The impact of foreign direct investment on domestic investment: evidence from developed and developing economies

Abstract Foreign direct investment (FDI) is a global catalyst for economic growth. However, its effects, particularly on domestic investment (DI), have been inconclusive. This study examines the impact of FDI on DI using a panel dataset from 2011 to 2022 across countries from developed and developing economies, employing a Dynamic Fixed Effect Panel ARDL to assess the long- and short-run effects with error correction models (ECMs) for short-term and long-run equilibrium robustness. Cointegration among variables is established using the Pedroni and Kao cointegration tests. Past DI significantly influences current investment decisions in both economies, while in developing economies, FDI has a substantial negative long-term effect, such that a 1% increase in FDI inflows reduces DI by 0.05%, whereas economic growth and institutional quality also have significant positive long-term effects, with a 1% increase in these variables raising DI by 3.8% and 0.5%, respectively, holding other factors constant. Technology transfer shows an immediate complementary effect to DI in both economies. The impact of FDI on DI is highly context-dependent, with divergent outcomes attributable to structural and institutional factors. Policy should treat FDI as a conditional catalyst, not a substitute for DI. Governments need to tightly align FDI attraction with DI promotion, institutional reforms, and proactive technology transfer policies to counteract the mild long-run effect on DI, while harnessing the substantial gains for growth and institutional quality.