Fire‐sale FDI? The Impact of Financial Crises on Foreign Direct Investment

• Author: Olga Stoddard,Ilan Noy
• Published date: 01 May 2015
• DOI: http://doi.org/10.1111/rode.12149
• Date: 01 May 2015

Fire-sale FDI? The Impact of Financial Crises on

Foreign Direct Investment

Olga Stoddard and Ilan Noy*

Abstract

We analyze the evolution of foreign direct investment (FDI) inflows to developing and emerging countries

around financial crises. We empirically examine the Fire-Sale FDI hypothesis and describe the pattern of

FDI inflows surrounding financial crises. We also add a more granular detail about the types of financial

crises and their potentially differential effects on FDI. We distinguish between mergers and acquisitions

(M&A) and greenfield investment, as well as between horizontal (tariff jumping) and vertical (integrating

production stages) FDI. We find that financial crises have a strong negative effect on inward FDI in our

sample. Crises are also shown to reduce the value of horizontal and vertical FDI. We do not find empirical

evidence of fire-sale FDI; on the contrary, financial crises are shown to affect FDI flows and M&A activity

negatively.

1. Introduction

What happens to foreign direct investment (FDI) in the aftermath of large deprecia-

tions and financial crises? Do foreign investors purchase domestic firms in a fire sale?

Paul Krugman, in a much cited paper on the Asian 1997/1998 crisis, starts by arguing

that: “hard statistical evidence of a surge in FDI into Asia was not yet available” but

that anecdotal evidence strongly suggests an inflow of FDI in the post-crisis period

(Krugman, 2000, p. 44). The idea that financial crises are sometimes also accompanied

by “Fire-Sale FDI” (the title of Krugman’s paper) caught on. Krugman concludes his

paper by noting that: “What we need—surprise—is more research.” We believe this is

still the case. There is little empirical research that attempts to systematically docu-

ment the evolution of foreign direct investment around financial crises. This is what

we do here.

The importance of foreign direct investment (FDI) to the global economy since the

late 1980’s is quite obvious, with increasing volumes of FDI flowing between, into and

from the developing countries. In 2010, for the first time, developing and transition

economies together attracted more than half of global FDI inflows (UNCTAD, 2011).

Even though the theoretical literature in economics has identified several channels

through which FDI inflows are predicted to benefit the receiving economy, the

empirical literature has lagged behind and has had more trouble identifying these

advantages in practice. Notwithstanding these observations, most countries continue

to vigorously pursue policies aimed at encouraging more FDI inflows.

While much of the literature focuses on the impact of FDI on technological trans-

fer, increasing productivity and production and export upgrading, one frequently

* Stoddard: Department of Economics, Brigham Young University, 149 Faculty Office Building, Provo, UT

84604, Tel: +1-801-422-3580; E-mail: olga.stoddard@byu.edu. Noy: Victoria University of Wellington, New

Zealand. E-mail: ilan.noy@vuw.ac.nz. We thank audiences at the Indian National Institute of Public

Finance and Policy (NIPFP) in Delhi and in particular our discussant Veronica C. Warnock, and seminar

participants in Honolulu, San Francisco, and Menlo Park.

Review of Development Economics, 19(2), 387–399, 2015

DOI:10.1111/rode.12149

© 2015 John Wiley & Sons Ltd