The impact of financial openness on EU member states productivity

Abstract

Permanent economic growth is one of the essential goals of every country. Productivity is one of the most important components of economic growth. The economic performance of countries is directly related to productivity. According to economic theory, one of the sources of productivity growth is financial openness which is reflected by foreign direct investment (FDI) stock. However, growing FDI flows do not necessarily lead to productivity growth. Inward and outward FDI flows may affect productivity differently. The effects of FDI on productivity is a widely discussed topic. However, analysis of previous studies that examined the impact of FDI on productivity or/and economic growth reveals heterogeneous results: FDI can have positive, insignificant or even negative impact. FDI effects on productivity may depend on countries' conditions. Based on theoretical insight, we develop a hypothesis that one of condition that may influence FDI effects on productivity is countries productivity level. Moreover, positive significant impact may not occur immediately. The aim of this study is to examine the impact of financial openness on EU member states (MS) productivity taking into account countries achieved productivity level and possible lagged effect. We used fixed-effect and ordinary least square estimators for an examination of the relationship between financial openness variables and productivity. Consequently, EU member states using the cluster analysis were divided into two clusters: relatively high productivity (RHP) cluster and relatively low productivity (RLP) cluster. Assessment results reveal that inward FDI positively affected the productivity of both groups of countries, but the impact is stronger in RLP countries. Outward FDI has a positive impact only in RHP countries while in RLP countries impact is negative. Statistically significant FDI effect on productivity occurs in the first year and lasts for two years.