Report  October 2010

Best Policy Practices for 

Promoting Inward and Outward
Foreign Direct Investment

Trade, investment policy, and international cooperation

Electronic copy available at: http://ssrn.com/abstract=1722003

Best Policy Practices for Promoting Inward and Outward Foreign Direct Investment
by Steven Globerman and Victor Zitian Chen

About The Conference  Preface

Board of Canada This report identifies and discusses best practices to
attract and promote inward and outward foreign direct
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Contents

Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . i

Chapter 1—Introduction and Conceptual Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Conceptual Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Chapter 2—Methodology and Main Findings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Categories of Variables for the Determinants of FDI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Categories of Variables for the Determinants of FDI Spillovers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
What Affects Foreign Investment? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
What Determines Investment Quality? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Chapter 3—Policy Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Appendix A—Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Publications Related to FDI/FDO Determinants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Publications Related to Determinants of Spillover Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

Appendix B—Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
Acknowledgements
The authors thank Adrian Bibby for excellent research assistance. They also thank Ram Acharya, Danielle
Goldfarb, and Walid Hejazi for very helpful comments and suggestions on earlier drafts.

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1 These organizations do not necessarily endorse the research conclusions of this paper.
Executive Summary

Best Policy Practices for

Promoting Inward and Outward
Foreign Direct Investment
equity shares of local companies by foreign investors.
At a Glance When viewed from the perspective of the recipient (or
host) country, we are discussing inward foreign direct
 Best policy practices for attracting foreign dir-
investment—referred to as FDI in this report. When
ect investment, and for promoting “spillover”
viewed from the perspective of the sending (or home)
productivity benefits from that investment, are
country, we are discussing outward foreign direct
“framework policies”—such as transparent
investment—referred to as FDO in this report.
regulations and solid infrastructure and edu-
cation policies.

 It is less clear from the evidence whether
policies that specifically target foreign invest-
ors—such as subsidies and tax breaks—are
best practices for attracting investment. Such
policies could even reduce any spillover pro-
ductivity effects from that investment.
 Though there is less evidence on what directly
encourages outward foreign direct invest-
ment, it is clear that the framework policies
that favour inward foreign direct investment
also encourage outward direct investment
over the longer term.
This report identifies and discusses “best practices” to
attract and promote inward and outward FDI from the
perspective of national and sub-national governments.
While not without some disagreement, the broad con-
sensus of economists is that inward foreign direct
investment and outward foreign direct investment have
net economic benefits for host and home economies. As
a result, policy-makers have an interest in identifying
public policies that support inward and outward foreign
direct investment. There is also a potentially substantial
economic payoff to policies that leverage the economic
benefits of FDI and FDO.

T
his report identifies and discusses “best practices”
to attract and promote inward and outward for-
eign direct investment from the perspective of
national and sub-national governments. Foreign direct
investment can be thought of as investments in productive
assets that are managed by companies headquartered in
foreign countries, as opposed to financial investments in
This report offers an extensive and systematic review of
the empirical evidence on what factors affect FDI and
FDO. We identify the major policy and other factors
that influence the location decisions of foreign investors
and the decisions of domestics firms to expand abroad.
We review the evidence at both the national and sub-
national levels to better inform Canadian policy-making

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ii  |  Best Policy Practices for Promoting Inward and Outward Foreign Direct Investment—October 2010
at various levels of government. A related focus is to
evaluate how such factors affect the quality of foreign
direct investments. Specifically, we ask which policies
and other factors affect the degree to which foreign dir-
ect investment improves productivity in the economies
receiving the investment.
The limited available evidence suggests that best practices
for promoting outward direct investment are similar to
those for attracting inward direct investment.
Our detailed analysis of the literature indicates that:
1. Best practices that make locations attractive to foreign
investors include public policies that are convention-
ally associated with promoting productivity and real
economic growth more broadly. This includes a reli-
able and transparent legal and regulatory regime, an
educated and skilled workforce, good transportation
and telecommunications infrastructure, and an
environment that encourages innovation.
2. Such factors also contribute to greater “productivity
spillover” benefits from FDI.
3. Policies—such as subsidies and tax breaks—that
specifically target foreign investors are not necessarily
best practices for attracting investment. The evidence
is not clear that such fiscal incentives promote FDI in
the longer run. Such policies could even reduce any
spillover productivity effects from that investment.
This is particularly true if subsidies or tax breaks
result in FDI that geographically disperses industrial
and scientific capacity.
4. The limited available evidence suggests that best
practices for promoting outward direct investment
are largely similar to those for attracting inward dir-
ect investment. Contrary to popular conception, an
environment favourable for inward direct investment
is not unfavourable for outward direct investment. This
is because policies promoting improved productivity
and real economic growth ultimately strengthen the
competitive advantages of domestically owned firms.
This, in turn, encourages and enables domestic firms
to expand internationally, including investing abroad.
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5. Further, because outward direct investment focuses on
accessing specialized skills and knowledge abroad,
it can lead to greater productivity benefits at home.
This is because skills and knowledge transferred
from host countries to the home country are likely
to convey productivity benefits to organizations
beyond the home-country multinational company
responsible for directly or indirectly transferring the
skills and knowledge to the home country.
6. These findings have important implications for
Canadian policy-makers at the federal, provincial,
territorial, regional, and city levels. In choosing loca-
tions for foreign direct investment, investors largely
look at the quality of legal and regulatory governance,
physical and communications infrastructures, and
the workforce’s education and training level. These
components of a favourable FDI environment are
importantly influenced by public policy, including
government spending. While Canada and sub-
national political units in Canada rate relatively
highly on these attributes, there is certainly scope for
improvement. In particular, improvements to roads
and ports could be accelerated. Also, encouraging
increased science and related technical education in
publicly funded schools would enhance the quality
of Canada’s workforce and promote the ability of
Canadian companies to create and quickly adopt new
technology. This, in turn, would strengthen the ability
of Canada to encourage FDI and capture its produc-
tivity benefits.
7. The use of government agencies to attract FDI can
be an effective policy instrument at the national and
sub-national levels. Specifically, promotional agen-
cies can be effective tools to educate foreign invest-
ors about the advantages of a location, as well as to
mitigate administrative procedures and delays that
impose costs and risks on foreign investors. The
activities of promotional agencies might be espe-
cially relevant for sub-national governments, since
foreign investors are likely to be less aware of the
economic advantages of specific locations within
Canada than they are of the economic attributes of
the country, as a whole.

8. Higher taxes, by themselves, are a disincentive to
FDI, although their quantitative importance has been
difficult to estimate precisely; however, the public
services and amenities paid for through taxes—
including education, physical infrastructure, efficient
and reliable legal and regulatory governance, and so
forth—attract FDI, again at both the national and
sub-national levels. To the extent that lower taxes
require commensurate reductions in “desirable” public
services and amenities, FDI is likely to decrease, on
balance, as will the efficiency benefits from FDI.
9. A concentration of economic activity in geographic
locations encourages FDI and strengthens its produc-
tivity benefits. The implication is that public policies
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The Conference Board of Canada  |  iii
that intentionally (or unintentionally) geographically
disperse “agglomerations” of skilled labour and spe-
cialized production capacity are ill-advised from a
best-practices perspective. This observation is par-
ticularly relevant at the sub-national level.
10. There is no consistent evidence that requirements
imposed on foreign investors to buy inputs from
local suppliers, or to take in domestically owned
partners through joint ventures, enhance the benefits
from inward direct investment. Since such require-
ments are likely to discourage FDI, holding other
things constant, they are undesirable from a best-
practices perspective.
Chapter 1
Introduction and Conceptual
Background
Chapter Summary
 This report systematically reviews the empirical
evidence on which factors influence the quantity
of inward and outward foreign direct investment.
 The report also assesses which factors influence
the quality of that investment, or the degree to
which it confers productivity benefits on the
receiving country.
 More attention has been paid to productivity
benefits from inward foreign direct investment,
but outward investment can also confer produc-
tivity benefits to the home economy by intro-
ducing new technologies, expertise, and inputs.
 The factors that affect the degree to which
investments have spillover productivity benefits
tend to be similar for outward and inward for-
eign direct investment—an example is com-
panies’ capacities to absorb new technologies.
T
his report addresses the broad issue of whether
there are “best practices” to attract and promote
foreign direct investment from the perspective of
both host and home countries (or regions). In particular,
the report reviews and evaluates numerous empirical
studies that help answer two specific questions:
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1. Which factors influence inward foreign direct
investment (referred to as FDI in this report) and
outward foreign direct investment (referred to as
FDO in this report)?
2. Which factors influence the quality of that FDI to the
host country and FDO to the home country? We focus
specifically on whether that investment confers addi-
tional productivity benefits.
The evidence from the empirical studies provides the
basis for policy recommendations with regard to FDI
and FDO.
The report does not deal with arguments about whether
or not FDI and FDO have overall net economic benefits to
host and home countries. A long, complex, and extensive
body of literature deals with this broad concern, which
is well beyond the scope of this study. Furthermore, a
companion piece to this report to be prepared by The
Conference Board of Canada will discuss the economic
impact of FDO. The premise underlying this study—
which reflects the balance of the evidence—is that both
FDI and FDO convey net economic benefits, at least for
current volumes of both, such that it is in the economic
interests of governments to facilitate more of both types
of investments at the margin—that is, incrementally. In
this regard, knowledge about factors influencing FDI
and FDO should be of value to policy-makers, as should
insights into the factors that either increase or decrease
any spillover productivity or other economic benefits
2  |  Best Policy Practices for Promoting Inward and Outward Foreign Direct Investment—October 2010
from that investment. Hence, the specific questions
focused on in this report are fundamentally relevant to
the design and implementation of what might be identified
as “best practices” for two-way foreign direct investment.
Since the bulk of the relevant literature deals with for-
eign direct investment policy issues at the national
level, there is relatively little evidence on best practices
for sub-national political units, such as provinces.
Nevertheless, we review what evidence is available for
sub-national units with regard to the specific research
questions identified above, and compare and contrast
findings for the different levels of government.
Furthermore, while the specific policy focus is on
Canada, much of the existing evidence concerns other
countries. Hence, some attention is paid to how results
for other countries might be applied to Canada.
Often-recommended public policies to attract FDI include
transparent regulatory regimes, investments in infrastruc-
ture and education, corporate tax reductions, subsidies,
and eliminating limitations on foreign investments.
This report concludes that the main public policies
identified as best practices are neither unique to promo-
ting FDI and FDO flows, nor to promoting the benefits
of those flows. For example, policy recommendations
relevant to macroeconomic policy, rule of law, protection
of property rights, investment in physical infrastructure
and human capital, and so forth, are broadly appropriate
to influencing real economic growth, as well as FDI
and FDO. Specific policies of potential interest, such as
government subsidies to foreign investors, might influ-
ence the magnitude of FDI but also condition its net
benefits, and sometimes in the opposite direction of
their influence on the size of FDI flows. In other words,
while such policies might increase the amount of for-
eign direct investment, they could reduce any spillover
productivity effects from that investment. (See
Appendix C for a glossary of terms used in this report.)
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Conceptual Background
Policy discussions in the literature are disproportion-
ately focused on FDI as opposed to FDO. In particular,
while the economic impacts of FDI have been widely
acknowledged and discussed, and numerous statistical
studies of these potential impacts exist, the economic
impacts of FDO are poorly understood; in part because
empirical studies addressing those impacts are few in
number.1 As a result, far more attention has been paid
to policies that influence FDI and to the effects of FDI
on the host or receiving country than to policies that
influence FDO and to the effects of FDO on the origin-
ating country. In addition, far more has been written
about the determinants of the location choices of for-
eign investors than about the determinants of the eco-
nomic impacts of foreign direct investment.
Factors That Affect the Quantity of Foreign
Direct Investment
A number of often-recommended public policies to
attract FDI can be identified in the literature. They
include the following eight policies:
1. Establish and maintain legal and regulatory regimes
that protect property rights, create transparent and
fair rules of law, and minimize the transaction cost
burdens and other unwanted consequences of regu-
lation.
2. Implement macroeconomic policies that encourage
real economic growth with low inflation.
3. Invest in transportation and communication infra-
structure to lower the costs of coordinating and
carrying out international business transactions.
4. Invest in education and worker training programs to
improve the quality of labour available to employers.2
1 For an overview of theory and evidence regarding the FDI pro-
cess and the impact of FDI on host countries, see Graham and
Krugman (1995) and Lipsey and Sjoholm (2005). For an overview
of the impacts of FDO on home countries, see Globerman (1994).
2 Establishing foreign investment promotion agencies is not exten-
sively discussed in the academic literature but represents a policy
initiative for numerous governments. We discuss the effectiveness
of such agencies on page 13 of this report, in the section “What
Affects FDI at the Sub-National or Provincial Level?”

Other more controversial public policies can also be
identified, including:
5. Reduce corporate tax rates.
6. Weaken or eliminate regulatory review processes
applying to foreign investors.
7. Offer financial subsidies to prospective foreign
investors.
8. Eliminate limitations on foreign ownership levels in
“sensitive” industrial sectors.
It should be noted that foreign direct investment is rela-
tively footloose, particularly at the sub-national level.
That is, foreign investors ordinarily compare alternative
geographic locations when making investment deci-
sions. Hence, the attractiveness of any host country to
foreign investors will depend on public policies imple-
mented not only by that host country’s government but
also in other countries and regions.
Initiatives 1–4 above clearly are not solely relevant to
investment decisions of foreign investors, since domes-
tic investors should also find that such initiatives make
their home country a more desirable location in which
to invest. Therefore, in the short run, at least, initiatives
1–4 might discourage FDO at the same time as they
encourage FDI. In the longer run, domestic firms are
likely to become more efficient, and therefore more
competitive internationally, as a consequence of govern-
ments implementing these initiatives. Domestic firms
may therefore find FDO more profitable in the long run,
such that factors promoting increased FDI also poten-
tially promote FDO. This is not to say that domestic
investment will necessarily decrease as FDO increases.
Indeed, domestic investment, FDI, and FDO may all
increase as an economy becomes more productive.
In short, initiatives 1–4 are relatively uncontroversial
policy recommendations designed to increase a loca-
tion’s attractiveness to foreign investors. This is not the
case for the other initiatives identified above. For
example, reducing corporate tax rates should attract
increased quantities of FDI, other things being constant;
however, if the result is lower tax revenues that, in turn,
lead to reductions in publicly provided services and
amenities such as good public schools and safe and
clean cities, the impact of lower corporate tax rates on
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The Conference Board of Canada  |  3
FDI is more uncertain. For the same reason, the rela-
tionship between domestic corporate tax rates and FDO
is ambiguous. Specifically, lower tax rates in combina-
tion with a degradation of public goods amenities might
lead to increased FDO rather than increased domestic
investment by local firms.
Foreign ownership restrictions have been defended by
reference to a sector’s activities being “sensitive” or
otherwise critical to the national interest—thus necessi-
tating domestic rather than foreign ownership.
Weakening or eliminating FDI review procedures, as well
as sectoral restrictions on foreign ownership, should
encourage inward FDI. Nevertheless, they are contro-
versial initiatives. In particular, some observers con-
tinue to argue that reviewing FDI inflows for approval
enables policy-makers to improve the host country
benefits from FDI by allowing the host government to
demand specific commitments or activities that aug-
ment the net benefits from FDI to the host country. For
example, as a condition of approval, the host-country
government could demand that a foreign investor pro-
posing to acquire a domestically owned firm maintain
the level of research and development spending of the
domestically acquired firm. It is not necessary to assess
the merits of FDI review procedures such as those man-
dated under the Investment Canada Act. Although we
do not review available evidence in this report, the evi-
dence generally discredits the argument that FDI review
procedures benefit the host economy and cast doubts on
the magnitude of net benefits claimed by governments
for the review procedures.3
Eliminating restrictions on FDI also promotes increased
FDI flows to a host country. Foreign ownership restric-
tions have been defended by reference to a sector’s
activities being “sensitive” or otherwise critical to the
national interest and, therefore, necessitating domestic
rather than foreign ownership. Without going into detail,
such defences of foreign ownership restrictions are
3 Globerman (2008) provides a critical analysis of the FDI review
process in Canada.
4  |  Best Policy Practices for Promoting Inward and Outward Foreign Direct Investment—October 2010
ordinarily vague and fail to withstand critical analysis.4
Nevertheless, foreign ownership restrictions are politic-
ally difficult to eliminate, since strong vested domestic
interests will lobby against their elimination.
To the extent that FDI review procedures and foreign
ownership restrictions indirectly reduce foreign compe-
tition faced by domestic firms, they may contribute to
domestic investors earning economic profits, thereby
discouraging FDO, at least in the short run. However,
reduced FDO is not necessarily a desirable conse-
quence, since FDO can provide net economic benefits
to the home country as discussed below.
Policies to attract FDI may discourage FDO in the short-
run, and stimulate increased FDO over the longer-run.
In summary, suggested policies to attract FDI can be
readily identified in the academic literature. Those same
framework policies may discourage FDO in the short
run, but they arguably also stimulate increased FDO in
the longer run by contributing to an economic environment
in which domestically owned firms become more inter-
nationally competitive over time. FDO is a business mode
through which domestically owned firms can participate
in international markets as they become more competitive.
The majority of relevant policy recommendations should
make a domestic economy more attractive to all investors,
both foreign and domestic. A literature review of empir-
ical studies can therefore assess the importance of specific
policies affecting both FDI and FDO.
Factors That Affect the Economic Benefits of FDI
The policy literature focusing on the determinants of
the economic benefits of FDI and FDO is both more
limited and more equivocal than the literature on the
determinants of FDI and FDO flows. The economic
benefits of FDI and FDO primarily derive from two
phenomena: 1) increased specialization of production   including employment, at least in the short run. However, these
in the economy; 2) spillover efficiency benefits to the
host or home economy. More specifically, the primary
4 For an extensive and critical rejection of arguments in favour of
sectoral foreign ownership restrictions, see Sidak (1997).
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economic benefits of FDI and FDO derive from their
contribution to productivity and, therefore, to higher
real incomes in the host and home countries.5 Both
FDI and FDO promote increased specialization of pro-
duction across and within industries, and even within
individual firms by serving as relatively efficient modes
for reallocating productive resources across geographic
locations. For well-known reasons, increased specializa-
tion of production contributes to improved productivity
and higher real incomes for host and home countries.
While foreign direct investment can promote increased
international specialization of production, so can inter-
national trade. In fact, the contribution of foreign direct
investment to the international specialization of produc-
tion has typically taken a back seat to international trade’s
contribution. Indeed, in some early theories of foreign
direct investment, FDI was seen to be a “second-best”
instrument of international specialization of production.
Specifically, foreign direct investment was seen as being
primarily motivated by the incentive to jump over tariff
and non-tariff barriers that discouraged exports by firms
enjoying efficiency or other competitive advantages in the
international marketplace. Later theories of foreign direct
investment de-emphasized the role of barriers to trade as
the motivation for foreign direct investment. In these later
theories, foreign direct investment is seen as a relatively
efficient and profitable way for firms to exploit specific
competitive advantages tied to the possession of intangible
assets. That is, trade and foreign direct investment are
increasingly seen as complementary phenomena. Modern
theories of international production also emphasize the
impact of spillover benefits, which are seen as important
potential consequences of the international transfer of
technology and other intangible assets.6 In this report, the
“quality” of foreign investment is determined by the spill-
over benefits derived from that investment.
5 FDI and FDO might also affect overall levels of economic activity,
types of broad macroeconomic impacts are not seen as being
specific to foreign investment but are seen as distinct from
domestic investment. See Lipsey and Sjoholm (2005).
6 For an overview of models linking foreign direct investment to
international production patterns, see Dunning (1993). It is beyond
the scope of this report to review the evidence linking FDI to
increased trade specialization.

Spillover efficiency benefits encompass productivity
improvements enjoyed by firms other than those
involved in the direct investment activity, but which
arise from that activity. Most of the focus in the litera-
ture has been on spillover efficiency benefits from FDI
to domestically owned firms in the host country. However,
some recent attention has been paid to spillover efficiency
benefits to home-country firms from FDO undertaken
by other home-country firms. Spillover efficiency benefits
from FDI can potentially arise from “leakages” of tech-
nology and management expertise from foreign-owned
firms to domestically owned firms, through the general
skill upgrading of employees working for foreign-owned
firms who then migrate to domestically owned firms, and
so forth. Spillover efficiency benefits from FDO can
arise from leakages of new technology and management
expertise brought into the home economy by domestic-
ally based multinational companies, the availability of
higher quality inputs to the home economy through
importing activities of domestically owned multinational
companies, and other phenomena. New theories of FDO
emphasize the importance of resource-seeking motives
for FDO, including efforts to acquire new brands, product
designs, and technologies in overseas markets to exploit
in the home country.
Knowledge-seeking FDO may generate potential spillover
efficiency benefits for other domestically owned home-
country firms.
Relatively little has been written discussing the potential
determinants of spillover efficiency benefits from foreign
direct investment for host countries, and especially for
home countries.7 Nevertheless, several characteristics of
host country and home-country firms have been linked
to the existence and magnitude of spillover efficiency
benefits. One is the so-called absorptive capacity of
host country firms—that is, the ability of those firms to
adopt and exploit new technologies and management
processes that are brought into the host country through
FDI. Absorptive capacity, in turn, is determined by a
number of factors, including the scientific and engineering
7 For a review and extension of the literature, see Blomstrom,
Kokko, and Globerman (2001).
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The Conference Board of Canada  |  5
expertise possessed by host country firms. Another factor
is the market structure of industries in the host economy.
On the one hand, stronger competition in host country
industries should intensify incentives for domestically
owned firms to adopt new technologies and administra-
tive processes, thereby promoting increased spillover
efficiency benefits. On the other hand, stronger compe-
tition dilutes the economic profits that domestically
owned firms can expect to enjoy from early and more
complete adoption of new technologies and administrative
processes. A third broad factor is government policies
and regulations related to the activities of foreign-owned
affiliates. In particular, policies that require or encourage
foreign-owned affiliates to transfer technology more
quickly than they otherwise would to domestically
owned firms might enhance potential spillover benefits
from FDI by enriching the pool of appropriable tech-
nology in the host country. However, if the relevant
policies reduce the ex ante profitability of foreign
investment in the host country, the overall pool of
appropriable technology might actually decline as a
result of substantial reductions in FDI.
Absorptive capacity is also a prominent conceptual  
variable influencing the spillover efficiency benefits to
home-country firms from FDO. In particular, FDO is
often undertaken to seek and appropriate knowledge in
other markets that would be more costly to identify and
appropriate through some other mode of international
business such as importing. Since it is ordinarily diffi-
cult for firms to completely protect their proprietary
technologies, knowledge-seeking FDO can be expected
to generate potential spillover efficiency benefits for
other domestically owned home-country firms. That is,
the indirect importation of technology into the home
country by parent companies of foreign affiliates
expands the potential efficiency frontiers of other
domestically owned firms in the home country. The
extent to which domestically owned companies can take
advantage of potential efficiency gains will be a function
of their absorptive capacity, among other things. Domestic
market structure conditions can also affect incentives to
exploit potential spillover benefits in the home country.
In short, a number of the factors that can be linked to
spillover benefits from FDI can also be linked to spill-
over benefits from FDO.
Chapter 2
Methodology and Main Findings
Chapter Summary
 An extensive literature review was undertaken
to identify empirical studies of the determin-
ants of FDI and FDO, as well as the determin-
ants of their productivity benefits.
 Among policy-related variables influencing
FDI are the political, regulatory, and physical
infrastructures of a country or region, the
quality of the labour force, and the use of FDI
promotion agencies. The influence of tax rates
is not simple or clear-cut.
 Factors encouraging FDI also promote FDO,
in the longer run, by strengthening the inter-
national competiveness of domestic firms.
Benefits to the host country from FDI are
primarily related to the absorptive capacity
of the host country.
T
he major focus of this report is to identify, sum-
marize, and evaluate the empirical literature deal-
ing with the determinants of FDI and FDO, as
well as the determinants of their spillover efficiency bene-
fits. The following section discusses the methodology
underlying our data gathering and analysis.
The same basic procedure was followed to identify
empirical studies relevant to the determinants of foreign
direct investment and of FDI spillover efficiency benefits.
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A keyword search was done of the main databases that
could be expected to identify papers on these two topics
of interest. One is Business Source Complete, which
indexes about 1,300 scholarly journals in the areas of
economics, finance, and business. A second is JSTOR,
which indexes journal articles, as well as books, book
chapters, conference papers and proceedings, and work-
ing papers in the subject areas of business, economics,
finance, law, political science, arts, and humanities. A
third is Google Scholar Beta, which extends our search
to non-indexed papers such as professional reports and
online repository documents. Prior to the preparation of
this report, the database search covered the time period
1970–2009; a follow-up survey was done to include
papers published in 2010.
The report’s main focus is to identify, summarize, and
evaluate the empirical literature dealing with the deter-
minants of FDI and FDO and spillover efficiency benefits.
In the first stage of the database search, a number of key-
words were used to identify potentially relevant studies.
After identifying a large list of potential studies, the sample
of studies was reduced by eliminating all non-empirical
studies—those that did not use statistical models to quan-
tify the determinants of foreign direct investment or the
determinants of spillover benefits from foreign direct
investment. The remaining studies provide the basis for
our analysis. The “Publications Related to FDI/FDO
Determinants” section in Appendix A identifies the studies
 The Conference Board of Canada  |  7

used to evaluate the determinants of foreign direct invest- reported in the literature. The first category is identified
ment. The “Publications Related to Determinants of as “economic gravity relationships.” It includes variables
Spillover Benefits” section in Appendix A identifies the that are typically specified in so-called gravity models,
studies used to evaluate the determinants of spillover which represent the basic theoretical structure of most
benefits from foreign direct investment.1 We don’t claim
to have reviewed every published study on the two main
Table 1
topics of interest. Nevertheless, we believe this report
Broad Variable Categories for Determinants of FDI and FDO
provides a comprehensive overview of the relevant litera-
ture that fairly summarizes empirical work on the topics Category Specific Variables
of interest.
Economic gravity relationships  Geographical proximity
 Trade values
 Free trade agreement
Eleven broad categories encompass the numerous specific  Cultural proximity
variables identified in statistical models of FDI and FDO.
Macroeconomic conditions  Market size
 Exchange rate
 Market size growth
For the studies referenced in these two sections of  Per capita income
Appendix A, one of us read and summarized all of the
Industry characteristics  Degree of competition
publications listed in “Publications Related to FDI/FDO
 Productivity
Determinants,” while the other author read and summar-  Trade and investment openness
ized all of the publications listed in “Publications Related
to Determinants of Spillover Benefits.” After reading Institutional infrastructure  Socio-political stability
 Government efficiency
the articles, we developed a template for summarizing
 Legal protection
them. The template sets out the major categories of
 Corruption
variables identified in the various studies. Specifically,
Table 1 identifies the main sets of variables we identified Physical infrastructure  Transportation
in empirical studies addressing the determinants of for-  Electricity
 Telecommunications
eign direct investment. As can be seen, there are 11 broad
categories that encompass the numerous specific variables Openness to foreign investment  Investment restrictions
identified in statistical models of FDI and FDO. Table 2  Trade-related aspects of intellectual
focuses on the determinants of spillover benefits from property matters (TRIPs)
foreign direct investment.  Foreign investment promotion
agencies

Openness to international trade  Trade to GDP ratio

Categories of Variables for the  Tariff and other barriers
Determinants of FDI
Financial markets  Interest rate
 Stock market capitalization
While the clustering of variables into categories is
somewhat subjective, it provides a convenient way to Labour markets  Unit labour costs
summarize the extensive and eclectic set of findings  Skill endowment/education

Technological capabilities  R&D activities

 Intangible capital
1 This study is not meant to be a critical review of the relevant lit-
erature. Hence, it does not assess the reliability of the underlying Taxes  Corporate tax rate
methodologies; however, given the comprehensive coverage of our  Other taxes (direct and indirect)
review, it seems fair to conclude that our conclusions are unlikely
to be distorted by individual poorly designed or executed studies.
Source: Steven Globerman and Victor Zitian Chen.

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8  |  Best Policy Practices for Promoting Inward and Outward Foreign Direct Investment—October 2010
empirical studies of trade and capital flows. Gravity
models include variables such as physical distance
between trade or investment partners, similarity of   specified in different ways depending on the studies in
cultures and language, membership of the trading or
investing partners in a free trade area or common market,
and so forth.2
The second category encompasses variables describing the
macroeconomic attributes of the home and/or host country,
including market size, per capita income, exchange rates,
rates of inflation, and so forth. The third category includes
industry attributes in the home and/or host country, includ-
ing ownership concentration, productivity levels, minimum
efficiency scale, and others. The fourth and fifth categories
include measures of the physical and institutional infra-
structures of host and/or home countries, such as the qual-
ity of telecommunications and transportation facilities, the
strength of legal protection of property rights, rule of law,
and similar attributes.
The sixth and seventh categories encompass measures
of openness to foreign investment and foreign trade.
Examples of relevant variables include foreign owner-
ship restrictions and the ratio of trade to gross domestic
product. A related policy measure is the use of invest-
ment promotion agencies by the host country.
Categories eight through ten include variables that iden-
tify the availability of resources such as financial capital,
human capital, and technology in home and/or host
countries. Specific variables include skill endowments
and education levels of the population, labour costs,
financial market development, R&D activity, and cap-
acity to innovate. The final category focuses on taxes
and related variables in the home and host countries.
In reviewing our findings on the determinants of foreign
direct investment, we discuss in more detail the specific
variables used in the sample of studies, as well as their
empirical relationships to foreign direct investment.
Similar variables may be measured in different ways
across studies. Hence, it is arguably more reliable to
draw inferences from broad measures of a specific
attribute of the home or host country than from one or
2 For a discussion of gravity models of foreign direct investment,
see Blonigen (2005).
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more narrowly specified measure of that attribute. For
example, tax rates in host and home countries may be
question. If the general finding is that higher tax rates
in the host country discourage FDI, it is less important
whether the tax rate is measured as the ratio of tax rev-
enues to GDP or as the nominal average or marginal
corporate tax rate. In short, conclusions drawn with
respect to broad categories of variables are likely to be
more reliable than those drawn from specific variables
that make up the broader categories.
Variables that studies assess as possibly affecting FDI
and FDO quantity and quality include trade openness,
proximity, market size, and corporate tax rates.
Categories of Variables for the
Determinants of FDI Spillovers
The literature on spillovers is relatively small compared
with the number of empirical studies on the determin-
ants of FDI and FDO. Furthermore, virtually all of the
available studies focus on spillover effects for the host
country to the exclusion of impacts on the home coun-
try. Hence, it is not surprising that the list of variables
identified and discussed in empirical studies of spill-
overs is smaller than the list of variables identified and
discussed in empirical studies of the determinants of
foreign direct investment.
Table 2 clusters the relevant variables identified in our
review of the publications listed in the “Publications
Related to Determinants of Spillover Benefits” section
in Appendix A into six broad categories. It also identi-
fies the main specific variables associated with each
broad category. Unsurprisingly, there is substantial
overlap between Tables 1 and 2 in terms of both the
broad and the specific variables that form the focus of
the literature reviewed. This is expected in light of our
earlier discussion of the theoretical literature on the
determinants of foreign direct investment and the deter-
minants of spillover efficiency benefits.
 The Conference Board of Canada  |  9

Table 2 Table 3
Broad Variable Categories for Determinants of Summary of Empirical Findings on the Determinants of FDI and FDO:
Spillover Effects Macroeconomic Variables

Category Specific Variables Macroeconomic Variables Relationship to FDI Relationship to FDO

Absorptive capacity  R&D performance Market size Positive Positive

 Innovativeness
Exchange rate (home per host) Mixed Mixed
 Education/skill level
Market size growth Positive Mixed
Openness of economy  Trade/GDP
 Migration/immigration Per capita income Mixed Mixed

Nature of FDI and  Wholly owned affiliates Inflation rate Negative n.a.
FDO linkages  Vertical linkages
 Joint ventures Exchange rate stability Positive Negative

Regulations and related  “Buy local” Note: “Mixed” means that the positive and negative results for the variable in question
policies  Requirements to export were about equal in number, and/or the majority of the results for the variable in ques-
 Location requirements tion were not statistically significant; “n.a.” indicates only a small number of studies
reported results for the variable in question, such that no reliable inferences about the
Infrastructure  Transportation variable could be drawn.
Source: Steven Globerman and Victor Zitian Chen.
 Telecommunications

Industrial structure  Industrial concentrations

 Geographical concentrations
Source: Steven Globerman and Victor Zitian Chen.
What Affects Foreign Investment?
As noted above, Table 1 summarizes the main categories
of variables used in the empirical studies of the deter-
minants of FDI and FDO that we reviewed. It also iden-
tifies specific variables most frequently specified in the
empirical models discussed in the reviewed papers. Our
review of the literature is organized around the frame-
work set out in Table 1.
What Affects FDI and FDO at the National Level?
1. Macroeconomic Variables: Market Size
Of all of the variable categories identified in Table 1,
the category encompassing macroeconomic attributes
tends to be the most widely represented in empirical
studies of foreign direct investment. In particular, the
market sizes of the host and home countries, as well as
market size growth, are frequently specified in empir-
ical models. Table 3 summarizes the macroeconomic
variables used in the studies we reviewed. The summar-
ized results are based on the number of times an estimated
result was reported for each variable in our sample
studies. Hence, results could be reported for a variable
more than once in any given study. We do not provide
the number of studies reporting results for each of the
variables discussed in the report. However, if there were
fewer than four studies reporting findings, we identified
results as being “not available.”
The variable most frequently included in the studies  
is the market size of either the host or home country,
depending on whether the model focused on FDI or FDO.
In the overwhelming majority of studies, the market
size of the host economy is positively and significantly
related to FDI. Simply put, larger economies attract
inward direct investment. This finding reflects the simple
fact that market opportunities for foreign investors are
generally more abundant in larger economies. Also, in
the majority of cases, the market size of the home econ-
omy is positively and significantly related to FDO. That
is, larger countries are sources of FDO. This latter result
reflects the fact that larger economies tend to be home
to multinational companies. It should be noted, however,
that the results for FDO are less consistent than those

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 10  |  Best Policy Practices for Promoting Inward and Outward Foreign Direct Investment—October 2010

for FDI. A plausible reason is that some relatively small undertake profitable FDO. In any case, it is clear from
economies such as The Netherlands and Canada are also the literature that effective public governance is a key
home to a significant number of multinational companies. factor encouraging inward direct investment.

2. Industry and Infrastructure Conditions 3. Openness to Foreign Investment and Trade

Table 4 summarizes empirical results for variables
describing industry conditions in home and host coun-
tries, as well as infrastructure conditions. The main
conclusion to be drawn is that political stability, protec-
tion of property rights, rule of law, and a relatively effi-
cient public sector are strong attractors of FDI. So is
good physical infrastructure in the host country, including
transportation and communication facilities. Very few
studies identify the impact of industry conditions and
infrastructure on FDO. If their impacts were estimated,
the findings would likely be mixed. On the one hand,
good infrastructure in the home country should make it
more profitable to operate in the home country and
therefore discourage outward direct investments. On the
other hand, good home-country infrastructure should
promote the emergence and growth of competitive
multinational companies that are willing and able to
Table 4
Summary of Empirical Findings on the Determinants of FDI and FDO:
Industry Attributes and Infrastructure
Relationship Relationship
to FDI to FDO
Table 5 summarizes the findings from studies that
include measures of an economy’s openness to foreign
investment and trade. It is not surprising to find that
foreign investment approval procedures, such as those
mandated under Canada’s Foreign Investment Review
Act and its successor legislation (the Investment Canada
Act), discourage inward direct investment. Also unsurpris-
ing is the finding that foreign ownership restrictions are
negatively related to FDI. Somewhat less expected are
the findings that subsidies to foreign investors, as well
as requirements imposed on foreign investors, such as
requirements to undertake a minimum level of exporting
or to purchase inputs from local suppliers, are not con-
sistently related in a positive or negative way to FDI.
One would have expected to find that requirements
Table 5
Summary of Empirical Findings on the
Determinants of FDI and FDO: Openness
to Trade and Investment
Relationship Relationship
Openness Variable to FDI to FDO
Investment protection Negative Mixed

Industry Competitive Mixed Mixed Foreign ownership Negative n.a.

attributes conditions restrictions

Productivity and Positive n.a. Investment promo- Positive n.a.

growth tion agencies

Infrastructure Socio-political Positive n.a. Subsidies Mixed n.a.

stability
Requirements Mixed n.a.
Protection of Positive n.a.
property rights Trade to GDP ratio Positive Mixed

Government efficiency Positive n.a. Tariff and other Mixed Mixed

Physical infrastructure Positive n.a.
Note: “Mixed” means that the positive and negative results for the variable in question
were about equal in number, and/or the majority of the results for the variable in ques-
tion were not statistically significant; “n.a.” indicates only a small number of studies
reported results for the variable in question, such that no reliable inferences about the
variable could be drawn.
Source: Steven Globerman and Victor Zitian Chen.
barriers
Note: “Mixed” means that the positive and negative results for
the variable in question were about equal in number, and/or
the majority of the results for the variable in question were not
statistically significant; “n.a.” indicates only a small number of
studies reported results for the variable in question, such that no
reliable inferences about the variable could be drawn.
Source: Steven Globerman and Victor Zitian Chen.

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 The Conference Board of Canada  |  11

imposed on foreign investors would discourage inflows
of direct investment, other things being constant. However,
it should be noted that very few studies focus on how
these variables affect FDI. Furthermore, it is possible
that the costs imposed on foreign investors by such
requirements are implicitly passed on to host country
firms in the form of lower acquisition prices.
Relatively few studies identify the relationship of open-
ness variables to FDO. In the few cases where findings
are reported, the results are mixed. In brief, available
studies provide no consistent evidence on whether the
openness of the home country to investment and trade
encourages outward direct investment.
possessing a skilled and educated workforce. On the
other hand, higher unit costs of labour discourage
inward foreign direct investment, although unionization,
per se, is not linked consistently, either positively or
negatively, to FDI. R&D capabilities, as well as an
active innovation system more generally, attract foreign
direct investment to host countries. Interestingly, R&D
also encourages outward direct investment from home
countries. This finding, again, presumably reflects the
fact that countries characterized by advanced innovation
activities are likely home to efficient and highly suc-
cessful multinational companies that, in turn, seek to
exploit their competitive advantages in foreign markets,
often through FDO.

4. Country Resource Attributes: Labour Force

Characteristics and R&D Capabilities Available studies provide no consistent evidence on
Table 6 summarizes findings with respect to the whether the openness of the home country to investment
resource attributes of host and home countries, particu- and trade encourages outward direct investment.
larly the characteristics of the labour force. Once again,
relatively little evidence is available on the determinants
of FDO. However, the evidence linking labour force 5. Tax Structures
characteristics and FDI is quite consistent. Specifically, Given the relatively few studies that link host and home-
foreign direct investment is attracted to host countries country tax structures to FDI and FDO, it was not worth-
while to create a separate summary table. Suffice it to say
that most of those few studies focus on the corporate tax
Table 6 rate. On balance, a higher host-country corporate tax rate
Summary of Empirical Findings on the discourages inward foreign direct investment. Specifically,
Determinants of FDI and FDO: Resources
we identified 14 studies that attempted to link corporate
Relationship Relationship tax rates to FDI. Nine of the studies identified a statistic-
Resource Variable to FDI to FDO ally significant and negative linkage, while five studies
found no statistically significant relationship between the
R&D activeness Positive Positive
two variables.3 A handful of studies also focus on other
Skill endowment Positive n.a. indicators of the tax structures of host and home countries,
such as income taxes or total tax revenues as a ratio of
Total employment Positive n.a.
GDP. While the individual number of such studies is
Unit wages Negative n.a. small, they tend to identify higher taxes as having a statis-
tically significant and negative impact on inward foreign
Unionization Mixed n.a.
direct investment. A very few studies (four, to be precise)
Large, liquid Positive Positive discussed findings for the relationship between home-
stock markets country tax rates and outward foreign direct investment.
Interest rates Negative n.a.

Note: “n.a.” indicates only a small number of studies reported
results for the variable in question, such that no reliable infer-
ences about the variable could be drawn.
Source: Steven Globerman and Victor Zitian Chen.
3 In his review of the literature, Moran (2005) concludes that tax
considerations have become more important influences on the
location decisions of multinational companies since 1990. He also
asserts that multinational companies have become more respon-
sive to tax concessions and other investment incentives.

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12  |  Best Policy Practices for Promoting Inward and Outward Foreign Direct Investment—October 2010
They all report that higher corporate tax rates are nega-
tively and significantly related to FDO. That is, higher
home-country corporate tax rates discourage FDO. This
seemingly surprising result might reflect the fact that high
corporate tax rates in developed countries often accom-
pany well-developed infrastructures for corporations in
which to do business; something that, in turn, discourages
outward direct investment. By the same reasoning, one
would expect higher corporate tax rates to attract FDI, if
the revenues collected were used to improve the infra-
structure used by host country businesses. That is, if
physical and other social infrastructure is funded by tax
revenue to any significant extent, the impact on FDI will
reflect the net effect of both government taxes and the
availability and quality of physical and related infrastructure.
Specifically, physical and cultural proximity—including
a similar language, a shared border, similar political
institutions, and a strong trade relationship—all promote
bilateral foreign direct investment.
In short, and notwithstanding extensive discussions in
the popular business media about the important influ-
ence of taxes on the investment decisions of multi-
national companies, hard statistical evidence on the
linkages between taxes and direct investment decisions
is limited, and the available results do not necessarily
tell a consistent story. This conclusion is consistent with
Blonigen’s interpretation of the available evidence.4 He
argues that the linkage is uncertain because the way in
which parent companies reduce double taxation on their
multinational companies can have different implications
for foreign direct investment activities. More generally,
it is difficult to measure the precise incidence of corpor-
ate income taxes.
Bilateral Foreign Direct Investment
Next to the number of foreign direct investment studies
encompassing macroeconomic attributes, the second
single-largest number of studies focuses on bilateral
investment flows. That is, they focus on the determinants
of direct investment flows that take place between two
4 Blonigen, Foreign Direct Investment Behavior of Multinational
Corporations.
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particular countries, e.g., Canada and the United States.
These studies are usually set up as gravity models and
include such variables as physical and cultural proxim-
ity, bilateral trade volumes, sharing a common physical
border, and sharing a common language. In effect, stud-
ies of bilateral foreign direct investment flows consider
why two-way foreign direct investment between Canada
and the United States is likely to be larger than two-
way foreign direct investment between Canada and, say,
Germany. The earlier studies we reviewed in this sec-
tion address the issue of what makes a country such as
Canada attractive to FDI from any potential source
country. Numerous countries are sources of FDI in
multi-country models, unlike in bilateral models.
Domestic R&D “activeness” and a more highly skilled
and educated workforce can encourage FDI into Canada.
The findings from studies of bilateral foreign direct
investment all report plausible results. Specifically,
physical and cultural proximity—including a similar
language, a shared border, similar political institutions,
and a strong trade relationship—all promote bilateral
foreign direct investment. Membership of the bilateral
partners in a free trade area or a customs union also
encourages increased bilateral foreign direct investment.
We identified 12 empirical studies that focused specifically
on inward and outward foreign direct investment at the
national level in Canada. The limited number of Canadian
studies militates against drawing strong conclusions from
the Canadian experience. Nevertheless, the results for
Canada are consistent with those from the full sample of
studies. In particular, domestic R&D “activeness” and a
more highly skilled and educated workforce are identified
as encouraging FDI into Canada.
There is no reason to believe that the results pertaining
more broadly to the determinants of FDI and FDO
should not apply to Canada, although the precise impact
of any specific determinant is likely to differ across
countries and regions. For example, improvements in
public sector governance are likely to have a larger
impact on FDI in developing countries than in developed

countries.5 Furthermore, the precise determinants of
FDI will vary across industrial sectors. Since the eco-
nomic importance of specific sectors, such as energy,
differs across countries, FDI determinants are unlikely to
be identical, even for developed countries. Nevertheless,
the broad policy inferences that can be drawn from the
empirical evidence seem applicable to most countries,
including Canada.
What Affects FDI at the Sub-National or
Provincial Level?
There are far fewer empirical studies of the determin-
ants of FDI at the sub-national level than at the national
level.6 Given the relatively few studies that focus on
FDI determinants at the sub-national level, we provide a
qualitative assessment of the relevant literature in this
section of the report, using the broad variable category
outline provided in Table 1.
Only a small majority of relevant studies find that higher
unit labour costs have a statistically significant and nega-
tive relationship to foreign direct investment.
The location attribute receiving perhaps the greatest
attention in studies of FDI at the sub-national level is
the market size of the relevant region or city. As in the
case of FDI studies at the national level, the evidence is
unambiguous in pointing to a strong and positive rela-
tionship between FDI and larger market size; however,
the precise interpretation of the market size variable dif-
fers in sub-national studies. Specifically, measures of
overall market size at the sub-national level can be
interpreted in some cases as indicators of agglomeration
economies, particularly when market size is measured
as total industrial or services-sector output, as opposed
to a measure of overall output such as total income.
5 Globerman and Shapiro, “Global Foreign Direct Investment Flows:
The Role of Governance Infrastructure,” 1899–1919.
6 We found only five Canadian-specific FDI studies at sub-national
(i.e., sectoral or provincial) levels and were unable to identify a
single empirical study that examines the determinants of FDO at
the sub-national level.
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The Conference Board of Canada  |  13
Agglomeration economies encompass the efficiency
benefits that firms enjoy by operating in close geographic
proximity to suppliers of specialized inputs and services,
as well as to organizations in the same industry that are
potential sources of spillover efficiency benefits and
other external economies of scale. Indeed, in a number of
studies, measures of geographical density of manufac-
turing establishments are found to be positively and sig-
nificantly related to FDI in regions and cities. The
presence of foreign-owned firms in a location often
attracts other foreign investors from the same home coun-
tries by signalling the advantages of operating in that
location, thereby strengthening agglomeration economies.
Physical infrastructure is another location attribute that
is regularly incorporated into FDI models applied at the
sub-national level. Available studies consistently report
a positive and statistically significant linkage between
measures of physical infrastructure and FDI, although
there is some variation in the particular components of
physical infrastructure that seem to matter most to foreign
investors. For example, in some cases, transportation
facilities are identified as being particularly important,
while in other cases, telecommunications capabilities are
cited. Such differences in emphasis are to be expected
given the fact that available studies focus on different
industries. For some manufacturing industries, access to
water or rail transportation is a critical determinant of a
location’s attractiveness, whereas service industries are
likely to be more concerned about the state of a loca-
tion’s telecommunications infrastructure.
Studies are more equivocal about the nature and import-
ance of labour market conditions to foreign investors. In
particular, only a small majority of relevant studies find
that higher unit labour costs have a statistically signifi-
cant and negative relationship to FDI. However, there is
more consistent support for a positive and statistically
significant relationship between FDI and the “quality”
of the available labour force in a region or city.
Although differences across sub-national regions in tax
rates and government subsidies are a conceptually
important issue, few available statistical studies address
the issue. A possible reason for this paucity of evidence
is the difficulty in measuring effective tax rates at the
regional or city level, particularly when effective tax rates
14  |  Best Policy Practices for Promoting Inward and Outward Foreign Direct Investment—October 2010
can vary substantially across different industries and
organizations, even within the same region or urban
area. The limited amount of evidence militates against
drawing strong conclusions about the practical import-
ance of taxes and subsidies to foreign investors.
Furthermore, what evidence is available tends to be
inconclusive. Specifically, there is no consistent evi-
dence that fiscal concessions to foreign investors in the
form of lower taxes and/or direct or indirect subsidies
promote increased FDI in the longer run.
We should be cautious in concluding that taxes and
other financial conditions in a region are unimportant to
foreign investors. Certainly, anecdotal evidence sup-
ports arguments to the contrary. Indeed, the inconsistent
evidence might reflect, in part, the competition among
neighbouring political jurisdictions to keep tax rates and
other fiscal attributes comparable.7 To the extent that
provinces and other sub-national jurisdictions base their
own tax policies on policies in other sub-national juris-
dictions, we might find little tax or fiscal policy varia-
tion, and therefore observe only a small impact of fiscal
regimes on FDI location divisions.
There is no consistent evidence that fiscal concessions,
in the form of lower taxes and/or direct or indirect sub-
sidies, promote increased FDI in the longer run.
Therefore, it might well be the case that an individual
province or city might gain a location advantage by
lowering corporate taxes and/or extending fiscal benefits
to foreign investors. However, the advantage is likely to
be short-lived, given the likelihood that other provinces
or cities will offer comparable fiscal benefits to foreign
investors. Moreover, improvements in infrastructure
may be less easy for other jurisdictions to duplicate. So
tax reductions that come at the expense of maintaining
and expanding public infrastructure could be a rela-
tively ineffective policy instrument to attract FDI for
7 For an illustrative discussion of tax competition among states in
Switzerland to attract FDI, see Ball and Bryan-Law (2010).
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any province or city. Rather, a more effective policy
approach could involve public investments in infrastruc-
ture, even at the expense of higher taxes.8
Spending on foreign investment promotion agencies may
exceed the benefits if the agencies are operated inefficiently.
Many, if not most, countries, as well as many sub-national
political units, have foreign investment promotion pro-
grams. These programs typically include the use of gov-
ernment or quasi-government agencies to advertise and
promote the advantages of a particular location to pro-
spective foreign investors. In some cases, the mandate of
an agency might also include clearing bureaucratic hurdles
to FDI in a location, as well as providing assistance in
site selection, worker training, and even financing.9 The
limited available evidence, primarily from several stud-
ies of FDI in U.S. states, suggests that agencies promot-
ing FDI do, indeed, encourage FDI. However, this
evidence does not necessarily mean that the social
benefits of taxpayer funding of promotional agencies
will always exceed the relevant costs. As with other
public policies, spending on foreign investment promo-
tion agencies may exceed the associated benefits if the
agencies are operated inefficiently or attempt to imple-
ment unrealistic mandates.
What Determines Investment Quality?
Significantly fewer empirical studies focus on what
determines the quality of the investment—i.e., whether
there are productivity spillovers—rather than on what
determines the size of those investments. In Table 7,  
we examine factors that determine the quality of the
FDI based on a qualitative evaluation of the empirical
literature. There is virtually no statistical evidence on
8 Bellak and Leibrecht (2009) argue that a policy of contributing to
improvements in production-related infrastructure compensates
foreign investors for higher taxes.
9 Contractor, “Promoting Foreign Direct Investment in Developing
Countries,” 107–142
 The Conference Board of Canada  |  15

used are uniformly statistically significant). It is cer-

Table 7
Factors That Determine the Degree to Which FDI or
FDO Has Spillover Productivity Benefits
Variable
R&D
Education and skill level
Linkages to foreign affiliates
Domestic competition
Geographic density
Export orientation
Openness of economy
Regulation of foreign affiliates
tainly possible to interpret measures of R&D activity as
broad indicators of scientific and technical activity in
the host economy, since R&D activity is highly correl-
Impact ated with other indicators, such as patenting activity
and employment rates for scientists and engineers. In
Strongly positive
fact, a number of studies specify absorptive capacity
Weakly positive using other variables besides R&D activeness. In par-
ticular, measures of the education and skill level of the
Mixed
domestic workforce, as well as the export orientation of
Mixed the host country work force, have been used.11 Variables
measuring the education and skill level of the host
Strongly positive
country workforce tend to be positively related to spill-
Mixed over efficiency benefits from FDI, although the results
tend to be weaker than when absorptive capacity is
n.a.
measured as R&D activeness. Specifically, the workforce
n.a. quality variable is sometimes statistically insignificant.

Note: “Mixed” means that the positive and negative results for
the variable in question were about equal in number, and/or
the majority of the results for the variable in question were not
statistically significant; “n.a.” indicates only a small number of
studies reported results for the variable in question, such that no
reliable inferences about the variable could be drawn.
Source: Steven Globerman and Victor Zitian Chen.
what determines the quality of outward investments.
Only a handful of statistical studies look at the factors
that affect the quality of outward investments, and the
evidence is mixed. Specifically, there is no consistent
evidence of spillover benefits from FDO.10 We there-
fore focus on what affects the quality of inward direct
investments.
The primary focus of empirical studies of FDI quality
or spillover benefits is the absorptive capacity of host
country firms. The level of research and development
activity in the host country or among host country firms
is the most frequently specified measure of absorptive
capacity. The findings are unequivocal: R&D activity is
positively related to spillover efficiency benefits from
FDI (the estimated coefficients for the specific measures
Empirical results for export orientation are distinctly
mixed. That is, in several cases, export orientation is
positively related to spillovers, while in other cases it is
either negatively related to spillovers or the estimated
relationship is statistically insignificant. A possible
explanation for the mixed results is that in some cases,
particularly when the host countries are emerging econ-
omies, export orientation identifies labour-intensive
industries with relatively limited capabilities to adopt
relatively new production and managerial processes.
A number of available studies consider the empirical
relationship between FDI spillover benefits and the
nature of foreign ownership. In particular, they evaluate
whether the extent of foreign ownership is related to the
magnitude of spillover benefits. For example, several
studies consider whether FDI spillover benefits in a
sample of host country firms are larger when foreign
investment takes the form of joint ventures or minority
ownership than when it takes the form of majority or
wholly owned affiliates. These findings, which hold
obvious policy importance for foreign ownership
restrictions, can be prudently described as being mixed.  

10 See Zhao, Liu, and Zhao (2010), Iyer, Rambaldi and Tang (2008),
Singh (2007), Vahter and Masso (2007), and Braconier, Ekholm,
and Knarvik (2001). The potential economic benefits of FDO to the
home country are broader than just spillover benefits. Hence, one
should not conclude that FDO has no net economic benefits to
home countries.
11 The presumption is that export-oriented firms are likely to be
relatively efficient compared with domestic firms that focus exclu-
sively on serving the local market, since the former must compete
against world-class competitors in foreign markets.

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16  |  Best Policy Practices for Promoting Inward and Outward Foreign Direct Investment—October 2010
In several studies, spillover efficiency benefits to host
country firms seem to be larger when foreign ownership
primarily takes the form of joint ventures with domes-
tically owned firms. In other cases, spillover benefits
are either larger, or no smaller, when foreign investors
have dominant or wholly owned positions in host coun-
try firms. To the extent that foreign ownership limita-
tions discourage FDI at the margin, the overall impact
of such limitations on spillover efficiency benefits is
likely to be negative, since discouraging FDI will
indirectly limit potential (and actual) spillover effi-
ciency benefits.
Productivity spillovers from FDI are larger when foreign
and domestically owned companies are located near
each other.
Does the concentration of industry matter for the qual-
ity of FDI? As discussed earlier in this report, economic
theory is ambiguous concerning how industry attributes
like concentration of ownership affect FDI spillovers.
The empirical findings are also mixed. In some studies,
spillover efficiency benefits are larger when domestic
industries are more highly concentrated, and in other
studies they are smaller.
Geographic concentration does matter for the quality   export-oriented foreign affiliates to large domestic
of FDI. When activities are located close to each other,
there are more direct and indirect technology transfers
between organizations. One would therefore expect FDI
spillovers to be larger when foreign and domestically
owned establishments are near each other. This is,
indeed, a strong finding from the sample of empirical
studies that we reviewed.12
12 Few studies seek to identify whether the presence of foreign-
owned establishments has a stronger link to spillover benefits
than the presence of domestically owned establishments. Debaere,
Lee, and Paik (2010) find evidence from South Korean investment
in China that geographic concentration has particularly strong
beneficial impacts on spillovers when other Korean companies are
located in the specific region. Conversely, Lileeva (2010) finds that
U.S.-controlled and Canadian-controlled plants are both equally
likely to benefit from productivity spillover deriving from new tech-
nology brought into Canada by FDI from the United States.
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Several other potential factors that affect FDI quality
are included in the empirical models we have reviewed,
although the number of relevant studies is small. Again,
we hesitate to draw any firm conclusions. The openness
of the host economy to international trade is one such
additional variable. Again, the expected empirical rela-
tionship is ambiguous. On the one hand, a relatively
open economy might be expected to be relatively effi-
cient and competitive, in which case domestic firms are
more likely to have both the incentive and the capability
to exploit new processes and techniques brought into
the domestic economy through inward direct invest-
ment. On the other hand, in a relatively open economy,
new processes and techniques might also be embodied
in imports of capital equipment that would reduce the
scope for spillovers to be tied to FDI.13 As noted above,
the available empirical evidence on the linkage between
openness and FDI spillovers is limited, and what evi-
dence is available is mixed.
Finally, a few studies consider whether policies that
affect the behaviour of foreign-owned affiliates influ-
ence the efficiency or innovation of host country firms.
In particular, two studies consider whether more pro-
ductivity spillovers flow from export-oriented foreign
affiliates than from non-export-oriented foreign affili-
ates, and they differ in their findings. Specifically, one
study finds FDI spillovers are mainly transmitted from
firms,14 whereas a second finds no significant relation-
ship between the export orientation of foreign-owned
firms and domestic innovation.15 A third study exam-
ines whether government programs requiring foreign-
owned firms to source from local suppliers promotes
FDI spillovers, and finds no evidence that they do.16
13 Keller and Yeaple (2009) examine technology spillovers to U.S.
manufacturing firms from inward foreign direct investment and
from imports. They find that the former are stronger than the
latter, particularly in high-tech sectors.
14 Blyde, Kugler, and Stein, “Exporting Vs. Outsourcing by MNC
Subsidiaries: Which Determines FDI Spillovers?” 18.
15 Cheung and Lin, “Spillover Effects of FDI on Innovation in China:
Evidence From the Provincial Data,” 43.
16 Driffeld, “Regional Policy and Spillovers From FDI in the U.K,”
579-594.

Other reviews of the FDI spillover literature broadly
support our qualitative assessment summarized in Table 7.
For example, Görg and Greenaway also highlight find-
ings that the absorptive capacity of domestic firms is a
key factor determining whether domestic firms benefit
from FDI spillovers, and that spillovers benefit companies
in close proximity to foreign-owned affiliates.17 The
absorptive capacity of host economies is related to
technological activities and the availability of skilled
labour. They also note that what little work has been
completed on trade-related investment measures has
failed to establish a direct link between such measures
and the transfer of useful technologies to domestically
owned firms. One point of disagreement with our
assessment is Görg and Greenaway’s assertion that
economies with more open trade regimes benefit from
FDI more than countries with inward-oriented regimes.
There is no consistent evidence that FDI spillover
benefits will be larger if governments require investing
companies to commit to activities that they would not
otherwise find profitable.
In summary, a strong absorptive capacity is likely to
result in greater FDI spillover efficiency benefits. For
developed countries such as Canada, this absorptive
capacity includes the active performance of R&D and a
strong innovative infrastructure. An important component
of a strong innovative infrastructure is a skilled and
relatively highly educated workforce.
There is no consistent evidence to suggest that host
governments can gain larger FDI spillover benefits by
requiring foreign-owned affiliates to enter partnerships
or joint-venture arrangements with domestically owned
firms or to commit to activities that they would not other-
wise find profitable. Examples of such activities might
include local content or export target requirements.
17 Görg and Greenaway, “Much Ado About Nothing? Do Domestic
Firms Really Benefit From Foreign Direct Investment?” 15.
Find this report and other Conference Board research at www.e-library.ca
The Conference Board of Canada  |  17
In short, the policy implications for the quality of FDI
are roughly consistent with those for the magnitude of
FDI. Namely, the focus of government policies should
be on ensuring the efficient provisions of public goods
such as education and physical infrastructure, and on
promoting the technological capabilities of private firms
and non-profit institutions, such as universities, that
contribute indirectly to bolstering the absorptive cap-
acity of domestic organizations.
It is beyond the scope of this report to discuss govern-
ment financial support for R&D and other innovation-
related activities. We merely note that the spillover
efficiency benefits of FDI are larger when related indus-
trial activities are near each other. Indeed, the literature
suggests that as activities become more spread out,
technological spillovers tend to decline dramatically.
Therefore, deliberate efforts on the part of policy-makers
to “spread out” industrial activity geographically, par-
ticularly activities characterized as science- and tech-
nology-intensive, are likely to weaken society’s overall
technological capabilities.
Our broad policy conclusions for making sure invest-
ments are of the best quality—i.e., result in the greatest
productivity spillovers—are consistent with those of
other researchers. For example, Fan highlights the roles
that government policy can play by investing in infra-
structure, educating, and training, and by encouraging
domestic firms to invest in technology development.18
Another study concludes that regions can improve both
their access to and benefits from FDI by creating good
physical and communications infrastructures, by culti-
vating a highly educated workforce, and by encouraging
a high level of spending on R&D-related activities.19
18 Fan, “Technological Spillovers From Foreign Direct Investment—
A Survey,” 20.
19 Copenhagen Economics and Magnus Blomstrom, Study on FDI
and Regional Development: Final Report, 5.
Chapter 3
Policy Conclusions
Chapter Summary
 Public policies facilitating FDI and FDO, as
well as their spillover benefits, contribute
more generally to real economic growth.
 Best practices encompass improving infra-
structure, investing in education, and promot-
ing the capacity of domestic firms to use new
technology.
N
ational and sub-national governments both
have an interest in facilitating foreign direct
investment (both inward and outward), as well
as in leveraging the spillover efficient benefits from
foreign direct investment. In fact, policies that promise
to facilitate FDI and FDO, as well as their spillover
benefits, are largely consistent with public policies that
are recommended more generally for improving pro-
ductivity and economic growth. For example, improving
the physical and communications infrastructure of a
country or region, raising the education and skill level
of the workforce, and encouraging innovation-related
activities are important components of best practice
policies to encourage foreign direct investment.
In broad terms, best FDI practices can be seen as
“framework” policies. That is, they contribute to an
increased production capacity of the national or local
economy. It is less clear from the available evidence
that policies targeted specifically at foreign investors
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can fit the description of best practices. For example,
financial subsidies to foreign investors might attract
some FDI, at the margin; however, the impact of those
subsidies seems to weaken over time. Moreover, if the
subsidies, intentionally or unintentionally, encourage
investment outside concentrated “centres of excellence,”
the spillover benefits to domestically owned firms are
likely to be negligible. However, foreign investment
promotion agencies can be effective instruments to
encourage inward direct investment, particularly if they
focus on mitigating administrative costs and delays that
confront foreign investors.
In broad terms, best FDI practices can be seen as “frame-
work” policies—i.e., they contribute to an increased pro-
duction capacity of the national or local economy.
It is obvious that restrictions imposed specifically on
foreign investors, particularly limitations on foreign
ownership, will discourage inward foreign direct invest-
ment. Supporters of foreign ownership restrictions
sometimes argue that such restrictions encourage foreign
investors to take on domestically owned partners, and
that such shared ownership promotes spillover benefits
from FDI. In fact, there is no consistent evidence sup-
porting this presumption. Moreover, requirements
imposed on foreign-owned firms to source more inputs
domestically or to export more do not seem to increase
the benefits of FDI to the host economy. Hence, such
targeted policies seem inadvisable.

Government subsidies to foreign investors will increase
inward foreign direct investment, at the margin, pre-
suming that they are not matched by other governments.
Given the existence of spillover benefits to FDI, target-
ing subsidies to potential foreign investors would seem
to be an advisable policy; however, extending such sub-
sidies is not necessarily an element of best practices.
For one thing, if subsidies are linked to investing in
“have not” locations, the spillover benefits to the host
economy are likely to be severely compromised. For
another, the fiscal burden of significant investment sub-
sidies implies either that taxes must be increased to pay
for the subsidies or that government expenditures in
other areas, including possible expenditures on public
services, must be reduced. Either of these initiatives
will discourage inward direct investment. On balance,
national, but particularly sub-national, units might be
more effective in attracting FDI, and in leveraging the
benefits of FDI and FDO, by emphasizing governance
and infrastructure improvements, rather than fiscal sub-
sidies to foreign investors.
Tax policies are, perhaps, the most controversial aspect
of best practices. Popular opinion, as well as anecdotal
evidence, suggests that lowering tax rates should encour-
age increased investment, including investment by for-
eigners. However, difficulties in accurately measuring
effective tax rates, particularly at the sub-national level
and for specific industries and companies, limit rigor-
ous empirical examination of the relationship between
tax rates and foreign investment. Furthermore, since
taxes help fund the provision of public goods, and since
the supply of public goods encourages investment, the
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The Conference Board of Canada  |  19
full impact of lowering tax rates might be to discourage
investment, if the supply of public goods is diminished
as a consequence. Since public sector investments are
moderated by a broad range of social considerations,
there may be no policy inferences that apply uniquely
to best practices for promoting foreign investment.
However, it seems fair to argue that investments focused
on improving the efficient operations of government,
modernizing and enhancing physical infrastructure cap-
acity, and improving innovation capabilities are particu-
larly relevant components of best practices.
Good framework policies encourage both increased
FDI and greater spillover benefits from that FDI.
The available evidence is much more conclusive for
best practices for FDI than for FDO. In particular, the
available evidence suggests that good framework poli-
cies encourage both increased FDI and greater spillover
benefits from FDI. While it is plausible that those same
policies promote increased home-country spillover
benefits from FDO, there is simply not enough evidence
to support or disprove this presumption. While more
research on the home-country spillover benefits from
FDO is clearly desirable, there is no basis for imposing
policies that discourage FDO at the margin. Both FDI
and FDO are modes through which international pro-
duction becomes more specialized geographically, and
the benefits to production specialization are very well-
established. Framework policies that encourage FDI
will, over time, also encourage increased FDO.
Appendix A

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Publications Related to Determinants of Spillover Benefits

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 The Conference Board of Canada  |  29

Barrios, S. “Foreign Direct Investment and Productivity Spillovers: Evidence From the Spanish Experience.”
Fundación de Estudios de Economía Aplicada (FEDEA) Documento De Trabajo 2000–19. Madrid: FEDEA, 2000.

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Investment.” Canadian Journal of Economics/Revue canadienne d’économique, 41, 1 (2008), 320–340.

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30  |  Best Policy Practices for Promoting Inward and Outward Foreign Direct Investment—October 2010

Grether, J.M. “Determinants of Technological Diffusion in Mexican Manufacturing: A Plant-Level Analysis.”

World Development, 27, 7 (1999), 1287–1298.

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 The Conference Board of Canada  |  31

Marcin, Kolasa. “How Does FDI Inflow Affect Productivity of Domestic Firms? The Role of Horizontal and
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Appendix B
Glossary
Agglomeration economics: The productivity benefits that
derive from a concentration of input suppliers,   the labour force that are acquired through education and
producers, and customers in a specific location.
Absorptive capacity: The ability of firms to use new tech-
nology to improve their productivity.
Economic profits: Profits that are higher than necessary to
compensate for the investment risks assumed  
by companies.
Efficiency frontier: The productivity performance of the
most efficient organizations in an industry.
Framework policies: Public policies that shape the broad
business environment.
Gravity models: Economic models of international trade,
investment, and migration that emphasize the sizes of
national economies as key determinants of those phe-
nomena.
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Human capital: The skills and knowledge embodied in
experience.
Market structure: The degree of competitiveness
characterizing a market; primarily reflects the number
of competitors and the ease with which new firms can
enter the market.
Spillover productivity benefits: Improvements in the effi-
ciency of host and/or home-country firms arising from
inward (FDI) and outward (FDO) direct investment.
Trade-related investment measures (TRIMs): Domestic
regulations that a country applies to foreign investors,
often as part of an industrial policy. An example is a
requirement for foreign investors to buy inputs from
local suppliers.
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