The Relationship Between Economic Freedom, State Growth and Foreign Direct Investment in US States

Dennis Pearson, Dong Nyonna, Kil-Joong Kim


Researchers have identified economic freedom, growth rate of the economy, per capita income, unemployment rate, etc as determinants of foreign direct investment (FDI) inflows into the United States as a country. Whether or not these economic variables also determine FDI at the states’ level is often excluded from the literature.

This paper attempts to fill that gap by using a panel data from 1984 through 2007 for all 50 states. We employ the random effects regression model and find that both economic freedom and growth rate in each state are significant positive determinants of FDI inflows. This result is consistent with that of Ray (1989) who shows that high economic growth in the U. S. leads to more FDI inflows. Bengoa and Sanchez-Robles (2003), and Kapuria-Foreman (2007) document similar results for Latin American countries.

In addition, we show that both per capita income and unemployment rate exhibit significant negative relations with FDI. These results are consistent with that of Edwards (1992) and Jaspersen, Aylward, and Knox (2000), but inconsistent with that of Tsai (1994) and Lipsey (1999). We attribute the negative relation between FDI and per capita income to the fact that states with higher per capita income tend to discourage FDI inflows since higher per capita income translates into higher wages. The observed inverse relation between FDI and unemployment rate is due to the fact that states with high unemployment rates are more prone to crime, and therefore deters risk-averse foreign investors from assuming a lasting interest in those states.

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International Journal of Economics and Finance  ISSN  1916-971X (Print) ISSN  1916-9728 (Online)

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