Mediating effect of financial development on relationship between foreign trade and outward foreign direct investment

This study analyzes the factors affecting outward foreign direct investment (OFDI) in 64 countries, comprising 53 developing and 11 developed nations, from 2010 to 2022. It underscores the importance of financial development in mediating the relationship between foreign trade and OFDI in developing countries. Trends in foreign trade are similar for both developing and developed countries, yet the patterns of OFDI differ. Compared to foreign trade, OFDI requires substantial capital and the capacity to manage overseas risks. Due to the lack of large capitalization in banking and financial systems, most firms in developing countries are unable to engage in extensive OFDI. Considering the issue of endogeneity, this study analyzed all three research objectives using the System Generalized Method of Moments estimation method. The results indicated that foreign trade has a significant positive impact on OFDI. Moreover, when analyzing the 53 developing countries and the 11 developed countries separately, it was found that exports, imports, and openness have a positive effect on OFDI in both groups. This study delves into the influence of financial development on the generation of OFDI. The findings reveal that the scale, structure, and efficiency of financial development significantly positively affect OFDI. However, the impact varies between developed and developing countries. The third objective is to investigate whether financial development acts as a mediator in the relationship between foreign trade and OFDI using the Sobel test and Variance Accounted for (VAF). The findings demonstrate that only the structure of financial development mediates the relationship between foreign trade and OFDI. For developing countries, the scale and structure of financial development were found to mediate this relationship, while for developed countries, it was the efficiency of financial development that served as a mediator. This study supports the theory by providing novel evidence on the growth of OFDI from developing countries. It encompasses multiple factors, such as exports, imports, and openness, and examines their contributions to OFDI. Furthermore, the study investigates the link between financial development and OFDI, and develops a dynamic panel model to analyze this relationship. Lastly, the study offers new insights into the mediating effects of financial development.

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