Determinants of Foreign Direct Investment in Germany

ABSTRACT: Foreign direct investment is defined as the investment made by a firm or an individual or an entity based in local country, into a firm, or entity based in another country (Dunning, 1977). This thesis aimed to analyze the determinants of FDI in one of the most powerful economics at the world; Germany. The period chosen for the study was January 1985 – December 2013. The variables chosen for this study were foreign direct investment, effective exchange rate, real GDP, interest rate, inflation, labor cost, import and export. To analyze the obtained data on each variable, various approaches were introduced. To investigate the determinants of FDI, gravity model was considered to be the most accurate and helpful approach (Egger, 2003). Hence the current study used the gravity model to implement the methodology. Two different equations were used to evaluate the financial and economical determinants of FDI separately. The first model described changes in FDI according to the changes in financial factor and the second model took the macroeconomic factors into consideration. The results of unit root tests revealed that the data was stationary at first level. After this test Vector Error Correction model and Johansen Co-integration tests were applied. Results on these analysis showed that variables chosen for study were insignificant in the short run and it could be said that they did not have any short run association to foreign direct investment. On the other hand, in the long run, all variables except inflation could not significantly affect the amount of FDI in Germany. Results showed that FDI in Germany was likely to be under the effect of changes in both economic and financial factors. However, economical factors tended to make more changes in FDI level in Germany. Keywords: Foreign direct investment (FDI), Vector Error Corection Model (VECM), Johansen co-integration, Germany. …………………………………………………………………………………………………………………………