Foreign direct investment and its determinants in emerging economies

The four institutions contributing to FDI Fitness are government, markets, education, and socioculture. This study tests the FDI Fitness concept in an econometric cross-section of 67 emerging economies between 1978 and 1995. The analysis shows government and market variables as the most significant determinants of FDI inflows. Government fitness is reflected in economic openness with only minimal trade and exchange rate controls. Government fitness also means a strong rule of law and low corruption, based on legal and administrative equity and transparency. Market fitness is represented by high trade volume, low taxes, high urbanization, and ready availability of credit and energy. Given that these determinants reduce incentives for discretionary behavior and rent-seeking, the results demonstrate that, while investors are willing to negotiate, they seek stability and transparency, preferring clear-cut and consistently implemented regulations to individual privileges gained through wheeling and dealing. The regression analysis thus corroborates the Institutional FDI Fitness theory. The manner in which policymakers handle institutions, policies, laws, and their implementation is significantly more important to foreign direct investors than relatively intransigent factors such as population size and socioculture. The FDI Institutional Fitness theory suggests that every nation has the opportunity to identify and expand its competitive strengths to increase its share of global foreign direct investment. (Author abstract, modified)