Some New Evidence on Determinants of Foreign Direct Investment in Developing Countries
Grand Valley State University
Kwang W. Jun
World Bank Policy Research Working Paper No. 1531
An export orientation is the strongest variable explaining why a country attracts foreign direct investment.
Singh and Jun expand on earlier studies of the determinants of foreign direct investment (FDI) by empirically analyzing various factors - including political risk, business conditions, and macroeconomic variables - that influence direct investment flows to developing countries.
They try to fill a gap in the literature by examining qualitative factors. Using a pooled model of developing countries, they test three groups of hypotheses on what influences direct investment - that political risk matters, that business conditions matter, that macroeconomic variables matter.
Tests of the first hypothesis indicate that a qualitative index of political risk is a significant determinant of FDI flows for countries that have historically attracted high FDI flows. For countries that have not attracted such flows, sociopolitical instability (proxied by work hours lost in industrial disputes) has a negative impact on investment flows.
Tests of the second hypothesis show that a general qualitative index of business operation conditions is an important determinant of FDI in countries that receive high flows. This country group also shows a positive relationship between taxes on international transactions and FDI flows - supporting the tariff hopping hypothesis.
Results from tests of the third hypothesis reveal that exports generally, especially manufacturing exports, are a significant determinant of FDI flows for countries in which FDI is high. This hypothesis is supported by standard regression analysis and by Granger causality tests, which indicate that the feedback is predominantly from exports to FDI.
Export orientation is the strongest variable for explaining why a country attracts FDI. This finding is in line with the secular trend toward increasing complementarity between trade and FDI.
This paper - a product of the International Finance Division, International Economics Department - is part of a larger effort in the department to analyze private capital flows and their policy implications for developing countries.
Number of Pages in PDF File: 48
Date posted: April 20, 2016