THE CHANGING DRIVERS OF FOREIGN DIRECT INVESTMENT IN ICELAND: EVIDENCE FROM THE KNOWLEDGE-CAPITAL FRAMEWORK, 1998–2024
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Abstract
Foreign direct investment (FDI) is an important source of capital and economic development for small open economies, yet relatively little is known about whether the determinants of FDI remain stable during periods of major macroeconomic disruption. This study examines whether the drivers of inward FDI into Iceland changed across three distinct macroeconomic regimes: a pre-crisis expansion period (1998–2009), a post-crisis recovery period (2010–2019), and a pandemic and post-pandemic period (2020–2024). Using annual bilateral FDI stock data from fifteen source countries over the period 1998–2024, the analysis applies an extended Knowledge-Capital framework incorporating interaction effects between key explanatory variables and macroeconomic regimes. To accommodate the presence of zero and negative FDI observations and reduce the influence of extreme values, the primary specification employs a random-effects panel model using an inverse hyperbolic sine transformation of FDI stocks. Fixed-effects and alternative random-effects specifications are estimated as robustness checks. The results indicate significant temporal variation in the determinants of inward FDI. Joint Market Size and geographic distance exhibit statistically significant changes across macroeconomic regimes, whereas skill differences and institutional quality remain comparatively stable. Market-size effects are positive during the pre-crisis period, become negative during the post-crisis recovery period, and return to a positive association during the post-pandemic period. Geographic distance remains a significant deterrent to investment throughout the study period and becomes more influential during periods of heightened economic uncertainty. The findings suggest that the determinants of FDI in small open economies are not temporally fixed but vary according to broader macroeconomic conditions. The study contributes to the Knowledge-Capital literature by demonstrating the importance of accounting for regime-dependent effects when analysing long-run FDI patterns.
How to Cite
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Foreign Direct Investment (FDI), Knowledge-Capital Model, Macroeconomic Shocks, Small Open Economy, Time-Varying Determinants
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