Journal of Risk and Financial Management Article Causal Links between Trade Openness and Foreign Direct Investment in Romania Malsha Mayoshi Rathnayaka Mudiyanselage, Gheorghe Epuran * and Bianca Tescas, iu Faculty of Economics Sciences and Business Administration, Transilvania University of Brasov, Universitatii Street, No. 1, Building A, 500068 Brasov, Romania; [email protected] (M.M.R.M.); [email protected] (B.T.) * Correspondence: [email protected] Abstract: In this increasingly globalized era, foreign direct investments are considered to be one of the most important sources of external financing for all countries. This paper investigates the causal relationship between trade openness and foreign direct investment (FDI) inflows in Romania during the period 1997–2019. Throughout this study, Trade Openness is the main independent variable, and Gross Domestic Product (GDP), Real Effective Exchange Rate (EXR), Inflation (INF), and Education (EDU) act as control variables for investigating the relationships between trade openness (TOP) and FDI inflow in Romania. The Auto Regressive Distributed Lag (ARDL) Bounds test procedure was adopted to achieve the above-mentioned objective. Trade openness has negative and statistically significant long-run and short-run relationships with FDI inflows in Romania throughout the period. Trade openness negatively affects the FDI inflow, which suggest that the higher the level of openness is, the less likely it is that FDI will be attracted in the long run. The result of the Granger causality test indicated that Romania has a unidirectional relationship between trade openness and FDI. It also Citation: Rathnayaka showed that the direction of causality ran from FDI to trade openness. Mudiyanselage, Malsha Mayoshi, Gheorghe Epuran, and Bianca Keywords: foreign direct investment; trade openness; ARDL model Romania; panel data analysis Tescas, iu. 2021. Causal Links between Trade Openness and Foreign Direct Investment in Romania. Journal of Risk and Financial Management 14: 90. 1. Introduction https://doi.org/10.3390/jrfm14030090 Foreign direct investment (FDI) inflows play an increasingly strong role in economic development and progress of countries, and are considered to be one of the major drivers Academic Editor: Shuddhasattwa Rafiq of globalization. In general, FDI is a crucial component of development of host countries, and results in capital, external financing, infrastructure, technology, skills and market Received: 27 January 2021 access, etc. Most policy makers and economists believe that FDI can positively affect their Accepted: 12 February 2021 Published: 24 February 2021 countries. In recent years, most emerging and developing countries have implemented various economic reforms to restructure their economies in order to attract more FDI. In Publisher’s Note: MDPI stays neutral general, changing global economic situations, policy changes, and political environment with regard to jurisdictional claims in have a crucial impact on foreign direct investment. FDI decisions depend on a variety of published maps and institutional affil- characteristics of the host country, such as market size and potential, exchange rate, trade iations. openness, political stability or risk, labor costs, trade costs, investment costs, trade deficit, human capital, tax, inflation, budget deficit, etc. Many empirical studies have indicated that various aspects—such as trade openness and foreign direct investment—might influence a country’s economic development. There are many definitions concerning trade openness in the literature. Trade openness is defined as Copyright: © 2021 by the authors. Licensee MDPI, Basel, Switzerland. the sum of imports and exports normalized by the gross domestic product. This is the most This article is an open access article common and convenient measurement, and has been used in a variety of international studies distributed under the terms and (Adow and Tahmad 2018; Zaman et al. 2018; Ho et al. 2013; Nguyen and Nguyen 2007). conditions of the Creative Commons Trade openness is useful for observing the export–import balance of the country, Attribution (CC BY) license (https:// and is considered to be a key determinant of FDI inflows. Globalization and liberalized creativecommons.org/licenses/by/ trade policies affect the level of output and economic activity and attract foreign investors. 4.0/). Therefore, it is important to identify to what degree the trade policies are liberalized. J. Risk Financial Manag. 2021, 14, 90. https://doi.org/10.3390/jrfm14030090 https://www.mdpi.com/journal/jrfm J. Risk Financial Manag. 2021, 14, 90 2 of 18 Trade openness is useful for observing the export–import balance of the country, and is considered to be a key determinant of FDI inflows. Globalization and liberalized J. Risk Financial Manag. 2021, 14, 90 trade policies affect the level of output and economic activity and attract foreign 2inves- of 18 tors. Therefore, it is important to identify to what degree the trade policies are liberalized. Many countries have tried to attract more foreign direct investment by making their economy more open and implementing a variety of progressive policies. The impact of Many countries have tried to attract more foreign direct investment by making their trade openness on FDI inflow is expected to be mixed. Theoretically, trade openness af- economy more open and implementing a variety of progressive policies. The impact fects foreign direct investment positively or negatively, depending on the host country’s of trade openness on FDI inflow is expected to be mixed. Theoretically, trade openness trade policies (Liargovas and Skandalis 2012; Ponce 2006). First, the majority of empirical affects foreign direct investment positively or negatively, depending on the host country’s studies have found a positive relationship between trade openness and FDI inflows, as trade policies (Liargovas and Skandalis 2012; Ponce 2006). First, the majority of empirical demonstrated by the results in studies conducted by Makoni (2018), Sahoo (2006), Janick studies have found a positive relationship between trade openness and FDI inflows, as and Wunnava (2004), and Zaman et al. (2018). According to these studies, the positive demonstrated by the results in studies conducted by Makoni(2018), Sahoo(2006), Janick andrelationship Wunnava between(2004), and trade Zaman openness et al.( 2018and ).foreign According direct to theseinvestment studies, indicates the positive that a relationshipcountry with between fewer restrictions trade openness on imports and foreign and directexports investment has a higher indicates chance that of aattracting country withforeign fewer direct restrictions investment. on imports Secondly, and some exports studies has a have higher found chance a negative of attracting relationship foreign directbetween investment. trade openness Secondly, and some FDI inflow studies (Ado havew found and Tahmad a negative 2018; relationship Cantah et between al. 2018; tradeKhan opennessand Hye and2014). FDI Thirdly, inflow Ho (Adow et al. and (2013) Tahmad and 2018Wickramarachchi; Cantah et al. (2019) 2018; Khanfound andthat Hyetrade 2014 openness). Thirdly, had Ho no et significant al.(2013) and impact Wickramarachchi on FDI inflows(2019 in) BRICS found that(Brasil, trade Russia, openness India, hadChina, no significantand South impactAfrica) oncountries. FDI inflows in BRICS (Brasil, Russia, India, China, and South Africa)Incountries. line with the theory and earlier empirical papers, we seek to examine the causal relationshipIn line with between the theory trade andopenness earlier and empirical foreign papers, direct investment we seek to examineinflows in the Romania causal relationshipduring the period between from trade 1997 openness to 2019. and foreign direct investment inflows in Romania duringAt the the period beginning from 1997of this to period, 2019. between 1990 and 1995, the foreign direct invest- mentAt inflows the beginning in Romania of this increased, period, between but, comp 1990ared and to 1995,1994 theand foreign 1995, they direct still investment remained inflowslow from in Romania1990 to 1993. increased, In 1990, but, FDI compared inflows towere 1994 US$0.01 and 1995, million, they stillincreasing, remained in lowfive fromyears’ 1990 time, to to 1993. 419 million In 1990, in FDI 1995. inflows In 1996, were there US$0.01 was a slight million, decline increasing, in FDI inflows. in five years’ After time,1996, toforeign 419 million investments in 1995. inflow In 1996, grew, there wasrecording a slight higher decline values in FDI of inflows. over 1000 After million 1996, foreigndollars investmentsper year (for inflow instance, grew, they recording reached higher US$ 2031 values million of over dollars 1000 in million 1998). dollars This trend per yearof FDI (for growth instance, continued they reached during US$ the 2031 period million 2002–2008 dollars in(as 1998). shown This in Figure trend of 1), FDI reaching growth a continuedmaximum during value thein 2006, period and 2002–2008 corresponding (as shown to inan Figure amount1), reachingof 13,667 a million maximum dollars value in in2008, 2006, when and correspondingthe global crisis to started. an amount The ofchanging 13,667 million global economic dollars in 2008,situation when had the a globalcrucial crisisimpact started. on foreign The changingdirect investment, global economic as the global situation crisis had influenced a crucial the impact decision-making on foreign directprocess