The role of US based FDI flows for global output dynamics

This paper uses a global vector autoregressive (GVAR) model to analyze the relationship
between foreign direct investment (FDI) inflows and output dynamics in a multicountry
context. The GVAR model enables us to make two important contributions: First, to model
international linkages among a large number of countries, which is a key asset given the
diversity of countries involved, and second, to model foreign direct investment and output
dynamics jointly. The country-specific small-dimensional vector autoregressive
submodels are estimated utilizing a Bayesian version of the model coupled with stochastic
search variable selection priors to account for model uncertainty. Using a sample of 15
emerging and advanced economies over the period 1998:Q1–2012:Q4, we find that US
outbound FDI exerts a positive long-term effect on output. Asian and Latin American
economies tend to react faster and also stronger than Western European countries.
Forecast error variance decompositions indicate that FDI plays a prominent role in
explaining gross domestic product fluctuations, especially in emerging market economies.