltd. Open Selection
under and peer-review
CC BY-NC-ND under responsibility of the
license. Emerging
Markets
Selection and Queries
peer review in Finance of
under responsibility and Business
Emerging local
Markets organization
Queries in Finance and Business local organization.

Keywords: Foreign direct investment; financial crisis; CEE countries; economic growth; regression model.

1. Introduction

Investments across countries are a powerful tool in promoting economic relationships between different
parts of the world. Over the past two decades, the global foreign direct investments (FDI) flows had rapidly

* Corresponding author. Tel.: +40-232-201610; fax: +40-232-217000.

E-mail address: amartin@uaic.ro.

2212-6716 © 2012 The Authors. Published by Elsevier Ltd. Open access under CC BY-NC-ND license.
Selection and peer review under responsibility of Emerging Markets Queries in Finance and Business local organization.
doi:10.1016/S2212-5671(12)00266-3
 Adina Dornean et al. / Procedia Economics and Finance 3 (2012) 1012 – 1017 1013

increased. Despite turmoil in the global economy, global FDI flows exceeded the pre-crisis average in 2011,
reaching 1.5 trillion USD. However, they still remained some 23% below their 2007 peak (UNCTAD, 2012),
when the value of FDI was 1,971 billion USD, about ten times more than the value recorded in 1990.
Our paper will analyze the relationship between the FDI flows and the financial crisis which started in 2008,
emphasizing the case of CEE countries. Our study is the second attempt on a more extensive project that aims
to study, to analyze and to argue the macroeconomic and microeconomic effects of the global crisis on FDI.
Subsequently, this paper will be followed by more analyses, using existing data and recent research in the field.
Overall, the project aims to offer a fully documented response to the question: is it necessary a special
treatment (promotion policy) for FDI in time of crisis?
This paper is organized as follows: section 2 presents a short literature review on the relationship between
FDI, economic growth and crisis. In section 3, we describe the methodology used, we show the data selection
process and the characteristics of our sample and we report our results. Finally, we present our main
conclusions.

2. Literature review on the relationship between FDI, growth and crisis

This is not the first financial crisis that caused a lot of debates. Researchers (Reinhart and Rogoff, 2008)

Norway (1987), Finland (1991), Sweden (1991) and Japan (1992) and other small banking and financial crisis
such as: Australia (1989), Canada (1983), Denmark (1987), France (1994), Germany (1977), Greece (1991),
Iceland (1985), Italy (1990), New Zealand (1987), United Kingdom (1973, 1991, 1995) and United States
(1984).
A significant number of studies found similar results regarding the linkage between FDI and economic
growth, through a comprehensive empirical analysis, using countries from around the world as samples. Alforo
et all. (2000) pointed out the positive influence of FDI on economic growth, emphasizing the importance of
local financial markets in this process. Furthermore, these results are confirmed by a series of studies which
analyzed countries from different parts of the world. For Asia, Zhang (2001) found that the positive effect of
FDI in promoting economic performance is stronger in the costal part of China than the inland area. Moreover,
Choong et all. (2004) emphasized that, for Eastern Asian countries, it is very important the development level
of the financial sector. This can be seen as a source of competitive advantage in attracting FDI by host
countries and, in the end, in promoting economic growth, results that are valid also for Taiwan (Chang, 2006),
Malaysia and Thailand (Chowdhury and Mavrotas, 2006). This positive linkage between FDI and economic
growth was also found for 18 Latin American countries (Bengoa and Sanchez-Robles 2003), and it could be
improved by several elements from the host country, namely: adequate human capital, economic stability or
liberalized markets. The same relationship was found to be true for other 10 African countries (Esso, 2010).
But the results stated above were not confirmed by the empirical analysis conducted by Carkovic and Levine
(2005), through which it was pointed that the FDI do not exert an independent influence on economic
performance and their influence depends by other determinants of economic growth.
Even if there are a lot of papers that analyze different crisis in time, there is a scarce research regarding the
relationship between the recent global financial crisis and FDI. The interest of researchers, who approached this
topic, was to measure the strength of financial crisis over the FDI level. More specifically, the empirical study
conducted by Ucal et all. (2010) revealed that the financial crisis had a powerful influence on FDI. After
recording an upturn in the year(s) before the crisis, the level of FDI decreased in the followings years. Of
r for host countries and it can play a very complex and important
role in micro economic responses to the financial crisis. This aspect is supported by the empirical analysis
conducted by Alfaro and Chen (2010), through which, it is emphasized the importance of FDI in economic
growth, volatility and economic interdependence across the countries in order to minimize the negative aspects
1014 Adina Dornean et al. / Procedia Economics and Finance 3 (2012) 1012 – 1017

of financial crisis. Moreover, researchers wondered if the last financial crisis had less or much strength on FDI
than other past crisis. To answer this question, Poulsen and Hufbauer (2011) compared the current FDI
recession with the response in FDI to past crisis and they found that indeed, the financial crisis from 2008 was
the biggest one. At the same time, the global level of this crisis had led to a greater change in FDI.
After more than four years that the crisis started, there is a scarce research regarding the relationship
between the current global financial crisis and FDI and there is still room for further analysis. Thus, with this
paper, we aim to put another piece to the whole picture regarding this topic, by analyzing this link for CEE
countries.

3. Methodology

3.1. The model

The model used in this paper has as starting point the hypothesis of Growth-led FDI that relates with the
Multinational Corporations theory. The background is represented by the Eclectic Paradigm or OLI
(Ownership, Location and Internalization) described by Dunning (2000) and firstly discussed in 1977.
According to the location sub-paradigm of countries, a MNC with some ownership advantages will choose to
invest in countries with a location advantage, emphasizing the market size (usually proximate by GDP). The
rationality behind this theory is that an increase in the market size of the host country will led to an increase in
the level of FDI, due to a higher expected profitability. In our paper, we will extend the model, because we
want to capture the financial crisis effect on FDI, so the basic model will be given by Equation (1).

FDI i ,t 0 1 GROWTHi ,t 2 CRISIS i ,t (1)

where FDIi,t - the level of FDI for country i and year t as percentages of GDP; GROWTHi,t - the economic
growth for country i in year t (percentage change of GDP); CRISIS - is a dummy variable taking 1 for years
2009, 2010, 2011 and 0 otherwise 0, 1, 2 - i,t - error term. The econometric
method that will be used to estimate the regression model is last square method (LS) based on balanced panel
data. Also, we are interested in checking the robustness of our regression model. To achieve this objective, we
follow the methodology used by Carkovic and Levine (2005) and we select a control variable represented by
Openness trade. Based on table 3, we can see that our regression model is valid, economic growth and
financial crisis maintain their sign and significance.

3.2. Data and descriptive statistics

Data for CEE countries is available for the period 1994 2011 from United Nations Conference on Trade
and Development (UNCTAD) for FDI, GDP growth (without 2011) and imports as percentages of GDP (as a
proxy for Openness trade). For the last year of our analysis, 2011, we estimate the GDP growth rate based on
EUROSTAT data. Officially, the financial crisis started in September 2008, when Lehman Brothers filed for
Chapter 11 bankruptcy protection, followed by other financial institutions (e.g. Merrill Lynch, American
International Group). CEE countries have experienced the financial crisis more aggressively after the beginning
of 2009. In 2009, the level of FDI decreased to 2.52% of GDP, compared to the level of 2008 of 6.02% of
GDP. A worst situation was recorded by GDP growth that has fallen from 19.31% in 2008 to -15.73% in 2009.
The evolution of average FDI and average GDP growth can be clearly observed in Figure 1.
 Adina Dornean et al. / Procedia Economics and Finance 3 (2012) 1012 – 1017 1015

30%

25%

20%

15%

10%

5%

0%

-5%

-10% Financial
-15%
crisis
-20%
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Fore
reign
g Dire
r ct
c In
Investmen
ent (% of GD
GDP) GDP Gr
GD Growt
w h (%)
%

Fig. 1. Average FDI and average GDP growth for CEE countries (1994 - 2011)

Source: based on data from UNCTAD, available at: http://unctadstat.unctad.org/ReportFolders/reportFolders.aspx.

The descriptive statistics for FDI, GDP growth, crisis and openness trade series are given in Table 1.

Table 1: Descriptive statistics

Variable Mean Median Max. Min. Std. Dev. Skewness Kurtosis

Average series
FDI (%) 4.95 3.94 29.42 -1.18 4.19 2.36 11.67
GDP growth 10.37 10.03 44.31 -24.46 13.04 -0.18 3.02
(%) 0.14 0 1 0 0.35 2.12 5.49
CRISIS 8.84 8.66 17.46 3.56 2.91 0.55 3.01
(dummy)
Openness trade
Country level FDI (% of GDP) GDP Growth
series
Mean Max. Min. Mean Max. Min.
Bulgaria 8.97 29.42 0.68 9.96 34.99 -24.46
Czech Rep. 5.01 10.82 1.49 10.51 26.64 -12.99
Estonia 7.81 20.63 1.20 10.31 34.42 -19.36
Hungary 5.34 11.20 1.62 7.75 25.92 -17.90
Latvia 4.59 8.38 0.36 10.87 44.31 -22.72
Lithuania 3.36 8.22 0.47 11.46 31.33 -22.19
Poland 3.44 5.74 1.73 10.47 28.26 -18.67
Romania 3.86 9.26 0.71 11.91 39.06 -19.57
Slovakia 5.36 16.93 -0.06 12.19 36.00 -8.51
Slovenia 1.73 7.01 -1.19 8.24 39.16 -10.43

At first glance, we see that the highest level of FDI is recorded in Bulgaria (8.97%), while the lowest level
belongs to Slovenia (1.73%). Even if the highest value for average GDP growth is recorded for Slovakia
(12.19%), the maximum level of GDP growth was recorded in 2007 for Romania, when GDP has grown with
almost 39%.
In order to capture through the regression model the characteristics of FDI and GDP growth (both being
time series), we apply the Augmented Dickey Fuller (ADF) test to see if the time series are stationary.
According to the results both series are stationary.
1016 Adina Dornean et al. / Procedia Economics and Finance 3 (2012) 1012 – 1017

Table 2: Stationary Test Results

Variable FDI (%) GDP growth (%)

H0: I(1) 59.84*** 56.92***
***
- Indicates significant at the 0.01 level

3.3. Results

The empirical analysis is split in two parts. First, we conducted the Augmented Dickey Fuller Test and
secondly we estimated the regression model. The first step was necessary to check whether the series are
stationary in order to apply the appropriate regression model. Based on results from Table 2, we can see that
both series are stationary. The results are summarized in Table 3.

Table 3: FDI, Economic growth and Crisis

Variablea Constant GDP growth Crisis Openness R-squared R-squared

trade (adjusted)
Basic model 0.0456*** 0.0643** -0.0168* 0.0894 0.0790
(0.0047)b (0.0256) (0.0089)

Model robustness -0.0044 0.0621*** -0.0194** 0.5729*** 0.2478 0.2351

(0.0093) (0.0234) (0.0082) (0.0941)
a
dependent variable is represented by foreign direct investments
b
- (standard errors in parentheses)
*, ** , ***
- Indicates significant at the 0.1 level, 0.05 level and 0.01 level

Our findings suggest that economic growth has a significant influence over the level of FDI and, moreover,
a positive one. These results are according to authors cited in section 2 of our paper (Ucal et all., Poulsen and
Hufbauer, Alfaro and Chen etc.). An expected and interesting result is that the dummy variable included in the
model to capture the financial crisis effect has a significant impact on FDI. Moreover, the sign of this variable
is negative, like we expected it to be. Financial crisis is a phenomenon that is hard to capture through a single
variable, but the magnitude of the financial crisis started in 2008 in Unites States, amplified the effects, so the
crisis had a powerful negative effect on CEE countries.

4. Conclusions

In order to contribute to existing literature, we have analyzed the relationship between the financial crisis
and FDI in CEE Countries. The results show that the financial crisis affects directly the level of FDI. The
results seem to be logical, because the magnitude of the financial crisis started in 2008 in United States,
amplified the effects, so the crisis had a powerful negative effect on CEE economies. The regression model
might have some limitations due to the small size of the sample, only 18 annual observations for a sample of 10
countries, over the period 1994 2011. Further studies can replicate our analysis using a different sample of
data in order to identify if there are some special characteristics of selected countries which might affect the
intensity and effects of financial crisis on FDI. Another direction for further studies will be to analyze
are influencing more or less economic results in times of crisis compared to normal times through comparative
analysis by dividing the analyzed period into two subperiods (normal times and crisis times).
 Adina Dornean et al. / Procedia Economics and Finance 3 (2012) 1012 – 1017 1017

Taking into account our findings, the present study is very important in supporting the regulatory
environment, in order to attract more FDI, as a solution for recovery of the economies affected by crisis.

Acknowledgements

This work was supported by the project "Post-Doctoral Studies in Economics: Training Program for Elite
Researchers - SPODE" co-funded by the European Social Fund through the Development of Human Resources
Operational Program 2007-2013, contract no. POSDRU/89/1.5/S/61755.

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Appendix A. Central and Eastern Europe Countries

According to OECD definition, Central and Eastern European Countries (CEECs) is an OECD term for the
group of countries comprising Albania, Bulgaria, Croatia, the Czech Republic, Hungary, Poland, Romania, the
Slovak Republic, Slovenia, and the three Baltic States: Estonia, Latvia and Lithuania. In our analysis, we
include only the European Union member states: Bulgaria, the Czech Republic, Hungary, Poland, Romania, the
Slovak Republic, Slovenia, Estonia, Latvia and Lithuania.