What drives interdependence of FDI among host countries? The role of geographic proximity and similarity in public debt

We investigate the drivers of interdependence between flows of foreign direct investment (FDI), focusing on two potential channels: interdependence between geographically close FDI destination countries, and between destination countries with similar levels of public debt. Using data on bilateral FDI flows between the 27 EU member countries in 2007, we find that in addition to geographic proximity, similarity in public debt levels drives cross-country correlation in FDI inflows. The public debt threshold of 60% of GDP prescribed by the Maastricht Treaty is a crucial driver of interdependence between FDI inflows. FDI inflows are correlated within the group of compliant countries as well as within the group of non-compliers. This is consistent with the fact that foreign investors distinguish between countries which violate this Maastricht criterion and those that do not.