The Shadow Economy, Human Development and Foreign Direct Investment Inflows

Abstract

During the past few decades, competition between countries has intensified. Every country seeks to become an essential player in international economic relations and take a prominent place in the world market. In this context, foreign direct investment inflows are accepted as a source of competitiveness through knowledge, know-how and technology transfer, but competitiveness is also accepted as a significant determinant of foreign direct investment attraction. Therefore, the specification of foreign direct investment inflow determinants is also important to improve competitiveness. In this research article, we aim to evaluate the impact of shadow economies and human development on foreign direct investment inflows as a possible determinant of competitiveness in 11 post-transition EU members over 1995-2015 period. The methodology employed in the applied section includes comparative and systematic literature analysis as well as second generation panel cointegration and causality analyses regarding both cross-sectional dependence and heterogeneity. The empirical analyses revealed that both the shadow economy and human development are significant determinants of foreign direct investment inflows. The causality analysis revealed a mutual interaction between foreign direct investment inflows and human development for all the countries in the sample, but a two-way causality between the foreign direct investment inflows and shadow economies only for Bulgaria, Croatia, and Romania and a one-way causality from shadow economies to the foreign direct investment inflows in the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, and Slovenia. The long-run analysis revealed that shadow economies negatively affected foreign direct investment inflows, while human development positively affected foreign direct investment inflows.