The Impact of Free Zones on Foreign Direct Investment: Evidence from Nine Developing Countries

Abstract

This study examines the relationship between free zones and foreign direct investment (FDI) in a sample of nine developing countries—Cambodia, Colombia, India, Indonesia, Malaysia, Tanzania, Thailand, the United Arab Emirates, and Vietnam—over the period 2000–2024. Due to the lag structure of the Panel ARDL model, the effective estimation window is 2003–2024. The study aims to evaluate the relationship between free-zone development and FDI by distinguishing between short-run and long-run effects. To address the lack of a standardized indicator for measuring free-zone development, the study develops a quantitative indicator based on the cumulative area of free zones, using information on their establishment dates and spatial expansion over time. The study employs the Panel Autoregressive Distributed Lag (Panel ARDL) model with the Pooled Mean Group (PMG) estimator to examine the dynamic relationship between free zones and FDI. Unit root and Johansen–Fisher panel cointegration tests are used to assess the time-series properties of the variables and the existence of a long-run equilibrium relationship. The empirical findings indicate a positive and statistically significant long-run association between cumulative free-zone area and FDI stock, while the short-run association is not statistically significant. The results also show positive and statistically significant long-run associations between government spending, labor force participation, and urbanization with FDI stock, whereas only changes in government spending are statistically significant in the short run. Overall, the findings indicate that the relationship between free-zone development and FDI stock becomes more evident over the longer adjustment period.