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DETERMINANTS OF FOREIGN DIRECT INVESTMENTS

IN EUROPEAN COUNTRIES IN TRANSITION

DETERMINANTE STRANIH DIREKTNIH INVESTICIJA
U EVROPSKIM ZEMLJAMA U TRANZICIJI

Milica Delić, Dragana Kragulj
Faculty of Organizational Sciences, Belgrade
mild@fon.bg.ac.yu, kragulj@fon.bg.ac.yu

Abstract: Internationalization of the economic life and globalization of the world economy, have brought the
new quality elements into international economic relations, the same having reflected to the development of
the world market and to the economic growth at the world scale. This is illustrated by the high growth rates of
the world production and by the high growth rates of the world trade. Within the forthcoming period, we
should count with the already continuous process of the world economy, leading to the increase of number
of countries included into the international flows of trade, technology and investments. All this will have an
impact to the growth of foreign direct investments (FDI), owing to the fact that the world economy
globalization process is based on the trade and investments flows. In this paper, after survey of the FDI in
transition countries, will be discussed some econometric models, developed in order to describe the
influence of different characteristics of transition process to FDI.

Key words: Foreign direct investments (FDI), transition, econometric models.

Sadržaj: Internacionalizacija ekonomskog života i globalizacija svetske ekonomije, donela je kvalitetno nove
elemente u međunarodne ekonomske odnose, koji se odražavaju na razvoj svedskog tržišta i ekonomski rast
svetskih razmera. Ovo je ilustrovano velikim razmerama rasta proizvodnje i trgovine u svetu. U budućnosti,
može se računati sa nastavkom procesa širenja svetske ekonomije, koji vodi ka porastu broja zemalja
uključenih u međunarodne tokove trgovine, tehnologija i investicija. Sve ovo će uticati na porast stranih
direktnih investicija (SDI), zahvaljujući činjenici da se proces globalizacije svetske ekonomije bazira na
tokovima trgovine i investiranja. U ovom radu će, posle pregleda podataka o tokovima SDI u zemljama u
tranziciji i faktora koji utiču na njihov nivo, biti razmatrani neki ekonometrijski modeli, razvijeni sa ciljem da
opišu uticaj posmatranih faktora na nivo SDI.

Ključne reči: Strane direktne investicije (SDI), tranzicija, ekonometrijski modeli.

1. INTRODUCTION

While analyzing modern trends of exports of capital, it is necessary to percept the economic reality, such as
global economy, global markets and global competition. Exportation of capital from one to another country
represents the investments of capital into the economic development of some other country. It is done in
order to bring about higher profits from such investments than investing into one’s own country. The capital
moves to the regions where higher profits are expected. Movements of capital from one country to another
could be observed from various aspects. The main and the most important division implies two forms of
exportation of the capital: investments (existing when there is direct participation in the economic activities of
other countries and this is achieved through establishment of independent companies, purchase of the
already existing companies or by purchase and sale of shares or bonds – direct investments and portfolio
system) and credits, i.e. interest bearing (it appears when the credits are extended to foreign companies or
states, on which occasion the when the investor collects fixed interests from debtors). The basic criteria for
capital volume and movements consist in the difference in the profit amount or in dividends when the

and social issues. Today’s Global economy is characterized by many events related to changes in economic. which is fixed in nominal terms. FDI inflows in 27 countries in transition for the ten years period (1995 – 2004) are given in Table 1. 1994-2004 ( in US dollar million) Country fdi95 fdi96 fdi97 fdi98 fdi99 fdi00 fdi01 fdi02 fdi03 fdi04 Albania 70 90 48 45 43 143 207 135 178 341 Armenia 25 18 52 232 122 104 70 111 121 218 Azerbaijan 330 627 1115 1023 510 130 227 1392 3285 3556 Belarus 15 105 352 203 444 119 96 247 172 169 B&H .[7] FDI is generally considered less volatile during financial crises and unlike debt. 2. creation. harmonization. i. in the amount of interest rates if the loan capital is involved. development of transitional processes and integration in the European. 67 177 146 119 268 382 498 Bulgaria 90 109 505 537 819 1002 813 905 2097 1803 Croatia 114 511 538 935 1472 1089 1559 1124 2042 1076 Czech Republic 2562 1428 1300 3718 6324 4986 5641 8483 2101 4463 Estonia 202 151 267 581 305 387 542 284 919 1049 Georgia . 243 265 82 131 110 165 338 499 Hungary 4834 3333 4174 3350 3311 2777 3949 3021 2155 4178 Kazakhstan 964 1137 1321 1151 1472 1283 2835 2590 2088 4269 Kyrgyzstan 96 47 83 109 44 -2 5 5 46 35 Latvia 180 382 521 357 347 413 132 254 300 647 Lithuania 73 152 355 926 486 379 446 732 179 773 Macedonia 9 11 30 128 33 175 442 78 95 157 Poland 3659 4498 4908 6365 7270 9343 5714 4131 4124 6159 Republic of Moldova 67 23 79 76 38 127 102 132 71 148 Romania 420 267 1221 1976 1041 1037 1157 1146 2196 5088 Russian Federation 2066 2579 4865 2761 3309 2714 2748 3461 7958 11672 S&M . . Twenty-seven countries are currently going through the process of transition. . tend to crowd out domestic investment. . are the changes taking place in the counties of Eastern and Central Europe and Western Balkans where the centrally planned economic system is being dismantled. . 740 113 112 50 205 509 1510 994 Slovakia 308 353 231 707 428 1925 1579 4012 669 1107 Slovenia 151 174 334 216 107 136 370 1645 339 516 Tajikistan 20 18 18 25 21 24 9 36 32 272 Turkmenistan 233 108 108 62 . formulation of policies of openness and credibility. - Ukraine 267 521 623 743 496 595 792 693 1424 1715 Uzbekistan -24 90 167 140 121 75 83 . FDI inflows in European countries in transition. . Transition is a multidimensional process which encapsulates many objectives that must be achieved. . . and strengthening of the institutions and policies relevant to the functioning of a market economy. regional. are the changes in Western Europe which relate to economic and political integration of these countries. . creation of conditions for attracting foreign direct investments which will enable long-term economic growth.[3] FDI inflows are considered as “the engine of growth” in Central and Eastern Europe in the last 10 years. The most dramatic are the changes in Europe.e. etc.investment form of capital exportation is effected. They encompass 400 million people and 17% of the total surface area. - . domestic and foreign trade liberalization. On the one side. such as: liberalization of the market and prices. political. it is re-priced as conditions evolve and does not involve a currency or a maturity mismatch. . and hence the World economy. democratic. reforms in the sphere of politics. FDI INFLOWS IN THE EUROPEAN COUNTRIES IN TRANSITION Of the various types of capital flows. strengthening of laws and legislative order. privatization of enterprises. Table 1. and on the other. Capital inflows such as bank loans and bond funds. reform of the banking system and capital market. foreign direct investment is generally considered to be the most desirable. however FDI tends to increase national investment in an equal amount.

roads. possibility of financing new investments that exert an influence to the increase of employment. administration efficiency.) and social property. • privatisation policy. A country may gain the benefits from FDI without also being dependent on net capital inflows or increasing its net external debt [7].FDI can also provide the country with much needed technological and managerial expertise. Economic determinants: • Consumer needs for FDI: . Business possibilities: • investment promotion (including building of reputation. consumer preferences proper for the country concerned. as well increased exports. . • rules relating to establishment and operation of companies. costs of resources and intangible investments from previous list and adapted to productivity of the resources labour force. access to regional and global markets. • FDI needs for resources/intangible investments: . skilled labour force. . but it is essentially reduced to the increase of profits. revenue. • international FDI contracts. . raw materials.[4] Political circumstances: • economic. During 2003 worldwide FDI flows stabilized after declining in the previous two years due to the slowdown in economic activity during this period. . work productivity. cheap unskilled labour force. the capital exportation enables them to bring about the increased utilisation of capacities. trade mark) and real infrastructure (ports. • treatment standards for foreign branch offices. technical-technological. • post-investment services. energy. • investment incentive measures. . • trade policy. • costs (relating to corruption. When the importing countries are concerned. only after reaching a relatively higher level of development do significant outflows begin. transfer of new technologies and knowledge without need to purchase the licenses. market enlargement and new technologic development. etc. When the exporting countries are concerned. etc. market growth. • tax policy. creation of investment activities). innovative and other intangible investments (i. DETERMINANTS OF FDI INFLOWS Foreign capital has a key role in the economic development. market structure. especially on the medium and long-term basis. The basic determinants that determine the inflow of foreign direct investments into the host country are certain economic and political circumstances. . . • Needs for FDI efficiency: . As countries develop they initially receive inflows of FDI. 3.e. political and social stability. market size and level of per capita income. • functioning policy and market structure. . budgetary revenue. telecommunications). the capital importation provide them the additional accumulation.

clustering in certain locations—where the existing business infrastructure is set up to serve a particular industry or the presence of other investors provides positive externalities through network effects or backward and forward linkages—and “herding. Usually. Large investors are sometimes able to coax concessions from country governments in return for locating investment there. 2004 (EU-8): Poland. and privatization policies appear to be significant factors mobilizing inward FDI to the EU New Member States. since FDI flows are non-debt- creating. a number of host country factors. The idea of the gravity model is that amounts of bilateral resource flows will positively depend on size of source/destination countries (usually represented by GDP. The authors often suggest that both economic space and size similarity should have positive impact on FDI. can have different effects on HFDI and VFDI. Slovenia. First regards FDI in the new Central and Eastern European EU member states and second the potential FDI in Southeastern Europe. although in real life this distinction is often blurred. and its effects have been extensively studied. Horizontal FDI (HFDI) is market-seeking investment. was mainly VFDI. Regional trade integration. the Czech Republic. Market size is considered a significant FDI determinant as large markets offer opportunities of capturing . and negatively by transportation costs (that is reverse proportional to physical distance between countries). and improved access for exports abroad. There is broad agreement that HFDI is more prevalent. and often do. productivity spillovers. based on gravity model. It has long been recognized that the benefits of FDI for the host country can be significant. notably in the source country. One can check theories and hypotheses by introducing new variables that represent new influences. in principle. Cumbersome theoretical models usually lead to rather simple empirical models. Hungary. and transport costs. or even all mentioned factors are used simultaneously). However. Slovakia. common border. is often used. Both types of FDI are. In particular. Vertical FDI (VFDI) is cost-minimizing investment. labor cost. Lithuania and Estonia. Moreover. the model was the attempt to assess the main FDI determinants for these countries after accession. membership in various organizations and being former colony or colony owner.” where investors tend to follow a leader that establishes operations in a particular country. At the same time. whose aim was to provide some assessment of the FDI prospects of the eight transition countries acceded to the EU on May 1st. trade restrictions. membership according to regional integration agreement. abuse their dominant market positions and. Latvia. For example. there is also evidence that the recent surge in FDI flows to developing countries. subject to “agglomeration. FDI IN THE NEW CENTRAL AND EASTERN EUROPEAN EU MEMBER STATES In [5] is developed model. in particular. based on gravity model. As a result of these differences in motivation. gravity models are still used to examine various international trade theories. FDI related to exploiting abundant natural resources does not easily lend itself to categorization into vertical or horizontal FDI. where these deficits can be large and sustained.e. and production factor cost seeking. costs of other inputs. such as market size. enhanced competition. which just reflects potential supply/demand. Despite of relative simplicity. Two types of FDI are identified in theory.[1] Econometric models are used in the quantification of FDI determinants. Foreign direct investment. its determinants. developed approximately forty years ago. i. and aggressively use transfer pricing to minimize their tax obligations. Originally. especially in developing countries. gravity equation takes the log-linear form[2]: ln(FDIij) = α + β1ln(GDPi) + β2ln(GDPj) + β3ln(DISTij) + ΣγkDkij +εij In order to take into account other factors. FDI can be a mixed blessing. when local production is seen as a more efficient way to penetrate this market than exports from the source country. In small economies. country risk. So called gravity model. domestic market. sometimes by population size or land area. including knowledge and technology transfer to domestic firms and the labor force.” that is. they are a preferred method of financing external current account deficits. FDI motives may be classified in two broad categories: market seeking. large foreign companies can. attempt to influence the domestic political process. it was used to analyze only trade flows between countries. when a multinational corporation chooses the location of each link of its production chain to minimize global costs. Here will be discused in more details two models. Products. control dummy variables are usually used. aimed primarily at the domestic market in the host country. especially in developing countries. . one should use common language. 4. transportation and communication costs in/towards and within the framework of national economy and cost of other interm.

etc.81 2.37 1.56 1. IN. Labour in CEE is considered of high skill and training levels compared to other developing countries with large wage differentials vis-à-vis the EU-15.16 WR -3. of gaining access to domestic markets and establish market shares either in a game of international oligopoly competition. The model for the EU-8 is formulated as it follows: FDI =F(YN. avoiding transportation and/or trade restriction costs.wages in the country. WR. capabilities of product differentiation and marketing.77* MR -0.26 1.g. WR . PR .ratio of imports coming from EU over total imports of the country. inability to serve foreign debt.50 1. Relative interest rate approximates country risk.67** IR -0. WEU-15 .52** DW 2. IR . LI . Country risks as they are measured by interest rates. XR. PR.EBRD index of price.78 YN 0.g.inward FDI to the country.Privatization revenues of the country.GDP per capita of the country.36 2. sharp currency devaluations. etc. IN . [5] The results are presented in Table 2. ** Means significance at 5% level. or even by serving a market on equal competitive terms with local producers. LI. e. Low labour cost has been verified as a significant motive for FDI entering the CEE. YN . This uncertainty reduces as both the form of government and political stability consolidates and both economic and political liberalization assume a stable pace.09 * Means significance at 10% level. inflation. (XR represents trade integration in the EU. MR. for each of EU-8 countries.74* PR 0. forex and trade liberalization. state budget balance.84 F stat. Table 2: FDI estimates for the period 1992-2004 GLS estimates values of t-statistics Constant -2. and economic growth becomes positive and sustainable the business environment increases its investment friendliness by diminishing economic risks as they are portrayed in fiscal crises. macroeconomic imbalances are reduced.73* R2 0.Ratio of lending rate in the country over SDR interest rate.13 0. In addition as the economy overcomes the output transition shock.26 0.Wi over WEU-15 (Wi .relative labor cost .12 LI 2.) MR . closing the psychic distance between the home and host market. The higher the country interest rate over the SDR interest rate the higher the risk premium borrowers in country have to pay.EU average real wage) XR .ratio of exports to EU over total exports of the country. [5] Given that CEE countries are on a path of transition from centrally planned to a free market economic regime along a political transformation from one party autocratic regimes to pluralistic Western type democracies there is some uncertainty as whether or not this process is irrevocable.economies of scale.EBRD index of infrastructure reform for the country. or by preempting the market. etc. e. IR) Where. of seeking economic rents through internalizing the further use of already existing firm specific assets. are identified as having some effect on inward FDI to CEE by empirical studies. corruption.68** IN -0. The log linear form of the equation is estimated using GSL econometric technique (with cross section weights) over a set of panel annual data comprised by all EU-8 countries for the period 1992-2004. especially labour and capital cost is part of a global sourcing strategy for improving competitiveness aiming at assisting exports and increasing profits. the variables are: FDI . Low cost production. A number of studies on FDI in Central and Eastern Europe (CEE ) point out that market seeking motives are the dominant reasons for entering these markets. .43** XR 0. 10.31 4.

Romania moves several notches down). regardless of the region. e. Two characteristics of the process are interesting. The elasticity of the latter is below unit for all cases vis-à-vis elasticity above unit in the case of the relative labor cost. the sources of FDI are highly concentrated: Germany. the tax regime. The paper develops the concept of potential FDI for each country. This conclusion holds regardless of what metric is used to compare FDI across these two groups of countries. Just as with trade flows. and encourages private sector development can be expected to stimulate all private. and uses its deviation from actual levels to estimate what policies can realistically be expected to achieve in terms of additional FDI. the gravity model consistently explains about 60 percent of aggregate FDI flows. except for Croatia. At a very general level. There is clear evidence that Southeastern European countries as a group generally lag behind Central European countries in attracting FDI.g. minimizes distortions. relative labor cost and country risk are the statistically significant variables and they all have the expected sign. especially to the EU-15 countries. The studies examine whether horizontal or vertical FDI is predominant in the region and reports that in Central European economies HFDI is prevalent.[1] provides insight in “geographic” structure of FDI in Southeastern European countries. In absolute levels of FDI stock at the end of 2003 there is considerable differentiation within the Southeastern European group. Italy. supports competitiveness. The country ranking also is influenced by the size of these economies. Poland is ranked between the Slovak Republic and the Baltics. a predictable policy environment that promotes macroeconomic stability. ensures the rule of law and the enforcement of contracts. Several models. Exports appear to be a significant and positively related factor with inward FDI. are developed. and infrastructure are statistically significant only in some of the studies. Figure 2. As political and economic stability improves and a business friendly environment is consolidated. privatization revenues. The negative sign of the imports variable indicates that FDI is import substituting. POTENTIAL FDI IN SOUTHEASTERN EUROPEAN COUNTRIES In the paper [1] are analyzed determinants of FDI in the Southeastern European countries.GDP per capita. Southeastern European countries. However. but that the evidence for Southeastern European countries is inconclusive. this finding puts into perspective the efforts of policymakers in host countries to attract FDI. It also finds evidence that above a certain threshold. Labor costs and institutional variables (various indicators of progress in transition. Virtually all empirical studies find that gravity factors (market size and proximity to the source country) are the most important determinants of FDI. First. country risk reduces and FDI activity facilitates. Austria. Since gravity factors are exogenous. and Greece are among the top five sources for almost all Southeastern European countries. The policy environment does matter for FDI. The results of the econometric research presented here shows that factors pulling FDI to the accession countries are: their domestic market with both privatization of state owned firms and import substitution present attractive options for market entry. FDI is rather more elastic with respect wage differentials between the EU-8 and the EU-15 than the other statistically significant variables. investment. and progress in EU accession) also play a significant role. including foreign. Figure 1.[1] shows the stock of aggregate FDI at end-2003 in per capita terms. with Romania and Croatia having attracted more than their peers. political stability. . While the ranking of some countries changes (Croatia moves up the rank. the method of privatization. the importance of some policies for attracting FDI is distinctly different. based on gravity model. still lag well behind their Central European neighbors. Gravity factors explain a large part of Foreign Direct Investment inflows in Southeastern Europe.000 provides a clear demarcation line between the two groups. but the aim of the research was to see if the host- country policies also matter. A per capita FDI stock of about US$1. When empirical studies attempt to estimate the impact of individual policies on FDI. In the paper is emphasized that econometric research confirms that gravity factors are important determinants of FDI. increases of the per capita income. The implication is that future increases of the labor cost in the EU-8 towards convergence with the EU-15 would diminish the motivation of foreign firms to invest in the EU-8 to a greater extent than any favorable effect stemming from advances in the domestic market. index of economic freedom. openness to trade. estimated and discussed. the results are often ambiguous[1]. A pool of well-educated low cost labor form the basis for factor cost sourcing and then exports.[5] 5.

2003 (in US dollars) Figure 2. Figure 1. FDI: Top five source countries (2003 stock in US dollar million) . FDI stock per capita.

there are limits to the discretion policy-makers have. and Lithuania treated as one host destination. To determine the factors that influence FDI. What is the “best” value of the policy variables? Clearly. revenue considerations generally preclude driving tax or tariff rates to zero. in Bulgaria and Romania. . are gradually emerging as sources of FDI in the less advanced Southeastern European countries (Bosnia and Herzegovina. Russia. the standard workhorse used in the empirical literature of this kind. and even above that for Bosnia and Herzegovina. can be developed and estimated for the countries of interest. the distance between source and host capitals (also in logs). the statutory corporate income tax rate (IMF). It is the size of this impact that is of primary interest to policy-makers. the Slovak Republic. and the US. presents the results and Figure 3. the authors used the “best” level of the policy variables across the sample. Second. proximity. Moldova. Croatia. That is the highest value of the foreign exchange and trade liberalization and infrastructure reform indices. The gap between actual and potential FDI is found to be relatively small in the Central European and Baltic countries. Poland. The preponderance of gravity variables among the determinants of FDI. The dependent variable is a cross-section of bilateral FDI flows or stocks (in logs) between 15 host and 24 source countries averaged for 2000-2002 from the OECD’s International Direct Investment Statistics. These results should be treated with caution. Additional regressors include the ratio of tariff revenues to the value of imports (EBRD Transition Reports). Then can be defined a “potential” level of FDI for each host country using the actual values of exogenous variables and the “best” values of the policy variables. Bulgaria. some of the more advanced countries in the region. policy-makers in host countries use the level of policy variables in their neighbors and competitors as a benchmark. even if certain policy variables are unambiguously identified as significant determinants for FDI. the Czech Republic. or history of their country. The successful transition experience of Central European countries and the Baltics. The gap between actual FDI and this “potential” would measure how much each host country stands to gain from getting its policies right. In reality. On the right-hand side. the Czech Republic. as well as the case of Moldova. has drawn attention to the importance of the policy environment and catalyzed efforts to encourage FDI flows in Southeastern Europe. These countries have the most to gain from getting their policies right. often based on gravity model. Bosnia and Herzegovina. different econometric models. and Moldova. There is significant potential for generating further FDI in all Central and Southeastern European countries. To estimate the “potential” FDI stock. Latvia. the gap is around 50 percent. Serbia and Montenegro. Slovenia. supplemented by data provided by country authorities. While “better” values for these variables are of course possible. It also provides an appealing measure of the relative potential gain in terms of additional FDI across the countries of the region. shows the ratio between actual and “potential” non privatization FDI stock at end-2003. attributed to some extent to their ability to attract large amounts of foreign investment at an early stage. using the “best” values of the policy variables from the sample does not mean that these policies cannot be improved further. similar to one described in [5]. the FYR of Macedonia). in particular. FYR of Macedonia. Table 3. the GMM model estimated on the basis of the described data was used [1]. FYR of Macedonia. and a dummy capturing cultural or historical ties between source and host country. and the lowest unit labor cost. and endogenous or policy-related variables that are under their control. To estimate a realistic level of “potential” FDI in these conditions. The models. suggests that policies can have a relatively limited. themselves important hosts of FDI flows from Western Europe. Thus. as in the OECD database. To capture the impact that policies could have on FDI in this environment. impact. Switzerland. For Poland and Serbia and Montenegro. tariff level. location. Moreover. the authors distinguish between exogenous determinants— the gravity variables—that are taken as given by policymakers. As mentioned above. albeit still significant. and somewhat surprisingly. and corporate tax burden across the countries in Central and Southeastern Europe in 2003. Host countries are Albania. Hungary. or in conjunction with GDP per capita in purchasing power parity (PPP) terms. are used three gravity variables: population. Hungary. underscored by the existing empirical literature. Albania. provides strong prima facie support to the hypothesis that gravity variables. the calculated “potential” may underestimate what countries can actually achieve through better policies. and it reaches between two-thirds and three-quarters for Croatia. since they cannot affect the size.This. as well as Estonia. Poland. play a major role in determining FDI flows. even if this were beneficial for FDI. The authors in [1] started with bilateral cross- section regressions. Source countries are the EU15 plus Croatia. as a proxy for market size and potential. Slovenia. The goal of the further research was to estimate the impact that policies could have on FDI. the EBRD index of foreign exchange and trade liberalization (EBRD Transition Reports). either alone. are estimated. where FDI originates mostly in Russia. Cyprus. this approach gives a reasonable idea of the level of non privatization-related FDI that could realistically be expected if policy-makers in each host country emulated their best-performing neighbors.

donors.Table 3. and their estimated coefficients may thus be hard to interpret. On the one hand. such as the index of reforms or the estimated “bribery tax. and policymakers in Southeastern European countries on liberalizing the trade and foreign exchange regime and controlling labor costs is appropriate: the results suggest that these policies are indeed likely to have a beneficial direct impact on FDI. however. Estimated potential and actual nonprivatization FDI stocks. to a lesser extent. 2003 (In millions of US dollars) Country Potential FDI Actual FDI Gap (in percent) Hungary 38385 31488 18 Bulgaria 2729 2063 24 Baltic countries 16114 11785 27 Czech Republic 33638 23550 30 Slovak Republic 4813 3316 31 Slovenia 3321 2170 35 Romania 14206 8848 38 Serbia & Montenegro 2894 1441 50 Poland 52752 25080 52 Macedonia. On the other hand. These findings can provide an analytical foundation for the evaluation of policies aimed at making Southeastern European countries more attractive to foreign investors while. a high level of import tariffs discourage FDI. highlighting the limits of what these policies can achieve. FYR 1690 611 64 Croatia 21890 7547 66 Albania 3302 1067 68 Moldova 3205 742 77 Bosnia & Herzegovina 5763 1064 82 Figure 3. the policy environment in the host country still matters for FDI.” may be imperfect proxies: they may be correlated with each other or with other factors that also influence investment decisions. tax holidays and domestic corruption do not seem to have a statistically significant impact in the countries in our sample. at the same time. The results concerning institutional variables. In contrast. Gap between potential and actual non-privatization FDI stocks. come with a health warning. and. Explanatory variables that purport to measure the quality of institutions. a high corporate tax burden. efforts to improve governance . It can be seen that high unit labor costs. the emphasis placed by international financial institutions. while a liberal foreign exchange and trade regime and advanced reforms in the infrastructure sector encourage FDI. 2003 (in percent of potential FDI) Nevertheless.

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