Public Debt and Foreign Direct Investment in Transition Economies: A Data-Driven Comparative Analysis of Crisis Dynamics and Threshold Effects

Abstract

This study examines the relationship between public debt and foreign direct investment (FDI) in six Western Balkan (WB-6) countries and eleven Central and Eastern European Union (CE-EU-11) countries during the period 2000–2023. The results, based on a dynamic panel threshold regression model with endogenous regressors, indicate that public debt has a statistically significant adverse effect on FDI across both debt regimes, with the estimated threshold ranging between approximately 69% and 72% of GDP. These findings provide evidence of a persistent crowding-out effect of public debt on foreign investment. While the magnitude of the effect varies across debt regimes, public debt consistently discourages FDI inflows. The findings also reveal strong persistence in FDI, with moderate inflation and institutional quality exerting positive effects. Furthermore, the positive interaction between EU membership and public debt suggests that foreign investors are more tolerant of higher public debt levels in Central and Eastern European EU countries than in the Western Balkans.