Urbanization as a catalyst for structural transformation in developing countries: The mediating impact of foreign direct investment

Abstract

This article analyzes the link between urbanization and the process of structural transformation (ST) in developing countries, taking into account the mediating role that FDI can play. We use secondary data from 2000 to 2023 to determine if FDI positively or negatively influences the ST process in these countries, thereby, altering urbanization patterns. By estimating the Generalized Method of Moments (GMM), the study explores the relationship between urbanization, the ST process, and the mediating role played by FDI. In addition, it takes into account control variables such as gross fixed capital formation (GFCF), gross domestic product per capita (GDPPC), and diversification of production structure (DPS) to analyze their effect on urbanization and, more specifically, on the ST process. The econometric results showed a negative correlation between FDI flows and urbanization, demonstrating that FDI could hinder the success of the ST process in developing countries. On the contrary, econometric results showed that the control variables, GFCF, GDPPC, and DPS, positively influence urbanization in developing countries, indicating that these variables are more conducive to a successful ST process than FDI. Based on the econometric results, policymakers in developing countries are called upon to strengthen urbanization in these countries, by encouraging local investment and the diversification and sophistication of production and export structures, rather than relying solely on FDI. Over the period studied, FDI has not contributed as expected to advancing the urbanization process, a crucial element in the ST process in developing countries.