Recent Academic Research on the Determinants of Foreign Direct Investment

Is PRC's FDI policy a friend or an enemy to other developing economies in Asia and in Latin America? What determines foreign direct investment flows into the Asian, Latin American and other economies? Is there a "PRC Effect"? To get some insights as to what methodology we should pursue, we now look selectively at some recent relevant academic literature.³

Brainard (1997) empirically examines the determinants of the ratio of U.S. export sales to total foreign sales (the sum of export sales by sales by foreign affiliates) by industry. She uses a framework of focusing on factors that favor concentration of production (i.e. favoring exports) vs. proximity to overseas customers (i.e. favoring sales by foreign affiliates). The explanatory variables include freight costs to the export market, tariffs of the host country, per capita gross domestic product, corporate tax rates, measures of trade and foreign direct investment openness, measures of plant scale economies and corporate scale economies. She also adds a dummy representing whether a country has a political coup in the last decade. In her random effects estimation, almost all the variables have the right signs and are significant. The major exception is the corporate tax rates, which has the opposite sign as predicted.

Gastanaga, Nugent and Pashamova (1998) focus on policy reforms in developing countries as determinants of foreign direct investment inflows. They employ both ordinary least squares as well as panel estimations. The expected rates of growth, the corporate tax rates, the degree of corruption and the degree of openness to foreign direct investment are all important determinants of foreign direct investment flows into these economies. Hines (1995) and Wei (1997) both examine the impact of institutional factors on foreign direct investment. By employing a corruption index, Hines shows that after 1977, U.S. foreign direct investment grew faster in less corrupt countries. Wei (1997) uses OECD direct investment data and shows that both corruption and tax rates have negative effects on foreign direct investment flows. Wei's estimations are cross-sectional.⁴ Fung, Iizaka and Parker (2002) and Fung, Iizaka and Siu (2003) show with panel regressions that market sizes, labor costs and tax rates are important for determining various sources of FDI into different provinces of PRC. Weiss (2004) provides an up-to-date review of the literature related to the investment and trade opportunities and threats of a rising PRC.

Download this Discussion Paper [ PDF 213.2KB| 32 pages ].

Comment(s)

There are [0] comment(s) for this entry. Post a comment.